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Index to Consolidated Financial Statements +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2015 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California 92705 +(Address of Principal Executive Offices) (Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, $0.10 par value +NYSE MKT +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act +of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), +and (2) has been subject to such filing requirements for the past +90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to +be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes ý No o +Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this +Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See +definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer o +Non-accelerated filer o +(Do not check if a +smaller reporting company) +Smaller reporting company ý +Indicate +by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2014 was approximately $40,747,000. +For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate +status is not necessarily a conclusive determination for other purposes. As of June 8, 2015, there were 32,411,170 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III +of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2015 Annual Meeting of Stockholders, which will be +filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended March 31, 2015. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2015 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +10 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +21 +ITEM 2. +PROPERTIES +21 +ITEM 3. +LEGAL PROCEEDINGS +21 +ITEM 4. +MINE SAFETY DISCLOSURES +21 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF +EQUITY SECURITIES +22 +ITEM 6. +SELECTED FINANCIAL DATA +23 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +23 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +39 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +39 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL +DISCLOSURE +40 +ITEM 9A. +CONTROLS AND PROCEDURES +40 +ITEM 9B. +OTHER INFORMATION +41 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +41 +ITEM 11. +EXECUTIVE COMPENSATION +41 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER +MATTERS +41 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +42 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +42 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +43 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiaries. Abacus®, ClearAg™, +ClearPath™, ClearPath Weather™, Edge®, EdgeConnect™, iPerform®, iPeMS®, Iteris®, IterisPeMS™, +P10™, P100™, Pico™, RZ-4™, SmartCycle®, SmartSpan®, Vantage®, VantageNext™, Vantage Vector®, +VantageView™, Velocity™, and VersiCam™ are among the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of +their respective owners. +1 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the +meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's +beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the +words "expect(s)," "feel(s)," "believe(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are intended to identify +forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, capital needs, +backlog and manufacturing capabilities, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, the applications for and acceptance of our products +and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause +our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. We encourage you to +carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in "Risk Factors" set forth in Part I, Item 1A +of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any +reason, +including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +PART I +ITEM 1. BUSINESS +Overview +We are a leading provider of information solutions for the intelligent traffic systems ("ITS") and the precision agriculture ("PA") +markets. In the ITS market, we are focused on the development and application of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, +management and analytics, and that improve the efficiency and safety of surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound +traffic management, minimize the environmental impact of traffic congestion and enhance the adoption of advanced ITS solutions that are required for the deployment of connected and autonomous +vehicles. In the PA market, we have combined our unique intellectual property with enhanced soil, land surface, and agronomy modeling techniques utilizing our extensible EMPower hybrid computing +architecture to create a set of ClearAg™ solutions that provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. +We +were originally incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics (formerly known as +iPerform). The Roadway Sensors segment includes, among +2 +Table of Contents +other +products, our Vantage, Vantage Vector, VantageView, SmartCycle and vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection +applications. The Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. The Performance Analytics segment includes ClearAg, our precision agriculture solution that provides access to a comprehensive database of weather, soil and agronomic information, which +is essential to making informed agricultural decisions; iPeMS, our transportation performance measurement solution, which provides big data and software analytics solutions that help determine current +and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources; and ClearPath Weather, our road-maintenance application, which provides +maintenance and treatment recommendation for road networks. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for further +details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology to capture and analyze video images through +sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. +• Our Vantage video detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data +used in traffic management systems. Vantage video detection systems typically include up to four of our RZ-4 advanced cameras and an EdgeConnect processor. Our Vantage systems give traffic managers +the ability to mitigate roadway congestion by modifying traffic signal timing or detecting incidents quickly. Our VantageView software complements our Vantage video detection systems by providing an +integrated platform to manage video detection assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including +stop bar detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar sensing. +Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a +single video detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection +zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller +intersections that require only a few detection points. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +have historically experienced seasonality, particularly with respect to our Roadway Sensors revenues in our third and fourth fiscal quarters, due to reductions in road construction +and repairs during the winter months related to inclement weather conditions. +3 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, +development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design and implementation of surface +transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation +measures to reduce traffic congestion. +Our +Transportation Systems segment is largely dependent upon governmental funding and is affected by state and local budgetary issues. The current federal highway bill, which provides +federal funding for highway, transit, safety and related transportation programs, was due to expire at the end of September, 2014. The President signed a federal highway funding bill that kept the +federal highway bill operational until May 2015, and the House of Representatives recently approved a two-month extension to maintain funding for the federal highway bill through July 31, 2015. +We expect the extension and proposed federal highway bill to encourage government agencies to continue incorporating ITS technologies in transportation infrastructure projects. In addition, various +other funding mechanisms exist to support transportation infrastructure and related projects as regulatory deadlines approach, which require these technologies. These include bonds, dedicated sales +and gas tax measures and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will at least in part be dependent on the federal +government's use of funds under the federal highway bill. Delays in the release of funding may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely impact in the future, our Transportation Systems revenues and our overall +financial performance in future periods. +Performance Analytics (formerly known as iPerform) +Our Performance Analytics segment, formed during the first quarter of our fiscal year ended March 31, 2013 ("Fiscal 2013"), +includes our performance measurement and information management solutions, including all of the operations of Berkeley Transportation Systems, Inc. ("BTS"), which we acquired in November 2011. +BTS specialized in transportation performance measurement. The BTS performance measurement system leverages its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and +compute performance measurements. During the fiscal year ended March 31, 2012 ("Fiscal 2012"), we began the development of iPeMS (formerly, IterisPeMS). iPeMS is a state-of-the-art information +management software suite that utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and +management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of +improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use visualization and animation features based on historical traffic conditions. +The +Performance Analytics segment also includes the operations of Meridian Environmental Technology, Inc. ("MET"), which we acquired in January 2011. MET specializes in +511/Advanced Traveler Information Systems, as well as ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. With the addition of MET, we +have experienced seasonality particularly related to certain ClearPath Weather services in our first and second fiscal quarters, mainly because ClearPath Weather services are generally not required in +the summer months when weather conditions are typically less severe. Our Performance Analytics is a market leader in performance management solutions for federal and state organizations. We intend to +4 +Table of Contents +use +our strong brand and deep experience in the traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics. +Beginning +in late 2013, Iteris undertook a focused development activity to supplement its intellectual property, technology base and product suites to provide products and services for +the emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market as well as the development of several +products specifically intended for the PA market. Iteris refers to is products for the PA market generically as its ClearAg solutions. ClearAg, solutions provide access to a comprehensive database of +weather, soil and +agronomic information essential to making informed agricultural decisions. ClearAg application programming interfaces ("APIs") include historical, real-time and forecast weather content, soil and +plant health information, as well as real-time weather and other useful crop growing information, to provide solutions in the precision agriculture technology markets. We expect positive market +acceptance of our ClearAg solutions to continue in upcoming quarters. We plan to continue to fund these investments through internally generated cash flow from our Roadway Sensors and Transportation +Systems operating segments, as well as revenues from our Performance Analytics segment and our available cash if necessary. +Sales, Marketing and Principal Customers +We sell our Roadway Sensors products through direct and indirect sales channels. In the territories where we sell direct, we use a +combination of our own sales personnel and an outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is comprised of a +network of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers and sell directly +to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various +products for the construction and renovation of traffic intersections, and are generally well-known suppliers of high-quality ITS products to the traffic management market. We periodically hold +technical training classes for our distributors and end users and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When +appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and Performance Analytics solutions directly to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and municipal customers and generally provide for cancellation or renegotiation at the option +of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in +sales and business development functions. Our contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We +market and sell our ClearAg products to commercial entities in the PA market. We currently have two primary product sets which we are marketing for PA; our ClearAg API integration and +modeling services and our ClearAg Apps. Our ClearAg APIs are intended for large enterprises in the agriculture market that can benefit from the value of a tight integration of their processes with the +ClearAg modeling and forecasting engine; our ClearAg App was introduced in May 2015 and is intended for individual agriculture producers that can benefit from advisories based upon the ClearAg +5 +Table of Contents +platform +that are tailored for their specific locations of interest. We are dealing directly with customers interested in the ClearAg API products and, typically, through selling partners for those +interested in the ClearAg App products. +We +currently have a diverse customer base, but a large portion of our revenues historically has been derived from sales to federal, state and local government agencies. For our fiscal +year ended March 31, 2015 ("Fiscal 2015"), one individual customer represented approximately 10% of our total revenues and no other individual customer represented greater than 10% of our total +revenues. For the fiscal year ended March 31, 2014 ("Fiscal 2014"), one individual customer represented approximately 11% of our total revenues and no other individual customer represented +greater than 10% of our total revenues. For Fiscal 2013, one individual customer represented approximately 13% of our total revenues and no other individual customer represented greater than 10% of +our total revenues. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report for additional information regarding our significant +customers. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain +components from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and +components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include CTS Electronics +Manufacturing Solutions, Inc., Sony Electronics, Inc. and LG Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa +Ana facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of +the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such +service revenue was not a material portion of our total revenues for each of Fiscal 2015, Fiscal 2014 and Fiscal 2013. We believe customer support is a key competitive factor. +Our +ClearAg products are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we maintain a full-time support and customer +service activity for our ClearAg products. +Backlog +Our total backlog of unfulfilled firm orders was approximately $39.2 million as of March 31, 2015, which included +$29.6 million related to Transportation Systems. In the past three fiscal years, we have recognized approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the +subsequent fiscal year, and currently expect that trend to continue for the near future for both Transportation Systems and Performance Analytics. Substantially the entire backlog for Roadway Sensors +is expected to be recognized as revenue in Fiscal 2016. At March 31, 2014, we had backlog of approximately $35.6 million, which included $27.6 million related to Transportation +Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers +6 +Table of Contents +can +generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual +customers, which also can affect the timing of the conversion of our backlog into revenues. For these +reasons, among others, our backlog at a particular date may not be indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Performance Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facilities in Santa Ana, California. Our research and development costs and expenses were approximately $5.4 million for Fiscal 2015, $4.0 million +for Fiscal 2014 and $3.1 million for Fiscal 2013. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continue to develop new products to meet the needs of our ever-changing markets, +as well as to enhance and refine our existing product lines. We plan to focus our development efforts on our ClearAg products for the PA market; however, since 2012, our Roadway Sensors segment has +introduced our VantageNext, Vantage Vector, VersiCam and VersiCam wireless products, P10, P100, RZ-4 advanced camera and our RZ-4 advanced wide dynamic range camera, which significantly improve video +detection performance in certain harsh lighting conditions, as well as upgrades to our Abacus and VantageView products. Additionally, during Fiscal 2012, we began development of our software based +iPeMS performance measurement system, which continued through Fiscal 2014. We believe that developing new offerings across our segments and enhancing, refining and marketing our existing products are +key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced +gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Performance Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for iPeMS and ClearPath Weather +products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning and +design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with +a variety of entities that currently provide weather-related data to that market such as Climate Corp (now a division of Monsanto) and John Deere as well as new entrants such as Granular and +Conservis. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and other +non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive loop products, which have +historically, and currently continue to be, the predominant detection system in this market. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include national corporations that generally offer expertise +in traveler information, integration and transportation management. Our competitors in transportation +7 +Table of Contents +engineering, +planning and design include major regional firms, as well as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. +Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently hold seven U.S. patents, two U. S. allowed +but not issued patents, five foreign patent applications, and 20 U. S. non-provisional patent applications. One U.S. patent, which expires in May 2019, is for general technology related to CMOS +sensors. Two U.S. patents, which expire in 2029 and 2034, one foreign patent applications, and one U.S. non-provisional patent application relate specifically to our Roadway Sensors technology. Four +U.S. patents, which expire in 2034 and 2035, two allowed but not issued U. S. patents, and 17 U.S. non-provisional patent applications relate specifically to our Performance Analytics technology. Two +U. S. non-provisional patent applications relate to our Transportation Systems technology. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +8 +Table of Contents +Employees +We refer to our employees as associates. As of March 31, 2015, we employed 257 full-time associates and 28 part-time associates, +for a total of 285 associates. None of our associates are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our associates are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the +discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of +such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, +and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business and is not expected to have a material impact +in the near future. +9 +Table of Contents +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented +elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this +report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described +below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of +these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose +all or part of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues +and +fixed price contracts. A significant +portion of our revenues are derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. We anticipate that revenue from government contracts will +continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, +delays in the expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding; +• performance bond requirements; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements; +• changes in government policies and political agendas; +• milestone requirements and liquidated damage provisions for failure to meet contract milestones; and +• international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from +transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, could cause our revenues and income to drop substantially or to fluctuate significantly between fiscal periods. +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs would adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the +convenience of the government, which could +10 +Table of Contents +result +in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously +harm our business, financial condition and results of operations. +State budgetary constraints may have a material adverse impact on us. Many states have experienced, and are continuing to +experience, significant +budget shortfalls and other related budgetary issues and constraints. In particular, the state of California has historically been and is considered to be a key geographic region for our Roadway +Sensors and Transportation Systems segments. Ongoing uncertainty +as to the timing and accessibility of budgetary funding, changes in state funding allocations to local agencies and municipalities, or other delays in purchasing for, or commencement of, +transportation projects have had, and may continue to have, a negative impact on our revenues and our income. +The economic slowdown has reduced and delayed government funding for transportation infrastructure projects and initiatives, decreased availability of financial capital for our +customers +and adversely impacted real estate development, all of which have adversely impacted our revenues. Decreased consumer spending, the failure of certain financial +institutions and businesses, concerns about the availability and cost of credit, and reduced corporate profits and capital spending have resulted in a downturn in worldwide economic conditions, as +well as budgetary shortfalls at all levels of government. These unfavorable economic conditions are having, and are expected to continue to have, a negative impact on customer orders and government +funding of infrastructure projects incorporating our products and services. Such factors have resulted and may continue to result in delays, cancellations and rescheduling of backlog and customer +orders. Any of the foregoing economic conditions may adversely affect our revenues in future periods and make it extremely difficult for our customers, our suppliers and us to accurately forecast and +plan future business activities. Additionally, there was uncertainty in the past few years regarding allotment of government funds due to delays in the passage of a federal highway bill, which +adversely impacted our revenues and overall financial performance. The current federal highway bill, which provides federal funding for highway, transit, safety and related transportation programs, +was due to expire at the end of September 2014. The President signed an expansion of the federal highway funding bill to keep the current federal highway bill operational until May 2015, and the House +approved a two-month extension to maintain funding for the Highway Trust Fund through July 31, 2015. While we expect the extension to resolve the current uncertainty in federal funding, our +Transportation Systems revenues and overall financial performance in future periods could be negatively affected if funding concerns persist. Furthermore, despite the extension of the federal highway +bill, delays in the allocation of funds, the priority of infrastructure projects and the availability of funds for ITS related projects could continue to adversely impact our revenues and overall +financial performance. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely +decline. Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in the marketplace as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +11 +Table of Contents +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +We recently entered into the software development market and may be subject to additional challenges and additional costs and delays. We have only +been in the business of software development for a few years and may experience development and technical challenges. Our business and results of operations could +also be seriously harmed by any significant delays in our software development and updates. Certain of our new products could contain undetected design faults and software errors or "bugs" when first +released by us, despite our testing. We may not discover these faults or errors until after a product has been installed and used by our customers. Any faults or errors in our existing products or in +any new products may cause delays in product introduction and shipments, require design modifications or harm customer relationships, any of which could adversely affect our business and competitive +position. We cannot assure you that our customer base will broadly accept any of our new products, product enhancements or software related offerings such as iPeMS, ClearPath Weather and ClearAg. In +addition, the software development industry can frequently experience litigation concerning intellectual property disputes, which could be costly and distract our management. +If we are unable to develop and introduce new products and product enhancements successfully and in a cost-effective and timely manner, or are unable to achieve market acceptance +of our +new products, our operating results would be adversely affected. We believe our revenue growth and future operating results will depend on our ability to complete +development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production +costs. We cannot guarantee the success of these products, and we may not be able to introduce any new products, including the iPeMS software, ClearPath Weather, ClearAg or any enhancements to our +existing products on a timely basis, or at all. The introduction of any new Performance Analytics products and services could have longer than anticipated sales cycles, which could adversely impact +our operating results. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in +response to evolving customer requirements. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected +if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product +transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +The markets in which we operate are highly competitive and have many more established competitors than we do, which could adversely affect our revenues or the market acceptance of +our +products. We compete with numerous other companies in our target markets including, but not limited to, large, multinational corporations and many smaller regional +engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a small portion of the intersection traffic +market has adopted advanced video detection technologies, and our future success will depend in part upon +gaining broad market acceptance for video detection in this market. Certain technological barriers to entry make it difficult for new competitors to enter the market with competing video or other +technologies; however, we are aware of new market entrants from time to time. Increased competition +12 +Table of Contents +could +result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local regional firms. +The +markets in which our Performance Analytics segment operates vary from public sector customers who focus on performance measurement systems to help measure and manage the +effectiveness of their transportation systems to commercial sector customers who ingest and disseminate traffic and weather related data, information and analytics through various consumer outlets. +Our competitors include divisions of large, multi-national corporations as well as a variety of small providers. In the public sector, we compete with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide traffic and/or weather +related data to that market. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. If we are not able +to adequately protect or enforce the proprietary aspects of our technology, competitors could be able to access our proprietary technology and our business, financial condition and results of +operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party +nondisclosure agreements and similar means. Despite our efforts, other parties may attempt +to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design +around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary +rights adequately in the U.S. or abroad. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse +outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or +using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is +determined that we have infringed upon or misappropriated another party's intellectual property. Our recent expansion into software development activities may subject us to increased possibility of +litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, +including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, +financial condition and results of operations. +13 +Table of Contents +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. Due +to the specialized +nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The loss of any of our officers, or +any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations. Our success will also depend in large part upon our ability +to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel, as well as a new Chief Executive Officer. The future success of our Transportation +Systems segment will depend on our ability to hire additional qualified engineers, planners and technical personnel. The future success of our Performance Analytics segment will depend on our ability +to hire additional software developers, qualified engineers and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense. We may +not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our +current key employees could adversely affect our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our Transportation Systems and Performance Analytics +workforce. The cost of providing our Transportation Systems and Performance Analytics engineering and consulting services, including the extent to which we utilize +our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; +and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An +inability to properly and fully utilize our Transportation Systems workforce could have an adverse effect on our results of operations. +Our failure to successfully bid on new contracts and renew existing contracts could reduce our revenues and profits. Our +business depends on our +ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. Contract proposals and negotiations are complex and frequently involve a lengthy +bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. For example, a customer may require us +to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions continue, or if we fail to secure adequate +financing arrangements or the required governmental approval or fail to +meet other required conditions, we may not be able to pursue particular projects, which could reduce or eliminate our profitability. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in +our +operating results. Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past +expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are +14 +Table of Contents +unable +to manage these activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +We are currently not profitable and we may be unable to become profitable on a quarterly or annual basis. For the year ended +March 31, 2015, +we had a net loss and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by budgetary constraints, government and +political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from the Company's segments to fund investments in sales and marketing +and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our expenses are fixed in +advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned +investments. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund our operations and achieve our business plan, and could +cause the market price of our common stock to decline. +Our use of the percentage of completion method of accounting for our Transportation Systems and Performance Analytics revenues could result in a reduction or reversal of previously +recorded revenues and profits. A portion of Transportation Systems and Performance Analytics revenues are measured and recognized using the percentage of +completion method of accounting. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs +incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts +are known or can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress +towards completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual +costs to vary materially from estimates, including reductions or reversals of previously recorded revenues and profits. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely +affected. Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial +reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. In connection with the +audit of our consolidated financial statements for Fiscal 2014, we determined that we had significant deficiencies relating to our accounting for consulting services revenues that constituted a +material weakness in our internal control over financial reporting, such that there was a reasonable possibility that a material misstatement of our financial statements will not be prevented or +detected on a timely basis, and that our internal control over financial reporting was not effective as of the end of Fiscal 2014. +As +of the end of Fiscal 2015, we remediated the foregoing material weakness in our internal control over financial reporting by hiring additional personnel and making improvements to or +upgrades of our enterprise systems, process and procedures. Although we believe we have remediated the foregoing material weakness, we may in the future, experience one or more material weaknesses. In +the event we experience further material weaknesses in our internal control over financial reporting, management's attention may also be diverted from other business concerns, which could have an +adverse effect on our business, financial condition and results of operations. If we experience one or more material weaknesses in the future, our ability to report our financial condition and results +of operations accurately and in a timely manner may be adversely affected and could adversely affect the market price of our common stock. +15 +Table of Contents +As +a smaller reporting company, for Fiscal 2015, we were exempt from the auditor attestation requirement over our internal control over financial reporting; however, to the extent we do +not qualify as a non-accelerated filer or smaller reporting company in subsequent fiscal years, we will be subject to the auditor attestation requirement under Section 404(b) of the +Sarbanes-Oxley Act. In such an event, we may not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent +registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +Our +management, including our CEO and CFO, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well +designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there +are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that judgments in +decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any +design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in the degree +of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could +cause +our stock price to decline. Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number +of factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as +well as increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• our ability to raise additional capital; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• seasonality due to winter weather conditions; +16 +Table of Contents +• seasonality with respect to revenues from our ClearPath Weather and related weather forecasting services due to the decrease in +revenues generated for such services during the spring and summer time periods; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in +a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• general economic and political conditions; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +We may be subject to traffic related litigation. The traffic industry in general is subject to litigation claims due to the +nature of personal +injuries that result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could in the future continue to be, from time to time, subject to +litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not +be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or +more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims +could cause us to incur significant expenses and result in a diversion of management's attention. +We may experience production gaps that could materially and adversely impact our sales and financial results and the ultimate acceptance of our +products. It is possible that we could experience unforeseen quality control issues or part shortages as we adjust production to meet current demand for our +products. We have historically used single suppliers for certain significant components in our products. Should any such delay or disruption occur, or should a key supplier discontinue operations +because of the current economic climate, our future sales will likely be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our +products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the +foreseeable +17 +Table of Contents +future +and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a production gap if for any reason our contract manufacturers +were unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. +We may engage in acquisitions of companies or technologies that may require us to undertake significant capital infusions and could result in disruptions of our business and +diversion of +resources and management +attention. We have completed three acquisitions since April 2009 and, in the future, we may acquire additional complementary businesses, products, and +technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and +information system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits anticipated from any acquisition. +Our international business operations may be threatened by many factors that are outside of our control. While we historically +have had limited +international sales, revenues and operations experience, we began work on our first overseas contracts in the United Arab Emirates in the fiscal year ended March 31, 2010. We may further expand +our international efforts, and in particular, plan to expand our distribution channels in Latin America. We cannot assure you that we will be successful in our expansion efforts. International +operations subject us to various inherent risks including, among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S. and each other country in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +18 +Table of Contents +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, +including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. We have +historically +experienced volatility in our earnings and cash flows from operations from year to year. Although we have a revolving line of credit, should we continue to be in default, which includes, among other +things, a failure to meet certain financial covenants and a material adverse change in the business, the bank could choose to not provide covenant waivers, or limit or take away our ability to borrow +these or any funds. Should this occur, or if the credit markets further tighten or our business declines, we may need or choose to raise additional capital to repay indebtedness, pursue acquisitions +or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a +timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• potential acquisitions of businesses and product lines; +• our relationships with customers and suppliers; +19 +Table of Contents +• government budgets, political agendas and other funding issues, including potential delays in government contract awards; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets, in general; and +• general economic conditions, including the effects of the current economic slowdown and international conflicts. +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common +stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms, we may +be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The trading price of our common stock is highly volatile. The trading price of our common stock has been subject to wide +fluctuations in the past. +From April 2012 through May 2015, our common stock has traded at prices as low as $1.25 per share and as high as $2.50 per share. The market price of our common stock could continue to fluctuate in +the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. +This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, +companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action +lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Certain provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common +stock. Certain provisions of our certificate of incorporation could make it difficult for a third party to acquire us, even though an acquisition might be +beneficial to +20 +Table of Contents +our +stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of incorporation, our +Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our +common stock. In August 2009, we adopted a new stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. Generally, the stockholder rights plan provides +that if a person or group acquires 15% or more of our common stock, subject to certain exceptions and under certain circumstances, the rights may be exchanged by us for common stock or the holders of +the rights, other than the acquiring person or group, could acquire additional shares of our capital stock at a discount off of the then current market price. Such exchanges or exercise of rights +could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a merger, tender +offer or other acquisition more difficult. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 41,000 square feet of leased office, manufacturing and warehouse +space located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 9 of Notes to Consolidated +Financial Statements, included in Part IV, Item 15 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 9 of Notes to Consolidated Financial +Statements, included in Part IV, Item 15 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +21 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information and Holders +Our common stock is traded on the NYSE MKT under the symbol "ITI." The following table sets forth, for the periods indicated, the +highest and lowest sales prices for our common stock as reported by NYSE MKT: +High +Low +Fiscal 2015 +Quarter Ended June 30, 2014 +$ +2.11 +$ +1.66 +Quarter Ended September 30, 2014 +2.23 +1.48 +Quarter Ended December 31, 2014 +2.00 +1.58 +Quarter Ended March 31, 2015 +1.94 +1.60 +Fiscal 2014 +Quarter Ended June 30, 2013 +$ +1.84 +$ +1.55 +Quarter Ended September 30, 2013 +1.85 +1.70 +Quarter Ended December 31, 2013 +2.29 +1.76 +Quarter Ended March 31, 2014 +2.50 +1.92 +On +June 8, 2015, the last reported sales price of our common stock on the NYSE MKT was $1.76. As of June 8, 2015, we had 378 holders of record of our common stock according +to information furnished by our transfer agent. +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable +future. We currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will +depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general +business conditions, the consent of our lender and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to +$3 million of our outstanding common +stock from time to time through August 2012. On August 9, 2012, our Board of Directors approved a new stock repurchase program pursuant to which we may acquire up to $3 million of our +outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open-market and privately negotiated transactions and block trades, and +may also repurchase shares pursuant to an existing or future 10b5-1 trading plan to facilitate repurchases during our closed trading windows. There is no guarantee as to the exact number of shares +that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase +to our existing stock repurchase program, pursuant to which we may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +From +inception of the original stock repurchase program in August 2011 through March 31, 2015, we repurchased approximately 2,766,000 shares of our common stock for an aggregate +repurchase price +22 +Table of Contents +of +approximately $4.4 million at an average purchase price of $1.59 per share. The table below details our common stock repurchases during the fiscal quarter ended March 31, 2015. All +repurchased shares have been retired and resumed their status as authorized and unissued shares of our common stock. As of March 31, 2015, there was approximately $2.9 million of +remaining funds available under the stock repurchase program. +Issuer Purchases of Equity Securities +Period +Total Number +of Shares +Purchased +Average +Price Paid +per Share +Total Number of +Shares +Purchased as +Part of Publicly +Announced Plans +or Programs +Maximum Number +(or Approximate +Dollar Value) of +Shares that May Yet +Be Purchased Under +the Plans or +Programs +January 1 to January 31, 2015 +— +$ +— +— +February 1 to February 28, 2015 +— +— +— +March 1 to March 31, 2015 +142,706 +1.79 +142,706 +Total +142,706 +$ +1.79 +142,706 +$ +2,883,911 +ITEM 6. SELECTED FINANCIAL DATA +As a smaller reporting company, we are not required to make any disclosure pursuant to this Item 6. +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements +and related Notes thereto included in Part IV, Item 15 of this report and the "Risk Factors" section in Item 1A, as well as the other cautionary statements and risks described +elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General. We are a leading provider of information solutions for the intelligent traffic systems ("ITS") and the precision +agriculture ("PA") markets. +In the ITS market, we are focused on the development and application of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, management and +analytics, and that improve the efficiency and safety of surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound traffic management, +minimize the environmental impact of traffic congestion and enhance the adoption of advanced ITS solutions that are required for the deployment of connected and autonomous vehicles. In the PA market, +we have combined our unique intellectual property with enhanced soil, land surface, and agronomy modeling techniques utilizing our extensible EMPower hybrid computing architecture to create a set of +ClearAg™ solutions that provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. +Acquisitions. In November 2011, we acquired all of the outstanding capital stock of Berkeley Transportation Systems, Inc. +("BTS"), a +privately-held company based in Berkeley, California which specialized in transportation performance measurement, for an initial cash payment of approximately $840,000. In the quarter ended +June 30, 2012, we entered into an amendment to the BTS stock purchase agreement which modified certain earn-out provisions and, as a result, we paid an additional $700,000 in cash to the BTS +shareholders for achievement of those modified earn-out provisions in the +23 +Table of Contents +fourth +quarter of Fiscal 2013. This payment completed our obligation under the earn-out provisions of the purchase agreement. During the third quarter of the Fiscal 2014, we paid $250,000 pursuant to +certain holdback provisions. Additionally, in the third quarter of Fiscal 2015, we paid the BTS shareholders approximately $336,000 pursuant to certain deferred payment provisions. This payment +completed our obligations under the deferred payment provisions of the purchase agreement. +In +January 2011, we acquired all of the outstanding capital stock of Meridian Environmental Technology, Inc. ("MET") for an initial cash payment of approximately +$1.6 million. MET specialized in 511/Advanced Traveler Information Systems and also offers ClearPath Weather management tools, which we formerly referred to as our Maintenance Decision Support +System or MDSS. ClearPath Weather management tools and weather forecasting capabilities allow users to create solutions to meet roadway maintenance decision needs. We also agreed to pay up to +$1.0 million to the former MET shareholders on each of the first two anniversaries of the closing of the acquisition upon the satisfaction of certain conditions, as well as up to an additional +$2.0 million under a 24-month earn-out provision. +In +January 2012, we made a cash payment of approximately $668,000 of the first deferred payment to the shareholders of MET and held back $250,000 in accordance with certain provisions of +the purchase agreement. In June 2012, we determined the contingencies related to the release of the $250,000 holdback were not met. As a result, no portion of the $250,000 holdback was released and +the entire amount was reversed into operating income during the second quarter of Fiscal 2013. Additionally, no amounts were earned by the MET shareholders related to the first and second year +earn-out provisions, which ended on June 30, 2011 and 2012, respectively. The second deferred payment of $1.0 million was due in the fourth quarter of Fiscal 2013. As a result of certain +offsets and deductions, we paid approximately $409,000 to the MET shareholders in the second quarter of Fiscal 2014, which payment completed our obligations under the deferred payment provisions of +the purchase agreement. +Refer +to Note 4 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for additional discussion on these acquisitions. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +Upon the closing, Bendix paid us $14.0 million in cash, subject to a $2.0 million holdback and adjustments based upon the working capital of the Vehicle Sensors segment at the closing, +and Bendix assumed certain specified obligations and liabilities of the Vehicle Sensors segment. In October 2012, we received approximately $1.7 million in connection with the release of the +holdback. Furthermore, we are entitled to additional consideration in the form of certain performance and royalty-related earn-outs through June 30, 2017. As of March 31, 2015, we +received approximately +$1.2 million in connection with such royalty-related earn-out provisions, resulting in a total payment of $14.9 million in cash from the Asset Sale. We also had approximately $180,000 in +royalty-related receivables included in the prepaid expenses and other current assets in the accompanying consolidated balance sheet as of March 31, 2015. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment, and we determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for additional +discussion regarding the Asset Sale. +24 +Table of Contents +Business Segments. Subsequent to the Asset Sale and our acquisition of BTS, we now operate in three reportable segments: Roadway +Sensors, +Transportation Systems and Performance Analytics. +Roadway Sensors +The Roadway Sensors segment provides vehicle detection and information systems, which includes hardware and software products for +multiple segments of the ITS market. These systems are used for traffic intersection control, incident detection and certain roadway traffic data collection applications. Our Roadway Sensors products +include, among other things, our Vantage, VantageNext, VersiCam, Vantage Vector, Vantage View, SmartCycle, SmartSpan, Velocity, P10, P100 and Abacus products. +Transportation Systems +The Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation +management and traveler information systems for the ITS industry. During Fiscal 2013, this segment included the operations of MET, which specializes in 511/Advanced Traveler Information Systems and +offers predictive weather and ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. As of April 1, 2013, the predictive weather and +ClearPath Weather services were reassigned to the Performance Analytics segment to better align our predictive weather and traffic capabilities, resources and initiatives. +Performance Analytics (formerly known as our iPerform segment) +The Performance Analytics segment includes our performance measurement and information management solution iPeMS, which is a +specialized transportation performance measurement and traffic analytics solution, as well as ClearPath Weather and ClearAg solutions and other operations reassigned from Transportation Systems +segment on April 1, 2013. iPeMS provides big data and software analytics solutions that help determine current and future traffic patterns, permitting the effective performance analysis and +management of traffic infrastructure resources. Our ClearPath Weather management tools and weather forecasting capabilities provide maintenance and treatment recommendation for road networks, and +ClearAg, our precision agriculture solution, provides a comprehensive database of weather, soil and agronomic information essential to making informed agricultural decisions. +Business Outlook. Given the current ongoing uncertainties regarding global economic conditions, as well as the macroeconomic +dynamics in the U.S., we +continue to remain cautious about our overall business. We believe the recent economic slowdown, as well as the reduction and delay in government funding for transportation infrastructure projects and +initiatives, may adversely impact our financial results for the foreseeable future, and may impair our ability to accurately forecast our future financial performance and other business trends. In +addition, since the end users of a majority of our products and services are currently governmental entities, we have been, and may continue to be, negatively affected by delays in the passage of a +new federal highway bill (or additional extensions of the existing bill) and budgetary issues and delays in purchasing decisions that many municipalities and other state and local agencies continue to +face. Spending for new roadways, new systems to address traffic congestion and other transportation infrastructure improvements has been delayed or eliminated in some instances. However, we believe +the need to rebuild and modernize aging transportation infrastructure will continue, and in addition to funds available through the federal highway bill, there exist various other funding mechanisms +that support transportation infrastructure and related projects. +These include bonds, dedicated sales and gas tax measures and other alternative funding sources. Furthermore, through investments in research, development, sales, and marketing, we are entering into +new commercial markets, in particular the agriculture industry, offering our ClearAg precision agriculture solutions, and we expect positive market acceptance to continue in upcoming quarters. +25 +Table of Contents +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial +statements included herein, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires +management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial +statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to revenue +recognition, the collectability of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for +stock-based compensation, the valuation of equity instruments, the valuation of contingent acquisition consideration, warranty reserves and other contingencies. We base these estimates on historical +experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and +liabilities that are not readily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of +our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assets and liabilities at the date of the financial statements +and the reported amounts of revenues and expenses during the reporting period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Product revenues and related costs of sales are recognized when all of the following criteria are met: +(i) persuasive +evidence of an arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of +the receivable is reasonably assured. These criteria are typically met at the time of product shipment, +but in certain circumstances, may not be met until receipt or acceptance by the customer. Accordingly, at the date revenue is recognized, the significant obligations or uncertainties concerning the +sale have been resolved. +Transportation +Systems and Performance Analytics revenues are derived primarily from long-term contracts. When appropriate, revenues are recognized using the percentage of completion +method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. Any anticipated losses on +contracts are charged to earnings when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may +result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably +assured. Certain of our revenues are recognized and amounts are earned as services are performed, which is measured by time incurred or other contractual milestones or output measures. Revenues +accounted for in this manner generally relate to certain fixed fee professional services, cost-plus fixed fee, time-and-materials contracts or subscription services. Revenues for ongoing operations +and maintenance services contracts are generally accounted for ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are +deferred and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that +26 +Table of Contents +deliverable. +In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling +prices of those elements. Overall arrangement consideration is allocated to each element (both delivered and undelivered items) that has stand-alone value based on their relative selling prices, +regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our estimated selling prices. +We +account for multiple-element arrangements that consist only of software and software-related services in accordance with applicable accounting guidance for software and +software-related transactions. For such transactions, revenue on arrangements that include multiple elements is allocated to each element based on the relative fair value of each element, and fair +value is determined by VSOE. If we cannot objectively determine the fair value of any undelivered element included in such multiple-element arrangements and the only undelivered element is +post-contract customer support or maintenance, and VSOE of the fair value of such support or maintenance does not exist, revenue from +the entire arrangement is recognized ratably over the support period. When the fair value of a delivered element has not been established but VSOE of fair value exists for the undelivered elements, we +use the residual method to recognize revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the +remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue. +Accounts Receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and +ongoing credit evaluations +of our customers' financial condition. We record an allowance for doubtful accounts for specific receivables deemed to be at risk for collection, as well as a general allowance based on our historical +collections experience. Considerable judgment is required in assessing and estimating the ultimate realization of trade receivables, including the current credit-worthiness of each customer. If the +financial condition of our customers deteriorates, resulting in an impairment of their ability to make required payments, additional allowances may be required that could adversely affect our +operating results. +Inventories. Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or +market. We write down +the carrying value of our inventories to net realizable value for estimated excess and obsolete inventories in an amount equal to the difference between the cost of the inventories and their estimated +realizable value. These estimates are based on management's judgments and assumptions as to future demand requirements and our evaluation of market conditions. Demand for our products may fluctuate +significantly over time, and actual demand and market conditions may be more or less favorable than those projected by management. In the event that actual demand is lower than originally projected, +additional inventory write-downs may be required. Estimated inventory write-downs, once established, are not reversed until the related inventory has been sold or scrapped, so if actual market +conditions are more favorable in the fiscal periods subsequent to those in which we record significant write-downs, we may have higher gross margins when products are sold. +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent purchased intangible assets including developed technology, customer relationships, trade +names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method that reflects the pattern in which the economic +benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method over the estimated useful life of the +asset. +27 +Table of Contents +We +evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. We have determined that our reporting units for +purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. In Fiscal 2012, we early adopted the provisions issued by the Financial +Accounting Standards Board ("FASB") that were intended to simplify goodwill impairment testing. This guidance permits us to first assess qualitative factors to determine whether it is more likely than +not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, +we conduct a two-step goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their carrying values. We determine the +fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting +unit's fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting +unit's goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor +the indicators for goodwill impairment testing between annual tests. Certain adverse business conditions impacting one or more reporting units would cause us to test goodwill for impairment on an +interim basis. As part of our annual assessment, management determines the most appropriate and efficient method to assess goodwill for impairment, which could include either the simplified testing +approach or the two-step goodwill test described above. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset are expected to generate. If an asset is not recoverable, we record an impairment loss +equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets and purchased +intangible assets. +Warranty. We generally provide a one to three year warranty from the original invoice date on our products, materials and +workmanship. Products sold +to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. Should our actual experience of warranty returns be higher than anticipated, additional +warranty reserves may be required, which would adversely affect our product gross margins and our operating results. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This +estimation process can result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so +that the year-to-date provision +28 +Table of Contents +reflects +the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall effective tax rate from quarter to +quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are reversed in +the first subsequent financial reporting period in which that threshold is no longer met. +The +application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a +result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from +our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the +estimated grant date fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this +model meets established requirements, the estimated fair values generated by it may not be indicative of the actual fair values of our stock option awards as it does not consider certain factors +important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability of the awards. The fair value of our restricted stock units +is based on the closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to +accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Recent Accounting Pronouncements +Refer to Note 1 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for a +discussion of recent accounting pronouncements. +29 +Table of Contents +Results of Operations +The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated. +Year Ended March 31, +2015 +2014 +2013 +Total revenues +100.0 +% +100.0 +% +100.0 +% +Cost of revenues +61.0 +61.9 +62.3 +Gross profit +39.0 +% +38.1 +% +37.7 +% +Operating expenses: +Selling, general and administrative +33.8 +28.3 +29.3 +Research and development +7.5 +5.9 +5.0 +Amortization of intangible assets +0.6 +0.9 +1.0 +Change in fair value of contingent consideration +0.0 +0.0 +(0.3 +) +Total operating expenses +41.9 +35.1 +35.0 +Operating (loss) income +(2.9 +) +3.0 +2.7 +Non-operating income (expense): +Other (expense) income, net +(0.0 +) +— +0.0 +Interest income (expense), net +0.0 +— +(0.0 +) +(Loss) income from continuing operations before income taxes +(2.9 +) +3.0 +2.7 +Benefit (provision) for income taxes +1.1 +(1.0 +) +(1.2 +) +(Loss) income from continuing operations +(1.8 +) +2.0 +1.5 +Gain on sale of discontinued operation, net of tax +0.3 +0.1 +2.4 +Net (loss) income +(1.5 +)% +2.1 +% +3.9 +% +Analysis of Fiscal 2015, Fiscal 2014 and Fiscal 2013 Results of Operations +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Performance Analytics +segments. The +following tables present details of total revenues for Fiscal 2015 compared to Fiscal 2014, and Fiscal 2014 compared to Fiscal 2013: +Year Ended March 31, +% +Change +2015 +2014 +Increase +(In thousands, except percentages) +Total revenues +$ +72,251 +$ +68,228 +$ +4,023 +5.9 +% +Year Ended March 31, +% +Change +2014 +2013 +Increase +(in thousands, except percentages) +Total revenues +$ +68,228 +$ +61,685 +$ +6,543 +10.6 +% +Total +revenues for Fiscal 2015 increased approximately 5.9% to $72.3 million, compared to $68.2 million in Fiscal 2014, due primarily to an increase of approximately 15% in +Roadway Sensors revenues. The increase in revenues was partially offset by decreases of approximately 1% in Transportation Systems revenues and approximately 6% in Performance Analytics revenues in +Fiscal 2015. +30 +Table of Contents +Total revenues for Fiscal 2014 increased approximately 10.6% to $68.2 million, compared to $61.7 million in Fiscal 2013, due primarily to an +increase of approximately 22% in Roadway Sensors revenues, approximately 2% in Transportation Systems revenues and approximately 5% in Performance Analytics revenues in Fiscal 2014. +Roadway +Sensors revenues in Fiscal 2015 increased approximately 15% compared to Fiscal 2014, primarily due to the success of various growth initiatives, including increases in our +distribution of certain third party products for the traffic intersection market, including traffic controllers, traffic cabinets and related equipment, and to a lesser extent, due to increases in +unit sales of our existing products. Revenue generated through the distribution of certain third party products was approximately $5.0 million and approximately $2.0 million for Fiscal +years 2015 and 2014, respectively. We believe these third party offerings can benefit sales of our core video detection products by providing a more comprehensive suite of solutions to our customers. +Roadway Sensors revenues in Fiscal 2014 increased approximately 22% compared to Fiscal 2013, primarily due to higher international sales and increases in unit sales of certain third party products. +Going forward, we plan to focus on our core domestic intersection market and refine and deliver products that address the needs of this market, namely our Vantage processor and camera systems and our +Vantage Vector video/radar hybrid sensor, as well as our SmartCycle and SmartSpan products. Additionally, we plan to continue focusing on international distribution channel expansion and expect to +continue to refine products that address these markets, namely our Abacus, P10 and P100 (formerly known as our Pico products) products. +Transportation +Systems revenues in Fiscal 2015 decreased approximately 1% compared to Fiscal 2014, primarily as a result of timing delays in starting certain new projects in our backlog, +as well as a reduction in sub-consultant revenues. Transportation Systems revenues in Fiscal 2014 increased approximately 2% compared to Fiscal 2013, primarily as a result of backlog fulfillment on +certain projects. Revenues from our Transportation Systems segment are primarily dependent upon the continued availability of funding at the local, state and federal levels from the various agencies +and departments of transportation. Going forward, we plan to continue to pursue larger contracts that may contain significant sub-consulting content, which will likely contribute to variability in the +timing and amount of our Transportation Systems revenues and related gross margins from period to period. Among other factors, we believe the ability of our Transportation Systems segment to grow and +successfully win and service new contracts will be highly dependent upon our continued success in recruiting and retaining qualified personnel, as well as the continued availability of funding at the +local, state and federal levels from the various agencies and departments of transportation. Any delays in the approval of a new federal highway bill could adversely impact our future revenues. +Performance +Analytics revenues in Fiscal 2015 decreased approximately 6% compared to Fiscal 2014, which was primarily due to delays in contract awards with certain public agencies and +the timing of backlog fulfillment on certain projects. Performance Analytics revenues in Fiscal 2014 increased approximately 5% compared to Fiscal 2013, primarily attributable to additional contract +awards with certain public agencies. Going forward, we plan to continue investing in this segment, particularly in research, development, sales and marketing of the ClearAg, ClearPath Weather and +iPeMS performance measurement solutions. We also plan to pursue commercial opportunities in the precision agriculture technology markets, by offering software applications, content, and modeling +services that provide analytics and decision support services that leverage our precision weather, soil and agronomic content and application intellectual property. While revenue from ClearAg products +was not significant, we expect to release general availability versions of a set of ClearAg products early in Fiscal 2016 and anticipate revenue from these products will contribute to overall Fiscal +2016 revenue. +31 +Table of Contents +Gross Profit. The following tables present details of our gross profit for Fiscal 2015 compared to Fiscal 2014, and Fiscal 2014 +compared to Fiscal +2013: +Year Ended March 31, +% +Change +2015 +2014 +Increase +(In thousands, except percentages) +Gross profit +$ +28,182 +$ +25,974 +$ +2,208 +8.5 +% +Gross profit as a % of total revenues +39.0 +% +38.1 +% +Year Ended March 31, +2014 +2013 +Increase +% Change +(in thousands, except percentages) +Gross profit +$ +25,974 +$ +23,258 +$ +2,716 +11.7 +% +Gross profit as a % of total revenues +38.1 +% +37.7 +% +Our +total gross profit as a percentage of total revenues for Fiscal 2015 increased approximately 90 basis points compared to Fiscal 2014 primarily due as a result of our product and +service mix. Revenues derived from our Roadway Sensors segment increased to approximately 50.3% of our total revenues in Fiscal 2015, compared to 46.6% in Fiscal 2014. Roadway Sensors revenues +generally carry higher gross margins than Transportation Systems and Performance Analytics revenues. Therefore, the increase in Roadway Sensors revenues had a positive impact on our overall margin. +The increase in gross profit as a percentage of total revenues was also attributable to an increase in Transportation Systems gross profit percentage, primarily due to timing of revenue recognition on +certain projects and an increase in the percentage of revenue generated by internal labor compared to revenue generated by our sub-consultants, which typically generates lower profit margins. +Our +total gross profit as a percentage of total revenues for Fiscal 2014 increased approximately 40 basis points compared to Fiscal 2013 also primarily as a result of our product and +service mix. Revenues derived from our Roadway Sensors segment increased to approximately 46.6% of our total revenues in Fiscal 2014 as compared to approximately 42.2% in Fiscal 2013. +Roadway +Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix, competitive pricing requirements, product warranty +costs and provisions for excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining activities, which we record as cost of goods sold. +We +recognize a portion of our Transportation Systems and Performance Analytics revenues and related gross profit using percentage of completion contract accounting, and the underlying +mix of contract activity affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future periods due +to our contract mix and the amount of related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could cause +fluctuations in our margins from period to period. +32 +Table of Contents +Selling, General and Administrative Expense +The following table presents selling, general and administrative expense for Fiscal 2015 and Fiscal 2014: +Year Ended March 31, +2015 +2014 +Amount +% of +Revenues +Amount +% of +Revenues +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +15,896 +22.0 +% +$ +12,955 +19.0 +% +$ +2,941 +22.7 +% +Facilities, insurance and supplies +2,522 +3.5 +2,603 +3.8 +(81 +) +(3.1 +) +Travel and conferences +1,681 +2.3 +1,502 +2.2 +179 +11.9 +Professional and outside services +3,982 +5.5 +1,593 +2.3 +2,389 +150.0 +Other +344 +0.5 +616 +0.9 +(272 +) +(44.2 +) +Selling, general and administrative +$ +24,425 +33.8 +% +$ +19,269 +28.2 +% +$ +5,156 +26.8 +The +overall increase in selling, general and administrative expense for Fiscal 2015, as compared to Fiscal 2014, was primarily due to an increase in salary and personnel-related expenses +and audit and consulting fees incurred in connection with the audit of our Fiscal 2014 financial statements. As previously disclosed, we delayed our Fiscal 2014 earnings release and the filing of our +Annual Report on Form 10-K for the year ended March 31, 2014 with the SEC until September 3, 2014, which was primarily due to additional procedures performed by our auditors +related to contract revenue testing. As a result of these additional procedures and related delays, we incurred an increase of approximately $940,000 in audit fees during the first and second quarters +of Fiscal 2015. We also incurred an increase of approximately $175,000 in service fees for the review of our Fiscal 2015 quarters. In addition, we incurred approximately $770,000 of outside +professional consulting costs to assist with the completion of the Fiscal 2014 annual audit and the Fiscal 2015 quarterly reviews. We have strengthened our internal controls to mitigate the need for +the incremental audit work, and we expect these costs to decline for future annual audits and quarterly reviews. However, we expect additional recurring costs in future periods for the related +augmentation of our internal accounting resources and improvements to our internal controls and procedures. The increase in selling, general and administrative expenses were also attributable to +approximately $594,000 of severance costs for our previous CEO and approximately +$383,000 for professional recruiting services costs incurred in connection with retaining a new CEO and CFO. +Selling, +general and administrative expenses also increased due to planned investments in Performance Analytics sales and marketing costs, consisting primarily of increased headcount +which resulted in higher salary and personnel-related costs, recruiting and travel. +33 +Table of Contents +The +following table presents selling, general and administrative expense for Fiscal 2014 and 2013: +Year Ended March 31, +2014 +2013 +Amount +% of +Revenues +Amount +% of +Revenues +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +12,955 +19.0 +% +$ +12,223 +19.8 +% +$ +732 +6.0 +% +Facilities, insurance and supplies +2,603 +3.8 +2,255 +3.7 +348 +15.4 +Travel and conferences +1,502 +2.2 +1,281 +2.1 +221 +17.3 +Professional and outside services +1,593 +2.3 +1,964 +3.2 +(371 +) +(18.9 +) +Other +616 +0.9 +367 +0.6 +249 +67.8 +Selling, general and administrative +$ +19,269 +28.2 +% +$ +18,090 +29.3 +% +$ +1,179 +6.5 +The +overall increase in selling, general and administrative expense for Fiscal 2014, as compared to Fiscal 2013, was primarily due to planned investments in Roadway Sensors and +Performance Analytics sales and marketing, including increased headcount which resulted in higher salary and personnel-related costs and travel. The overall increase was also attributable to business +travel, facility related costs, supplies and other miscellaneous expenses. +Research and Development Expense +The following table presents research and development expense for Fiscal 2015 and Fiscal 2014: +Year Ended March 31, +2015 +2014 +Amount +% of +Revenues +Amount +% of +Revenues +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +2,674 +3.7 +% +$ +2,314 +3.4 +% +$ +360 +15.6 +% +Facilities, development and supplies +1,543 +2.1 +1,232 +1.8 +311 +25.2 +Other +1,179 +1.6 +483 +0.7 +696 +144.1 +Research and development +$ +5,396 +7.5 +% +$ +4,029 +5.9 +% +$ +1,367 +33.9 +Research +and development expense for Fiscal 2015 increased approximately 33.9% compared to Fiscal 2014, primarily due to the planned expenditures for software development in the +Performance Analytics segment. The increase in research and development was also attributable to additional salary and personnel costs related in the Performance Analytics segment. In addition, we +submitted several patent applications during the third and fourth quarters of Fiscal 2015, and we expect to continue investing in securing intellectual property rights going forward. +In +Fiscal 2015, we continued to invest in the Performance Analytics segment largely related to the development of ClearAg and ClearPath Weather solutions. ClearAg application programming +interfaces include historical, real-time and forecast weather content, soil and plant health information, real-time weather and other useful crop growing information to provide solutions in the +precision agriculture technology markets. We expect to release general availability versions of a set of ClearAg products early in Fiscal 2016. Going forward, we expect to continue investing in our +Performance Analytics segment to enhance the ClearAg, ClearPath Weather and iPeMS solutions. +34 +Table of Contents +The +following table presents research and development expense for Fiscal 2014 and Fiscal 2013: +Year Ended March 31, +2014 +2013 +Amount +% of +Revenues +Amount +% of +Revenues +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +2,314 +3.4 +% +$ +1,454 +2.4 +% +$ +860 +59.1 +% +Facilities, development and supplies +1,232 +1.8 +1,378 +2.2 +(146 +) +(10.6 +) +Other +483 +0.7 +239 +0.4 +244 +102.1 +Research and development +$ +4,029 +5.9 +% +$ +3,071 +5.0 +% +$ +958 +31.2 +Research +and development expense for Fiscal 2014 increased approximately 31.2% compared to Fiscal 2013, primarily due to increased salary and personnel costs related to certain planned +expenditures for software development in the Performance Analytics segment, including increased headcount, as well as investments in securing intellectual property rights. +Impairment of Goodwill +In Fiscal 2012, we adopted the provisions issued by the FASB that are intended to simplify goodwill impairment testing. The updated +guidance permits us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it +is more likely than not that the fair value of a reporting unit is less than its carrying amount, we conduct a two-step goodwill impairment test. We performed annual impairment assessments of the +carrying value of goodwill for Fiscal 2015, Fiscal 2014 and Fiscal 2013 in their fourth fiscal quarters, respectively. We determined it was more appropriate to perform quantitative first-step +assessments in Fiscal 2015, Fiscal 2014 and Fiscal 2013 to estimate the fair value of our reporting units using both the income approach and market approach. Based on our assessments, we determined +that no impairment was indicated as the estimated fair value of each reporting unit exceeded its respective carrying value. +Based +on our goodwill impairment testing for Fiscal 2015, Fiscal 2014 and Fiscal 2013, we believe the carrying value of our goodwill was not impaired as of March 31, 2015, 2014 +and 2013, as the estimated fair values of our reporting units exceeded their carrying values at the end of such fiscal years. If our actual financial results, or the plans and estimates used in future +goodwill impairment analyses, are +lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Interest Income (Expense), Net +Net interest income was approximately $6,000 in Fiscal 2015. Net interest expense was approximately $0 and $6,000 in Fiscal 2014 and +Fiscal 2013, respectively. The sequential decreases in net interest expense were primarily due to a continuous decrease in the overall level of borrowings on our term note. During the first quarter of +Fiscal 2013, all principal and interest under the term note were paid in full. See "Liquidity and Capital Resources" below for additional details on our borrowings. +35 +Table of Contents +Income Taxes +The following table presents our provision for income taxes for Fiscal 2015, Fiscal 2014 and Fiscal 2013: +Year Ended March 31, +2015 +2014 +2013 +(In thousands, except +percentages) +(Benefit) provision for income taxes +$ +(816 +) +$ +704 +$ +716 +Effective tax rate +39.0 +% +34.8 +% +43.9 +% +The +difference between the statutory and the effective tax rate is primarily attributable to state income taxes. Additionally, our effective tax rate for Fiscal 2015 was favorably +impacted by the recognition of approximately $233,000 of tax credits in Fiscal 2015, partially offset by permanent non-deductible tax items, including share-based payments and other permanent +differences amounting to approximately $156,000. +Our +effective tax rate for Fiscal 2014 was favorably impacted by the recognition of approximately $359,000 of tax credits, partially offset by permanent non-deductible tax items, +including share-based payments and other permanent differences amounting to approximately $103,000, and by the recording of a valuation allowance against certain of our state net operating losses in +the amount of $185,000, net of federal benefit. +Our +effective tax rate for Fiscal 2013 was unfavorably impacted by permanent non-deductible tax items, including share-based payments and other permanent differences amounting to +approximately $82,000, and by the recording of a valuation allowance against certain of our state net operating losses in the amount of $188,000, net of federal benefit. These unfavorable impacts were +partially offset by the recognition of tax credits of approximately $122,000 for research and development and hiring activities, and by approximately $62,000 of tax benefit from non-taxable favorable +fair value adjustments recognized for financial statement purposes. +As +of March 31, 2014, we recorded a valuation allowance against certain of our state net operating loss carryforwards, which we estimated were likely to not be realized within the +applicable carryforward period in the amount of $373,000, net of federal tax benefit. As of March 31, 2015, the applicable state NOLs expired and, therefore, we reduced the related deferred tax +asset and removed the associated +valuation allowance. In making our determination as to the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax +liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may become necessary. We anticipate this should cause our future overall +effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax +assets to the extent that we believe these assets will more likely than not be realized. +At +March 31, 2015, we had approximately $18.5 million of federal net operating loss carryforwards and approximately $92,000 of state net operating loss carryforwards that +begin to expire in 2022 and 2031, respectively. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will cause us to have future +income tax payments that are substantially lower than the income tax liability calculated using statutory tax rates. Due to changes in stock ownership that occur in the open market, our federal net +operating loss carryforwards and other federal attributes are subject to a Section 382 annual limitation. +36 +Table of Contents +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations, borrowings under credit facilities and +the sale of equity securities. We currently rely on cash flows from operations, our cash reserves and the availability of borrowings on a line of credit facility to fund our operations, which we +believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future +growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing +equity or convertible debt securities, our existing stockholders may +experience significant dilution and any equity securities that may be issued may have rights senior to our existing stockholders. +At +March 31, 2015, we had $30.9 million in working capital, which included $22.0 million in cash and cash equivalents and reflected no borrowings on our +$12.0 million line of credit. This compares to working capital of $30.9 million at March 31, 2014, which included no borrowings on our line of credit and $20.4 million in +cash and cash equivalents. +The +following table summarizes our cash flows for Fiscal 2015, Fiscal 2014 and Fiscal 2013: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +3,577 +$ +3,274 +$ +3,193 +Investing activities +(844 +) +(779 +) +367 +Financing activities +(1,186 +) +(759 +) +(3,583 +) +Operating Activities. Cash provided by our operations in Fiscal 2015 was primarily the result of approximately $4.6 million +provided by +improvements in our accounts receivables, net costs and estimated earnings in excess of billings, and accounts payable and accrued expenses. Cash provided by operations was also attributable to +approximately $1.5 million of non-cash items for depreciation, amortization and stock-based compensation expense. This was offset by a decrease of approximately $0.5 million used in +working capital for inventories. +Our +accounts receivable and net costs and estimated earnings in excess of billings decreased approximately $2.8 million, or 17.0%, during Fiscal 2015 mainly as a result of more +timely collections of our outstanding receivables in Fiscal 2015. In the near future, our accounts receivable and net costs and estimated earnings in excess of billings accounts are likely to be +determined based upon, among other factors, increases or decreases in revenues, the timing of collections of existing receivables and our ability to timely invoice our billings in excess of costs. We +try to offset significant increases in accounts receivables through increased and focused collection efforts; however, we cannot assure you that our collection efforts will be successful. +Cash +provided by our operations in Fiscal 2014 was primarily the result of our net income of approximately $1.4 million and approximately $2.6 million non-cash items for +depreciation, amortization, stock-based compensation expense and adjustments to deferred tax assets. This was offset by approximately $0.7 million used in working capital, consisting of +approximately $1.5 million from accounts receivable, inventories, and net costs and estimated earnings in excess of billings, net of approximately $0.8 million for prepaid expenses and +other assets and accounts payable and accrued activities. +37 +Table of Contents +Our +accounts receivable and net costs and estimated earnings in excess of billings increased approximately $0.9 million, or 4.9%, during Fiscal 2014 mainly as a result of an +approximate 11.0% year-over-year increase in total revenues. In the near future, our accounts receivable and net costs and estimated earnings in excess of billings accounts are likely to be determined +based upon, among other factors, increases or decreases in revenues, the timing of collections of existing receivables and our ability to timely invoice our billings in excess of costs. We try to +offset significant increases in accounts receivables through increased and focused collection efforts; however, we cannot assure you that our collection efforts will be successful. The increase in +accounts payable by approximately $502,000 at March 31, 2014 compared to March 31, 2013 was largely driven by the general timing of payments to vendors and sub-consultants. +Investing Activities. Cash used in our investing activities during Fiscal 2015 consisted of approximately $986,000 for purchases +of property and +equipment, primarily related to leasehold improvements on our headquarters facility, which was offset by approximately $142,000 in proceeds from the sale of the Vehicle Sensors segment. Cash used in +our investing activities during Fiscal 2014 consisted of approximately $452,000 for purchases of property and equipment and approximately $301,000 used for the development of software and data +acquisitions in the Performance Analytics segment. Cash provided by our investing activities for Fiscal 2013 primarily consisted of $1.4 million in proceeds from the sale of the Vehicle Sensors +segment, approximately $815,000 for purchases of property and equipment, and approximately $190,000 for capitalized software related to iPeMS. +Financing Activities. Net cash used in financing activities during Fiscal 2015 was primarily the result of approximately +$863,000 in cash used to +repurchase shares of our common stock under our stock repurchase program and approximately $336,000 in cash used for the final deferred payment for the prior acquisition of BTS. +Net +cash used in financing activities during Fiscal 2014 was primarily the result of approximately $409,000 in cash used for a deferred payment for the prior acquisition of MET, +approximately $250,000 in cash used for an earn-out payment for the prior acquisition of BTS, and approximately $339,000 in cash used to repurchase shares of our common stock under our stock +repurchase program. This was partially offset by our receipt of proceeds of $270,000 from stock option and warrant exercises. Net cash used in our financing activities during Fiscal 2013 primarily +consisted of $2.5 million used to repurchase our common stock under our stock repurchase program, $634,000 in payments on our long-term debt and $700,000 paid to the BTS shareholders for +achievement of earn-out provisions of the purchase agreement. +Borrowings +In October 2008, we entered into a $19.5 million credit facility with California Bank & Trust ("CB&T"). This credit +facility provided for a two-year revolving line of credit with borrowings of up to $12.0 million and a 48-month term note in the original principal amount of $7.5 million. In September +2010, we entered into a modification agreement with CB&T to extend the expiration date of our revolving line of credit to October 1, 2012. We repaid in full all principal and accrued interest +under the term note in September 2012. The term note did not contain any early termination fees or prepayment penalties. +In +September 2012, we entered into a second modification agreement with CB&T to extend the expiration date of our revolving line of credit to October 1, 2014. In September 2014, +we entered into a modification agreement with CB&T to extend the expiration date of our revolving line of credit to December 1, 2014. In November 2014, we entered into another modification +agreement with CB&T to extend the expiration date of our revolving line of credit to March 1, 2015. In February 2015, we entered into another modification agreement with CB&T to extend the +expiration date of our revolving line of credit to October 1, 2016 and modified certain financial and other covenants. Interest on +38 +Table of Contents +borrowed +amounts under the revolving line of credit is payable monthly at a rate equal to the current stated prime rate (3.25% at March 31, 2015) plus 0.25%, depending on aggregate deposit +balances maintained at CB&T in relation to the total loan commitment under the credit facility. We are obligated to pay an unused line fee of 0.15% per annum applied to the average unused portion of +the revolving line of credit during the preceding month. The revolving line of credit does not contain any early termination fees and is secured by substantially all of our assets. +As +of March 31, 2015 and 2014, no amounts were outstanding under the credit facility with CB&T. Availability under this line of credit may be reduced or otherwise limited as a +result of our obligations to comply with certain financial and other covenants. As of March 31, 2015 and 2014, we were in compliance with all such financial covenants. We cannot assure you that +we will not violate one or more covenants in the future. If we were to be in violation of certain covenants under this agreement, our lender could decline to extend further credit to us, or choose to +accelerate payment on all outstanding loan balances, if any, and pursue its security interest in our assets. In this event, we cannot assure you that we would be able to quickly obtain equivalent or +suitable replacement financing on acceptable terms, on a timely basis, or at all. If we were not able to secure alternative sources of financing, such acceleration could have a material adverse impact +on our business and financial condition. +Off-Balance Sheet Arrangements +Other than our operating leases, which are further described at Note 9 of Notes to Consolidated Financial Statements, included +in Part IV, Item 15 of this report, we do not believe we have any other material off-balance sheet arrangements at March 31, 2015. +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such +sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter +generally impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal +quarter due to the increased number of holidays, causing a reduction in available billable hours. We have also experienced seasonality related to certain ClearPath Weather services, which adversely +affects such sales in our first and second fiscal quarters mainly because these services are generally not required during spring and summer when weather conditions are comparatively milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +Our exposure to interest rate risk is limited to our line of credit, which bears interest equal to the prevailing prime rate (3.25% at +March 31, 2015) plus 0.25%. We do not believe that a 10% increase in the interest rate on our line of credit would have a material impact on our financial position, operating results or cash +flows. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements and supplementary data required by Regulation S-X are included in Part IV, Item 15 of +this report. +39 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, +as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive +Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based +upon their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures +were effective as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a +timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely +decisions regarding required disclosure. +(b) Changes in internal control. In order to improve and to maintain the effectiveness of our internal controls +over financial reporting +and disclosure controls and procedures, we remediated the material weakness identified in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014. Our remediation process +began in our third quarter of Fiscal 2015 with our hiring of a Director of Revenue Recognition, and implementing processes and controls to evaluate revenues resulting from contracts, including +multiple-element arrangements, to ensure revenue is recognized and accounted for in accordance with GAAP. Except as discussed above, during the fourth quarter of Fiscal 2015, there has been no +significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely +to materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives +of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can +provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. +These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by +the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions +about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent +limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse +and material effect on our business, financial condition and results of operations. +Management's Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control +system was designed to provide reasonable assurance to +40 +Table of Contents +management +and our Board of Directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of published financial statements. +We +have assessed the effectiveness of our internal controls over financial reporting as of March 31, 2015. In making this assessment, we used the criteria set forth by the +Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013) . Based on our assessment, +we believe that, as of March 31, 2015, our internal control over financial reporting was effective. This annual report does not include an attestation report of our independent registered +public accounting firm regarding internal control over financial reporting. Such a report is not required pursuant to the rules of the SEC applicable to smaller reporting companies. +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +(a) Identification of Directors. The information under the caption "Election of Directors," appearing in our +proxy statement for the +2015 Annual Meeting of Stockholders, is incorporated herein by reference. +(b) Identification of Executive Officers. The information under the caption "Executive Compensation and Other +Information—Executive Officers," appearing in our proxy statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +(c) Compliance with Section 16(a) of the Exchange Act. The information under the caption "Section 16(a) +Beneficial +Ownership Reporting Compliance," appearing in our proxy statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +(d) Corporate Governance. The information under the caption "Corporate Governance," appearing in our proxy +statement for the 2015 Annual +Meeting of Stockholders, is incorporated herein by reference. +(e) Audit Committee. The information under the caption "Board Meetings and Committees—Audit Committee," +appearing in our +proxy statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information under the caption "Executive Compensation and Other Information," appearing in our proxy statement for the 2015 Annual +Meeting of Stockholders, is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information under the captions "Equity Compensation Plans" and "Principal Stockholders and Common Stock Ownership of Certain +Beneficial Owners and Management," appearing in our proxy statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +41 +Table of Contents +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in +our proxy +statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information under the caption "Fees Paid to Independent Registered Public Accounting Firm," appearing in our proxy statement for +the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. +42 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. The following financial statements of +Iteris, Inc. are +included in a separate section of this Annual Report on Form 10-K commencing on the pages referenced below: +Report of Independent Registered Public Accounting Firm +47 +Consolidated Balance Sheets as of March 31, 2015 and 2014 +48 +Consolidated Statements of Operations for the fiscal years ended March 31, 2015, 2014 and 2013 +49 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2015, 2014 and 2013 +50 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2015, 2014 and 2013 +51 +Notes to Consolidated Financial Statements +52 +2. Exhibits . +The +exhibits listed on the accompanying Exhibit Index immediately following the financial statements are filed or furnished as part of, or hereby incorporated by reference into, this +report. +43 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this +report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 17, 2015 +ITERIS, INC. +(Registrant) +By +/s/ KEVIN C. DALY +Kevin C. Daly, Ph.D +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Andrew C. Schmidt and Kevin +C. Daly, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all +capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, +granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, +as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may +lawfully do or cause to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ KEVIN C. DALY +Kevin C. Daly, Ph.D +Director, President and Chief Executive Officer (principal executive officer) +June 17, 2015 +/s/ ANDREW C. SCHMIDT +Andrew C. Schmidt +Chief Financial Officer (principal financial and accounting officer) +June 17, 2015 +/s/ GREGORY A. MINER +Gregory A. Miner +Chairman of the Board +June 17, 2015 +/s/ RICHARD CHAR +Richard Char +Director +June 17, 2015 +44 +Table of Contents +Signature +Title +Date +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 17, 2015 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Director +June 17, 2015 +/s/ MIKEL WILLIAMS +Mikel Williams +Director +June 17, 2015 +45 +Table of Contents +Iteris, Inc. +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm +47 +Consolidated Balance Sheets as of March 31, 2015 and 2014 +48 +Consolidated Statements of Operations for the fiscal years ended March 31, 2015, 2014 and 2013 +49 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2015, 2014 and 2013 +50 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2015, 2014 and 2013 +51 +Notes to Consolidated Financial Statements +52 +46 +Table of Contents +Report of Independent Registered Public Accounting Firm +To +the Board of Directors and Stockholders +Iteris, Inc. +We +have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiaries as of March 31, 2015 and 2014, and the related consolidated statements of +operations, stockholders' equity, and cash flows for each of the three years in the period ended March 31, 2015. These financial statements are the responsibility of the Company's management. +Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal +control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, +but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes +examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well +as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Iteris, Inc. and subsidiaries as of +March 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2015, in conformity with U.S. generally +accepted accounting principles. +/s/ +McGladrey LLP +Irvine, California +June 17, 2015 +47 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2015 +2014 +Assets +Current assets: +Cash and cash equivalents +$ +21,961 +$ +20,414 +Trade accounts receivable, net of allowance for doubtful accounts of $314 and $532 at March 31, 2015 and March 31, 2014, +respectively +11,206 +12,349 +Costs and estimated earnings in excess of billings on uncompleted contracts +4,266 +5,813 +Inventories +3,062 +2,546 +Deferred income taxes +2,680 +1,429 +Prepaid expenses and other current assets +1,338 +1,275 +Total current assets +44,513 +43,826 +Property and equipment, net +1,990 +1,546 +Deferred income taxes +5,610 +6,112 +Intangible assets, net +987 +1,584 +Goodwill +17,318 +17,318 +Other assets +214 +221 +Total assets +$ +70,632 +$ +70,607 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +5,915 +$ +5,913 +Accrued payroll and related expenses +4,871 +3,971 +Accrued liabilities +1,320 +1,643 +Billings in excess of costs and estimated earnings on uncompleted contracts +1,549 +1,391 +Total current liabilities +13,655 +12,918 +Deferred rent +826 +— +Unrecognized tax benefits +183 +199 +Total liabilities +14,664 +13,117 +Commitments and contingencies +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 +Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2015 and March 31, 2014 +Issued and outstanding shares—32,411 at March 31, 2015 and 32,788 at March 31, 2014 +3,242 +3,280 +Additional paid-in capital +135,572 +135,986 +Accumulated deficit +(82,846 +) +(81,776 +) +Total stockholders' equity +55,968 +57,490 +Total liabilities and stockholders' equity +$ +70,632 +$ +70,607 +See accompanying notes. +48 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2015 +2014 +2013 +Total revenues +$ +72,251 +$ +68,228 +$ +61,685 +Cost of revenues +44,069 +42,254 +38,427 +Gross profit +28,182 +25,974 +23,258 +Operating expenses: +Selling, general and administrative +24,425 +19,269 +18,090 +Research and development +5,396 +4,029 +3,071 +Amortization of intangible assets +431 +627 +644 +Change in fair value of contingent consideration +9 +25 +(181 +) +Total operating expenses +30,261 +23,950 +21,624 +Operating (loss) income +(2,079 +) +2,024 +1,634 +Non-operating income (expense): +Other (expense) income, net +(20 +) +— +2 +Interest income (expense), net +6 +— +(6 +) +(Loss) income from continuing operations before income taxes +(2,093 +) +2,024 +1,630 +Benefit (provision) for income taxes +816 +(704 +) +(716 +) +(Loss) income from continuing operations +(1,277 +) +1,320 +914 +Gain on sale of discontinued operation, net of tax +207 +89 +1,465 +Net (loss) income +$ +(1,070 +) +$ +1,409 +$ +2,379 +(Loss) income per share from continuing operations—basic and diluted +$ +(0.04 +) +$ +0.04 +$ +0.03 +Gain per share from sale of discontinued operation—basic and diluted +$ +0.01 +$ +0.00 +$ +0.04 +Net (loss) income per share—basic and diluted +$ +(0.03 +) +$ +0.04 +$ +0.07 +Shares used in basic per share calculations +32,595 +32,665 +33,491 +Shares used in diluted per share calculations +32,595 +32,847 +33,609 +See accompanying notes. +49 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at March 31, 2012 +33,909 +$ +3,391 +$ +137,645 +$ +(85,564 +) +$ +55,472 +Stock option exercises +190 +20 +232 +— +252 +Stock-based compensation +— +— +279 +— +279 +Issuance of shares pursuant to vesting of restricted stock units +51 +5 +(29 +) +— +(24 +) +Repurchases of common stock +(1,524 +) +(152 +) +(2,325 +) +— +(2,477 +) +Net income +— +— +— +2,379 +2,379 +Balance at March 31, 2013 +32,626 +3,264 +135,802 +(83,185 +) +55,881 +Stock option exercises +299 +29 +241 +— +270 +Stock-based compensation +— +— +300 +— +300 +Issuance of shares pursuant to vesting of restricted stock units +59 +6 +(37 +) +— +(31 +) +Repurchases of common stock +(196 +) +(19 +) +(320 +) +— +(339 +) +Net income +— +— +— +1,409 +1,409 +Balance at March 31, 2014 +32,788 +3,280 +135,986 +(81,776 +) +57,490 +Stock option exercises +24 +2 +31 +— +33 +Stock-based compensation +— +— +398 +— +398 +Issuance of shares pursuant to vesting of restricted stock units +72 +7 +(27 +) +— +(20 +) +Repurchases of common stock +(473 +) +(47 +) +(816 +) +— +(863 +) +Net loss +— +— +— +(1,070 +) +(1,070 +) +Balance at March 31, 2015 +32,411 +$ +3,242 +$ +135,572 +$ +(82,846 +) +$ +55,968 +See accompanying notes. +50 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Year Ended March 31, +2015 +2014 +2013 +Cash flows from operating activities +Net (loss) income +$ +(1,070 +) +$ +1,409 +$ +2,379 +Adjustments to reconcile net income to net cash provided by operating activities: +Deferred income taxes +(749 +) +710 +1,414 +Depreciation of property and equipment +525 +768 +901 +Stock-based compensation +398 +300 +279 +Amortization of intangible assets +597 +733 +644 +Change in fair value of contingent consideration +9 +25 +(181 +) +Gain on sale of discontinued operation, net of tax +(207 +) +(89 +) +(1,465 +) +Loss on disposal of equipment +17 +— +— +Loss on impairment of intangible asset +— +108 +— +Changes in operating assets and liabilities, net of effects of discontinued operation: +Accounts receivable +1,143 +(1,403 +) +135 +Net costs and estimated earnings in excess of billings +1,705 +(34 +) +(570 +) +Inventories +(516 +) +(81 +) +(11 +) +Prepaid expenses and other assets +9 +140 +(793 +) +Accounts payable and accrued expenses +1,716 +688 +461 +Net cash provided by operating activities +3,577 +3,274 +3,193 +Cash flows from investing activities +Purchases of property and equipment +(986 +) +(452 +) +(815 +) +Capitalized software +— +(301 +) +(190 +) +Net proceeds from sale of business segment +142 +(26 +) +1,372 +Net cash (used in) provided by investing activities +(844 +) +(779 +) +367 +Cash flows from financing activities +Payments on long-term debt +— +— +(634 +) +Deferred payment for prior business combination +(336 +) +(659 +) +(700 +) +Repurchases of common stock +(863 +) +(339 +) +(2,477 +) +Proceeds from stock option exercises +33 +270 +252 +Issuance of common stock pursuant to restricted stock units +(20 +) +(31 +) +(24 +) +Net cash used in financing activities +(1,186 +) +(759 +) +(3,583 +) +Increase (decrease) in cash and cash equivalents +1,547 +1,736 +(23 +) +Cash and cash equivalents at beginning of period +20,414 +18,678 +18,701 +Cash and cash equivalents at end of period +$ +21,961 +$ +20,414 +$ +18,678 +Supplemental cash flow information: +Cash paid during the year for: +Interest +$ +30 +$ +33 +$ +45 +Income taxes +141 +128 +339 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units +7 +6 +5 +Landlord contribution for tenant improvements +328 +— +— +See accompanying notes. +51 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its subsidiaries in these consolidated financial statements as "Iteris," the +"Company," "we," "our" and "us") is a leading provider of intelligent information solutions for the traffic management market. We are focused on the development and application of advanced +technologies and software-based information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface +transportation systems infrastructure. We also believe our products, services and solutions, in conjunction with sound traffic management, minimize the environmental impact of traffic congestion. By +combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a broad range of Intelligent +Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. We are also making significant investments to leverage our existing technologies and further expand our +software-based information systems to offer solutions to the precision agriculture technology markets. Iteris was incorporated in Delaware in 1987. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and its subsidiaries and have been prepared in +accordance with generally accepted accounting principles +in the United States of America ("GAAP"). All significant intercompany accounts and transactions have been eliminated in consolidation. +The +results of continuing operations for all periods presented in the consolidated financial statements exclude the financial impact of a discontinued operation. See Note 3, "Sale +of Vehicle Sensors," for further discussion related to the discontinued operation presentation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and +assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues +and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the +collectability of accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, inventory and warranty reserves, +costs to complete long-term contracts, indirect cost rates used in cost-plus contracts, contract reserves, the valuation of purchased intangible assets and goodwill, the valuation of equity +instruments and estimates of future cash flows used to assess the recoverability of long-lived assets and the impairment of goodwill, fair value of our stock option awards used to calculate the +stock-based compensation and other contingencies. +Revenue Recognition +Product revenues and related costs of sales are recognized when all of the following criteria are met: (i) persuasive evidence +of an arrangement exists, (ii) delivery under the terms of the arrangement +52 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +has +occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the receivable is reasonably assured. These criteria are typically met at the time of +product shipment, but in certain +circumstances, may not be met until receipt or acceptance by the customer. Accordingly, at the date revenue is recognized, the significant obligations or uncertainties concerning the sale have been +resolved. +Transportation +Systems and Performance Analytics revenues are derived primarily from long-term contracts with governmental agencies. When appropriate, revenues are recognized using the +percentage of completion method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. +Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final +contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their +realization is reasonably assured. Certain of our revenues are recognized as services are performed and amounts are earned, which is measured by time incurred or other contractual milestones or output +measures. Revenues accounted for in this manner generally relate to certain fixed fee professional services, cost-plus fixed fee or time-and-materials contracts. Revenues for ongoing operations and +maintenance services contracts are generally accounted for ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are deferred +and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the standalone selling price for one or more +delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +We +account for multiple-element arrangements that consist only of software and software-related services in accordance with applicable accounting guidance for software and +software-related transactions. For such transactions, revenue on arrangements that include multiple elements is allocated to each element based on the relative fair value of each element, and fair +value is determined by VSOE. If we cannot objectively determine the fair value of any undelivered element included in such multiple-element arrangements and the only undelivered element is +post-contract customer support or maintenance, and VSOE of the fair value of such support or maintenance does not exist, revenue from the entire arrangement is recognized ratably over the support +period. When the fair value of a delivered element has not been established but VSOE of fair value exists for the undelivered elements, we use the residual method to recognize revenue if the fair +value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and +53 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +the +remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue. +Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts +Costs and estimated earnings in excess of billings on uncompleted contracts in the accompanying consolidated balance sheets represent +unbilled amounts earned and reimbursable under services sales arrangements. At any given period-end, a large portion of the balance in this account represents the accumulation of labor, materials and +other costs that have not been billed due to timing, whereby the accumulation of each month's costs and earnings are not administratively billed until the subsequent month. Also included in this +account are amounts that will become billable according to contract terms, which usually require the consideration of the passage of time, achievement of milestones or completion of the project. Such +unbilled amounts are expected to be billed and collected within the next twelve months. +Costs +and estimated earnings in excess of billings on uncompleted contracts at March 31, 2015 and 2014 include approximately $1.0 million in each year, which were not +billable because certain milestone objectives specified in the contracts had not been attained. The costs and estimated earnings in excess of billings at March 31, 2015 are expected to be +billed and collected during the fiscal year ending March 31, 2016 ("Fiscal 2016"). +Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts +Billings in excess of costs and estimated earnings on uncompleted contracts in the accompanying consolidated balance sheets is +comprised of cash collected from customers and billings to customers on contracts in advance of work performed, advance payments negotiated as a contract condition, estimated losses on uncompleted +contracts, project-related legal liabilities and other project-related reserves. The unearned amounts are expected to be earned within the next twelve months. +We +record provisions for estimated losses on uncompleted contracts in the period in which such losses become known. The cumulative effects of revisions to contract revenues and estimated +completion costs are recorded in the accounting period in which the amounts become evident and can be reasonably estimated. These revisions can include such items as the effects of change orders and +claims, warranty claims, liquidated damages or other contractual penalties and adjustments for contract closeout settlements. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents +and trade accounts receivable. +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +54 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in the Middle East, Europe, South America and Asia. We generally +do not require collateral or other security from our customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's +expectations. +Fair Values of Financial Instruments +The fair value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of +the short period of time to maturity. +Cash and Cash Equivalents +Cash and cash equivalents consist of cash and short-term investments with initial maturities of ninety days or less. +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or market. Cost is +determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging +from three to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Goodwill and Long-Lived Assets +We evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. +We have determined that our reporting units for purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. We adopted the provisions issued +by the Financial Accounting Standards Board ("FASB") that were intended to simplify goodwill impairment testing. This guidance permits us to first assess qualitative factors to determine whether it is +more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a +55 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +reporting +unit is less than its carrying amount, we conduct a two-step goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting +units with their carrying values. We determine the fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. If the carrying +amount of a reporting unit exceeds the reporting unit's fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the +implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is +recognized as an impairment loss. We performed an annual impairment assessment of the carrying value of goodwill for each of the fiscal years ended March 31, 2015, 2014 and 2013. Based on these +assessments, we determined that no impairment as of each of these dates was indicated as the estimated fair value of each of our reporting units exceeded its respective carrying value. Indicators +which could result in future impairment charges include, among others, changes in economic conditions, changes in competitive conditions and customer preferences. We monitor the indicators for +goodwill impairment testing between annual tests. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset are expected to generate. If an asset is not recoverable, we record an impairment loss +equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets and purchased +intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are +derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in the consolidated statements of operations as an expense, based on the estimated grant date fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, +the estimated fair values generated by it may not be indicative +56 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +of +the actual fair values of our common stock option awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting +requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any +modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Advertising Expenses +Advertising costs are expensed in the period incurred and totaled $134,000, $168,000 and $165,000 in the fiscal years ended +March 31, 2015, 2014 and 2013, respectively. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products +sold to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain +criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is +recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent +improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. +Non-permanent repair and maintenance costs are charged to expense as incurred. +Comprehensive Income +Comprehensive income equals net income for all periods presented. +57 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Recent Accounting Pronouncements +In May 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts +with Customers ("ASU 2014-09"), which supersedes the revenue recognition requirements in Accounting Standards Codification 605, Revenue +Recognition . ASU 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the +consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of +revenue and cash flows arising from customer contracts, including significant judgments and changes in judgment and assets recognized from costs incurred to obtain or fulfill a contract. The effective +date will be the first quarter of our fiscal year ending March 31, 2018, using one of two retrospective application methods. The Company has not determined the potential effects on its +consolidated financial statements of the adoption of ASU 2014-09. +In +June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation ("ASU 2014-12") to resolve +diversity in accounting treatment for share based awards in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. +The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 and may be applied prospectively or retrospectively. The Company +does not anticipate a significant impact on its consolidated financial statements upon adoption of ASU 2014-12. +In +August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern ("ASU 2014-15"), +which requires a business entity to evaluate +whether there is substantial doubt about the ability to continue as a going concern for each annual and interim reporting period. If substantial doubt exists, additional disclosure is required. The +standard is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The Company does not anticipate a +significant impact on its consolidated financial statements upon adoption of ASU 2014-15. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2015 +2014 +(In thousands) +Materials and supplies +$ +1,566 +$ +1,320 +Work in process +216 +175 +Finished goods +1,280 +1,051 +$ +3,062 +$ +2,546 +58 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +2. Supplementary Financial Information (Continued) +Property and Equipment +The following table presents details of our property and equipment: +March 31, +2015 +2014 +(In thousands) +Equipment +$ +6,473 +$ +6,541 +Leasehold improvements +2,463 +1,975 +Accumulated depreciation +(6,946 +) +(6,970 +) +$ +1,990 +$ +1,546 +Property +and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging from three to eight years. Leasehold improvements +are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Depreciation +expense was approximately $525,000 and $768,000 in the fiscal year ended March 31, 2015 ("Fiscal 2015") and the fiscal year ended March 31, 2014 ("Fiscal +2014"), respectively. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, +2015 +2014 +Gross +Carrying +Amount +Accumulated +Amortization +Gross +Carrying +Amount +Accumulated +Amortization +(In thousands) +Technology +$ +1,856 +$ +(1,565 +) +$ +1,856 +$ +(1,422 +) +Customer contracts / relationships +750 +(497 +) +750 +(371 +) +Trade names and non-compete agreements +1,110 +(916 +) +1,110 +(754 +) +Capitalized software development costs +498 +(249 +) +498 +(83 +) +Total +$ +4,214 +$ +(3,227 +) +$ +4,214 +$ +(2,630 +) +Amortization +expense for intangible assets subject to amortization was approximately $597,000 for Fiscal 2015, of which approximately $166,000 was recorded to cost of revenues and +approximately +$431,000 recorded to amortization expense in the consolidated statement of operations. Approximately $733,000 and $644,000 was recorded to amortization expense for Fiscal 2014 and Fiscal 2013, +respectively. +We +capitalized $0 and approximately $172,000 for Fiscal 2015 and Fiscal 2014, respectively, of internal costs incurred in developing software products to be sold. These costs related to +the internal development of our performance measurement software offerings. +59 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +2. Supplementary Financial Information (Continued) +Capitalized +software development costs for the iPeMS platform began to be amortized in October 2013, resulting in approximately $166,000 and $106,000 recorded to cost of revenues in the +accompanying consolidated statements of operations for the fiscal years ended March 31, 2015 and 2014, respectively. We do not have any intangible assets with indefinite useful lives. As of +March 31, 2015, the future estimated amortization expense of approximately $1.0 million is entirely associated with our Performance Analytics business segment, as follows: +Year Ending March 31, +(In thousands) +2016 +$ +526 +2017 +365 +2018 +88 +2019 +8 +2020 +— +Thereafter +— +$ +987 +Refer +to Note 4 for additional information regarding intangible assets acquired during the last three fiscal years. +Goodwill +The following table presents the activity related to the carrying value of our goodwill by reportable segment for Fiscal 2013, Fiscal +2014 and Fiscal 2015: +Roadway +Sensors +Transportation +Systems +Performance +Analytics +Total +(In thousands) +Balance—March 31, 2013 +Goodwill +$ +8,214 +$ +16,278 +$ +796 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +8,308 +$ +796 +$ +17,318 +Balance—March 31, 2014 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +8,214 +6,936 +2,168 +17,318 +Balance—March 31, 2015 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +6,936 +$ +2,168 +$ +17,318 +In +Fiscal 2013, the Company established the Performance Analytics segment, which included the performance measurement and information management solutions, including all the operations +of +60 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +2. Supplementary Financial Information (Continued) +Berkeley +Transportation Systems, Inc. ("BTS"). As a result, the goodwill attributed to the BTS acquisition of approximately $796,000 was transferred to the newly created Performance Analytics +segment. +In +the first quarter of Fiscal 2014, as part of an internal reorganization, the Company's ClearPath Weather operations (formerly, Maintenance Decision Support System or MDSS), +historically included in the Transportation Systems segment, was reassigned to the Performance Analytics segment to better align the Company's predictive weather and traffic capabilities, resources, +and initiatives. As a result, the goodwill attributed to the ClearPath Weather operations from the Meridian Environmental +Technology, Inc. ("MET") acquisition of approximately $1.4 million was transferred to the Performance Analytics segment. +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Balance at beginning of fiscal year +$ +184 +$ +169 +$ +231 +Additions charged to cost of sales +134 +179 +139 +Warranty claims +(137 +) +(164 +) +(201 +) +Balance at end of fiscal year +$ +181 +$ +184 +$ +169 +61 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +2. Supplementary Financial Information (Continued) +Earnings Per Share +The following table sets forth the computation of basic and diluted (loss) income from continuing operations per share: +Year Ended March 31, +2015 +2014 +2013 +(In thousands, except per share +amounts) +Numerator: +(Loss) Income from continuing operations +$ +(1,277 +) +$ +1,320 +$ +914 +Denominator: +Weighted average common shares used in basic computation +32,595 +32,665 +33,491 +Dilutive stock options +— +111 +60 +Dilutive restricted stock units +— +70 +56 +Dilutive warrants +— +1 +2 +Weighted average common shares used in diluted computation +32,595 +32,847 +33,609 +(Loss) income from continuing operations per share: +Basic +$ +(0.04 +) +$ +0.04 +$ +0.03 +Diluted +$ +(0.04 +) +$ +0.04 +$ +0.03 +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted (loss) income per share from continuing +operations as their effect would have been anti- dilutive: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Stock options +2,252 +854 +1,049 +Restricted stock units +198 +— +— +Warrants +— +— +4 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial Vehicle +Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement (the "Agreement") signed on July 25, 2011 (the "Asset Sale"). +Pursuant +to the terms of the Agreement, upon the closing of the Asset Sale, Bendix paid us $14.0 million in cash, subject to a $2.0 million holdback and adjustments based +upon the working capital of the Vehicle Sensors segment at closing, and Bendix assumed certain specified obligations and +62 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +3. Sale of Vehicle Sensors (Continued) +liabilities +of the Vehicle Sensors segment. In October 2012, we received approximately $1.7 million in connection with the release of the holdback. Furthermore, we are entitled to additional +consideration in the form of the following performance and royalty-related earn-outs: Bendix is obligated to pay us an amount in cash equal to (i) 85% of revenue associated with royalties +received under our license and distribution agreements with Audiovox Electronics Corporation and Valeo Schalter and Sensoren GmbH through December 31, 2017 and (ii) 30% of the +amount, if any, by which the amount of revenue generated from the sale of our lane departure warning systems exceeds Bendix's projection for such revenue for the two years following the closing, each +subject to certain reductions and limitations set forth in the Agreement. As of March 31, 2015, we received approximately $1.2 million in connection with royalty-related earn-outs +provisions for a total of $14.9 million in cash from the Asset Sale. We also had approximately $180,000 in royalty-related receivables included in the prepaid expenses and other current assets +in the accompanying consolidated balance sheet as of March 31, 2015. +Upon +the closing of the Asset Sale and resolution of working capital adjustments (as described above), we recorded aggregate proceeds received of approximately $12.0 million. +Legal and other professional fees of approximately $0.6 million that were directly related to the sale transaction were offset against the proceeds to calculate net proceeds from the Asset Sale +of approximately $11.4 million. We recorded a gain on the Asset Sale of $207,000, $89,000 and $1.5 million, after tax, in the accompanying consolidated statements of operations for +Fiscal 2015, Fiscal 2014, and Fiscal 2013, respectively, related to certain performance and royalty-related earn-outs (as described above). +In +accordance with applicable accounting guidance, we determined that due to the Asset Sale, the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a +discontinued operation. The applicable financial results of the Vehicle Sensors segment have been reported as a discontinued operation in the consolidated statements of operations for all periods +presented. Vehicle Sensors net sales have been reclassified as part of discontinued operation was $0 for the fiscal years ended March 31, 2015, 2014 and 2013. +4. Acquisitions +Berkeley Transportation Systems, Inc. +In Fiscal 2012, we acquired all of the outstanding capital stock of Berkeley Transportation Systems, Inc. ("BTS"). BTS was a +privately-held company based in Berkeley, California, which specialized in transportation performance measurement. BTS' Performance Measurement System leverages its real-time data collection, +diagnostic, fusion and warehousing platform to aggregate and compute performance measures. This information is used to analyze how a transportation system is performing based on pre-determined +measures of effectiveness such as stops, delays and travel time. Our primary reasons for the acquisition were to add key technologies to complement our Performance Analytics solutions and strengthen +our performance measurement and management initiative as a whole. +63 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +4. Acquisitions (Continued) +Our consolidated financial statements for Fiscal 2015, Fiscal 2014 and Fiscal 2013 include the results of operations of BTS. On or shortly after the acquisition date, we paid a total of +approximately $840,000 in cash to the shareholders of BTS. On December 17, 2012, the Company entered into an amendment to the BTS stock purchase agreement, which modified certain earn-out +provisions, and as a result, the Company paid $700,000 in cash to the BTS shareholders for achievement of those modified earn-out provisions in our fourth quarter of Fiscal 2013. The amendment did not +have a material impact on previous estimated amounts accrued in connection with the earn-out provisions. This payment completed the Company's obligation under the earn-out provisions of the agreement. +During the third quarter of Fiscal 2014, the Company paid $250,000 pursuant to certain holdback provisions. Additionally, the Company paid the BTS shareholders approximately $336,000 in November 2014 +pursuant to certain deferred payment provisions. This payment completed the Company's obligations under the deferred payment provisions of the purchase agreement. +Meridian Environmental Technology, Inc. +In Fiscal 2012, we acquired all of the capital stock of Meridian Environmental Technology, Inc. ("MET"), a privately-held +company based in Grand Forks, North Dakota. MET specialized in 511/Advanced Traveler Information Systems, as well as the ClearPath Weather management tools (formerly known as Maintenance Decision +Support System) that allow users to create solutions to meet roadway maintenance decision needs. Our primary reasons for the acquisition were (i) to enhance our ability to provide travelers and +traffic management authorities with more accurate and real-time information and network performance management tools and (ii) to provide Iteris with key capabilities in the emerging performance +measurement and management market. +On +or shortly after the acquisition date, we paid approximately $1.6 million in cash, exclusive of $369,000 of cash acquired. We also agreed to pay up to $1.0 million on +each of the first two anniversaries of the closing of the acquisition upon the satisfaction of certain conditions, as well as up to an additional $2.0 million under a 24-month earn-out +provision. +In +January 2012, we made a cash payment of approximately $668,000 of the first deferred payment to the shareholders of MET and held back $250,000 in accordance with certain provisions of +the purchase agreement. In June 2012, we determined the contingencies related to the release of the $250,000 holdback were not met. As a result, no portion of the $250,000 holdback was released and +the entire amount was reversed into operating income during the second quarter of Fiscal 2013. Additionally, no amounts were earned by the MET shareholders related to the first and second year +earn-out provisions which ended on December 31, 2011 and 2012, respectively. The second deferred payment of $1.0 million was due in the fourth quarter of Fiscal 2013. As a result of +certain holdback provisions and other deductions, the Company paid approximately $409,000 to the MET shareholders in the second quarter of Fiscal 2014. This payment completed the Company's obligations +under the deferred payment provisions of the purchase agreement. The total purchase price paid for this business acquisition was approximately $2.7 million. +64 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +4. Acquisitions (Continued) +Purchased Intangible Assets +The following table presents details of the intangible assets acquired from MET: +Estimated +Useful Life +Amount +(In years) +(In thousands) +Technology +6 +$ +570 +Customer contracts / relationships +6 +500 +Other purchased intangible assets +3 - 7 +550 +$ +1,620 +5. Impairment of Goodwill +As discussed in Note 1, goodwill is tested for impairment on an annual basis in our fourth fiscal quarter or more frequently if indicators of impairment exist. +In +Fiscal 2012, we early adopted the provisions issued by the FASB that are intended to simplify goodwill impairment testing. The updated guidance permits us to first assess qualitative +factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of +a reporting units is less than its carrying amount, we conduct a two-step goodwill impairment test. We determined it was appropriate to perform a qualitative assessment and a quantitative first-step +assessment in Fiscal 2013, Fiscal 2014 and Fiscal 2015 to estimate the fair value of our reporting units using both the income approach and the market approach. Based on our assessments, we determined +that no impairment was indicated as of March 31, 2015 as the estimated fair value of each reporting unit exceeded its respective carrying value. +6. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets and liabilities; Level 2, defined as observable inputs +other than Level 1 prices such as quoted prices for similar assets or liabilities or prices quoted in inactive markets; and Level 3, defined as unobservable inputs that are significant +to the fair value of the asset or liability, and for which little or no market data exists, therefore requiring management to utilize its own assumptions to provide its best estimate of what market +participants would use in valuing the asset or liability. +The +liability for the estimated fair value of the contingent consideration in connection with our acquisitions of MET and BTS was initially determined using Level 3 inputs based +on a probabilistic calculation whereby we assigned estimated probabilities to achieving the earn-out targets and then discounted the total contingent consideration to net present value. The MET and +BTS earn-out targets were completed during Fiscal 2013 and the remaining liability at March 31, 2014 and March 31, 2013 +65 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +6. Fair Value Measurements (Continued) +related +to deferred acquisition payments discounted to net present value using Level 1 inputs. The following table reconciles this liability measured at fair value on a recurring basis for +Fiscal 2015 (in thousands): +Balance at March 31, 2014 +$ +327 +Earn-out payments made to BTS shareholders +(336 +) +Change in fair value included in net income +9 +Balance at March 31, 2015 +$ +— +The +change in the estimated fair value of this liability during the current fiscal year resulted primarily from payments to the shareholders of BTS related to the achievement of earn-out +targets and reductions to our MET estimates regarding both the probability of achieving certain earn-out targets and the amounts of certain future deferred payments. +The +current portion of the liability at March 31, 2015 and 2014 of $0 and approximately $327,000, respectively, is included within accrued liabilities in the accompanying +consolidated balance sheets. The change in the estimated fair value of the liability for the years ended March 31, 2015, 2014 and 2013 is included as part of operating expenses in the +accompanying consolidated statements of operations. +Other +than the above, we did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2015 or +2014. +Our +non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a non-recurring basis, generally when there is a transaction +involving those assets such as a purchase transaction, a business combination or an adjustment for impairment. No non-financial assets were measured at fair value during the fiscal years ended +March 31, 2015 and 2014. +7. Credit Facility +In October 2008, we entered into a $19.5 million credit facility with California Bank & Trust ("CB&T"). This credit facility provided for a two-year revolving line of +credit with borrowings of up to $12.0 million and a 48-month term note in the original principal amount of $7.5 million. In September 2010, we entered into a modification agreement with +CB&T to extend the expiration date of our revolving line of credit to October 1, 2012. We repaid in full all principal and accrued interest under the term note in September 2012. The term note +did not contain any early termination fees or prepayment penalties. +In +September 2012, we entered into a second modification agreement with CB&T to extend the expiration date of our revolving line of credit to October 1, 2014. In September 2014, +we entered into a modification agreement with CB&T to extend the expiration date of our revolving line of credit to December 1, 2014. In November 2014, we entered into another modification +agreement with CB&T to extend the expiration date of our revolving line of credit to March 1, 2015. In February 2015, we entered into another modification agreement with CB&T to extend the +expiration date of our revolving line of credit to October 1, 2016 and modified certain financial and other covenants. Interest on borrowed amounts under the revolving line of credit is payable +monthly at a rate equal to the current stated prime rate (3.25% at March 31, 2015) plus 0.25%, depending on aggregate deposit balances +66 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +7. Credit Facility (Continued) +maintained +at CB&T in relation to the total loan commitment under the credit facility. We are obligated to pay an unused line fee of 0.15% per annum applied to the average unused portion of the +revolving line of credit during the preceding month. The revolving line of credit does not contain any early termination fees and is secured by substantially all of our assets. +As +of March 31, 2015 and 2014, no amounts were outstanding under the credit facility with CB&T. Availability under this line of credit may be reduced or otherwise limited as a +result of our obligations to comply with certain financial and other covenants. As of March 31, 2015 and 2014, we were in compliance with all such covenants. +8. Income Taxes +The reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +(Benefit) provision for income taxes at statutory rates +$ +(712 +) +$ +688 +$ +554 +State income taxes net of federal benefit +(108 +) +48 +18 +Tax credits +(148 +) +(290 +) +(39 +) +Change in fair value of contingent acquisition consideration +3 +8 +(62 +) +Compensation charges +88 +22 +31 +Change in valuation allowance +— +185 +188 +Other +61 +43 +26 +(Benefit) provision for income taxes +$ +(816 +) +$ +704 +$ +716 +67 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +8. Income Taxes (Continued) +The +components of deferred tax assets and liabilities are as follows: +March 31, +2015 +2014 +(In thousands) +Deferred tax assets: +Net operating losses +$ +5,420 +$ +5,835 +Credit carry forwards +1,610 +1,350 +Deferred compensation and payroll +1,163 +958 +Bad debt allowance and other reserves +504 +516 +Deferred rent +364 +165 +Other, net +271 +198 +Total deferred tax assets +9,332 +9,022 +Valuation allowance +— +(373 +) +Total deferred tax assets, net of valuation allowance +9,332 +8,649 +Deferred tax liabilities: +Property and equipment +(137 +) +(285 +) +Acquired intangibles +(252 +) +(276 +) +Goodwill +(653 +) +(547 +) +Total deferred tax liabilities +(1,042 +) +(1,108 +) +Net deferred tax assets +$ +8,290 +$ +7,541 +The +components of current and deferred federal and state income tax provisions and (benefits) are as follows: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Current income tax provision (benefit): +Federal +$ +3 +$ +21 +$ +(20 +) +State +49 +20 +99 +Deferred income tax (benefit) provision: +Federal +(655 +) +330 +425 +State +(213 +) +333 +212 +Net income tax (benefit) provision +$ +(816 +) +$ +704 +$ +716 +At +March 31, 2015, we had approximately $840,000 in federal alternative minimum tax credit carryforwards that can be carried forward indefinitely, and $538,000 in federal research +credits that begin to expire in 2031. We also had $352,000 in state tax credits that begin to expire in 2025. We had approximately $18.5 million of federal net operating loss carryforwards at +March 31, 2015 that begin to expire in 2022. We also had approximately $92,000 of state net operating loss carryforwards at March 31, 2015 that begin to expire in 2031. +68 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +8. Income Taxes (Continued) +Due +to changes in stock ownership, our federal net operating loss carryforwards of approximately $18.5 million as of March 31, 2015 and other federal attributes are subject +to an annual limitation under Section 382 of the Internal Revenue Code. As of March 31, 2015, based on the cumulative amount of tax attributes that have become available under the +limitation imposed by Section 382, all of our net operating losses are now fully available for use. Our deferred tax assets at March 31, 2015 do not include approximately $874,000 of +excess tax benefits from employee stock option exercises that are a component of our net operating loss carryforwards. If and when such excess tax benefits are realized, stockholders' equity will be +increased. +As +of March 31, 2014, we recorded a valuation allowance against certain of our state net operating loss ("NOL") carryforwards which we estimated were likely to not +be realized within the applicable carryforward period in the amount of $373,000, net of federal tax benefit. As of March 31, 2015, the applicable state NOLs expired and, therefore, we reduced +the related deferred tax asset and removed the associated valuation allowance. In making our determination as to the realizability of our deferred tax assets, we review all available positive and +negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. +Unrecognized Tax Benefits +As of March 31, 2015 and 2014, our gross unrecognized tax benefits were $319,000 and $281,000, respectively, of which $184,000 +and $135,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are $257,000 and $217,000, respectively. +We +recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31, 2015 and 2014, we had accrued cumulatively $47,000 and $53,000, +respectively, for the payment of potential interest and penalties. The total amount of interest and penalties recognized in the consolidated statements of operations for Fiscal 2015 and Fiscal 2014 +was $6,000 and $14,000, respectively. +A +reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +281 +$ +218 +$ +1,692 +Increases for tax positions taken in prior years +14 +106 +— +Decreases for tax positions taken in prior years +(3 +) +(53 +) +(1,431 +) +Increases for tax positions taken in the current year +46 +41 +17 +Lapse in statute of limitations +(19 +) +(31 +) +(60 +) +Gross unrecognized tax benefits at March 31 +$ +319 +$ +281 +$ +218 +69 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +8. Income Taxes (Continued) +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We +are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2012 or later, and state and local income tax examination for fiscal tax years ended March 31, 2011 or +later. However, if NOL carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +9. Commitments and Contingencies +Litigation and Other Contingencies +On October 24, 2014, Wavetronix LLC, an Idaho limited liability company, filed a lawsuit against us in the United States +District Court for the Western District of Texas alleging infringement of United States Patent No. 7,991,542. The lawsuit related to our Vantage Vector product, which is a vehicle detection +sensor used in traffic control applications. Wavetronix was seeking unspecified compensatory and treble damages, attorney fees and a permanent injunction. In March, 2015, the Company entered into a +settlement agreement with Wavetronix, pursuant to which the lawsuit was settled for an amount that did not have a material impact on our financial statements and the lawsuit was dismissed. Pursuant to +the terms of the settlement agreement, the Company agreed to remove the Continuous Mode Dilemma Zone feature from its Vantage Vector product. Neither party admitted liability and the remaining terms +of the settlement are confidential, but did not have a material impact on the Company's financial statements. +In +addition to the matter described above, as a provider of traffic engineering services, products and solutions, we may be, from time to time, involved in other litigation relating to +claims arising out of our operations in the normal course of business. We cannot accurately predict the outcome of any such litigation including whether the adverse outcome of such litigation, +individually or in the aggregate, would have a material adverse effect on our consolidated results of operations, financial position or cash flows. +Operating Leases +In May 2007, we entered into an agreement to lease 52,000 square feet of office space in Santa Ana, California for a term of +88 months. In September 2007, we relocated our headquarters and principal operations into this space. The monthly lease rate was $102,000 during the first year of the lease and increased each +year thereafter, to $120,000 per month during the last year of the lease. In February 2014, we entered into an amendment to the lease, which reduced our office space by approximately 11,000 square +feet and changed the lease term to 96 months, commencing on April 1, 2014. The monthly lease rate is approximately $76,000 during the first year of the amended term and increases each +year thereafter, up to a maximum of approximately $90,000 during the last year of the term. Additionally, the lease amendment provided for approximately $328,000 in incentives in the form of tenant +improvement allowances, which we recorded as fixed assets and deferred rent in our consolidated balance sheet. The leasehold improvements were capitalized into fixed assets during Fiscal 2015 and will +be depreciated over the estimated useful life of the improvements, or the term of the lease amendment, whichever is shorter. The corresponding deferred rent amount will reduce monthly rent expense +over the term of the lease amendment. +70 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +9. Commitments and Contingencies (Continued) +We +have lease commitments for facilities in various locations throughout the U.S., as well as for certain equipment. Future minimum rental payments under these non-cancelable operating +leases at March 31, 2015 were as follows: +Year Ending March 31, +(In thousands) +2016 +$ +1,738 +2017 +1,642 +2018 +1,485 +2019 +1,328 +2020 +1,114 +Thereafter +2,143 +$ +9,450 +Rent +expense totaled approximately $1.7 million, $1.9 million and $1.9 million for Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in +September 2003. Maxxess is currently owned by an investor group that includes our current Chief Executive Officer ("CEO") and director, who is also the CEO of Maxxess, although he is on temporary +leave from Maxxess while holding the CEO position with Iteris, Inc. The Maxxess investor group also includes one former director of Iteris, Inc. The sublease terminated in September +2007, at which time Maxxess owed us an aggregate of $274,000 related to this sublease and certain ancillary corporate services that we provided to Maxxess. In August 2009, Maxxess executed a +promissory note payable to Iteris in the original principal amount of $274,000. The promissory note accrued interest at a rate of 6% per annum, compounded annually, with accrued interest to be paid +annually on the first business day of each calendar year; and allowed payments under the note to be made in bona fide services rendered by Maxxess to Iteris, to the extent such services and amounts +were pre-approved in writing by us. All amounts outstanding under the note were to become due and payable on the earliest of (i) August 10, 2014, (ii) a change of control in +Maxxess, or (iii) a financing by Maxxess resulting in gross proceeds of at least $10 million. +On +July 23, 2013, the promissory note from Maxxess was amended and restated. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with +accrued interest to be paid quarterly on the first business day of each calendar quarter. Payments under the amended and restated note may only be paid in cash and all amounts outstanding will become +due and payable on the earliest of (i) August 10, 2016, (ii) a change of control in Maxxess, or (iii) a financing by Maxxess resulting in gross proceeds of at least +$10 million. As of March 31, 2015, approximately $259,000 of the original principal balance was outstanding and payable to Iteris. We have previously fully reserved amounts owed to us by +Maxxess and all outstanding principal remains fully reserved. +71 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +9. Commitments and Contingencies (Continued) +Inventory Purchase Commitments +At March 31, 2015, we had firm commitments to purchase approximately $3.8 million of inventory, operating assets and +other supplies, which are expected to occur primarily during the first and second quarters of Fiscal 2016. +10. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is +authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, +limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of +March 31, 2015 and 2014, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior +Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between +Iteris and Computershare Trust Company, N.A., as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of Designations, which +created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred +stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. +Common Stock Warrants +As of March 31, 2015, we had no outstanding warrants to purchase shares of our common stock. All warrants have been exercised, +forfeited or cancelled. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2015: +Number of Shares +(In thousands) +Stock options outstanding +2,199 +Restricted stock units outstanding +194 +Authorized for future issuance under stock incentive plans +1,423 +3,816 +72 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +11. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase +shares of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on +the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. The 2007 Plan also +allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to +satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and +reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common +stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. On October 17, 2014, our stockholders approved an amendment of the 2007 Plan to +increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. At March 31, 2015, there were +approximately 1,423,000 shares of common stock available for grant under this plan. As of March 31, 2015, options to purchase approximately 2,003,000 shares of common stock, as well as 194,000 +RSUs, were outstanding under the 2007 Plan. +Our +1997 Stock Incentive Plan (the "1997 Plan") terminated in September 2007; however, all stock options outstanding under the 1997 Plan remain outstanding pursuant to the terms of such +stock options. As of March 31, 2015, options to purchase approximately 196,000 shares of our common stock were outstanding under the 1997 Plan. No further options or other stock-based awards +may be granted under the 1997 Plan. +Certain +options granted under the 2007 Plan and the 1997 Plan (collectively, the "Plans") and the RSUs granted under the 2007 Plan provide for accelerated vesting of unvested options in +the event of a change in control under certain circumstances. +73 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +11. Employee Benefit Plans (Continued) +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2015 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2014 +2,019 +$ +1.88 +Granted +730 +1.85 +Exercised +(24 +) +1.40 +Forfeited +(427 +) +1.88 +Expired +(99 +) +2.88 +Options outstanding at March 31, 2015 +2,199 +$ +1.83 +5.8 +$ +315 +Options exercisable at March 31, 2015 +1,324 +$ +1.85 +3.6 +$ +268 +Vested and expected to vest at March 31, 2015 +2,061 +$ +1.83 +5.5 +$ +313 +Options exercisable at March 31, 2015 pursuant to a change-in-control +2,199 +$ +1.83 +5.8 +$ +315 +Restricted Stock Units +In August 2010, we began granting RSUs under the 2007 Plan to certain of our employees. RSU awards are stock-based awards that entitle +the holder to receive one share of our common stock for each RSU upon vesting. RSUs vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains +in service (as defined by the 2007 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A +summary of activity with respect to our RSUs for Fiscal 2015 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2014 +195 +$ +1.58 +Granted +90 +1.87 +Vested +(83 +) +1.51 +Forfeited +(8 +) +1.81 +RSUs outstanding at March 31, 2015 +194 +$ +1.74 +2.6 +$ +21 +Expected to vest at March 31, 2015 +153 +$ +1.71 +2.5 +$ +20 +Common stock issuable (for RSUs) at March 31, 2015 upon a change-in-control +194 +$ +1.74 +2.6 +$ +21 +74 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +11. Employee Benefit Plans (Continued) +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated +statements of operations: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Cost of revenues +$ +21 +$ +30 +$ +42 +Selling, general and administrative expense +315 +246 +237 +Research and development expense +62 +24 +— +Total stock-based compensation +$ +398 +$ +300 +$ +279 +At +March 31, 2015, there was approximately $894,000 of unrecognized compensation expense related to unvested stock options and RSUs. This expense is currently expected to be +recognized over a weighted average period of approximately 2.8 years. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, +increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant +additional stock options, RSUs or other stock-based awards. +The +grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2015 +2014 +2013 +Expected life—years +7.7 +7.0 +7.0 +Risk-free interest rate +2.0 +% +2.0 +% +1.2 +% +Expected volatility of common stock +50 +% +51 +% +52 +% +Dividend yield +— +% +— +% +— +% +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2015 +2014 +2013 +(In thousands, except per +share amounts) +Weighted average grant date fair value per share of options granted +$ +1.01 +$ +0.99 +$ +0.81 +Intrinsic value of options exercised +$ +9 +$ +281 +$ +42 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of +Directors. No contributions were made during the fiscal years ended March 31, 2015, 2014 and 2013. +75 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +11. Employee Benefit Plans (Continued) +We sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible associates voluntarily contribute to the plan, up to IRS maximums, through +payroll deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the +401(k) Plan were approximately $495,000, $504,000 and $498,000 for the fiscal years ended March 31, 2015, 2014 and 2013, respectively. +12. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors approved a new stock repurchase program pursuant to which we may acquire up to $3 million of our outstanding common stock for an unspecified length of time. Under the new program, we +may repurchase shares from time to time in open-market and privately negotiated transactions and block trades, and may also repurchase +shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase +program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to +which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For +our fiscal year ended March 31, 2015, 2014 and 2013, we repurchased approximately 473,000, 196,000 and 1,524,000 shares of our common stock, respectively. From inception of +the program in August 2011 through March 31, 2015, we repurchased approximately 2,766,000 shares of our common stock for an aggregate price of approximately $4.4 million, at an average +price per share of $1.59. As of March 31, 2015, all repurchased shares have been retired and resumed their status as authorized and unissued shares of our common stock. As of March 31, +2015, approximately $2,884,000 remains available for the repurchase of our common stock under our current program. +13. Business Segments, Significant Customer and Geographic Information +Business Segments +We operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics. +The +Roadway Sensors segment provides hardware and software products to multiple segments of the ITS market. These various vehicle detection and information systems are used for traffic +intersection +control, incident detection and roadway traffic data collection applications. These include, among other products, our Vantage, VantageNext, VersiCam, Vantage Vector, SmartCycle, SmartSpan, Velocity, +P10, P100 and Abacus products. +The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. During Fiscal 2013, this segment included the operations of MET, which specializes in +76 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +13. Business Segments, Significant Customer and Geographic Information (Continued) +511/Advanced +Traveler Information Systems and offers predictive weather and ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. As of +April 1, 2013, the predictive weather and ClearPath Weather services were reassigned to the Performance Analytics segment to better align our predictive weather and traffic capabilities, +resources and initiatives. +The +Performance Analytics segment includes our performance measurement and information management solution iPeMS, a specialized transportation performance measurement and traffic +analytics solution, as well as ClearPath Weather, our road-maintenance application, and ClearAg, our precision agriculture solution. iPeMS provides big data and software analytics solutions that help +determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic +professionals to measure how a transportation network is performing and to identify potential areas of improvement. Our ClearAg platform provides access to a comprehensive database of weather, soil +and agronomic information essential to making informed agricultural decisions. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate expenses, +including interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct +products or provide services with different processes. All reported segment revenues are derived from external customers. +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2015, 2014 and 2013 is as follows: +Roadway +Sensors +Transportation +Systems +Performance +Analytics +Total +(In thousands) +Year Ended March 31, 2015 +Revenues +$ +36,370 +$ +30,294 +$ +5,587 +$ +72,251 +Depreciation +119 +115 +142 +376 +Segment income (loss) +6,302 +4,239 +(4,449 +) +6,092 +Year Ended March 31, 2014 +Revenues +$ +31,769 +$ +30,524 +$ +5,935 +$ +68,228 +Depreciation +208 +161 +118 +487 +Segment income (loss) +5,791 +3,363 +(1,575 +) +7,579 +Year Ended March 31, 2013 +Revenues +$ +26,002 +$ +30,010 +$ +5,673 +$ +61,685 +Depreciation +221 +362 +20 +603 +Segment income (loss) +4,119 +3,561 +(233 +) +7,447 +77 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +13. Business Segments, Significant Customer and Geographic Information (Continued) +The +following table reconciles total segment income to consolidated income from continuing operations before income taxes: +Year Ended March 31, +2015 +2014 +2013 +(In thousands) +Segment income: +Total income from reportable segments +$ +6,092 +$ +7,579 +$ +7,447 +Unallocated amounts: +Corporate and other expenses +(7,731 +) +(4,903 +) +(5,350 +) +Amortization of intangible assets +(431 +) +(627 +) +(644 +) +Change in fair value of contingent acquisition consideration +(9 +) +(25 +) +181 +Other (expense) income, net +(20 +) +— +2 +Interest income (expense), net +6 +— +(6 +) +(Loss) income from continuing operations before income taxes +$ +(2,093 +) +$ +2,024 +$ +1,630 +Significant Customer and Geographic Information +We currently have, and historically have had, a diverse customer base. For Fiscal 2015, one individual customer represented +approximately 10% of our total revenues and no other individual customer represented greater than 10% of our total revenues. For Fiscal 2014, one individual customer represented approximately 11% of +our total revenues and no other individual customer represented greater than 10% of our total revenues. For Fiscal 2013, one individual customer represented approximately 13% of our total revenues and +no other individual customer represented greater than 10% of our total revenues. +No +individual customer or government agency had a receivable balance at March 31, 2015 or 2014 greater than 10% of our total trade accounts receivable balances as of +March 31, 2015 and 2014, respectively. +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended March 31, +2015 +2014 +2013 +Middle East +3 +% +4 +% +3 +% +Other +— +1 +1 +3 +% +5 +% +4 +% +Substantially +all of our long-lived assets are held in the U.S. +78 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2014 +14. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross Profit +Net (Loss) +Income +Basic Net +(Loss) Income +per Share +Diluted Net +(Loss) Income +per Share +(In thousands, except per share amounts) +June 30, 2014 +$ +18,116 +$ +6,807 +$ +(19 +) +$ +— +$ +— +September 30, 2014 +18,550 +7,299 +(187 +) +(0.01 +) +(0.01 +) +December 31, 2014 +17,540 +6,862 +(98 +) +— +— +March 31, 2015 +18,045 +7,214 +(766 +) +(0.02 +) +(0.02 +) +$ +72,251 +$ +28,182 +$ +(1,070 +) +$ +(0.03 +)* +$ +(0.03 +)* +June 30, 2013 +$ +17,030 +$ +6,726 +$ +460 +$ +0.01 +$ +0.01 +September 30, 2013 +17,027 +6,912 +661 +0.02 +0.02 +December 31, 2013 +16,548 +6,192 +238 +0.01 +0.01 +March 31, 2014 +17,623 +6,144 +50 +0.00 +0.00 +$ +68,228 +$ +25,974 +$ +1,409 +$ +0.04 +* +$ +0.04 +* +* Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +79 +Table of Contents +Exhibit Index +Exhibit +Number +Description +Reference +2.1 ++ +Stock Purchase Agreement dated December 23, 2010 by and among Iteris, Inc., Meridian Environmental Technology, Inc., ("MET") the shareholders of MET and Kathy J. Osborne as the Shareholders +Representative +Exhibit 2.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2010 as filed with the SEC on February 14, 2011 +2.2 ++ +Asset Purchase Agreement by and between Iteris, Inc. and Bendix Commercial Vehicle Systems LLC, dated as of July 25, 2011 +Exhibit 2.1 to the registrant's Current Report on Form 8- K/A as filed with the SEC on November 1, 2011 +3.1 +Restated Certificate of Incorporation of the registrant +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.2 +Certificate of Designations of Series A Junior Participating Preferred Stock +Exhibit 3.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.3 +Bylaws of the registrant, as amended +Exhibit 4.2 to the registrant's Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993 +3.4 +Certificates of Amendment to Bylaws of the registrant dated April 24, 1998 and August 10, 2001 +Exhibit 3.4 to the registrant's Annual Report on Form 10- K/A for the year ended March 31, 2003 as filed with the SEC on July 29, 2003 +3.5 +Certificate of Amendment to Bylaws of registrant dated September 9, 2004 +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 as filed with the SEC on November 15, 2004 +3.6 +Certificate of Amendment to Bylaws of registrant effective September 16, 2005 +Exhibit 3.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2007 +3.7 +Certificate of Amendment to Bylaws of registrant effective December 7, 2007 +Exhibit 3.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 13, 2007 +3.8 +Certificate of Amendment to Bylaws of registrant, effective August 20, 2009 +Exhibit 3.3 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +4.1 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +80 +Table of Contents +Exhibit +Number +Description +Reference +4.2 +Rights Agreement dated August 20, 2009 between the registrant and Computershare Trust Company, N.A., which includes the form of Certificate of Designations for the Series A Junior Participating Preferred Stock, +the form of Right Certificate, and Summary of Rights to Purchase Preferred Stock as exhibits thereto +Exhibit 4.1 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +4.3 +Amendment No. 1 to Rights Agreement, entered into as of August 8, 2012 by and between Iteris, Inc. and Computershare Trust Company, N.A. +Exhibit 4.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 10, 2012 +10.1 +Form of Indemnity Agreement entered into by the registrant and certain of its officers and directors +Exhibit 19.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 +10.2 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +* +1997 Stock Incentive Plan (the "1997 Plan") as amended on May 3, 2003, as further amended on December 15, 2004 +Exhibit 10.32 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2005 as filed with the SEC on July 14, 2005 +10.4 +* +Form of Notice of Grant of Stock Option for 1997 Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.5 +* +Form of Stock Option Agreement for the 1997 Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.6 +* +Form of Addendum to Stock Option Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction or Change in Control +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.7 +* +Form of Stock Issuance Agreement for 1997 Plan +Exhibit 99.6 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Addendum to Stock Issuance Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction/Change in Control +Exhibit 99.7 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Initial Grant +Exhibit 99.8 to Exhibit 99.8 to registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +81 +Table of Contents +Exhibit +Number +Description +Reference +10.10 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Annual Grant +Exhibit 99.9 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.11 +* +Form of Automatic Stock Option Agreement for 1997 Plan +Exhibit 99.10 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 19, 2000 +10.12 +* +Iteris Inc. 1998 Stock Incentive Plan (as amended on February 7, 2000) ("1998 Plan") [Confirm there are no further options outstanding under this plan. Also confirm the rsa form has no continuing obligations and +that all RSAs under the 1998 Plan have vested in full. If so, these plan docs can be removed too] +Exhibit 10.24 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2005 as filed with the SEC on July 14, 2005 +10.13 +* +Form of Notice of Grant for 1998 Plan, including forms of Option Agreement and Stock Purchase Agreement for Abbas Mohaddes +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No. 333-126834) as filed with the SEC on July 22, 2005 +10.14 +* +Form of Addendum to Stock Option Agreement for 1998 Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No. 333-126834) as filed with the SEC on July 22, 2005 +10.15 +* +Form of 1997 Stock Option Agreements +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-126834) as filed with the SEC on July 22, 2005 +10.16 +Sublease, dated September 30, 2003, by and between Odetics, Inc. and Maij, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.17 +Office Lease, dated May 24, 2007, by and between Crown Carnegie Associates, LLC and Iteris, Inc. +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.18 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.19 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +82 +Table of Contents +Exhibit +Number +Description +Reference +10.20 +Amended and Restated Loan and Security Agreement dated February 4, 2009 by and between California Bank & Trust and the registrant +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2008 as filed with the SEC on February 13, 2009 +10.21 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.22 +Modification Agreement dated September 30, 2010 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 6, 2010 +10.23 +Modification Agreement dated September 28, 2012 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 3, 2012 +10.24 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.25 +* +Employment Agreement, dated July 29, 2013, by and between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.26 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +10.27 +Modification Agreement dated September 23, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q as filed with the SEC on November 12, 2014 +10.28 +Modification Agreement dated November 18, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on November 24, 2014 +10.29 +Separation Agreement and Release of Claims dated February 25, 2015 between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.30 +Modification Agreement dated February 24, 2015 between the Iteris, Inc. and California Bank & Trust +Exhibit 10.2 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.31 +Employment Agreement dated March 9, 2015 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on March 15, 2015 +21 +Subsidiaries of the registrant +Filed herewith +83 +Table of Contents +Exhibit +Number +Description +Reference +23 +Consent of Independent Registered Public Accounting Firm, dated June 17, 2015 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS +XBRL Instance Document +Filed herewith +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. ++ Confidential +treatment has been previously granted by the SEC for certain portions of the referenced exhibit pursuant to Rule 24b-2 of the Securities +Exchange Act of 1934, as amended. In accordance with Rule 24b-2, these confidential portions have been omitted from the exhibit and filed separately with the SEC. +# Pursuant +to Rule 406T of Regulation S-T, these interactive data files i) are not deemed filed or part of a registration statement or +prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, irrespective of any +general incorporation language included in any such filings, and otherwise are not subject to liability under these sections; and ii) are deemed to have complied with Rule 405 of +Regulation S-T ("Rule 405") and are not subject to liability under the anti-fraud provisions of the Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the +Securities Exchange Act of 1934 or under any other liability provision if we have made a good faith attempt to comply with Rule 405 and, after we become aware that the interactive data files +fail to comply with Rule 405, we promptly amend the interactive data files. +84 \ No newline at end of file diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/filing_metadata.csv b/raw/filings/0000350868/2014/0001047469-15-005534/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..6b5ebdb938d575ce763c39bee8ae322c2355a4da --- /dev/null +++ b/raw/filings/0000350868/2014/0001047469-15-005534/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2015-06-18,2015-03-31,2015-06-18T01:28:19.000Z,0001047469-15-005534,a2225120z10-k.htm,10-K,13202770,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746915005534/a2225120z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746915005534/,2014,2014,1 diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/item1.txt b/raw/filings/0000350868/2014/0001047469-15-005534/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..791564a7f304062ee007b57b8109079044c23c12 --- /dev/null +++ b/raw/filings/0000350868/2014/0001047469-15-005534/item1.txt @@ -0,0 +1,224 @@ +ITEM 1. BUSINESS +Overview +We are a leading provider of information solutions for the intelligent traffic systems ("ITS") and the precision agriculture ("PA") +markets. In the ITS market, we are focused on the development and application of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, +management and analytics, and that improve the efficiency and safety of surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound +traffic management, minimize the environmental impact of traffic congestion and enhance the adoption of advanced ITS solutions that are required for the deployment of connected and autonomous +vehicles. In the PA market, we have combined our unique intellectual property with enhanced soil, land surface, and agronomy modeling techniques utilizing our extensible EMPower hybrid computing +architecture to create a set of ClearAg™ solutions that provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. +We +were originally incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics (formerly known as +iPerform). The Roadway Sensors segment includes, among +2 +Table of Contents +other +products, our Vantage, Vantage Vector, VantageView, SmartCycle and vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection +applications. The Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. The Performance Analytics segment includes ClearAg, our precision agriculture solution that provides access to a comprehensive database of weather, soil and agronomic information, which +is essential to making informed agricultural decisions; iPeMS, our transportation performance measurement solution, which provides big data and software analytics solutions that help determine current +and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources; and ClearPath Weather, our road-maintenance application, which provides +maintenance and treatment recommendation for road networks. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for further +details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology to capture and analyze video images through +sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. +• Our Vantage video detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data +used in traffic management systems. Vantage video detection systems typically include up to four of our RZ-4 advanced cameras and an EdgeConnect processor. Our Vantage systems give traffic managers +the ability to mitigate roadway congestion by modifying traffic signal timing or detecting incidents quickly. Our VantageView software complements our Vantage video detection systems by providing an +integrated platform to manage video detection assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including +stop bar detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar sensing. +Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a +single video detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection +zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller +intersections that require only a few detection points. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +have historically experienced seasonality, particularly with respect to our Roadway Sensors revenues in our third and fourth fiscal quarters, due to reductions in road construction +and repairs during the winter months related to inclement weather conditions. +3 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, +development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design and implementation of surface +transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation +measures to reduce traffic congestion. +Our +Transportation Systems segment is largely dependent upon governmental funding and is affected by state and local budgetary issues. The current federal highway bill, which provides +federal funding for highway, transit, safety and related transportation programs, was due to expire at the end of September, 2014. The President signed a federal highway funding bill that kept the +federal highway bill operational until May 2015, and the House of Representatives recently approved a two-month extension to maintain funding for the federal highway bill through July 31, 2015. +We expect the extension and proposed federal highway bill to encourage government agencies to continue incorporating ITS technologies in transportation infrastructure projects. In addition, various +other funding mechanisms exist to support transportation infrastructure and related projects as regulatory deadlines approach, which require these technologies. These include bonds, dedicated sales +and gas tax measures and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will at least in part be dependent on the federal +government's use of funds under the federal highway bill. Delays in the release of funding may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely impact in the future, our Transportation Systems revenues and our overall +financial performance in future periods. +Performance Analytics (formerly known as iPerform) +Our Performance Analytics segment, formed during the first quarter of our fiscal year ended March 31, 2013 ("Fiscal 2013"), +includes our performance measurement and information management solutions, including all of the operations of Berkeley Transportation Systems, Inc. ("BTS"), which we acquired in November 2011. +BTS specialized in transportation performance measurement. The BTS performance measurement system leverages its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and +compute performance measurements. During the fiscal year ended March 31, 2012 ("Fiscal 2012"), we began the development of iPeMS (formerly, IterisPeMS). iPeMS is a state-of-the-art information +management software suite that utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and +management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of +improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use visualization and animation features based on historical traffic conditions. +The +Performance Analytics segment also includes the operations of Meridian Environmental Technology, Inc. ("MET"), which we acquired in January 2011. MET specializes in +511/Advanced Traveler Information Systems, as well as ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. With the addition of MET, we +have experienced seasonality particularly related to certain ClearPath Weather services in our first and second fiscal quarters, mainly because ClearPath Weather services are generally not required in +the summer months when weather conditions are typically less severe. Our Performance Analytics is a market leader in performance management solutions for federal and state organizations. We intend to +4 +Table of Contents +use +our strong brand and deep experience in the traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics. +Beginning +in late 2013, Iteris undertook a focused development activity to supplement its intellectual property, technology base and product suites to provide products and services for +the emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market as well as the development of several +products specifically intended for the PA market. Iteris refers to is products for the PA market generically as its ClearAg solutions. ClearAg, solutions provide access to a comprehensive database of +weather, soil and +agronomic information essential to making informed agricultural decisions. ClearAg application programming interfaces ("APIs") include historical, real-time and forecast weather content, soil and +plant health information, as well as real-time weather and other useful crop growing information, to provide solutions in the precision agriculture technology markets. We expect positive market +acceptance of our ClearAg solutions to continue in upcoming quarters. We plan to continue to fund these investments through internally generated cash flow from our Roadway Sensors and Transportation +Systems operating segments, as well as revenues from our Performance Analytics segment and our available cash if necessary. +Sales, Marketing and Principal Customers +We sell our Roadway Sensors products through direct and indirect sales channels. In the territories where we sell direct, we use a +combination of our own sales personnel and an outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is comprised of a +network of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers and sell directly +to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various +products for the construction and renovation of traffic intersections, and are generally well-known suppliers of high-quality ITS products to the traffic management market. We periodically hold +technical training classes for our distributors and end users and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When +appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and Performance Analytics solutions directly to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and municipal customers and generally provide for cancellation or renegotiation at the option +of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in +sales and business development functions. Our contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We +market and sell our ClearAg products to commercial entities in the PA market. We currently have two primary product sets which we are marketing for PA; our ClearAg API integration and +modeling services and our ClearAg Apps. Our ClearAg APIs are intended for large enterprises in the agriculture market that can benefit from the value of a tight integration of their processes with the +ClearAg modeling and forecasting engine; our ClearAg App was introduced in May 2015 and is intended for individual agriculture producers that can benefit from advisories based upon the ClearAg +5 +Table of Contents +platform +that are tailored for their specific locations of interest. We are dealing directly with customers interested in the ClearAg API products and, typically, through selling partners for those +interested in the ClearAg App products. +We +currently have a diverse customer base, but a large portion of our revenues historically has been derived from sales to federal, state and local government agencies. For our fiscal +year ended March 31, 2015 ("Fiscal 2015"), one individual customer represented approximately 10% of our total revenues and no other individual customer represented greater than 10% of our total +revenues. For the fiscal year ended March 31, 2014 ("Fiscal 2014"), one individual customer represented approximately 11% of our total revenues and no other individual customer represented +greater than 10% of our total revenues. For Fiscal 2013, one individual customer represented approximately 13% of our total revenues and no other individual customer represented greater than 10% of +our total revenues. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report for additional information regarding our significant +customers. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain +components from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and +components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include CTS Electronics +Manufacturing Solutions, Inc., Sony Electronics, Inc. and LG Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa +Ana facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of +the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such +service revenue was not a material portion of our total revenues for each of Fiscal 2015, Fiscal 2014 and Fiscal 2013. We believe customer support is a key competitive factor. +Our +ClearAg products are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we maintain a full-time support and customer +service activity for our ClearAg products. +Backlog +Our total backlog of unfulfilled firm orders was approximately $39.2 million as of March 31, 2015, which included +$29.6 million related to Transportation Systems. In the past three fiscal years, we have recognized approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the +subsequent fiscal year, and currently expect that trend to continue for the near future for both Transportation Systems and Performance Analytics. Substantially the entire backlog for Roadway Sensors +is expected to be recognized as revenue in Fiscal 2016. At March 31, 2014, we had backlog of approximately $35.6 million, which included $27.6 million related to Transportation +Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers +6 +Table of Contents +can +generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual +customers, which also can affect the timing of the conversion of our backlog into revenues. For these +reasons, among others, our backlog at a particular date may not be indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Performance Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facilities in Santa Ana, California. Our research and development costs and expenses were approximately $5.4 million for Fiscal 2015, $4.0 million +for Fiscal 2014 and $3.1 million for Fiscal 2013. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continue to develop new products to meet the needs of our ever-changing markets, +as well as to enhance and refine our existing product lines. We plan to focus our development efforts on our ClearAg products for the PA market; however, since 2012, our Roadway Sensors segment has +introduced our VantageNext, Vantage Vector, VersiCam and VersiCam wireless products, P10, P100, RZ-4 advanced camera and our RZ-4 advanced wide dynamic range camera, which significantly improve video +detection performance in certain harsh lighting conditions, as well as upgrades to our Abacus and VantageView products. Additionally, during Fiscal 2012, we began development of our software based +iPeMS performance measurement system, which continued through Fiscal 2014. We believe that developing new offerings across our segments and enhancing, refining and marketing our existing products are +key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced +gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Performance Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for iPeMS and ClearPath Weather +products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning and +design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with +a variety of entities that currently provide weather-related data to that market such as Climate Corp (now a division of Monsanto) and John Deere as well as new entrants such as Granular and +Conservis. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and other +non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive loop products, which have +historically, and currently continue to be, the predominant detection system in this market. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include national corporations that generally offer expertise +in traveler information, integration and transportation management. Our competitors in transportation +7 +Table of Contents +engineering, +planning and design include major regional firms, as well as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. +Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently hold seven U.S. patents, two U. S. allowed +but not issued patents, five foreign patent applications, and 20 U. S. non-provisional patent applications. One U.S. patent, which expires in May 2019, is for general technology related to CMOS +sensors. Two U.S. patents, which expire in 2029 and 2034, one foreign patent applications, and one U.S. non-provisional patent application relate specifically to our Roadway Sensors technology. Four +U.S. patents, which expire in 2034 and 2035, two allowed but not issued U. S. patents, and 17 U.S. non-provisional patent applications relate specifically to our Performance Analytics technology. Two +U. S. non-provisional patent applications relate to our Transportation Systems technology. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +8 +Table of Contents +Employees +We refer to our employees as associates. As of March 31, 2015, we employed 257 full-time associates and 28 part-time associates, +for a total of 285 associates. None of our associates are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our associates are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the +discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of +such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, +and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business and is not expected to have a material impact +in the near future. +9 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/item13.txt b/raw/filings/0000350868/2014/0001047469-15-005534/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..a3a584caba7624ca117aab5a3d70c91a5fcd02c7 --- /dev/null +++ b/raw/filings/0000350868/2014/0001047469-15-005534/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in +our proxy +statement for the 2015 Annual Meeting of Stockholders, is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/item9a.txt b/raw/filings/0000350868/2014/0001047469-15-005534/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..fc20a1299998ca5549e921f715954c2ea79c1d75 --- /dev/null +++ b/raw/filings/0000350868/2014/0001047469-15-005534/item9a.txt @@ -0,0 +1,37 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, +as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive +Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based +upon their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures +were effective as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a +timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely +decisions regarding required disclosure. +(b) Changes in internal control. In order to improve and to maintain the effectiveness of our internal controls +over financial reporting +and disclosure controls and procedures, we remediated the material weakness identified in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014. Our remediation process +began in our third quarter of Fiscal 2015 with our hiring of a Director of Revenue Recognition, and implementing processes and controls to evaluate revenues resulting from contracts, including +multiple-element arrangements, to ensure revenue is recognized and accounted for in accordance with GAAP. Except as discussed above, during the fourth quarter of Fiscal 2015, there has been no +significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely +to materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives +of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can +provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. +These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by +the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions +about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent +limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse +and material effect on our business, financial condition and results of operations. +Management's Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control +system was designed to provide reasonable assurance to +40 +Table of Contents +management +and our Board of Directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of published financial statements. +We +have assessed the effectiveness of our internal controls over financial reporting as of March 31, 2015. In making this assessment, we used the criteria set forth by the +Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013) . Based on our assessment, +we believe that, as of March 31, 2015, our internal control over financial reporting was effective. This annual report does not include an attestation report of our independent registered +public accounting firm regarding internal control over financial reporting. Such a report is not required pursuant to the rules of the SEC applicable to smaller reporting companies. \ No newline at end of file diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/rp_note.txt b/raw/filings/0000350868/2014/0001047469-15-005534/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2014/0001047469-15-005534/rpt_disclosure.txt b/raw/filings/0000350868/2014/0001047469-15-005534/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/filing.txt b/raw/filings/0000350868/2015/0001047469-16-013877/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..505c7bb559e071c476c893fc54b48e4181ed4573 --- /dev/null +++ b/raw/filings/0000350868/2015/0001047469-16-013877/filing.txt @@ -0,0 +1,4336 @@ +10-K +1 +a2228979z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +PART IV +Iteris, Inc. Index to Consolidated Financial Statements +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE +SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2016 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California 92705 +(Address of Principal Executive Offices) (Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, $0.10 par value +The NASDAQ Stock Market LLC +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act +of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the +past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to +be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes ý No o +Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this +Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See +definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer o +Non-accelerated filer o +(Do not check if a +smaller reporting company) +Smaller reporting company ý +Indicate +by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2015 was approximately $63,350,000. +For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate +status is not necessarily a conclusive determination for other purposes. As of June 8, 2016, there were 32,057,503 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2016 Annual Meeting of +Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended March 31, 2016. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2016 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +3 +ITEM 1A. +RISK FACTORS +9 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +20 +ITEM 2. +PROPERTIES +20 +ITEM 3. +LEGAL PROCEEDINGS +20 +ITEM 4. +MINE SAFETY DISCLOSURES +20 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +21 +ITEM 6. +SELECTED FINANCIAL DATA +22 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +22 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +35 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +35 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +35 +ITEM 9A. +CONTROLS AND PROCEDURES +35 +ITEM 9B. +OTHER INFORMATION +36 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +37 +ITEM 11. +EXECUTIVE COMPENSATION +37 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +37 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +37 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +37 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +38 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiary. Abacus®, ClearAg®, +ClearPath 511®, ClearPath Weather®, Edge®, EdgeConnect™, iPerform®, iPeMS®, Iteris®, Next®, +P10™, P100™, Pegasus™, Radius™, Reverse 511™, RZ-4™, SmartCycle®, SmartSpan®, +TransitHelper®, Vantage®, VantageNext®, VantagePegasus®, VantageRadius™, Vantage Vector®, VantageView™, +Velocity®, and VersiCam™ are among the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +1 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the +meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's +beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the +words "expect(s)," "feel(s)," "believe(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are intended to identify +forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, capital needs, +backlog and manufacturing capabilities, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, the applications for and acceptance of our products +and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause +our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of +the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in "Risk Factors" set +forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any +forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +2 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its subsidiary in this report as "Iteris," the "Company," "we," "our" and "us") is a +provider of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application of advanced technologies and +software-based information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface transportation +systems infrastructure. By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a +broad range of Intelligent Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. We believe our products, services and solutions, in conjunction with sound +traffic management, minimize the environmental impact of traffic congestion. +In +the agribusiness markets, we have combined our unique intellectual property with enhanced soil, land surface and agronomy modeling techniques to create a set of ClearAg solutions. +These solutions provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. We continue to make significant investments to leverage +our existing technologies and further expand our software-based information systems to offer solutions to the precision agriculture technology markets. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics. The Roadway +Sensors segment provides various vehicle detection and information systems and products for traffic intersection control, incident detection and roadway traffic data collection applications. The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the ITS industry. The +Performance Analytics segment includes iPeMS, our specialized transportation performance measurement and traffic analytics solutions, as well as ClearPath Weather, our road-maintenance applications, +and ClearAg, our precision agriculture solutions. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for further details on +our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology and other techniques to capture and analyze sensor +data through sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among +other products, our +Vantage, VantageNext, VersiCam, Vantage Vector, SmartCycle, SmartSpan, Pegasus, Velocity, P10, P100 and Abacus products. +3 +Table of Contents +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in +traffic management systems. Vantage detection systems typically include up to four of our advanced cameras or radars. Our Vantage systems give traffic managers the ability to mitigate roadway +congestion by modifying traffic signal timing or detecting incidents quickly. Our various software complement our Vantage detection systems by providing integrated platforms to manage and view +detection assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including +stop bar detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar sensing. +Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a +single video detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection +zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller +intersections that require only a few detection points. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +have historically experienced seasonality, particularly with respect to our Roadway Sensors revenues in our third and fourth fiscal quarters, due to reductions in road construction +and repairs during the winter months related to inclement weather conditions. +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, +development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design and implementation of surface +transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation +measures to reduce traffic congestion. +Our +Transportation Systems segment is largely dependent upon governmental funding and is affected by state and local budgetary issues. On December 4, 2015, the Fixing America's +Surface Transportation ("FAST") Act was signed into law, providing approximately $305 billion over five years for surface transportation projects and programs. In addition, various other +funding mechanisms exist to support transportation infrastructure and related projects as regulatory deadlines approach, which require these technologies. These include bonds, dedicated sales and gas +tax measures and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal +government's use of funds under the federal highway bill. Delays in the allocation of funds may prolong uncertainty regarding the +4 +Table of Contents +allotment +of transportation funds in federal, state and local budgets. We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely +impact in the future, our Transportation Systems revenues and our overall financial performance in future periods. +Performance Analytics +Our Performance Analytics segment, formed during the first quarter of our fiscal year ended March 31, 2013 ("Fiscal 2013"), +includes our performance measurement and information management solutions, including all of the operations of our former subsidiary, Berkeley Transportation Systems, Inc. ("BTS"), which we +acquired in November 2011. BTS specialized in transportation performance measurement systems that leverage its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and +compute performance measurements. iPeMS is a state-of-the-art information management software suite that provides big data and software analytics solutions that help determine current and future +traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine +current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to +measure how a transportation network is performing and to identify potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use +visualization and animation features based on historical traffic conditions. +The +Performance Analytics segment also includes the operations of our former subsidiary, Meridian Environmental Technology, Inc. ("MET"), which we acquired in January 2011. MET +specializes in 511/Advanced Traveler Information Systems, and includes our ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. Our +ClearPath Weather tools provide winter road maintenance recommendations for state agencies, municipalities and for commercial companies. +With +the addition of MET, we have experienced seasonality particularly related to certain ClearPath Weather services in our first and second fiscal quarters, mainly because ClearPath +Weather services are generally not required in the summer months when weather conditions are typically less severe. Our Performance Analytics is a market leader in performance management solutions for +federal and state organizations. We intend to use our strong brand and deep experience in the traffic management market, as well as our market-specific intellectual property, to expand our leadership +in data aggregation and analytics. +Beginning +in late 2013, we undertook a focused development activity to supplement our intellectual property, technology base and product suites to provide products and services for the +emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market, as well as the development of several +products +specifically intended for the PA market. We refer to our products for the PA market generically as ClearAg solutions. Our ClearAg platform provides access to a comprehensive database of weather, soil +and agronomic information essential to making informed agricultural decisions. Our ClearAg application programming interfaces ("APIs") include historical, real-time and forecast weather content, soil +and plant health information, as well as real-time weather and other useful crop growing information, to provide solutions in the precision agriculture technology markets. We commenced commercial +sales of our ClearAg platform and related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015") and introduced our first ClearAg Application ("App") in the first +quarter of our fiscal year ended March 31, 2016 ("Fiscal 2016"). We expect positive market acceptance of our ClearAg solutions to continue in upcoming quarters. We plan to continue to fund the +5 +Table of Contents +investments +in our ClearAg solutions through internally generated cash flow from our Roadway Sensors and Transportation Systems operations, as well as revenues from our Performance Analytics segment +and our available cash on hand, if necessary. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell +direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is +comprised of a network of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent +distributors are trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers +and sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the +supply of various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. +We periodically hold technical training classes for our distributors and end users and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance +when needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and Performance Analytics solutions primarily directly to government agencies pursuant to negotiated contracts that +involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and municipal customers and generally provide for cancellation or renegotiation at +the option of +the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in sales +and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We +currently market and sell our ClearAg products to commercial entities in the PA market. We currently have two primary product sets which we are marketing for our PA segment; our +ClearAg API integration and modeling services and our ClearAg Apps. Our ClearAg APIs are intended for large enterprises in the agriculture market that can benefit from the value of a tight integration +of their processes with the ClearAg modeling and forecasting engine; our ClearAg App was introduced in May 2015 and is intended for individual agriculture producers that can benefit from advisories +based upon the ClearAg platform that are tailored for their specific locations of interest. We generally deal directly to customers interested in the ClearAg API products, whereas we typically sell +through selling partners for our ClearAg App products. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain +components from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and +components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris +Manufacturing, Sony Electronics, Inc. and LG Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California +facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of +6 +Table of Contents +the +hardware used in the transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such +service revenue was not a material portion of our total revenues for each Fiscal 2016, Fiscal 2015 and our fiscal year ended March 31, 2014 ("Fiscal 2014"). We believe customer support is a key +competitive factor. +Our +ClearAg products are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer service +for our ClearAg products. +Backlog +Our total backlog of unfulfilled firm orders was approximately $63.3 million as of March 31, 2016, which included +$53.3 million related to Transportation Systems. In the past three fiscal years, we have recognized approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the +subsequent fiscal year, and currently expect that trend to continue for the near future for both Transportation Systems and Performance Analytics. Substantially the entire backlog for Roadway Sensors +as of March 31, 2016 is expected to be recognized as revenue in the fiscal year ending March 31, 2017. At March 31, 2015, we had backlog of approximately $39.2 million, +which included $29.6 million related to Transportation Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Performance Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $6.9 million for Fiscal 2016, $5.4 million +for Fiscal 2015 and $4.0 million for Fiscal 2014. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our +Performance Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continue to develop new products to meet the needs of our ever-changing markets, +as well as to enhance and refine our existing product lines. We plan to focus our development efforts in the near future in our Performance Analytics segment on our ClearAg products for the PA market; +however, since 2014, our Roadway Sensors segment has introduced our VantageNext, Vantage Vector, SmartCycle, SmartSpan, Pegasus, Velocity, P10 and P100 products. Additionally, during Fiscal 2015 and +Fiscal 2016, we engaged in development activities of our ClearAg precision agriculture solutions. We believe that developing new offerings across our segments and enhancing, refining and marketing our +existing products are key components for strong organic growth and profitability. +7 +Table of Contents +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced +gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Performance Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for iPeMS and ClearPath Weather +products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning and +design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with +a variety of entities that currently provide weather-related data to that market such as Climate Corp (now a division of Monsanto) and John Deere as well as new entrants such as Granular and +Conservis. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and manufacturers +and distributors and other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation engineering, planning and design include major regional ITS engineering firms, as well +as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. +Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We have (i) two U.S. non-provisional patent +applications relating to our Roadway Sensors technologies, (ii) twelve issued U.S. patents, two U.S. non-provisional patent applications that were allowed and issued in 2007 and twelve U.S. +non-provisional patents, relating to our Performance Analytics technologies, and (iii) four issued U.S. patents and one U.S. non-provisional patent relating specifically +to our Transportation Systems technologies. The twelve issued patents relating to our Performance Analytics technologies expire between 2033 and 2035, and our four issued U.S. patents relating to our +Transportation Systems technologies expire between 2033 and 2035. +8 +Table of Contents +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other +proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material +licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent +applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +We refer to our employees as associates. As of March 31, 2016, we employed 366 full-time associates and 34 part-time associates, +for a total of 400 associates. None of our associates are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our associates are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the +discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of +such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, +and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, +foreign laws and regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented +elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this +report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described +below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of +these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose +all or part of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues +and +fixed price contracts. A significant portion of our revenues are derived from contracts with governmental agencies, either as a +9 +Table of Contents +general +contractor, subcontractor or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, +subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, +delays in the expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding; +• performance bond requirements; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements; +• changes in government policies and political agendas; +• milestone requirements and liquidated damage provisions for failure to meet contract milestones; and +• international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from +transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and +income to drop substantially or to fluctuate significantly between fiscal periods. +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs would adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the +convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any +material government contract could seriously harm our business, financial condition and results of operations. +We recently expanded our Performance Analytics capabilities to address a new market segment, the +agricultural market, which may not broadly accept our technologies and new products. The application of precision analytics to the agricultural market is a +relatively new development that has required us to invest, and is expected to continue to require us to invest, in additional research and development and sales and marketing without any guarantee of +a commensurate increase in revenues. The introduction of any new performance analytics products and services could have longer than expected sales cycles, which could adversely impact our operating +results. We cannot assure you that growers or other companies in this market will perceive the value proposition of our performance analytics or that our new ClearAg products for this market, will +achieve broad market acceptance in the near future or at +10 +Table of Contents +all. +If the agricultural market fails to understand the benefit of our performance analytics products or chooses not to adopt our technologies, our business, financial condition and results of +operations will be adversely affected. +Uncertainty and delays in government funding for transportation infrastructure projects and initiatives have adversely impacted our revenues. There +was uncertainty in the past few years regarding allocation of government funds for transportation projects due to delays in the passage of a federal highway bill. On December 4, 2015, the +Fixing America's Surface Transportation ("FAST") Act was signed into law, providing $305 billion over five years for surface transportation projects and programs. Despite the recently enacted +federal highway bill, delays in the allocation of such funds, the priority of infrastructure projects and the availability of funds for ITS related projects could continue to adversely impact our +revenues and overall financial performance. +We recently entered into the software development market and may be subject to additional challenges and additional costs and delays. We have only +been in the business of software development for a few years and may experience development and technical challenges. Our business and results of operations could also be seriously harmed by any +significant delays in our software development and updates. Certain of our new products have contained undetected software errors or "bugs" when first released by us, despite our testing. We may not +discover these faults or errors until after a product has been installed and used by our customers. Any faults or errors in our existing products or in any new products may cause delays in product +introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, the +software development industry frequently experiences litigation concerning intellectual property disputes, which could be costly and distract our management. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely +decline. Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in the marketplace as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements successfully and in a cost-effective and timely manner, or are unable to achieve market acceptance +of our +new products, our operating results would be adversely affected. We believe our revenue growth and future operating results will depend on our ability to complete +development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production +costs. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, +the introduction of any new products could adversely affect the sales of certain of our existing products. +11 +Table of Contents +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in +response to evolving customer requirements. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected +if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product +transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +The markets in which we operate are highly competitive and have many more established competitors than us, which could adversely affect our revenues or the market acceptance of our +products. We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many smaller +regional engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a small portion of the traffic intersection +market has adopted advanced detection technologies, and our future success will depend in part upon gaining broad market acceptance for detection in this above-ground market. Certain technological +barriers to +entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could +result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local regional firms. +The +markets in which our Performance Analytics segment operates vary from public sector customers who focus on performance measurement systems to help measure and manage the +effectiveness of their transportation systems to commercial sector customers who ingest and disseminate traffic, weather and agronomic related data, information and analytics through various consumer +outlets. Our competitors include divisions of large, multi-national corporations as well as a variety of small providers. In the public sector, we compete with some of the same transportation +engineering, planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide traffic and/or +weather related data to that market. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. If we are not able +to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations +will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, +12 +Table of Contents +employee +and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also +be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our +proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or abroad. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse +outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or +using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is +determined that we have infringed upon or misappropriated another party's intellectual property. Our recent expansion into software development activities may subject us to increased possibility of +litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, +including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, +financial condition and results of operations. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. Due +to the specialized +nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The loss of any of our officers, or +any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations. Our success will also depend in large part upon our ability +to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. The future success of our Transportation Systems segment will depend on our ability to +hire additional qualified engineers, planners and technical personnel. The future success of our Performance Analytics segment will depend on our ability to hire additional software developers, +qualified engineers and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense. We may not be able to continue to attract and +retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect +our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our Transportation Systems and Performance Analytics +workforce. The cost of providing our Transportation Systems and Performance Analytics engineering and consulting services, including the extent to which we utilize +our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; +and +• our ability to match the skill sets of our employees to the needs of the marketplace. +13 +Table of Contents +An +inability to properly and fully utilize our Transportation Systems and Performance Analytics workforce could have an adverse effect on our results of operations. +Our failure to successfully bid on new contracts and renew existing contracts could reduce our revenues and profits. Our business +depends on our +ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. Contract proposals and negotiations are complex and frequently involve a lengthy +bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. For example, a customer may require us +to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions continue, or if we fail to secure adequate +financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue particular projects, which could reduce or eliminate our +profitability. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in +our +operating results. Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past +expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these +activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +We are currently not profitable on a consolidated basis and we may be unable to become profitable on a quarterly or annual basis. For Fiscal 2016, we +had a net loss, and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by governmental budgetary constraints, +government and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from the Company's segments to fund investments in sales +and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our +expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or +increases in planned investments. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund our operations and achieve our +business plan, and could cause the market price of our common stock to decline. +Our use of the percentage of completion method of accounting for our Transportation Systems and Performance Analytics revenues could result in a reduction or reversal of previously +recorded revenues and profits. A portion of Transportation Systems and Performance Analytics revenues are measured and recognized using the percentage of +completion method of accounting. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs +incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably +estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of +long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially +from estimates, including reductions or reversals of previously recorded revenues and profits. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely +affected. Section 404 of the Sarbanes-Oxley Act +14 +Table of Contents +of +2002 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year and to include a management report assessing the +effectiveness of our internal controls over financial reporting in all annual reports. +As +a smaller reporting company, for Fiscal 2016, we were exempt from the auditor attestation requirement over our internal control over financial reporting; however, to the extent we do +not qualify as a non-accelerated filer or smaller reporting company in subsequent fiscal years, we will be subject to the auditor attestation requirement under Section 404(b) of the +Sarbanes-Oxley Act. In such an event, we may not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent +registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A +control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of +a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control +systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations +include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of +some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future +events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in +conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may +occur and not be detected. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could +cause +our stock price to decline. Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number +of factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as +well as increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• our ability to raise additional capital; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• seasonality due to winter weather conditions; +15 +Table of Contents +• seasonality with respect to revenues from our ClearPath Weather and related weather forecasting services due to the decrease in +revenues generated for such services during the spring and summer time periods; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in +a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• general economic and political conditions; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +We may be subject to traffic related litigation. The traffic industry in general is subject to litigation claims due to the +nature of personal +injuries that result from traffic accidents. As a provider of traffic engineering services, products and solutions, we have been, and could in the future continue to be, from time to time, subject to +litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not +be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or +more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims +could cause us to incur significant expenses and result in a diversion of management's attention. +We rely on outside suppliers that could experience supply shortages or may experience production gaps that could materially and adversely impact our sales and financial +results. It is possible that we could experience unforeseen quality control issues or part shortages as we adjust production to meet current demand for our +products. We have historically used single suppliers for certain significant components in our products, and have had to reengineer products from time to time to address obsolete components, +especially in our Roadway Sensors products. Should any such delay or disruption occur, or should a key supplier discontinue operations, our future sales will likely be materially and adversely +affected. +Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we +16 +Table of Contents +believe +our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many +of our products, if necessary, we could experience a production gap if for any reason our contract manufacturers were unable to meet our production requirements and our cost of goods sold could +increase, adversely affecting our margins. +We may engage in acquisitions of companies or technologies that may require us to undertake significant capital infusions and could result in disruptions of our business and +diversion of +resources and management attention. We have completed two acquisitions since November 2011 and, in the future, we may acquire additional complementary businesses, +products, and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and +information system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits anticipated from any acquisition. +Our international business operations may be threatened by many factors that are outside of our control. While we historically +have had limited +international sales, revenues and operations experience, we currently have three transportation systems contracts in the United Arab Emirates and have been expanding our distribution capabilities for +our Roadway Systems segment internationally, particularly in Australia, New Zealand and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we will +be successful in such efforts. International operations subject us to various inherent risks including, among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S. and each other country in which we operate; +17 +Table of Contents +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, +including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. We have +historically +experienced volatility in our earnings and cash flows from operations from year to year. Although we have a revolving line of credit, it includes, among other things, certain financial covenants, and +a failure to meet such covenants or a material adverse change in the business could result in the bank limiting or eliminating our ability to borrow these or any funds. Should this occur, or if the +credit markets further tighten or our business declines, we may need or choose to raise additional capital to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital +may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and +such additional financing may result in further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +18 +Table of Contents +• potential acquisitions of businesses and product lines; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets, in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common +stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms, we may +be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The trading price of our common stock is highly volatile. The trading price of our common stock has been subject to wide +fluctuations in the past. +From April 1, 2013 through June 8, 2016, our common stock has traded at prices as low as $1.48 per share and as high as $2.96 per share. The market price of our common stock could +continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. +This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, +companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action +lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +19 +Table of Contents +Certain provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common +stock. Certain provisions of our certificate of incorporation could make it difficult for a third party to acquire us, even though an acquisition might be +beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of +incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior +to those of our common stock. In August 2009, we adopted a new stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. Generally, the stockholder rights +plan provides that if a person or group acquires 15% or more of our common stock, subject to certain exceptions and under certain circumstances, the rights may be exchanged by us for common stock or +the holders of the rights, other than the acquiring person or group, could acquire additional shares of our capital stock at a discount off of the then current market price. Such exchanges or exercise +of rights could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a +merger, tender offer or other acquisition more difficult. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 41,000 square feet of leased office, manufacturing and warehouse +space located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 9 of Notes to Consolidated +Financial Statements, included in Part IV, Item 15 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 9 of Notes to Consolidated Financial +Statements, included in Part IV, Item 15 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +20 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information and Holders +Our common stock is traded on the NASDAQ Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common +stock traded on the NYSE MKT under the same symbol. The following table sets forth, for the periods indicated, the highest and lowest sales prices for our common stock: +High +Low +Fiscal 2016 +Quarter Ended June 30, 2015 +$ +1.91 +$ +1.64 +Quarter Ended September 30, 2015 +2.96 +1.62 +Quarter Ended December 31, 2015 +2.65 +2.00 +Quarter Ended March 31, 2016 +2.65 +1.89 +Fiscal 2015 +Quarter Ended June 30, 2014 +$ +2.11 +$ +1.66 +Quarter Ended September 30, 2014 +2.23 +1.48 +Quarter Ended December 31, 2014 +2.00 +1.58 +Quarter Ended March 31, 2015 +1.94 +1.60 +On +June 8, 2016, the last reported sales price of our common stock on the NASDAQ Capital Market was $2.33. As of June 8, 2016, we had 349 holders of record of our common +stock according to information furnished by our transfer agent. +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable +future. We currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will +depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general +business conditions, the consent of our lender and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to +$3.0 million of our outstanding +common stock from time to time through August 2012. On August 9, 2012, our Board of Directors approved a new stock repurchase program pursuant to which we may acquire up to $3.0 million +of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open-market and privately negotiated transactions and block +trades, and may also repurchase shares pursuant to an existing or future 10b5-1 trading plan to facilitate repurchases during our closed trading windows. There is no guarantee as to the exact number +of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a +$3.0 million increase to our existing stock repurchase program, pursuant to which we may continue to acquire shares of its outstanding common stock from time to time for an unspecified length +of time. +21 +Table of Contents +From +inception of the original stock repurchase program in August 2011 through March 31, 2016, we repurchased approximately 3,422,000 shares of our common stock for an aggregate +repurchase price of approximately $5.6 million at an average purchase price of $1.63 per share. We did not repurchase any shares of our common stock during the three months ended +March 31, 2016. All repurchased shares from prior periods have been retired and resumed their status as authorized and unissued shares of our common stock. As of March 31, 2016, there +was approximately $1.7 million of remaining funds available under the stock repurchase program. +ITEM 6. SELECTED FINANCIAL DATA +As a smaller reporting company, we are not required to make any disclosure pursuant to this Item 6. +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements +and related Notes thereto included in Part IV, Item 15 of this report and the "Risk Factors" section in Item 1A, as well as the other cautionary statements and risks described +elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General. We are a provider of information solutions for the intelligent traffic systems ("ITS") and the precision agriculture +("PA") markets. In the +ITS market, we are focused on the development and application of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, management and +analytics, and that improve the efficiency and safety of surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound traffic management, +minimize the environmental impact of traffic congestion and enhance the adoption of advanced ITS solutions that are required for the deployment of connected and autonomous vehicles. In the PA market, +we have combined our unique intellectual property with enhanced soil, land surface, and agronomy modeling techniques utilizing our extensible EMPower hybrid computing architecture to create a set of +ClearAg™ solutions that provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. +Acquisitions. In November 2011, we acquired all of the outstanding capital stock of Berkeley Transportation Systems, Inc. +("BTS"), a +privately-held company based in Berkeley, California which specialized in transportation performance measurement. During the third quarter of the Fiscal 2014, we paid the former BTS shareholders +$250,000 pursuant to certain holdback provisions in the original stock purchase agreement. Additionally, in the third quarter of Fiscal 2015, we paid the former BTS shareholders approximately $336,000 +pursuant to certain deferred payment provisions in the stock purchase agreement. This payment completed our obligations under the deferred payment provisions of the purchase agreement. +In +January 2011, we acquired all of the outstanding capital stock of Meridian Environmental Technology, Inc. ("MET"), which specialized in 511/Advanced Traveler Information +Systems. +In +connection with this acquisition, we held back $250,000 of the purchase price. After we determined that the contingencies related to the release of the $250,000 holdback were not met, +no portion of the $250,000 holdback was released and the entire amount was reversed into operating income during the second quarter of Fiscal 2013. In addition, in the fourth quarter of Fiscal 2013, +we paid to the former MET shareholders a deferred earn-out payment in the amount of $409,000, which payment completed our obligations under the deferred payment provisions of the purchase agreement. +22 +Table of Contents +Refer +to Note 4 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for additional discussion on these acquisitions. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +In connection with the Asset Sale, we are entitled to additional consideration in the form of certain performance and royalty-related earn-outs through June 30, 2017. As of March 31, +2016, we received approximately $1.6 million in connection with such royalty-related earn- out provisions. We also had approximately $160,000 in royalty-related receivables included in the +prepaid expenses and other current assets in the accompanying consolidated balance sheet as of March 31, 2016. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment, and we determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for additional +discussion regarding the Asset Sale. +Business Segments. Subsequent to the Asset Sale and our acquisition of BTS, we have operated in three reportable segments: +Roadway Sensors, +Transportation Systems and Performance Analytics. +The +Roadway Sensors segment provides hardware and software products to multiple segments of the ITS market. These various vehicle detection and information systems are used for traffic +intersection control, incident detection and roadway traffic data collection applications. +The +Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, development and implementation of software-based systems +that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of +emergency crews and distribute real-time information about traffic conditions. +The +Performance Analytics segment includes our performance measurement and information management solution iPeMS, a specialized transportation performance measurement and traffic +analytics solution, as well as ClearPath Weather, our road-maintenance application, and ClearAg, our precision agriculture solution. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial +statements included herein, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires management +to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and +the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to revenue recognition, the +collectability of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for stock-based +compensation, the valuation of equity instruments, warranty reserves and other contingencies. We base these estimates on historical experience and on various other factors that we believe to be +reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other +23 +Table of Contents +sources. +These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any +material respect, it could have a material adverse effect on our reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses +during the reporting period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Product revenues and related costs of sales are recognized when all of the following +criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or +determinable, and (iv) collection of the receivable is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until +receipt or acceptance by the customer. Accordingly, at the date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Performance Analytics revenues are also derived from long-term +contracts with governmental agencies, as well as contracts with commercial companies. When appropriate, revenues are recognized using the percentage of completion method of accounting, whereby revenue +is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. Any anticipated losses on contracts are charged to earnings +when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and +revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. Certain of our revenues are +recognized as services are performed and amounts are earned, which is measured by time incurred or other contractual milestones or output measures. Revenues accounted for in this manner generally +relate to certain fixed fee professional services, cost-plus fixed fee or time-and-materials contracts. Revenues for ongoing operations and maintenance services contracts are generally accounted for +ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are deferred and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +Accounts Receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and +ongoing credit evaluations +of our customers' financial condition. We record an allowance for doubtful accounts for specific receivables deemed to be at risk for collection, as well as a general allowance based on our historical +collections experience. Considerable judgment is required in assessing and estimating the ultimate realization of trade receivables, including the current credit-worthiness of each customer. If the +financial condition of our customers deteriorates, resulting in an +24 +Table of Contents +impairment +of their ability to make required payments, additional allowances may be required that could adversely affect our operating results. +Inventories. Inventories consist of finished goods, work-in- process and raw materials and are stated at the lower of cost or +market. We write down +the carrying value of our inventories to net realizable value for estimated excess and obsolete inventories in an amount equal to the difference between the cost of the inventories and their estimated +realizable value. These estimates are based on management's judgments and assumptions as to future demand requirements and our evaluation of market conditions. Demand for our products may fluctuate +significantly over time, and actual demand and market conditions may be more or less favorable than those projected by management. In the event that actual demand is lower than originally projected, +additional inventory write-downs may be required. Estimated inventory write-downs, once established, are not reversed until the related inventory has been sold or scrapped, so if actual market +conditions are more favorable in the fiscal periods subsequent to those in which we record significant write-downs, we may have higher gross margins when products are sold. +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent purchased intangible assets including developed technology, customer relationships, trade +names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method that reflects the pattern in which the economic +benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight- line amortization method over the estimated useful life of the +asset. +We +evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. We have determined that our reporting units for +purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. In the fiscal year ended March 31, 2012 ("Fiscal 2012"), we early adopted +the provisions issued by the Financial Accounting Standards Board ("FASB") that were intended to simplify goodwill impairment testing. This guidance permits us to first assess qualitative factors to +determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting +unit is less than its carrying amount, we conduct a two-step goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting units with +their carrying values. We determine the fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. If the carrying amount of a +reporting unit exceeds the reporting unit's fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied fair +value of the affected reporting unit's goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair +value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. Certain adverse business conditions impacting one or more reporting +units would cause us to test goodwill for impairment on an interim basis. As part of our annual assessment, management determines the most appropriate and efficient method to assess goodwill for +impairment, which could include either the simplified testing approach or the two-step goodwill test described above. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset are expected to generate. If an asset is not recoverable, we record an impairment loss +equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets and purchased +intangible assets. +25 +Table of Contents +Warranty. We generally provide a one to three year warranty from the original invoice date on our products, materials and +workmanship. Products sold +to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. Should our actual experience of warranty returns be higher than anticipated, additional +warranty reserves may be required, which would adversely affect our product gross margins and our operating results. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This +estimation process can +result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so that the year-to-date +provision reflects the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall effective tax rate from +quarter to quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than- not threshold are reversed +in the first subsequent financial reporting period in which that threshold is no longer met. +The +application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a +result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from +our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the +estimated grant date fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our stock option awards as it does not consider certain factors important to those awards to employees, such as +continued employment and periodic vesting requirements, as well as limited transferability of the awards. The fair value of our restricted stock units is based on the closing market price of our +common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining +unearned stock- based compensation expense. +26 +Table of Contents +Recent Accounting Pronouncements +Refer to Note 1 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report for a +discussion of recent accounting pronouncements. +Results of Operations +The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated. +Year Ended March 31, +2016 +2015 +2014 +Total revenues +100.0 +% +100.0 +% +100.0 +% +Cost of revenues +60.6 +61.0 +61.9 +Gross profit +39.4 +% +39.0 +% +38.1 +% +Operating expenses: +Selling, general and administrative +34.4 +33.8 +28.3 +Research and development +8.9 +7.5 +5.9 +Amortization of intangible assets +0.5 +0.6 +0.9 +Change in fair value of contingent consideration +— +0.0 +0.0 +Total operating expenses +43.8 +41.9 +35.1 +Operating (loss) income +(4.4 +) +(2.9 +) +3.0 +Non-operating income (expense): +Other income (expense), net +0.0 +(0.0 +) +— +Interest income, net +0.0 +0.0 +— +(Loss) income from continuing operations before income taxes +(4.4 +) +(2.9 +) +3.0 +(Provision) benefit for income taxes +(11.7 +) +1.1 +(1.0 +) +(Loss) income from continuing operations +(16.1 +) +(1.8 +) +2.0 +Gain on sale of discontinued operation, net of tax +0.3 +0.3 +0.1 +Net (loss) income +(15.8 +)% +(1.5 +)% +2.1 +% +Analysis of Fiscal 2016, Fiscal 2015 and Fiscal 2014 Results of Operations +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Performance Analytics +segments. The +following tables present details of total revenues for Fiscal 2016 compared to Fiscal 2015, and Fiscal 2015 compared to Fiscal 2014: +Year Ended +March 31, +$ +Increase +% +Change +2016 +2015 +(In thousands, except percentages) +Total revenues +$ +77,748 +$ +72,251 +$ +5,497 +7.6 +% +Year Ended +March 31, +$ +Increase +% +Change +2015 +2014 +(in thousands, except percentages) +Total revenues +$ +72,251 +$ +68,228 +$ +4,023 +5.9 +% +27 +Table of Contents +Total +revenues for Fiscal 2016 increased approximately 7.6% to $77.7 million, compared to $72.3 million in Fiscal 2015, due primarily to an increase of approximately 11% in +Roadway Sensors revenues and approximately 7% in Transportation Systems revenues. The increases in revenues were partially offset by a decrease of approximately 8% in Performance Analytics revenues in +Fiscal 2016. +Total +revenues for Fiscal 2015 increased approximately 5.9% to $72.3 million, compared to $68.2 million in Fiscal 2014, due primarily to an increase of approximately 15% in +Roadway Sensors revenues. The increase in revenues was partially offset by decreases of approximately 1% in Transportation Systems revenues and approximately 6% in Performance Analytics revenues in +Fiscal 2015. +Roadway +Sensors revenues in Fiscal 2016 increased approximately 11% compared to Fiscal 2015, primarily due to higher unit sales of our legacy Roadway Sensors products, and to a lesser +extent, due to increases in our distribution of certain original equipment manufacturer ("OEM") products for the traffic intersection market. Revenue generated through the distribution of certain +third party products was approximately $5.3 million and approximately $5.0 million for Fiscal 2016 and Fiscal 2015, respectively. Roadway Sensors revenues in Fiscal 2015 increased +approximately 15% compared to Fiscal 2014, primarily due to increases in our distribution of certain third party products and increases in unit sales of our existing products. While OEM products +generally have lower gross margins than our core video detection products, we believe the offering of OEM products will benefit sales of our core products by providing a more comprehensive suite of +traffic solutions for our customers. Going forward, we plan to continue growing revenues by focusing on our core domestic intersection market, +and refine and deliver products that address the needs of this market, primarily our VantageNext processors and camera systems and our Vantage Vector video/radar hybrid sensor, as well as our +SmartCycle and SmartSpan products. Additionally, we plan to grow revenues by focusing on international distribution channel expansion and expect to continue to refine products that address these +markets, namely our Abacus, P10 and P100 products. +Transportation +Systems revenues in Fiscal 2016 increased approximately 7% compared to Fiscal 2015, primarily as a result of two large contract wins during the third quarter of Fiscal +2016, which positively impacted revenue growth in our fourth quarter of Fiscal 2016, as well as timing of backlog fulfilment on certain other projects. The Transportation Systems segment backlog +experienced significant growth in Fiscal 2016 and reached approximately $53.3 million as of March 31, 2016, compared to approximately $29.6 million as of March 31, 2015. +Transportation Systems revenues in Fiscal 2015 decreased approximately 1% compared to Fiscal 2014, primarily as a result of timing delays in starting certain new projects in our backlog, as well as a +reduction in sub-consultant revenues. Going forward, we plan to continue to pursue larger contracts that may contain significant sub-consulting content. While larger contracts will likely contribute +to overall revenue growth, the mix of sub-consulting content will likely reduce the related gross profit from period to period, as revenues derived from sub-consultants generally have lower gross +margins than our professional services. +Performance +Analytics revenues in Fiscal 2016 decreased approximately 8% compared to Fiscal 2015, which was primarily due to reductions in our iPeMS revenues as a result of deferred +revenue on certain iPeMS implementation projects, delays in contract awards with certain public agencies, and the timing of backlog fulfillment on certain other projects, which were partially offset +by increased revenues from our ClearAg solutions under newly signed contracts during Fiscal 2016. Performance Analytics revenues in Fiscal 2015 decreased approximately 6% compared to Fiscal 2014, +which was primarily due to delays in contract awards with certain public agencies and the timing of backlog fulfillment. Going forward, we plan to continue investing in this segment, particularly in +the research and development and sales and marketing of the ClearAg, ClearPath Weather and iPeMS performance measurement solutions. We also plan to pursue commercial opportunities in the precision +agriculture technology markets by offering software applications, content, and modeling services that provide analytics and +28 +Table of Contents +decision +support services that leverage our precision weather, soil and agronomic content and application intellectual property. +Gross Profit. The following tables present details of our gross profit for Fiscal 2016 compared to Fiscal 2015, and Fiscal 2015 +compared to Fiscal +2014: +Year Ended +March 31, +$ +Increase +% +Change +2016 +2015 +(In thousands, except percentages) +Gross profit +$ +30,669 +$ +28,182 +$ +2,487 +8.8 +% +Gross profit as a % of total revenues +39.4 +% +39.0 +% +Year Ended +March 31, +$ +Increase +% +Change +2015 +2014 +(in thousands, except percentages) +Gross profit +$ +28,182 +$ +25,974 +$ +2,208 +8.5 +% +Gross profit as a % of total revenues +39.0 +% +38.1 +% +Our +total gross profit as a percentage of total revenues for Fiscal 2016 increased approximately 40 basis points compared to Fiscal 2015 primarily due to higher revenues derived +from our Roadway Sensors segment, which has generally experienced higher gross profits than our other segments and which increased to approximately 51.8% of our total revenues for Fiscal 2016, as +compared to 50.3% for Fiscal 2015. Roadway Sensors revenues generally carry higher gross margins than Transportation Systems and Performance Analytics revenues. Therefore, the increase in Roadway +Sensors revenues had a positive impact on our overall margin. The increase in gross profit as a percentage of total revenues was also attributable to an increase in Transportation Systems gross profit +percentage, primarily due to timing of revenue recognition on certain projects and an increase in the percentage of revenue generated by internal labor compared to revenue generated by our +sub-consultants, which typically generates lower profit margins. +Our +total gross profit as a percentage of total revenues for Fiscal 2015 increased approximately 90 basis points compared to Fiscal 2014 also due to our product and service mix. +Revenues derived from our Roadway Sensors segment increased to approximately 50.3% of our total revenues in Fiscal 2015, compared to 46.6% in Fiscal 2014. +Roadway +Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix, competitive pricing requirements, product warranty +costs and provisions for excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining activities, which we record as cost of goods sold. +We +recognize a portion of our Transportation Systems and Performance Analytics revenues and related gross profit using percentage of completion contract accounting, and the underlying +mix of contract activity affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future periods due +to our contract mix and the amount of related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could cause +fluctuations in our margins from period to period. +29 +Table of Contents +Selling, General and Administrative Expense +The following table presents selling, general and administrative expense for Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2016 +2015 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +18,546 +23.9 +% +$ +15,896 +22.0 +% +$ +2,650 +16.7 +% +Facilities, insurance and supplies +2,727 +3.5 +2,522 +3.5 +205 +8.1 +Travel and conferences +2,136 +2.7 +1,681 +2.3 +455 +27.1 +Professional and outside services +2,658 +3.4 +3,982 +5.5 +(1,324 +) +(33.2 +) +Other +779 +1.0 +344 +0.5 +435 +126.5 +Selling, general and administrative +$ +26,846 +34.5 +% +$ +24,425 +33.8 +% +$ +2,421 +9.9 +The +overall increase in selling, general and administrative expense for Fiscal 2016, as compared to Fiscal 2015, was primarily due to planned investments in Performance Analytics sales +and marketing, including an increase in the salesforce headcount, as well as increased headcount in general and administrative positions, which resulted in higher salary and personnel-related costs. +The overall increase for Fiscal 2016 was also attributable to certain transition costs relating to the Company's previous CEO and interim CEO. These increases in sales, marketing, general and +administrative expenses were offset by decreases in professional and outside services for audit fees incurred during Fiscal 2015 in connection with the audit of our financial statements for Fiscal +2014. As previously disclosed, the Company delayed its Fiscal 2014 earnings release and the filing of its Annual Report on Form 10-K for Fiscal 2014 until September 3, 2014, due to +additional procedures performed by its auditors related to contract revenue testing. As a result of these additional procedures and related delays, we incurred an increase of approximately $940,000 in +audit fees during the first and second quarters of Fiscal 2015. We also incurred an increase of approximately $175,000 in service fees for the review of our Fiscal 2015 quarters. In addition, in +Fiscal 2015, we incurred approximately $770,000 of outside professional consulting costs to assist with the completion of the Fiscal 2014 annual audit and the Fiscal 2015 quarterly reviews. +The +following table presents selling, general and administrative expense for Fiscal 2015 and 2014: +Year Ended March 31, +2015 +2014 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +15,896 +22.0 +% +$ +12,955 +19.0 +% +$ +2,941 +22.7 +% +Facilities, insurance and supplies +2,522 +3.5 +2,603 +3.8 +(81 +) +(3.1 +) +Travel and conferences +1,681 +2.3 +1,502 +2.2 +179 +11.9 +Professional and outside services +3,982 +5.5 +1,593 +2.3 +2,389 +150.0 +Other +344 +0.5 +616 +0.9 +(272 +) +(44.2 +) +Selling, general and administrative +$ +24,425 +33.8 +% +$ +19,269 +28.2 +% +$ +5,156 +26.8 +The +overall increase in selling, general and administrative expense for Fiscal 2015, as compared to Fiscal 2014, was primarily due to an increase in salary and personnel related expenses +and audit and consulting fees incurred in connection with the audit of our Fiscal 2014 financial statements. The overall increase was also increased due to planned investments in Performance Analytics +sales and +30 +Table of Contents +marketing +costs, consisting primarily of increased headcount which resulted in higher salary and personnel related costs, recruiting and travel. +Research and Development Expense +The following table presents research and development expense for Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2016 +2015 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +3,325 +4.3 +% +$ +2,674 +3.7 +% +$ +651 +24.3 +% +Facilities, development and supplies +2,404 +3.1 +1,543 +2.1 +861 +55.8 +Other +1,204 +1.5 +1,179 +1.6 +25 +2.1 +Research and development +$ +6,933 +8.9 +% +$ +5,396 +7.5 +% +$ +1,537 +28.5 +The +overall increase in research and development expense for Fiscal 2016 compared to Fiscal 2015, was primarily due to an increase in headcount, which resulted in higher salary and +personnel-related costs. The increases were also attributable to research costs for certain software and application developments in the Performance Analytics segment and investments in securing +intellectual property rights. +The +Performance Analytics segment continued to invest in the development of ClearAg and ClearPath Weather solutions. ClearAg products include historical, real-time and forecast weather +content, soil and crop growth information, and other useful crop health information to provide solutions in the precision agriculture technology markets. We successfully released generally available +versions of a set of ClearAg products during the first half of Fiscal 2016 and the ClearAg iOS Mobile App in March 2016. Going forward, we expect to continue investing in our Performance Analytics +segment to enhance the ClearAg, ClearPath Weather and iPeMS solutions. This continued investment may result in increases in research and development costs. +The +following table presents research and development expense for Fiscal 2015 and Fiscal 2014: +Year Ended March 31, +2015 +2014 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +2,674 +3.7 +% +$ +2,314 +3.4 +% +$ +360 +15.6 +% +Facilities, development and supplies +1,543 +2.1 +1,232 +1.8 +311 +25.2 +Other +1,179 +1.6 +483 +0.7 +696 +144.1 +Research and development +$ +5,396 +7.5 +% +$ +4,029 +5.9 +% +$ +1,367 +33.9 +Research +and development expense for Fiscal 2015 increased approximately 33.9% compared to Fiscal 2014, primarily due to the planned expenditures for product research, discovery and +developments in the Performance Analytics segment. The increase in research and development was also attributable to additional salary and personnel costs related in the Performance Analytics segment. +Impairment of Goodwill +In Fiscal 2012, we adopted the provisions issued by the FASB that are intended to simplify goodwill impairment testing. The updated +guidance permits us to first assess qualitative factors to +31 +Table of Contents +determine +whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting +unit is less than its carrying amount, we conduct a two-step goodwill impairment test. We performed annual impairment assessments of the carrying value of goodwill in the fourth quarter of each of +Fiscal 2016, Fiscal 2015 and Fiscal 2014. We determined it was more appropriate to perform quantitative first-step assessments in Fiscal 2016, Fiscal 2015 and Fiscal 2014 to estimate the fair value of +our reporting units using both the income approach and market approach. Based on our assessments, we determined that +no impairment was indicated as the estimated fair value of each reporting unit exceeded its respective carrying value. +Based +on our goodwill impairment testing for Fiscal 2016, Fiscal 2015 and Fiscal 2014, we believe the carrying value of our goodwill was not impaired as of March 31, 2016, 2015 +and 2014, as the estimated fair values of our reporting units exceeded their carrying values at the end of such fiscal years. If our actual financial results, or the plans and estimates used in future +goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Interest Income (Expense), Net +Net interest income was approximately $12,000 in Fiscal 2016. Net interest expense was approximately $6,000 and $0 in Fiscal 2015 and +Fiscal 2014, respectively. +Income Taxes +The following table presents our provision for income taxes for Fiscal 2016, Fiscal 2015 and Fiscal 2014: +Year Ended March 31, +2016 +2015 +2014 +(In thousands, except +percentages) +Provision (benefit) for income taxes +$ +9,079 +$ +(816 +) +$ +704 +Effective tax rate +(262.6 +)% +39.0 +% +34.8 +% +The +difference between the statutory and the effective tax rate is primarily attributable to the recording of a valuation allowance against our deferred tax assets during Fiscal 2016. +The +difference between the statutory and the effective tax rate is primarily attributable to state income taxes. Additionally, our effective tax rate for Fiscal 2015 was favorably +impacted by the recognition of approximately $233,000 of tax credits, partially offset by permanent non-deductible tax items, including share-based payments and other permanent differences amounting +to approximately $156,000. +Our +effective tax rate for Fiscal 2014 was favorably impacted by the recognition of approximately $359,000 of tax credits, partially offset by permanent non-deductible tax items, +including share-based payments and other permanent differences amounting to approximately $103,000, and by the recording a valuation allowance against certain of our state net operating losses in the +amount of $185,000, net of federal benefit. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As of December 31, 2015, the Company had generated a cumulative pre-tax loss over the trailing three +years. As such, we considered it appropriate to record a valuation allowance of approximately $10.1 million in our third quarter of +32 +Table of Contents +Fiscal +2016 against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective +tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to +the extent that we believe these assets will more likely than not be realized. +At +March 31, 2016, we had $9.7 million of federal net operating loss carryforwards and $794,000 of state net operating loss carryforwards that begin to expire in 2022 and +2031, respectively. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will cause us to have future income tax payments that are +substantially lower than the income tax liability calculated using statutory tax rates. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations, borrowings under credit facilities and +the sale of equity securities. We currently rely on cash flows from operations, our cash reserves and the availability of borrowings on a line of credit facility to fund our operations, which we +believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future +growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing +equity or convertible debt securities, our existing stockholders may experience significant dilution and any equity securities that may be issued may have rights senior to our existing stockholders. +At +March 31, 2016, we had $24.3 million in working capital, which included $16.0 million in cash and cash equivalents and reflected no borrowings on our +$12.0 million line of credit. This compares to working capital of $30.9 million at March 31, 2015, which included no borrowings on our line of credit and $22.0 million in +cash and cash equivalents. +The +following table summarizes our cash flows for Fiscal 2016, Fiscal 2015 and Fiscal 2014: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +(4,110 +) +$ +3,577 +$ +3,274 +Investing activities +(978 +) +(844 +) +(779 +) +Financing activities +(844 +) +(1,186 +) +(759 +) +Operating Activities. Cash used in our operations during Fiscal 2016 was primarily the result of our net loss of approximately +$12.3 million, +adjusted by approximately $10.5 million in non-cash items, of which approximately $9.0 million related to the change in our deferred income taxes and related valuation allowance recorded +against our federal net operating loss carryforwards. Such non-cash items also included higher stock-based compensation primarily due to the recent large equity grant to our new CEO, as well as +depreciation, amortization, gain on the sale of discontinued operation and loss on disposal of property and equipment. Cash used in our operations was also driven by approximately $2.3 million +used in working capital. +33 +Table of Contents +Cash +provided by our operations in Fiscal 2015 was primarily the result of approximately $4.6 million provided by improvements in our accounts receivables, net costs and estimated +earnings in excess of billings, and accounts payable and accrued expenses. Cash provided by operations was also attributable to approximately $1.5 million of non-cash items for depreciation, +amortization and stock-based compensation expense. This was offset by a decrease of approximately $0.5 million used in working capital for inventories. +Cash +provided by our operations in Fiscal 2014 was primarily the result of our net income of approximately $1.4 million and approximately $2.6 million non-cash items for +depreciation, amortization, stock-based compensation expense and adjustments to deferred tax assets. This was offset by approximately $0.7 million used in working capital, consisting of +approximately $1.5 million from accounts receivable, inventories, and net costs and estimated earnings in excess of billings, net of approximately $0.8 million for prepaid expenses and +other assets and accounts payable and accrued activities. +Investing Activities. Cash used in our investing activities during Fiscal 2016 consisted of approximately $856,000 for purchases +of property and +equipment, primarily related to computers and related equipment and approximately $490,000 of capitalized software development in the Performance Analytics business segment related to ClearAg assets, +which were offset by approximately $368,000 in proceeds from the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2015 consisted of approximately $986,000 for purchases of property and equipment, primarily related to leasehold improvements on our +headquarters facility, which was offset by approximately $142,000 in proceeds from the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2014 consisted of approximately $452,000 for purchases of property and equipment and approximately $301,000 used for the development +of software and data acquisitions in the Performance Analytics segment. +Financing Activities. Net cash used in financing activities during Fiscal 2016 was primarily the result of approximately +$1.2 million in cash +used to repurchase shares of our common stock under our stock repurchase program, which was offset by approximately $383,000 of cash proceeds received from the exercises of stock options. +Net +cash used in financing activities during Fiscal 2015 was primarily the result of approximately $863,000 in cash used to repurchase shares of our common stock under our stock +repurchase program +and approximately $336,000 in cash used for the final deferred payment for the prior acquisition of BTS. +Net +cash used in financing activities during Fiscal 2014 was primarily the result of approximately $409,000 in cash used for a deferred payment for the prior acquisition of MET, +approximately $250,000 in cash used for an earn- out payment for the prior acquisition of BTS, and approximately $339,000 in cash used to repurchase shares of our common stock under our stock +repurchase program. This was partially offset by our receipt of proceeds of $270,000 from stock option and warrant exercises. +Borrowings +We currently have a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expires on +October 1, 2016. Interest on borrowed amounts under the revolving line of credit is payable monthly at a rate equal to the current stated prime rate (3.50% at March 31, 2016). We are +obligated to pay an unused line fee of 0.15% per annum applied to the average unused portion of the revolving line of credit during the preceding month. The revolving line of credit does not contain +any early termination fees and is secured by substantially all of our assets. As of March 31, 2016 and 2015, no amounts were outstanding under the line of credit with CB&T. Availability under +this line of credit +34 +Table of Contents +may +be reduced or otherwise limited in accordance with (or pursuant to) certain financial and other covenants. As of March 31, 2016 and 2015, we were in compliance with all such financial +covenants. If we were to be in violation of certain covenants under this agreement, our lender could decline to extend further credit to us, or choose to accelerate payment on all outstanding loan +balances, if any, and pursue its security interest in our assets. In this event, we cannot assure you that we would be able to quickly obtain equivalent or suitable replacement financing on acceptable +terms, on a timely basis, or at all. If we were not able to secure alternative sources of financing, such acceleration could have a material adverse impact on our business and financial condition. +Off-Balance Sheet Arrangements +Other than our operating leases, which are further described at Note 9 of Notes to Consolidated Financial Statements, included +in Part IV, Item 15 of this report, we do not have any other material off-balance sheet arrangements at March 31, 2016. +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such +sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter +generally impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal +quarter due to the increased number of holidays, causing a reduction in available billable hours. In addition, we have experienced seasonality related to certain ClearPath Weather services, which +adversely impacts such sales in our first and second fiscal quarters, mainly because these services are generally not required during Spring and Summer when weather conditions are comparatively +milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +Our exposure to interest rate risk is limited to our line of credit, which bears interest equal to the prevailing prime rate plus +0.25%. We do not believe that a 10% increase in the interest rate on our line of credit would have a material impact on our financial position, operating results or cash flows. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements and supplementary data required by Regulation S- X are included in Part IV, Item 15 of +this report. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and +Chief Executive Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the +Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the President +35 +Table of Contents +and +Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the date of such evaluation in ensuring that information +required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and +reported in a timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, +to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during Fiscal 2016 that has materially affected, or is reasonably likely to materially affect, our +internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives +of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can +provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control +system was designed to provide reasonable assurance to management and our Board of Directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of +published financial statements. +We +have assessed the effectiveness of our internal controls over financial reporting as of March 31, 2016. In making this assessment, we used the criteria set forth by the +Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework +(2013) . Based on our assessment, we believe that, as of March 31, 2016, our internal control over financial reporting was effective. This annual report does not include +an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Such a report is not required pursuant to the rules of the SEC +applicable to smaller reporting companies. +ITEM 9B. OTHER INFORMATION +None. +36 +Table of Contents +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +(a) Identification of Directors. The information under the caption "Election of Directors," appearing in our +proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +(b) Identification of Executive Officers. The information under the caption "Executive Compensation and Other +Information—Executive Officers," appearing in our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +(c) Compliance with Section 16(a) of the Exchange Act. The information under the caption +"Section 16(a) Beneficial Ownership Reporting Compliance," appearing in our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +(d) Corporate Governance. The information under the caption "Corporate Governance," appearing in our proxy +statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +(e) Audit Committee. The information under the caption "Board Meetings and Committees—Audit +Committee," appearing in our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information under the caption "Executive Compensation and Other Information," appearing in our proxy statement for the 2016 Annual +Meeting of Stockholders, is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information under the captions "Equity Compensation Plans" and "Principal Stockholders and Common Stock Ownership of Certain +Beneficial Owners and Management," appearing in our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in +our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information under the caption "Fees Paid to Independent Registered Public Accounting Firm," appearing in our proxy statement for +the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. +37 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. The following financial statements of Iteris, Inc. are included in a separate +section of this Annual Report on Form 10-K commencing on the pages referenced below: +Report of Independent Registered Public Accounting Firm +42 +Consolidated Balance Sheets as of March 31, 2016 and 2015 +44 +Consolidated Statements of Operations for the fiscal years ended March 31, 2016, 2015 and 2014 +45 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2016, 2015 and +2014 +46 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2016, 2015 and 2014 +47 +Notes to Consolidated Financial Statements +48 +2. Exhibits . +The +exhibits listed on the accompanying Exhibit Index immediately following the financial statements are filed or furnished as part of, or hereby incorporated by reference into, this +report. +38 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this +report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 17, 2016 +ITERIS, INC. +(Registrant) +By +/s/ JOE BERGERA +JOE BERGERA +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Andrew C. Schmidt, +and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to +sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said +attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all +intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause +to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ JOE BERGERA +Joe Bergera +Director, President and Chief Executive Officer (principal executive officer) +June 17, 2016 +/s/ ANDREW C. SCHMIDT +Andrew C. Schmidt +Chief Financial Officer (principal financial and accounting officer) +June 17, 2016 +/s/ GREGORY A. MINER +Gregory A. Miner +Chairman of the Board +June 17, 2016 +/s/ RICHARD CHAR +Richard Char +Director +June 17, 2016 +39 +Table of Contents +Signature +Title +Date +/s/ KEVIN C. DALY +Kevin C. Daly, Ph.D +Director +June 17, 2016 +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 17, 2016 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Director +June 17, 2016 +/s/ MIKEL WILLIAMS +Mikel Williams +Director +June 17, 2016 +40 +Table of Contents +Iteris, Inc. +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm +42 +Consolidated Balance Sheets as of March 31, 2016 and 2015 +44 +Consolidated Statements of Operations for the fiscal years ended March 31, 2016, 2015 and 2014 +45 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2016, 2015 and +2014 +46 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2016, 2015 and 2014 +47 +Notes to Consolidated Financial Statements +48 +41 +Table of Contents +Report of Independent Registered Public Accounting Firm +To +the Board of Directors and Stockholders +Iteris, Inc. +We +have audited the accompanying consolidated balance sheet of Iteris, Inc. and subsidiary as of March 31, 2016, and the related consolidated statements of operations, +stockholders' equity, and cash flows for the year ended March 31, 2016. These financial statements are the responsibility of the +Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal +control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but +not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, +on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by +management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Iteris, Inc. and +subsidiary as of March 31, 2016, and the consolidated results of their operations and their cash flows for the year ended March 31, 2016, in conformity with accounting principles +generally accepted in the United States of America. +/s/ +Deloitte & Touche LLP +Costa Mesa, California +June 17, 2016 +42 +Table of Contents +Report of Independent Registered Public Accounting Firm +To +the Board of Directors and Stockholders +Iteris, Inc. +We +have audited the accompanying consolidated balance sheet of Iteris, Inc. and subsidiaries (the Company) as of March 31, 2015, and the related consolidated statements of +operations, stockholders' equity and cash flows for each of the two years in the period ended March 31, 2015. These financial statements are the responsibility of the Company's management. Our +responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal +control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, +but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes +examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well +as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Iteris, Inc. and subsidiaries as of +March 31, 2015, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2015, in conformity with U.S. generally accepted +accounting principles. +/s/ +RSM US LLP +Irvine, California +June 17, 2015 +43 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2016 +2015 +Assets +Current assets: +Cash and cash equivalents +$ +16,029 +$ +21,961 +Trade accounts receivable, net of allowance for doubtful accounts of $714 and $314 at March 31, 2016 and March 31, 2015, +respectively +13,241 +11,206 +Costs and estimated earnings in excess of billings on uncompleted contracts +5,250 +4,266 +Inventories +3,153 +3,062 +Deferred income taxes +— +2,680 +Prepaid expenses and other current assets +1,505 +1,338 +Total current assets +39,178 +44,513 +Property and equipment, net +2,139 +1,990 +Deferred income taxes +— +5,610 +Intangible assets, net +951 +987 +Goodwill +17,318 +17,318 +Other assets +434 +214 +Total assets +$ +60,020 +$ +70,632 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +5,469 +$ +5,915 +Accrued payroll and related expenses +5,719 +4,871 +Accrued liabilities +1,445 +1,320 +Billings in excess of costs and estimated earnings on uncompleted contracts +2,294 +1,549 +Total current liabilities +14,927 +13,655 +Deferred rent +750 +826 +Deferred income taxes +685 +— +Unrecognized tax benefits +196 +183 +Total liabilities +16,558 +14,664 +Commitments and contingencies (Note 9) +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 +Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2016 and March 31, 2015 Issued and outstanding shares—32,048 at March 31, 2016 and 32,411 +at March 31, 2015 +3,205 +3,242 +Additional paid-in capital +135,424 +135,572 +Accumulated deficit +(95,167 +) +(82,846 +) +Total stockholders' equity +43,462 +55,968 +Total liabilities and stockholders' equity +$ +60,020 +$ +70,632 +See accompanying notes. +44 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2016 +2015 +2014 +Total revenues +$ +77,748 +$ +72,251 +$ +68,228 +Cost of revenues +47,079 +44,069 +42,254 +Gross profit +30,669 +28,182 +25,974 +Operating expenses: +Selling, general and administrative +26,846 +24,425 +19,269 +Research and development +6,933 +5,396 +4,029 +Amortization of intangible assets +360 +431 +627 +Change in fair value of contingent consideration +— +9 +25 +Total operating expenses +34,139 +30,261 +23,950 +Operating (loss) income +(3,470 +) +(2,079 +) +2,024 +Non-operating income (expense): +Other income (expense), net +2 +(20 +) +— +Interest income, net +12 +6 +— +(Loss) income from continuing operations before income taxes +(3,456 +) +(2,093 +) +2,024 +(Provision) benefit for income taxes +(9,079 +) +816 +(704 +) +(Loss) income from continuing operations +(12,535 +) +(1,277 +) +1,320 +Gain on sale of discontinued operation, net of tax +214 +207 +89 +Net (loss) income +$ +(12,321 +) +$ +(1,070 +) +$ +1,409 +(Loss) income per share from continuing operations—basic and diluted +$ +(0.39 +) +$ +(0.04 +) +$ +0.04 +Gain per share from sale of discontinued operation—basic and diluted +$ +0.01 +$ +0.01 +$ +0.00 +Net (loss) income per share—basic and diluted +$ +(0.38 +) +$ +(0.03 +) +$ +0.04 +Shares used in basic per share calculations +32,049 +32,595 +32,665 +Shares used in diluted per share calculations +32,049 +32,595 +32,847 +See accompanying notes. +45 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at April 1, 2013 +32,626 +$ +3,264 +$ +135,802 +$ +(83,185 +) +$ +55,881 +Stock option exercises +299 +29 +241 +— +270 +Stock-based compensation +— +— +300 +— +300 +Issuance of shares pursuant to vesting of restricted stock units +59 +6 +(37 +) +— +(31 +) +Repurchases of common stock +(196 +) +(19 +) +(320 +) +— +(339 +) +Net income +— +— +— +1,409 +1,409 +Balance at March 31, 2014 +32,788 +3,280 +135,986 +(81,776 +) +57,490 +Stock option exercises +24 +2 +31 +— +33 +Stock-based compensation +— +— +398 +— +398 +Issuance of shares pursuant to vesting of restricted stock units +72 +7 +(27 +) +— +(20 +) +Repurchases of common stock +(473 +) +(47 +) +(816 +) +— +(863 +) +Net loss +— +— +— +(1,070 +) +(1,070 +) +Balance at March 31, 2015 +32,411 +3,242 +135,572 +(82,846 +) +55,968 +Stock option exercises +243 +24 +359 +— +383 +Stock-based compensation +— +— +659 +— +659 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +50 +5 +(37 +) +— +(32 +) +Repurchases of common stock +(656 +) +(66 +) +(1,129 +) +— +(1,195 +) +Net loss +(12,321 +) +(12,321 +) +Balance at March 31, 2016 +32,048 +$ +3,205 +$ +135,424 +$ +(95,167 +) +$ +43,462 +See accompanying notes. +46 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Year Ended March 31, +2016 +2015 +2014 +Cash flows from operating activities +Net (loss) income +$ +(12,321 +) +$ +(1,070 +) +$ +1,409 +Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: +Deferred income taxes +8,859 +(749 +) +710 +Depreciation of property and equipment +649 +525 +768 +Stock-based compensation +659 +398 +300 +Amortization of intangible assets +526 +597 +733 +Change in fair value of contingent consideration +— +9 +25 +Gain on sale of discontinued operation, net of tax +(214 +) +(207 +) +(89 +) +Loss on disposal of equipment +58 +17 +— +Loss on impairment of intangible asset +— +— +108 +Changes in operating assets and liabilities, net of effects of discontinued operation: +Accounts receivable +(2,035 +) +1,143 +(1,403 +) +Net costs and estimated earnings in excess of billings +(239 +) +1,705 +(34 +) +Inventories +(91 +) +(516 +) +(81 +) +Prepaid expenses and other assets +(407 +) +9 +140 +Accounts payable and accrued expenses +446 +1,716 +688 +Net cash (used in) provided by operating activities +(4,110 +) +3,577 +3,274 +Cash flows from investing activities +Purchases of property and equipment +(856 +) +(986 +) +(452 +) +Capitalized software development costs +(490 +) +— +(301 +) +Net proceeds from sale of business segment +368 +142 +(26 +) +Net cash used in investing activities +(978 +) +(844 +) +(779 +) +Cash flows from financing activities +Deferred payment for prior business combination +— +(336 +) +(659 +) +Repurchases of common stock +(1,195 +) +(863 +) +(339 +) +Proceeds from stock option exercises +383 +33 +270 +Tax withholding payments for net share settlements of restricted stock units +(32 +) +(20 +) +(31 +) +Net cash used in financing activities +(844 +) +(1,186 +) +(759 +) +(Decrease) increase in cash and cash equivalents +(5,932 +) +1,547 +1,736 +Cash and cash equivalents at beginning of period +21,961 +20,414 +18,678 +Cash and cash equivalents at end of period +$ +16,029 +$ +21,961 +$ +20,414 +Supplemental cash flow information: +Cash paid during the year for: +Interest +$ +18 +$ +30 +$ +33 +Income taxes +177 +141 +128 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units +5 +7 +6 +Landlord contribution for tenant improvements +— +328 +— +See accompanying notes. +47 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its subsidiary in these consolidated financial statements as "Iteris," the +"Company," "we," "our" and "us") is a provider of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application +of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of +surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound traffic management, minimize the environmental impact of traffic congestion. +By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a broad range of Intelligent +Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. In the agribusiness markets, we have combined our unique intellectual property with enhanced soil, land +surface and agronomy modeling techniques to create a set of ClearAg solutions. These solutions provide analytical support to large enterprises in the agriculture market and field-specific advisories +to individual producers. We continue to make significant investments to leverage our existing technologies and further expand our software-based information systems to offer solutions to the precision +agriculture technology markets. Iteris was incorporated in Delaware in 1987. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and its subsidiary and have been prepared in +accordance with generally accepted accounting principles in the United States of America ("GAAP"). All intercompany accounts and transactions have been eliminated in consolidation. +The +results of continuing operations for all periods presented in the consolidated financial statements exclude the financial impact of a discontinued operation. See Note 3, "Sale +of Vehicle Sensors," for further discussion related to the discontinued operation presentation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and +assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues +and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the +collectability of accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves, costs to +complete long-term contracts, indirect cost rates used in cost-plus contracts, contract reserves, the valuation of purchased intangible assets and goodwill, the valuation of equity instruments and +estimates of future cash flows used to assess the recoverability of long-lived assets and the impairment of goodwill and fair value of our stock option awards used to calculate the stock-based +compensation. +48 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Revenue Recognition +Product revenues and related costs of sales are recognized when all of the following criteria are met: (i) persuasive evidence +of an arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the +receivable is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until receipt or acceptance by the customer. +Accordingly, at the date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Performance Analytics revenues are also derived from long-term +contracts with governmental agencies, as well as contracts with commercial companies. When appropriate, revenues are recognized using the percentage of completion method of accounting, whereby revenue +is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. Any anticipated losses on contracts are charged to earnings +when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and +revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. Certain of our revenues are +recognized as services are performed and amounts are earned, which is measured by time incurred or other contractual milestones or output measures. Revenues accounted for in this manner generally +relate to certain fixed fee professional services, cost-plus fixed fee or time-and-materials contracts. Revenues for ongoing operations and maintenance services contracts are generally accounted for +ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are deferred and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts +Costs and estimated earnings in excess of billings on uncompleted contracts in the accompanying consolidated balance sheets represent +unbilled amounts earned and reimbursable under services sales arrangements. At any given period-end, a large portion of the balance in this account represents the accumulation of labor, materials and +other costs that have not been billed due to timing, whereby the accumulation of each month's costs and earnings are not administratively billed until the subsequent +49 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +month. +Also included in this account are amounts that will become billable according to contract terms, which usually require the consideration of the passage of time, achievement of milestones or +completion of the project. +Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts +Billings in excess of costs and estimated earnings on uncompleted contracts in the accompanying consolidated balance sheets is +comprised of cash collected from customers and billings to customers on contracts in advance of work performed, advance payments negotiated as a contract condition, estimated losses on uncompleted +contracts, project-related legal liabilities and other project-related reserves. The unearned amounts are expected to be earned within the next twelve months. +We +record provisions for estimated losses on uncompleted contracts in the period in which such losses become known. The cumulative effects of revisions to contract revenues and estimated +completion costs are recorded in the accounting period in which the amounts become evident and can be reasonably estimated. These revisions can include such items as the effects of change orders and +claims, warranty claims, liquidated damages or other contractual penalties and adjustments for contract closeout settlements. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents +and trade accounts receivable. +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in the Middle East, Europe, South America and Asia. We generally +do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within +management's expectations. +Fair Values of Financial Instruments +The fair value of cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of the short +period of time to maturity. +Cash and Cash Equivalents +Cash and cash equivalents consist of cash and short-term investments with initial maturities of ninety days or less. +50 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Prepaid Expenses and Other Current Assets +Prepaid expenses and other current assets were $1.5 million as of March 31, 2016 and $1.3 million as of +March 31, 2015 and included approximately $520,000 of cash designated as collateral on performance bonds, as required under certain of our Transportation Systems contracts in the Middle East. +The performance bonds require us to maintain 100% cash value of the bonds as collateral in a bank that is local to the purchasing agency. The performance bond collateral is required throughout the +delivery of our services and is maintained in the local bank until the contract is closed by the purchasing agency. We expect these requirements, and the related cash collateral restrictions, to +remain in place through 2016. +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or market. Cost is +determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging +from three to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Goodwill and Long-Lived Assets +We evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. +We have determined that our reporting units for purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. We adopted the provisions issued +by the Financial Accounting Standards Board ("FASB") that were intended to simplify goodwill impairment testing. This guidance permits us to first assess qualitative factors to determine whether it is +more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its +carrying amount, we conduct a two-step goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their carrying values. +We determine the fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. If the carrying amount +51 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +of +a reporting unit exceeds the reporting unit's fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied +fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. The amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is +recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. As of March 31, 2016, following a quantative first-step assessment of the +Company's reporting units, management determined that no adjustments to the carrying value of its goodwill and intangible assets were required. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets +and purchased intangible assets. As of March 31, 2016, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. As such, we determined it was appropriate to record a valuation allowance of approximately $10.1 million in the third quarter of our fiscal year ended March 31, +2016 ("Fiscal 2016") against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are +derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, +the estimated fair values generated by it may not be indicative of the actual fair values of our common stock option awards as it does not consider certain factors important to those awards to +employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on +52 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +the +closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, +increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Advertising Expenses +Advertising costs are expensed in the period incurred and totaled $164,000, $134,000 and $168,000 in Fiscal 2016, the fiscal year ended +March 31, 2015 ("Fiscal 2015") and fiscal year ended March 31, 2014 ("Fiscal 2014"), respectively. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products +sold to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain +criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is +recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent +improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. +Non-permanent repair and maintenance costs are charged to expense as incurred. +Comprehensive Income +Comprehensive income equals net income for all periods presented. +53 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Recent Accounting Pronouncements +In May 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts +with Customers ("ASU 2014-09"), which establishes principles for reporting revenue and cash flows arising from an entity's contracts with customers. This new revenue +recognition standard will replace most of the recognition guidance within GAAP. This guidance was deferred by ASU No. 2015-14, Revenue from Contracts with +Customers (Topic 606): Deferral of the Effective Date, issued by the FASB in August 2015, and is now effective for fiscal years beginning on or after December 15, 2017 +with early adoption permitted as of the original effective date. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal +versus Agent Considerations , which further clarifies the implementation guidance in ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers +(Topic 606): Identifying Performance Obligations and Licensing , to expand the guidance on identifying performance +obligations and licensing within ASU 2014-09. These standards are effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. We +are currently evaluating the impact that these standards will have on our consolidated financial statements. +In +July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11") to simplify the +guidance on the measurement of inventory. Under the new standard, an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices +in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The standard is effective for interim and annual periods beginning after +December 15, 2016. We do not anticipate a significant impact on our consolidated financial statements upon adoption of ASU 2015-11. +In +November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17") to simplify the +presentation of deferred taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. ASU 2015-17 is effective for public companies for annual reporting +periods beginning after December 15, 2016, and interim periods within those fiscal years. The standard may be adopted prospectively or retrospectively and early adoption is permitted. The +Company early adopted ASU 2015-17, prospectively, in our fourth quarter of Fiscal 2016, which did not have a material impact on our consolidated financial statements. +In +March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based +Payment Accounting ("ASU 2016-09"), which is +intended to simplify several aspects of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The +guidance will be effective for the fiscal year beginning after December 15, 2016, including interim periods within that year. We are currently evaluating the impact of ASU 2016-09 on our +consolidated financial statements. +54 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2016 +2015 +(In thousands) +Materials and supplies +$ +1,754 +$ +1,566 +Work in process +217 +216 +Finished goods +1,182 +1,280 +$ +3,153 +$ +3,062 +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2016 +2015 +(In thousands) +Equipment +$ +6,530 +$ +6,473 +Leasehold improvements +2,463 +2,463 +Accumulated depreciation +(6,854 +) +(6,946 +) +$ +2,139 +$ +1,990 +Depreciation +expense was approximately $649,000, $525,000 and $768,000 in Fiscal 2016, Fiscal 2015 and Fiscal 2014, respectively. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, +2016 +2015 +Gross +Carrying +Amount +Accumulated +Amortization +Gross +Carrying +Amount +Accumulated +Amortization +(In thousands) +Technology +$ +1,856 +$ +(1,708 +) +$ +1,856 +$ +(1,565 +) +Customer contracts / relationships +750 +(622 +) +750 +(497 +) +Trade names and non-compete agreements +1,110 +(1,008 +) +1,110 +(916 +) +Capitalized software development costs +988 +(415 +) +498 +(249 +) +Total +$ +4,704 +$ +(3,753 +) +$ +4,214 +$ +(3,227 +) +Amortization +expense for intangible assets subject to amortization was approximately $526,000, $597,000 and $733,000 for Fiscal 2016, Fiscal 2015 and Fiscal 2014, respectively. +Approximately +55 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +2. Supplementary Financial Information (Continued) +$166,000, +$166,000 and $106,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $360,000, $431,000 and $627,000 was recorded to amortization expense for Fiscal +2016, Fiscal 2015 and Fiscal 2014, respectively, in the consolidated statement of operations. +Capitalized +software development costs for the iPeMS platform began to be amortized in October 2013, resulting in approximately $166,000 recorded to cost of revenues in the accompanying +consolidated statements of operations for the fiscal years ended March 31, 2016 and 2015. We do not have any intangible assets with indefinite useful lives. As of March 31, 2016, the +future estimated amortization expense of approximately $951,000 is entirely associated with our Performance Analytics business segment, as follows: +Year Ending March 31, +(In thousands) +2017 +$ +528 +2018 +251 +2019 +172 +$ +951 +Refer +to Note 4 for additional information regarding intangible assets acquired during the last three fiscal years. +Goodwill +The following table presents the activity related to the carrying value of our goodwill by reportable segment for Fiscal 2014, Fiscal +2015 and Fiscal 2016: +Roadway +Sensors +Transportation +Systems +Performance +Analytics +Total +(In thousands) +Balance—March 31, 2014 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +6,936 +$ +2,168 +$ +17,318 +Balance—March 31, 2015 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +8,214 +6,936 +2,168 +17,318 +Balance—March 31, 2016 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +6,936 +$ +2,168 +$ +17,318 +56 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +2. Supplementary Financial Information (Continued) +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Balance at beginning of fiscal year +$ +181 +$ +184 +$ +169 +Additions charged to cost of sales +236 +134 +179 +Warranty claims +(224 +) +(137 +) +(164 +) +Balance at end of fiscal year +$ +193 +$ +181 +$ +184 +Earnings Per Share +The following table sets forth the computation of basic and diluted (loss) income from continuing operations per share: +Year Ended March 31, +2016 +2015 +2014 +(In thousands, except per share +amounts) +Numerator: +(Loss) Income from continuing operations +$ +(12,535 +) +$ +(1,277 +) +$ +1,320 +Denominator: +Weighted average common shares used in basic computation +32,049 +32,595 +32,665 +Dilutive stock options +— +— +111 +Dilutive restricted stock units +— +— +70 +Dilutive warrants +— +— +1 +Weighted average common shares used in diluted computation +32,049 +32,595 +32,847 +(Loss) income from continuing operations per share: +Basic +$ +(0.39 +) +$ +(0.04 +) +$ +0.04 +Diluted +$ +(0.39 +) +$ +(0.04 +) +$ +0.04 +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted (loss) income per share from continuing +operations as their effect would have been anti-dilutive: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Stock options +3,220 +2,252 +854 +Restricted stock units +186 +198 +— +57 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial Vehicle +Systems LLC ("Bendix"), a member of Knorr-Bremse Group. In connection with the asset sale, we are entitled to additional consideration in the form of the following performance and +royalty-related earn-outs: Bendix is obligated to pay us an amount in cash equal to 85% of revenue associated with royalties received under our license and distribution agreements with Audiovox +Electronics Corporation and Valeo Schalter and Sensoren GmbH through December 31, 2017, subject to certain reductions and limitations set forth in the asset purchase agreement. From the +date of the asset sale, through March 31, 2016, we received approximately $1.6 million in connection with royalty-related earn-outs provisions for a total of $15.3 million in cash +from the asset sale. +In +accordance with applicable accounting guidance, we determined that the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a discontinued operation. +For the fiscal year ended March 31, 2016, 2015 and 2014, we recorded a gain on sale of discontinued operation of approximately $214,000, $207,000 and $89,000, respectively, net of tax, related +to the earn-out provisions of the asset purchase agreement. +4. Acquisitions +Berkeley Transportation Systems, Inc. +In the fiscal year ended March 31, 2012 ("Fiscal 2012"), we acquired all of the outstanding capital stock of Berkeley +Transportation Systems, Inc. ("BTS"). BTS was a privately-held company based in Berkeley, California, which specialized in transportation performance measurement. BTS' Performance Measurement +System leverages its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and compute performance measures. This information is used to analyze how a transportation +system is performing based on pre-determined measures of effectiveness such as stops, delays and travel time. Our primary reasons for the acquisition were to add key technologies to complement our +Performance Analytics solutions and strengthen our performance measurement and management initiative as a whole. +Our +consolidated financial statements for Fiscal 2016, Fiscal 2015 and Fiscal 2014 include the results of operations of BTS. On or shortly after the acquisition date, we paid a total of +approximately $840,000 in cash to the shareholders of BTS. On December 17, 2012, the Company entered into an amendment to the BTS stock purchase agreement, which modified certain earn out +provisions, and as a result, the Company paid $700,000 in cash to the former BTS shareholders for achievement of those modified earn-out provisions in our fourth quarter of the fiscal year ended +March 31, 2013 ("Fiscal 2013"). The amendment did not have a material impact on previous estimated amounts accrued in connection with the earn-out provisions. This payment completed the +Company's obligation under the earn- out provisions of the agreement. During the third quarter of Fiscal 2014, the Company paid $250,000 pursuant to certain holdback provisions. Additionally, the +Company paid the BTS shareholders approximately $336,000 in November 2014 pursuant to certain deferred payment provisions. These payments completed all of the Company's obligations under the purchase +agreement. +58 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +4. Acquisitions (Continued) +Meridian Environmental Technology, Inc. +In Fiscal 2012, we acquired all of the capital stock of Meridian Environmental Technology, Inc. ("MET"), a privately-held +company based in Grand Forks, North Dakota. MET specialized in 511/Advanced Traveler Information Systems, as well as the ClearPath Weather management tools that allow users to create solutions to meet +roadway maintenance decision needs. +On +or shortly after the acquisition date, we paid approximately $1.6 million in cash, exclusive of $369,000 of cash acquired. We also agreed to pay up to $1.0 million on +each of the first two anniversaries of the closing of the acquisition upon the satisfaction of certain conditions, as well as up to an additional $2.0 million under a 24-month earn-out +provision. +In +January 2012, we made a cash payment of approximately $668,000 of the first deferred payment to the shareholders of MET and held back $250,000 in accordance with certain provisions of +the purchase agreement. In June 2012, we determined the contingencies related to the release of the $250,000 holdback were not met. As a result, no portion of the $250,000 holdback was reversed into +operating income during the second quarter of Fiscal 2013. Additionally, no amounts were earned by the former MET shareholders related to the first and second year earn-out provisions which ended on +December 31, 2011 and 2012, respectively. The second deferred payment of $1.0 million was due in the fourth quarter of Fiscal 2013. As a result of certain holdback provisions and other +deductions, the Company paid approximately $409,000 to the former MET shareholders in the second quarter of Fiscal 2014. This payment completed the Company's obligations under the deferred payment +provisions of the purchase agreement. The total purchase price paid for this business acquisition was approximately $2.7 million. +5. Impairment of Goodwill +As discussed in Note 1, goodwill is tested for impairment on an annual basis in our fourth fiscal quarter or more frequently if indicators of impairment exist. +In +Fiscal 2012, we early adopted the provisions issued by the FASB that are intended to simplify goodwill impairment testing. The updated guidance permits us to first assess qualitative +factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of +a reporting units is less than its carrying amount, we conduct a two-step goodwill impairment test. We determined it was appropriate to perform a quantitative first-step assessment in Fiscal 2014, +Fiscal 2015 and Fiscal 2016 to estimate the fair value of our reporting units using both the income approach and the market approach. Based on our assessments, we determined that no impairment was +indicated as of March 31, 2016 as the estimated fair value of each reporting unit exceeded its respective carrying value. +6. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for +59 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +6. Fair Value Measurements (Continued) +identical +assets and liabilities; Level 2, defined as observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities or prices quoted in inactive +markets; and Level 3, defined as unobservable inputs that are significant to the fair value of the asset or liability, and for which little or no market data exists, therefore requiring +management to utilize its own assumptions to provide its best estimate of what market participants would use in valuing the asset or liability. +The +liability for the estimated fair value of the contingent consideration in connection with our acquisitions of MET and BTS was initially determined using Level 3 inputs based +on a probabilistic calculation whereby we assigned estimated probabilities to achieving the earn-out targets and then discounted the total contingent consideration to net present value. The MET and +BTS earn-out targets were completed during Fiscal 2013 and the deferred acquisition payments were completed during Fiscal 2015. +Other +than the above, we did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2016, +2015 or 2014. Our non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a non-recurring basis, generally when there is a transaction +involving those assets such as a purchase +transaction, a business combination or an adjustment for impairment. No non- financial assets were measured at fair value during the fiscal years ended March 31, 2016 and 2015. +7. Credit Facility +We currently have a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expires on October 1, 2016. Interest on borrowed amounts +under the revolving line of credit is payable monthly at a rate equal to the current stated prime rate (3.50% at March 31, 2016). We are obligated to pay an unused line fee of 0.15% per annum +applied to the average unused portion of the revolving line of credit during the preceding month. The revolving line of credit does not contain any early termination fees and is secured by +substantially all of our assets. As of March 31, 2016 and 2015, no amounts were outstanding under the credit facility with CB&T. Availability under this line of credit may be reduced or +otherwise limited as a result of our obligations to comply with certain financial and other covenants. As of March 31, 2016 and 2015, we were in compliance with all such financial and other +covenants. +60 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +8. Income Taxes +The components of current and deferred federal and state income tax provisions (benefits) are as follows: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Current income tax provision: +Federal +$ +170 +$ +3 +$ +21 +State +50 +49 +20 +Deferred income tax provision (benefit): +Federal +8,289 +(655 +) +330 +State +570 +(213 +) +333 +Net income tax provision (benefit) +$ +9,079 +$ +(816 +) +$ +704 +The +components of income tax expense (benefit) consist of the following: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Current income tax expense +$ +220 +$ +52 +$ +41 +Deferred income tax expense (benefit) +1,232 +(781 +) +663 +Benefit of operating loss carryforwards +(1,316 +) +(87 +) +— +Recording of valuation allowance +8,943 +— +— +Net income tax provision (benefit) +$ +9,079 +$ +(816 +) +$ +704 +The +reconciliation of our income tax provision (benefit) to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +(Benefit) provision for income taxes at statutory rates +$ +(1,175 +) +$ +(712 +) +$ +688 +State income taxes net of federal benefit +(184 +) +(108 +) +48 +Tax credits +(258 +) +(148 +) +(290 +) +Change in fair value of contingent acquisition consideration +— +3 +8 +Compensation charges +91 +88 +22 +Change in valuation allowance +10,557 +— +185 +Other +48 +61 +43 +Provision (benefit) for income taxes +$ +9,079 +$ +(816 +) +$ +704 +61 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +8. Income Taxes (Continued) +The +components of deferred tax assets and liabilities are as follows: +March 31, +2016 +2015 +(In thousands) +Deferred tax assets: +Net operating losses +$ +2,468 +$ +5,420 +Capitalized R&D +3,557 +— +Credit carry forwards +2,130 +1,610 +Deferred compensation and payroll +1,306 +1,163 +Bad debt allowance and other reserves +665 +504 +Deferred rent +335 +364 +Other, net +242 +271 +Total deferred tax assets +10,703 +9,332 +Valuation allowance +(10,561 +) +— +Total deferred tax assets, net of valuation allowance +142 +9,332 +Deferred tax liabilities: +Property and equipment +(71 +) +(137 +) +Acquired intangibles +(71 +) +(252 +) +Goodwill +(685 +) +(653 +) +Total deferred tax liabilities +(827 +) +(1,042 +) +Net deferred tax (liabilities) assets +$ +(685 +) +$ +8,290 +At +March 31, 2016, we had $1.0 million in federal alternative minimum tax credit carryforwards that can be carried forward indefinitely, and $797,000 in federal research +credits that begin to expire in 2031. We also had $480,000 in state tax credits that begin to expire in 2023. We had $9.7 million of federal net operating loss carryforwards at March 31, +2016 that begin to expire in 2022. We also had $794,000 of state net operating loss carryforwards at March 31, 2016 that begin to expire in 2031. +Our +deferred tax assets at March 31, 2016 do not include approximately $874,000 of excess tax benefits from employee stock option exercises that are a component of our net +operating loss carryforwards. If and when such excess tax benefits are realized, stockholders' equity will be increased. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. A valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets +will not be realized, which increases our income tax expense in the period such determination is made. As of December 31, 2015, the Company had generated a cumulative pre-tax loss over the +trailing three years. As such, we considered it appropriate to record a valuation allowance of approximately $10.1 million in our third quarter of Fiscal 2016 against our deferred tax assets. +We will continuously reassess the appropriateness of maintaining a valuation allowance. +62 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +8. Income Taxes (Continued) +Unrecognized Tax Benefits +As of March 31, 2016 and 2015, our gross unrecognized tax benefits were $394,000 and $319,000, respectively, of which $251,000 +and $184,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are $328,000 and $257,000, respectively. +We +recognize interest income and/or interest expense, net, and penalties related to income tax matters in income tax expense. As of March 31, 2016 and 2015, we had accrued +cumulatively $52,000 and $47,000, respectively, for the payment of potential interest and penalties. The total amount of interest expense and interest income, net, and penalties recognized in the +consolidated statements of operations for the fiscal years ended March 31, 2016 and 2015 was $5,000 and $(6,000), respectively. +A +reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +319 +$ +281 +$ +218 +Increases for tax positions taken in prior years +22 +14 +106 +Decreases for tax positions taken in prior years +— +(3 +) +(53 +) +Increases for tax positions taken in the current year +68 +46 +41 +Lapse in statute of limitations +(15 +) +(19 +) +(31 +) +Gross unrecognized tax benefits at March 31 +$ +394 +$ +319 +$ +281 +We +do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We +are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2013 or later, and state and local income tax examination for fiscal tax years ended March 31, 2012 or +later. However, if net operating loss ("NOL") carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain +subject to review by tax authorities. Our Fiscal 2015 federal tax return is currently under examination by the U.S. Internal Revenue Service. +9. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural +industries, the Company has in the past been, and may in the future be from time to time, involved in litigation relating to claims arising out of its operations in the normal course of business. +While the Company cannot accurately predict the outcome of any such litigation, except as described below, the Company is not a party to any legal proceeding, the outcome of which, in management's +opinion, individually or in the aggregate, would have a material effect on the Company's consolidated results of operations, financial position or cash flows. +63 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +9. Commitments and Contingencies (Continued) +In +November 2015, the City of Detroit, Michigan (the "City") filed a lawsuit against the Company in the United States Bankruptcy Court for the Eastern District of Michigan alleging that +the Company received a payment in the amount of approximately $124,000 from the City during the 90-day period prior to the City's bankruptcy filing in 2013. In March 2016, the Company entered into +such agreement with the City for an immaterial amount to fully resolve the matter. +Operating Leases +In May 2007, we entered into an agreement to lease 52,000 square feet of office space in Santa Ana, California for a term of +88 months. In September 2007, we relocated our headquarters and principal operations into this space. The monthly lease rate was $102,000 during the first year of the lease and increased each +year thereafter, to $120,000 per month during the last year of the lease. In February 2014, we entered into an amendment to the lease, which reduced our office space by approximately 11,000 square +feet and changed the lease term to 96 months, commencing on April 1, 2014. The monthly lease rate is approximately $76,000 during the first year of the amended term and increases each +year thereafter, up to a maximum of approximately $90,000 during the last year of the term. Additionally, the lease amendment provided for approximately $328,000 in incentives in the form of tenant +improvement allowances, which we recorded as fixed assets and deferred rent in our consolidated balance sheet. The leasehold improvements were capitalized into fixed assets during Fiscal 2015 and will +be depreciated over the estimated useful life of the improvements, or the term of the lease amendment, whichever is shorter. The corresponding deferred rent amount will reduce monthly rent expense +over the term of the lease amendment. +We +have lease commitments for facilities in various locations throughout the U.S., as well as for certain equipment. Future minimum rental payments under these non-cancelable operating +leases at March 31, 2016 were as follows: +Year Ending March 31, +(In thousands) +2017 +$ +1,861 +2018 +1,708 +2019 +1,454 +2020 +1,213 +2021 +1,161 +Thereafter +1,153 +$ +8,550 +Rent +expense totaled approximately $1.7 million, $1.7 million and $1.9 million for Fiscal 2016, Fiscal 2015 and Fiscal 2014, respectively. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in +September 2003. Maxxess is currently owned by an investor group that includes one current Iteris director and one former Iteris director. The sublease terminated in +64 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +9. Commitments and Contingencies (Continued) +September +2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated on July 23, 2013. +The +amended and restated note bears interest at a rate of 6% per annum, compounded annually, with accrued interest to be paid quarterly on the first business day of each calendar +quarter. Payments under the amended and restated note may only be paid in cash and all amounts outstanding will become due and payable on the earliest of (i) August 10, 2016, +(ii) a change of control in Maxxess, or (iii) a financing by Maxxess resulting in gross proceeds of at least $10 million. As of March 31, 2016, approximately $219,000 of +the original principal balance was outstanding and payable to Iteris. We have previously fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. +On +June 30, 2015, the Company entered into an agreement with Maxxess to provide professional services for the Company's Performance Analytics segment, in support of its ClearAg +software development initiative. The professional services commenced in July 2015 and continued through December 31, 2015. On February 19, 2016, the Company entered into an amendment of +the agreement to extend the duration for an additional six months, to continue through August 2016. The total effort under this agreement is limited to 300 hours, billed on a time and materials +basis, not to exceed $102,600. During the fiscal year ended March 31, 2016, approximately $54,000 of professional services were rendered to the Company. +Inventory Purchase Commitments +At March 31, 2016, we had firm commitments to purchase approximately $4.4 million of inventory, operating assets and +other supplies, which are expected to occur primarily during the first and second quarters of the fiscal year ended March 31, 2017. +10. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is +authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, +limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2016 and 2015, there were no +outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common +stock to buy one one-thousandth of one share of Series A Junior Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement +dated August 20, 2009 (as amended in August 2012) by and between Iteris and Computershare Trust Company, N.A., as rights agent. In connection with the stockholder rights plan, our Board of +Directors approved the adoption of a Certificate of Designations, which created the Series A Junior Participating +65 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +10. Stockholders' Equity (Continued) +Preferred +Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred stock, which were originally created in April 1998 +in connection with our previous stockholder rights plan which expired in 2008. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2016: +Number of Shares +(In thousands) +Stock options outstanding +3,309 +Restricted stock units outstanding +173 +Authorized for future issuance under stock incentive plans +902 +4,384 +11. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase +shares of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on +the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. The 2007 Plan also +allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to +satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and +reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common +stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase +the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an +amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. At +March 31, 2016, there were approximately 902,000 shares of common stock available for grant under this plan. As of March 31, 2016, options to purchase approximately 3,287,000 shares of +common stock, as well as 173,000 RSUs, were outstanding under the 2007 Plan. +Our +1997 Stock Incentive Plan (the "1997 Plan") terminated in September 2007; however, all stock options outstanding under the 1997 Plan remain outstanding pursuant to the terms of such +stock options. As of March 31, 2016, options to purchase approximately 23,000 shares of our common stock were outstanding under the 1997 Plan. No further options or other stock-based awards may +be granted under the 1997 Plan. +66 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +11. Employee Benefit Plans (Continued) +Certain options granted under the 2007 Plan and the 1997 Plan (collectively, the "Plans") and the RSUs granted under the 2007 Plan provide for accelerated vesting of unvested options in +the event of a change in control under certain circumstances. +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2016 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2015 +2,199 +$ +1.83 +Granted +1,808 +2.35 +Exercised +(243 +) +1.58 +Forfeited +(79 +) +1.82 +Expired +(376 +) +2.36 +Options outstanding at March 31, 2016 +3,309 +$ +2.07 +8.1 +$ +1,222 +Options exercisable at March 31, 2016 +1,057 +$ +1.70 +5.9 +$ +788 +Vested and expected to vest at March 31, 2016 +2,948 +$ +2.05 +8 +$ +1,167 +Options exercisable at March 31, 2016 pursuant to a change-in-control +3,309 +$ +2.07 +8.1 +$ +1,222 +Restricted Stock Units +In August 2010, we began granting RSUs under the 2007 Plan to certain of our employees. RSU awards are stock-based awards that entitle +the holder to receive one share of our common stock for each RSU upon vesting. RSUs vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains +in service (as defined by the 2007 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +67 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +11. Employee Benefit Plans (Continued) +A +summary of activity with respect to our RSUs for Fiscal 2016 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2015 +194 +$ +1.74 +Granted +63 +2.37 +Vested +(66 +) +1.61 +Forfeited +(18 +) +1.84 +RSUs outstanding at March 31, 2016 +173 +$ +2.00 +2.5 +$ +273 +Expected to vest at March 31, 2016 +150 +$ +1.99 +2.4 +$ +245 +Common stock issuable (for RSUs) at March 31, 2016 upon a change-in-control +173 +$ +2.00 +2.5 +$ +273 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated +statements of operations: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Cost of revenues +$ +42 +$ +21 +$ +30 +Selling, general and administrative expense +567 +315 +246 +Research and development expense +50 +62 +24 +Total stock-based compensation +$ +659 +$ +398 +$ +300 +At +March 31, 2016, there was approximately $2.1 million and $265,000 of unrecognized compensation expense related to unvested stock options and RSUs, respectively. This +expense is currently expected to be recognized over a weighted average period of approximately 3.1 years for stock options and 2.5 years for RSUs. If there are any modifications or +cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based compensation expense +and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +68 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +11. Employee Benefit Plans (Continued) +The +grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended +March 31, +2016 +2015 +2014 +Expected life—years +7.2 +7.7 +7.0 +Risk-free interest rate +1.9 +% +2.0 +% +2.0 +% +Expected volatility of common stock +47 +% +50 +% +51 +% +Dividend yield +— +% +— +% +— +% +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2016 +2015 +2014 +(In thousands, except per +share amounts) +Weighted average grant date fair value per share of options granted +$ +1.19 +$ +1.01 +$ +0.99 +Intrinsic value of options exercised +$ +135 +$ +9 +$ +281 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of +Directors. No contributions were made during the fiscal years ended March 31, 2016, 2015 and 2014. +We +sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible associates voluntarily contribute to the plan, up to IRS maximums, through +payroll deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the +401(k) Plan were approximately $716,000, $495,000 and $504,000 for the fiscal years ended March 31, 2016, 2015 and 2014, respectively. +12. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors approved a new stock repurchase program pursuant to which we may acquire up to $3 million of our outstanding common stock for an unspecified length of time. Under the new program, we +may repurchase shares from time to time in open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed +trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase +69 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +12. Stock Repurchase Program (Continued) +program +at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to +which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For +our fiscal year ended March 31, 2016, 2015 and 2014, we repurchased approximately 656,000, 473,000 and 196,000 shares of our common stock, respectively. From inception of the +program in August 2011 through March 31, 2016, we repurchased approximately 3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price +per share of $1.63. As of March 31, 2016, all repurchased shares have been retired and resumed their status as authorized and unissued shares of our common stock. As of March 31, 2016, +approximately $1.7 million remains available for the repurchase of our common stock under our current program. +13. Business Segments, Significant Customer and Geographic Information +Business Segments +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics. +The +Roadway Sensors segment provides hardware and software products to multiple segments of the ITS market. These various vehicle detection and information systems are used for traffic +intersection control, incident detection and roadway traffic data collection applications. These include, among other products, our Vantage, VantageNext, VersiCam, Vantage Vector, SmartCycle, +SmartSpan, Pegasus, Velocity, P10, P100 and Abacus products. +The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. +The +Performance Analytics segment includes our performance measurement and information management solution iPeMS, a specialized transportation performance measurement and traffic +analytics solutions, as well as ClearPath Weather, our road-maintenance applications, and ClearAg, our precision agriculture solutions. iPeMS provides big data and software analytics solutions that +help determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. ClearPath Weather provides winter road maintenance +recommendations for state agencies, municipalities and for commercial companies. Our ClearAg +platform provides access to a comprehensive database of weather, soil and agronomic information essential to making informed agricultural decisions. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate general and +administrative expenses, including general overhead functions such as information systems, accounting, human resources, marketing, compliance costs and certain administrative expenses, as well as +interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or +provide services with different processes. All reported segment revenues are derived from external customers. The +70 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +13. Business Segments, Significant Customer and Geographic Information (Continued) +Company's +Chief Executive Officer, who is the chief operating decision maker, or CODM, reviews financial information at the operating segment level. The Company's CODM does not review assets by +segment in his resource allocation and therefore assets by segment are not disclosed below. +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2016, 2015 and 2014 is as follows: +Roadway +Sensors +Transportation +Systems +Performance +Analytics +Total +(In thousands) +Year Ended March 31, 2016 +Revenues +$ +40,259 +$ +32,330 +$ +5,159 +$ +77,748 +Depreciation +152 +136 +161 +449 +Segment income (loss) +7,718 +4,031 +(7,380 +) +4,369 +Year Ended March 31, 2015 +Revenues +$ +36,370 +$ +30,294 +$ +5,587 +$ +72,251 +Depreciation +119 +115 +142 +376 +Segment income (loss) +6,302 +4,239 +(4,449 +) +6,092 +Year Ended March 31, 2014 +Revenues +$ +31,769 +$ +30,524 +$ +5,935 +$ +68,228 +Depreciation +208 +161 +118 +487 +Segment income (loss) +5,791 +3,363 +(1,575 +) +7,579 +The +following table reconciles total segment income to consolidated income from continuing operations before income taxes: +Year Ended March 31, +2016 +2015 +2014 +(In thousands) +Segment income: +Total income from reportable segments +$ +4,369 +$ +6,092 +$ +7,579 +Unallocated amounts: +Corporate and other expenses +(7,479 +) +(7,731 +) +(4,903 +) +Amortization of intangible assets +(360 +) +(431 +) +(627 +) +Change in fair value of contingent acquisition consideration +— +(9 +) +(25 +) +Other (expense) income, net +2 +(20 +) +— +Interest income, net +12 +6 +— +(Loss) income from continuing operations before income taxes +$ +(3,456 +) +$ +(2,093 +) +$ +2,024 +Significant Customer and Geographic Information +We currently have, and historically have had, a diverse customer base. For Fiscal 2016, no individual customer represented +approximately 10% of our total revenues. For Fiscal 2015, one individual customer represented approximately 10% of our total revenues and no other individual +71 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2016 +13. Business Segments, Significant Customer and Geographic Information (Continued) +customer +represented greater than 10% of our total revenues. For Fiscal 2014, one individual customer represented approximately 11% of our total revenues and no other individual customer represented +greater than 10% of our total revenues. +No +individual customer or government agency had a receivable balance at March 31, 2016 or 2015 greater than 10% of our total trade accounts receivable balances as of +March 31, 2016 and 2015, respectively. +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended +March 31, +2016 +2015 +2014 +Middle East +1 +% +3 +% +4 +% +Other +— +— +1 +1 +% +3 +% +5 +% +Substantially +all of our long-lived assets are held in the U.S. +14. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross Profit +Net Loss +Basic Net +Loss per +Share +Diluted Net +Loss per +Share +(In thousands, except per share amounts) +June 30, 2015 +$ +18,365 +$ +7,637 +$ +(192 +) +$ +(0.01 +) +$ +(0.01 +) +September 30, 2015 +20,573 +7,883 +(395 +) +(0.01 +) +(0.01 +) +December 31, 2015 +19,014 +7,211 +(10,442 +) +(0.33 +) +(0.33 +) +March 31, 2016 +19,796 +7,938 +(1,292 +) +(0.04 +) +(0.04 +) +$ +77,748 +$ +30,669 +$ +(12,321 +) +$ +(0.39) +* +$ +(0.39) +* +June 30, 2014 +$ +18,116 +$ +6,807 +$ +(19 +) +$ +— +$ +— +September 30, 2014 +18,550 +7,299 +(187 +) +(0.01 +) +(0.01 +) +December 31, 2014 +17,540 +6,862 +(98 +) +— +— +March 31, 2015 +18,045 +7,214 +(766 +) +(0.02 +) +(0.02 +) +$ +72,251 +$ +28,182 +$ +(1,070 +) +$ +(0.03) +* +$ +(0.03) +* +* Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +72 +Table of Contents +Exhibit Index +Exhibit +Number +Description +Reference +2.2 ++ +Asset Purchase Agreement by and between Iteris, Inc. and Bendix Commercial Vehicle Systems LLC, dated as of July 25, 2011 +Exhibit 2.1 to the registrant's Current Report on Form 8- K/A as filed with the SEC on November 1, 2011 +3.1 +Restated Certificate of Incorporation of the registrant +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.2 +Certificate of Designations of Series A Junior Participating Preferred Stock +Exhibit 3.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.3 +Bylaws of the registrant, as amended +Exhibit 4.2 to the registrant's Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993 +3.4 +Certificates of Amendment to Bylaws of the registrant dated April 24, 1998 and August 10, 2001 +Exhibit 3.4 to the registrant's Annual Report on Form 10- K/A for the year ended March 31, 2003 as filed with the SEC on July 29, 2003 +3.5 +Certificate of Amendment to Bylaws of registrant dated September 9, 2004 +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 as filed with the SEC on November 15, 2004 +3.6 +Certificate of Amendment to Bylaws of registrant effective September 16, 2005 +Exhibit 3.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2007 +3.7 +Certificate of Amendment to Bylaws of registrant effective December 7, 2007 +Exhibit 3.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 13, 2007 +3.8 +Certificate of Amendment to Bylaws of registrant, effective August 20, 2009 +Exhibit 3.3 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +4.1 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +4.2 +Rights Agreement dated August 20, 2009 between the registrant and Computershare Trust Company, N.A., which includes the form of Certificate of Designations for the Series A Junior Participating Preferred Stock, +the form of Right Certificate, and Summary of Rights to Purchase Preferred Stock as exhibits thereto +Exhibit 4.1 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +73 +Table of Contents +Exhibit +Number +Description +Reference +4.3 +Amendment No. 1 to Rights Agreement, entered into as of August 8, 2012 by and between Iteris, Inc. and Computershare Trust Company, N.A. +Exhibit 4.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 10, 2012 +10.1 +Form of Indemnity Agreement entered into by the registrant and certain of its officers and directors +Exhibit 19.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 +10.2 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +* +1997 Stock Incentive Plan (the "1997 Plan") as amended on May 3, 2003, as further amended on December 15, 2004 +Exhibit 10.32 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2005 as filed with the SEC on July 14, 2005 +10.4 +* +Form of Notice of Grant of Stock Option for 1997 Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.5 +* +Form of Stock Option Agreement for the 1997 Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.6 +* +Form of Addendum to Stock Option Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction or Change in Control +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.7 +* +Form of Stock Issuance Agreement for 1997 Plan +Exhibit 99.6 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Addendum to Stock Issuance Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction/Change in Control +Exhibit 99.7 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Initial Grant +Exhibit 99.8 to Exhibit 99.8 to registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.10 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Annual Grant +Exhibit 99.9 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.11 +* +Form of Automatic Stock Option Agreement for 1997 Plan +Exhibit 99.10 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 19, 2000 +74 +Table of Contents +Exhibit +Number +Description +Reference +10.15 +* +Form of 1997 Stock Option Agreements +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-126834) as filed with the SEC on July 22, 2005 +10.17 +Office Lease, dated May 24, 2007, by and between Crown Carnegie Associates, LLC and Iteris, Inc. +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.18 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.19 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.20 +Amended and Restated Loan and Security Agreement dated February 4, 2009 by and between California Bank & Trust and the registrant +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2008 as filed with the SEC on February 13, 2009 +10.21 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.22 +Modification Agreement dated September 30, 2010 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 6, 2010 +10.23 +Modification Agreement dated September 28, 2012 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 3, 2012 +10.24 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.25 +* +Employment Agreement, dated July 29, 2013, by and between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.26 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +75 +Table of Contents +Exhibit +Number +Description +Reference +10.27 +Modification Agreement dated September 23, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q as filed with the SEC on November 12, 2014 +10.28 +Modification Agreement dated November 18, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on November 24, 2014 +10.29 +Separation Agreement and Release of Claims dated February 25, 2015 between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.30 +Modification Agreement dated February 24, 2015 between the Iteris, Inc. and California Bank & Trust +Exhibit 10.2 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.31 +Employment Agreement dated March 9, 2015 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on March 15, 2015 +10.32 +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +16.1 +Letter from McGladrey LLP dated October 16, 2015 regarding change in certifying accountant +Exhibit 16.1 to the registrant's Current Report on Form 8-K as filed with the SEC on October 14, 2015 +21 +Subsidiaryies of the registrant +Filed herewith +23.1 +Consent of Independent Registered Public Accounting Firm, dated June 17, 2016 +Filed herewith +23.2 +Consent of Independent Registered Public Accounting Firm, dated June 17, 2016 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS +XBRL Instance Document +Filed herewith +76 +Table of Contents +Exhibit +Number +Description +Reference +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. ++ Confidential +treatment has been previously granted by the SEC for certain portions of the referenced exhibit pursuant to Rule 24b-2 of the Securities +Exchange Act of 1934, as amended. In accordance with Rule 24b- 2, these confidential portions have been omitted from the exhibit and filed separately with the SEC. +# Pursuant +to Rule 406T of Regulation S-T, these interactive data files i) are not deemed filed or part of a registration statement or +prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, irrespective of any +general incorporation language included in any such filings, and otherwise are not subject to liability under these sections; and ii) are deemed to have complied with Rule 405 of +Regulation S-T ("Rule 405") and are not subject to liability under the anti-fraud provisions of the Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the +Securities Exchange Act of 1934 or under any other liability provision if we have made a good faith attempt to comply with Rule 405 and, after we become aware that the interactive data files +fail to comply with Rule 405, we promptly amend the interactive data files. +77 \ No newline at end of file diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/filing_metadata.csv b/raw/filings/0000350868/2015/0001047469-16-013877/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a30d0ae94f1f132f978526a56feb4e9d01a76ff2 --- /dev/null +++ b/raw/filings/0000350868/2015/0001047469-16-013877/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2016-06-20,2016-03-31,2016-06-17T22:53:13.000Z,0001047469-16-013877,a2228979z10-k.htm,10-K,9235289,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746916013877/a2228979z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746916013877/,2015,2015,1 diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/item1.txt b/raw/filings/0000350868/2015/0001047469-16-013877/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..c30a77cb0624a7bf77ecbd9987e9bc495d69c5aa --- /dev/null +++ b/raw/filings/0000350868/2015/0001047469-16-013877/item1.txt @@ -0,0 +1,218 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its subsidiary in this report as "Iteris," the "Company," "we," "our" and "us") is a +provider of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application of advanced technologies and +software-based information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface transportation +systems infrastructure. By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a +broad range of Intelligent Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. We believe our products, services and solutions, in conjunction with sound +traffic management, minimize the environmental impact of traffic congestion. +In +the agribusiness markets, we have combined our unique intellectual property with enhanced soil, land surface and agronomy modeling techniques to create a set of ClearAg solutions. +These solutions provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. We continue to make significant investments to leverage +our existing technologies and further expand our software-based information systems to offer solutions to the precision agriculture technology markets. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Performance Analytics. The Roadway +Sensors segment provides various vehicle detection and information systems and products for traffic intersection control, incident detection and roadway traffic data collection applications. The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the ITS industry. The +Performance Analytics segment includes iPeMS, our specialized transportation performance measurement and traffic analytics solutions, as well as ClearPath Weather, our road-maintenance applications, +and ClearAg, our precision agriculture solutions. See Note 13 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for further details on +our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology and other techniques to capture and analyze sensor +data through sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among +other products, our +Vantage, VantageNext, VersiCam, Vantage Vector, SmartCycle, SmartSpan, Pegasus, Velocity, P10, P100 and Abacus products. +3 +Table of Contents +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in +traffic management systems. Vantage detection systems typically include up to four of our advanced cameras or radars. Our Vantage systems give traffic managers the ability to mitigate roadway +congestion by modifying traffic signal timing or detecting incidents quickly. Our various software complement our Vantage detection systems by providing integrated platforms to manage and view +detection assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including +stop bar detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar sensing. +Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a +single video detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection +zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller +intersections that require only a few detection points. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +have historically experienced seasonality, particularly with respect to our Roadway Sensors revenues in our third and fourth fiscal quarters, due to reductions in road construction +and repairs during the winter months related to inclement weather conditions. +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, +development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design and implementation of surface +transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation +measures to reduce traffic congestion. +Our +Transportation Systems segment is largely dependent upon governmental funding and is affected by state and local budgetary issues. On December 4, 2015, the Fixing America's +Surface Transportation ("FAST") Act was signed into law, providing approximately $305 billion over five years for surface transportation projects and programs. In addition, various other +funding mechanisms exist to support transportation infrastructure and related projects as regulatory deadlines approach, which require these technologies. These include bonds, dedicated sales and gas +tax measures and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal +government's use of funds under the federal highway bill. Delays in the allocation of funds may prolong uncertainty regarding the +4 +Table of Contents +allotment +of transportation funds in federal, state and local budgets. We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely +impact in the future, our Transportation Systems revenues and our overall financial performance in future periods. +Performance Analytics +Our Performance Analytics segment, formed during the first quarter of our fiscal year ended March 31, 2013 ("Fiscal 2013"), +includes our performance measurement and information management solutions, including all of the operations of our former subsidiary, Berkeley Transportation Systems, Inc. ("BTS"), which we +acquired in November 2011. BTS specialized in transportation performance measurement systems that leverage its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and +compute performance measurements. iPeMS is a state-of-the-art information management software suite that provides big data and software analytics solutions that help determine current and future +traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine +current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to +measure how a transportation network is performing and to identify potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use +visualization and animation features based on historical traffic conditions. +The +Performance Analytics segment also includes the operations of our former subsidiary, Meridian Environmental Technology, Inc. ("MET"), which we acquired in January 2011. MET +specializes in 511/Advanced Traveler Information Systems, and includes our ClearPath Weather management tools that allow users to create solutions to meet roadway maintenance decision needs. Our +ClearPath Weather tools provide winter road maintenance recommendations for state agencies, municipalities and for commercial companies. +With +the addition of MET, we have experienced seasonality particularly related to certain ClearPath Weather services in our first and second fiscal quarters, mainly because ClearPath +Weather services are generally not required in the summer months when weather conditions are typically less severe. Our Performance Analytics is a market leader in performance management solutions for +federal and state organizations. We intend to use our strong brand and deep experience in the traffic management market, as well as our market-specific intellectual property, to expand our leadership +in data aggregation and analytics. +Beginning +in late 2013, we undertook a focused development activity to supplement our intellectual property, technology base and product suites to provide products and services for the +emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market, as well as the development of several +products +specifically intended for the PA market. We refer to our products for the PA market generically as ClearAg solutions. Our ClearAg platform provides access to a comprehensive database of weather, soil +and agronomic information essential to making informed agricultural decisions. Our ClearAg application programming interfaces ("APIs") include historical, real-time and forecast weather content, soil +and plant health information, as well as real-time weather and other useful crop growing information, to provide solutions in the precision agriculture technology markets. We commenced commercial +sales of our ClearAg platform and related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015") and introduced our first ClearAg Application ("App") in the first +quarter of our fiscal year ended March 31, 2016 ("Fiscal 2016"). We expect positive market acceptance of our ClearAg solutions to continue in upcoming quarters. We plan to continue to fund the +5 +Table of Contents +investments +in our ClearAg solutions through internally generated cash flow from our Roadway Sensors and Transportation Systems operations, as well as revenues from our Performance Analytics segment +and our available cash on hand, if necessary. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell +direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is +comprised of a network of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent +distributors are trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers +and sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the +supply of various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. +We periodically hold technical training classes for our distributors and end users and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance +when needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and Performance Analytics solutions primarily directly to government agencies pursuant to negotiated contracts that +involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and municipal customers and generally provide for cancellation or renegotiation at +the option of +the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in sales +and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We +currently market and sell our ClearAg products to commercial entities in the PA market. We currently have two primary product sets which we are marketing for our PA segment; our +ClearAg API integration and modeling services and our ClearAg Apps. Our ClearAg APIs are intended for large enterprises in the agriculture market that can benefit from the value of a tight integration +of their processes with the ClearAg modeling and forecasting engine; our ClearAg App was introduced in May 2015 and is intended for individual agriculture producers that can benefit from advisories +based upon the ClearAg platform that are tailored for their specific locations of interest. We generally deal directly to customers interested in the ClearAg API products, whereas we typically sell +through selling partners for our ClearAg App products. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain +components from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and +components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris +Manufacturing, Sony Electronics, Inc. and LG Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California +facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of +6 +Table of Contents +the +hardware used in the transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such +service revenue was not a material portion of our total revenues for each Fiscal 2016, Fiscal 2015 and our fiscal year ended March 31, 2014 ("Fiscal 2014"). We believe customer support is a key +competitive factor. +Our +ClearAg products are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer service +for our ClearAg products. +Backlog +Our total backlog of unfulfilled firm orders was approximately $63.3 million as of March 31, 2016, which included +$53.3 million related to Transportation Systems. In the past three fiscal years, we have recognized approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the +subsequent fiscal year, and currently expect that trend to continue for the near future for both Transportation Systems and Performance Analytics. Substantially the entire backlog for Roadway Sensors +as of March 31, 2016 is expected to be recognized as revenue in the fiscal year ending March 31, 2017. At March 31, 2015, we had backlog of approximately $39.2 million, +which included $29.6 million related to Transportation Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Performance Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $6.9 million for Fiscal 2016, $5.4 million +for Fiscal 2015 and $4.0 million for Fiscal 2014. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our +Performance Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continue to develop new products to meet the needs of our ever-changing markets, +as well as to enhance and refine our existing product lines. We plan to focus our development efforts in the near future in our Performance Analytics segment on our ClearAg products for the PA market; +however, since 2014, our Roadway Sensors segment has introduced our VantageNext, Vantage Vector, SmartCycle, SmartSpan, Pegasus, Velocity, P10 and P100 products. Additionally, during Fiscal 2015 and +Fiscal 2016, we engaged in development activities of our ClearAg precision agriculture solutions. We believe that developing new offerings across our segments and enhancing, refining and marketing our +existing products are key components for strong organic growth and profitability. +7 +Table of Contents +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced +gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Performance Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for iPeMS and ClearPath Weather +products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning and +design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with +a variety of entities that currently provide weather-related data to that market such as Climate Corp (now a division of Monsanto) and John Deere as well as new entrants such as Granular and +Conservis. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and manufacturers +and distributors and other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation engineering, planning and design include major regional ITS engineering firms, as well +as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. +Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We have (i) two U.S. non-provisional patent +applications relating to our Roadway Sensors technologies, (ii) twelve issued U.S. patents, two U.S. non-provisional patent applications that were allowed and issued in 2007 and twelve U.S. +non-provisional patents, relating to our Performance Analytics technologies, and (iii) four issued U.S. patents and one U.S. non-provisional patent relating specifically +to our Transportation Systems technologies. The twelve issued patents relating to our Performance Analytics technologies expire between 2033 and 2035, and our four issued U.S. patents relating to our +Transportation Systems technologies expire between 2033 and 2035. +8 +Table of Contents +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other +proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material +licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent +applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +We refer to our employees as associates. As of March 31, 2016, we employed 366 full-time associates and 34 part-time associates, +for a total of 400 associates. None of our associates are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our associates are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the +discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of +such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, +and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, +foreign laws and regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/item13.txt b/raw/filings/0000350868/2015/0001047469-16-013877/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..8ada8f1cb1e6e7837fde242bf4681f8f0b85bdbe --- /dev/null +++ b/raw/filings/0000350868/2015/0001047469-16-013877/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in +our proxy statement for the 2016 Annual Meeting of Stockholders, is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/item9a.txt b/raw/filings/0000350868/2015/0001047469-16-013877/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..f9c135c8e2bafb9540704d3d75b9dce897febf59 --- /dev/null +++ b/raw/filings/0000350868/2015/0001047469-16-013877/item9a.txt @@ -0,0 +1,34 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and +Chief Executive Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the +Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the President +35 +Table of Contents +and +Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the date of such evaluation in ensuring that information +required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and +reported in a timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, +to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during Fiscal 2016 that has materially affected, or is reasonably likely to materially affect, our +internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives +of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can +provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control +system was designed to provide reasonable assurance to management and our Board of Directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of +published financial statements. +We +have assessed the effectiveness of our internal controls over financial reporting as of March 31, 2016. In making this assessment, we used the criteria set forth by the +Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework +(2013) . Based on our assessment, we believe that, as of March 31, 2016, our internal control over financial reporting was effective. This annual report does not include +an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Such a report is not required pursuant to the rules of the SEC +applicable to smaller reporting companies. \ No newline at end of file diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/rp_note.txt b/raw/filings/0000350868/2015/0001047469-16-013877/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2015/0001047469-16-013877/rpt_disclosure.txt b/raw/filings/0000350868/2015/0001047469-16-013877/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/filing.txt b/raw/filings/0000350868/2016/0001047469-17-003975/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..d5fbb2bdfbb1424515fefef792aa9155a71b5e98 --- /dev/null +++ b/raw/filings/0000350868/2016/0001047469-17-003975/filing.txt @@ -0,0 +1,4455 @@ +10-K +1 +a2232390z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +PART IV +Iteris, Inc. Index to Consolidated Financial Statements +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2017 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California +(Address of Principal Executive Offices) +92705 +(Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, $0.10 par value +The NASDAQ Stock Market LLC +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act +of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the +past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to +be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes ý No o +Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this +Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See +definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer ý +Non accelerated filer o +(Do not check if a +smaller reporting company) +Smaller reporting company o +Emerging growth company o +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting +standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2016 was approximately $84,800,000. +For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate +status is not necessarily a conclusive determination for other purposes. As of June 5, 2017, there were 32,493,210 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III +of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2017 Annual Meeting of Stockholders, which will be +filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended March 31, 2017. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2017 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +22 +ITEM 2. +PROPERTIES +22 +ITEM 3. +LEGAL PROCEEDINGS +22 +ITEM 4. +MINE SAFETY DISCLOSURES +22 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +23 +ITEM 6. +SELECTED FINANCIAL DATA +24 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +24 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +36 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +36 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +36 +ITEM 9A. +CONTROLS AND PROCEDURES +36 +ITEM 9B. +OTHER INFORMATION +37 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +38 +ITEM 11. +EXECUTIVE COMPENSATION +38 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +38 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +38 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +38 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +39 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiary. ClearAg®, ClearAg +Insights™, ClearAg Mobile™, ClearPath Weather®, Edge®, EdgeConnect™, EMPower™, iPeMS®, Iteris®, +Next®, P10™, P100™, PedTrax™, Pegasus™, Radius™, SmartCycle®, SmartSpan®, TransitHelper®, +Vantage®, +VantageNext®, VantagePegasus®, VantageRadius™, Vantage Vector®, VantageLive!™, VantageView™, Velocity®, +VersiCam™ and WeatherPlot™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their +respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of +the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and +certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words +"expect(s)," "feel(s)," "believe(s)," "intend(s)," "plans," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are +intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, +capital needs, backlog, manufacturing capabilities, the market acceptance of our products, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, +the applications for and acceptance of our products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to +certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only +as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in "Risk Factors" +set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly +any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its subsidiary in this report as "Iteris," the "Company," "we," "our" and "us") is a provider +of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application of advanced technologies and software-based +information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface transportation systems +infrastructure. By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a broad range +of Intelligent Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. We believe our products, services and solutions, in conjunction with sound traffic +management, minimize the environmental impact of traffic congestion. +In +the agribusiness markets, we have combined our unique intellectual property with enhanced soil, land surface and agronomy modeling techniques to create a set of ClearAg solutions. +These solutions provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. We continue to make significant investments to leverage +our existing technologies and further expand our software-based information systems to offer solutions to the precision agriculture technology markets. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that location +is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Recent Developments +In March 2017, our subsidiary, Iteris Michigan LLC, was dissolved as a legal entity and ceased operating as a wholly-owned subsidiary of +the Company. +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Agriculture and Weather Analytics (formerly known +as our Performance Analytics segment). On April 1, 2016, certain operations that were previously within the Agriculture and Weather Analytics segment, specifically our performance measurement +and information management solution, iPeMS, and related traffic analytic consulting services, were reassigned to the Transportation Systems segment to better align our traffic analytics capabilities, +resources and initiatives. All prior segment information presented in this report has been reclassified to reflect this change. +The +Roadway Sensors segment provides various vehicle detection and information systems and products for traffic intersection control, incident detection and roadway traffic data +collection applications. The Transportation Systems segment includes transportation engineering and consulting services, iPeMS, our specialized transportation performance measurement and traffic +analytics solutions, as well as the development of transportation management and traveler information systems for the ITS industry. The Agriculture and Weather Analytics segment includes ClearPath +Weather, our road maintenance applications, and ClearAg, our precision agriculture solutions. See Note 13 of Notes to +4 +Table of Contents +Consolidated +Financial Statements, included in Part IV, Item 15 of this report, for further details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology and other techniques to capture and analyze sensor data +through sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among other +products, our Vantage, VantageLive!, VantageNext, VersiCam, Vantage Vector, SmartCycle, SmartSpan, PedTrax, Pegasus, P-series and Velocity products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radars. Our Vantage systems give traffic managers the ability to mitigate roadway congestion by +modifying traffic signal timing or detecting incidents quickly. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection +assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including stop bar +detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all of the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle and pedestrian detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar +sensing. Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a single video +detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection zones that can +be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +• Our Vantage systems equipped with PedTrax capability provides bi-directional counting and speed tracking of pedestrians within the cross-walk +to help improve signal timing efficiency and provides additional data stream to existing vehicle and bicycle counts. PedTrax is included with all new Vantage video detection systems, field-upgradable +for the latest Vantage hardware platforms, and utilizes previously installed non-intrusive sensor systems. +• Our VantageLive! is a cloud-based subscription service release that was announced on May 2, 2017. Our VantageLive! service allows users +to collect, process and analyze advanced intersection data, and to view and understand intersection activity. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, intersection controllers and +component cabinets. +5 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, development and +implementation of software and hardware-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and +management of surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and +identify mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and information management solution, iPeMS. iPeMS is a state-of-the-art information management software +suite that provides big data and software analytics solutions that help determine current and future traffic patterns, permitting the effective performance analysis and management of traffic +infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and +management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how +a transportation network is performing and to identify potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use visualization and +animation features based on historical traffic conditions. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent, on federal governmental funding. As such, our Transportation +Systems business has been adversely affected by governmental budgetary issues. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, +including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future +will continue to be dependent at least in part on the federal government's use of funds under the federal highway bill. Delays in the allocation of funds may prolong uncertainty regarding the +allotment of transportation funds in federal, state and local budgets. We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely +impact in the future, our Transportation Systems revenues and our overall financial performance in future periods. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearAg solutions and our ClearPath Weather management tools. Our ClearPath Weather tools provide winter road maintenance recommendations for state agencies, municipalities and for commercial +companies that allow such users to create solutions to meet roadway maintenance decision needs. +Our +Weather Analytics business is a market leader in performance management solutions for federal and state organizations. We intend to use our strong brand and deep experience in the +traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook a focused development activity to supplement our intellectual property, technology base and product suites to provide products and services for the +emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market, as well as the development of several +products +6 +Table of Contents +specifically +intended for the PA market. We refer to our products for the PA market generically as our ClearAg solutions. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems. By using our ClearAg digital +platform, growers, researchers and other agribusinesses can access and use a comprehensive database of historical, real-time and forecasted weather content, soil and plant health information, as well +as other useful crop growing information to make better agricultural decisions and improve the efficiency and sustainability of farmlands. Companies use our ClearAg platform to simulate field +conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers leverage ClearAg solutions to determine the best times to plant, spray, fertilize and +harvest their crops. +We +currently offer our ClearAg solutions on an enterprise basis using our modeling solutions and ClearAg application programming interfaces ("APIs"), which can allow the integration of +ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. The APIs facilitate the integration of such companies' processes and solutions with the +ClearAg modeling and forecasting engine. We commenced commercial sales of our ClearAg platform and the related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). +We +also offer our ClearAg solutions to individual agriculture producers or growers who can benefit from the advisories based on our platform that are tailored for their specific location +of interest. These solutions can be accessed in a web based-product or pursuant to our mobile applications. Our first mobile application, ClearAg Mobile, was introduced in the first quarter of our +fiscal year ended March 31, 2016 ("Fiscal 2016"). ClearAg Mobile is an analytics application for individual growers that leverages weather, water, soil and crop growth information to provide +growers with field local specific advisories that help improve the management of crop production operations. Our harvest advisory tools of our ClearAg mobile application help growers better understand +up-to-the-minute environmental impact of weather, water and soil on crop growth and health, and to plan their harvest operations accordingly. Our ClearAg WeatherPlot and ClearAg Insights are +applications that help agronomists and crop consultants identify ideal environmental conditions for treatments and make recommendations based on forecasted or historical weather, water and soil +analytics. +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, largely for +expanded sales and marketing resources, through internally generated cash flow from our Roadway Sensors and Transportation Systems operations, as well as revenues from our Agriculture and Weather +Analytics segment and our available cash on hand, if necessary. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell direct, we use +a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent distributors are trained +in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers and sell directly to +government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products +for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold +technical training classes for our distributors and end users and maintain a full-time +7 +Table of Contents +staff +of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to +accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions, and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +We +currently market and sell our ClearAg products as a subscription-based service to seed and crop protection companies, allied providers and agriculture integrators, as well as to +growers and retailers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically involve long lead times. We generally sell directly to +customers interested in the ClearAg API products, but typically sell through selling partners for our ClearAg applications. Versions of ClearAg Mobile and WeatherPlot are currently available in the +Apple app store and on Google Play. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components +are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing, +MoboTrex, Inc., and Sony Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume +at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for our fiscal year ended March 31, 2017 ("Fiscal 2017"), Fiscal 2016 and Fiscal 2015. We believe customer support is a key competitive +factor. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $64.5 million as of March 31, 2017, which included +$54.4 million related to Transportation Systems. We typically recognize approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and +currently expect that trend to continue for the near future for both Transportation Systems and Agriculture and Weather Analytics. Substantially the entire backlog for +Roadway Sensors as of March 31, 2017 is expected to be recognized as revenue in the fiscal year ending March 31, 2018. At +8 +Table of Contents +March 31, +2016, we had backlog of approximately $63.3 million, which included $53.3 million related to Transportation Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Agriculture and Weather Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $6.9 million for both Fiscal 2017 and 2016, and +$5.4 million for Fiscal 2015. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Agriculture and Weather +Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to focus our development efforts in the near future in our Agriculture +and Weather Analytics segment on our ClearAg products for the PA market; however, since 2014, our Roadway Sensors segment has introduced our VantageNext, Vantage Vector, PedTrax, SmartCycle, +SmartSpan, Pegasus, Velocity, and P-series, products. Additionally, during Fiscal 2016 and Fiscal 2017, we engaged in development activities of our ClearAg precision agriculture solutions, including +WeatherPlot and ClearAg mobile applications. We believe that developing new offerings across our segments and +enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning +and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that market +such as IBM/The Weather Company, MeteoGroup and agronomic analytics companies such as FBN and Famer's Edge. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and manufacturers +and distributors and other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant +9 +Table of Contents +vehicle +detection system in this market. Additionally, products such as Velocity and Pegasus compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation +engineering, planning and design include major regional ITS engineering firms, as well as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of thirty-one issued U.S. patents, +including: (i) nine relating to our Roadway Sensors technologies, four of which issued in fiscal year 2017, (ii) seventeen relating to our Agriculture and Weather Analytics technologies, +five of which issued in fiscal year 2017, and (iii) six relating specifically to our Transportation Systems technologies, two of which issued in fiscal year 2017. We have a total of +twenty-three pending patent applications in the U.S. and nine pending foreign patent applications. We intend to pursue additional patent protection to the extent we believe it would be beneficial and +cost effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +10 +Table of Contents +Employees +As of March 31, 2017, we employed 397 full-time employees and 35 part-time employees, for a total of 432 employees. None of our employees +are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not +involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds +in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the +near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on +our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in +this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our +other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not +the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks +actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part +of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues +and +fixed price contracts. A significant portion of our revenues are derived from contracts with governmental agencies, either as a general contractor, subcontractor +or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and +challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, delays in the +expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the +new administration; +• performance bond requirements; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements; +• changes in government policies and political agendas; +• milestone requirements and liquidated damage provisions for failure to meet contract milestones; and +11 +Table of Contents +• international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from +transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and +income to drop substantially or to fluctuate significantly between fiscal periods. +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs would adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the +convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any +material government contract could seriously harm our business, financial condition and results of operations. +We recently expanded our Agriculture and Weather Analytics capabilities to address a new market segment, the agricultural market, which may not broadly accept our technologies and +new +products. The application of precision analytics to the agricultural market is a relatively new development that has required us to invest, and is expected to +continue to require us to invest, in additional sales and marketing without any guarantee of a commensurate increase in revenues. The introduction of any new Agriculture and Weather Analytics products +and services could have longer than expected sales cycles, which could adversely impact our operating results. We cannot assure you that growers or other companies in this market will perceive the +value proposition of our Agriculture and Weather Analytics or that our new ClearAg products for this market, will achieve broad market acceptance in the near future or at all. If the agricultural +market fails to understand the benefit of our Agriculture and Weather Analytics products or chooses not to adopt our technologies, our business, financial condition and results of operations will be +adversely affected. +Uncertainty and delays in government funding for transportation infrastructure projects and initiatives have adversely impacted our revenues. There +was uncertainty in the past few years regarding allocation of government funds for transportation projects due to delays in the passage of a federal highway bill. On December 4, 2015, the +Fixing America's Surface Transportation ("FAST") Act was signed into law, providing $305 billion over five years for surface transportation projects and programs. Despite the recently enacted +FAST Act, delays in the allocation of such funds, the priority of infrastructure projects and the availability of funds for ITS related projects could continue to adversely impact our revenues and +overall financial performance. +We recently entered into the software development market and may be subject to additional challenges and additional costs and delays. We have only +been in the business of software development for a few years and may experience development and technical challenges. Our business and results of operations could also be seriously harmed by any +significant delays in our software development and updates. Despite testing and quality control, we cannot be certain that errors will not be found in our software after its release. Any faults or +errors in our existing products or in any new products may cause delays in +12 +Table of Contents +product +introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In +addition, the software development industry frequently experiences litigation concerning intellectual property disputes, which could be costly and distract our management. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely +decline. Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in the marketplace as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements successfully and in a cost-effective and timely manner, or are unable to achieve market acceptance +of our +new products, our operating results would be adversely affected. We believe our revenue growth and future operating results will depend on our ability to complete +development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production +costs. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, +the introduction of any new products could adversely affect the sales of certain of our existing products. +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in +response to evolving customer requirements. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected +if we do not anticipate or respond adequately to technological developments or changing customer requirements +or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead +to any corresponding increase in revenue. +If our security measures are breached and unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our web-based and mobile +application +services, we may incur significant liabilities, our services may be perceived as not being secure and customers may curtail or stop using our services, we could incur significant liability to our +customers and to individuals or businesses whose information was being stored, our business may suffer and our reputation will be damaged. Because techniques used +to obtain unauthorized access to, or to sabotage, systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to +implement adequate preventive measures. If an actual or perceived breach of our +13 +Table of Contents +security +occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and customers. +The markets in which we operate are highly competitive and have many more established competitors than us, which could adversely affect our revenues or the market acceptance of +our +products. We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many smaller +regional engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a small portion of the traffic intersection +market has adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broad market acceptance for such technologies. Certain technological barriers +to entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition +could result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local regional firms. +The +markets in which our Agriculture and Weather Analytics segment operates vary from public sector customers who focus on snow and ice management for state and county roadways, to +commercial sector customers who employ our environmental content and agronomic models. Our competitors include divisions of large, international weather companies, as well as a variety of small +providers in the road weather market. In the commercial agriculture sector, we compete with a variety of public and private entities that currently market software, agronomic analytics and weather +forecast capabilities to global agribusiness. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. If we are not able +to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations +will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure +agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products +that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the +laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or abroad. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the +14 +Table of Contents +future, +be subject to litigation regarding our intellectual property rights. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, +require us to license disputed rights from others or require us to cease marketing or using certain products or +technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have +infringed upon or misappropriated another party's intellectual property. Our recent expansion into software development activities may subject us to increased possibility of litigation. Any of the +foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and +expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and +results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profits. Our business +depends on our +ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. Contract proposals and negotiations are complex and frequently involve a lengthy +bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. For example, a customer may require us +to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions continue, or if we fail to secure adequate +financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue particular projects, which could reduce or eliminate our +profitability. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. Due +to the specialized +nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The loss of any of our officers, or +any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations. Our success will also depend in large part upon our ability +to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. +The +future success of our Transportation Systems segment will depend on our ability to hire additional qualified engineers, planners and technical personnel. The future success of our +Agriculture and Weather Analytics segment will depend on our ability to hire additional software developers, qualified engineers and technical personnel. Competition for qualified employees, +particularly development engineers and software developers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to +attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our Transportation Systems and Agriculture and Weather Analytics +workforce. The cost of providing our Transportation Systems and Agriculture and Weather Analytics engineering and consulting services, +including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, +including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +15 +Table of Contents +• our ability to match the skill sets of our employees to the needs of the marketplace. +An +inability to properly and fully utilize our Transportation Systems and Agriculture and Weather Analytics workforce could have an adverse effect on our results of operations. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in +our +operating results. Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In +addition, our past expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable +to manage these activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +We are currently not profitable on a consolidated basis and we may be unable to become profitable on a quarterly or annual basis. For the fiscal year +ended March 31, 2017, we had a net loss, and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by governmental +budgetary constraints, government and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from certain of our business +segments to fund investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support +those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease +in anticipated revenues or increases in planned investments. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund our +operations and achieve our business plan, and could cause the market price of our common stock to decline. +Our use of estimates in conjunction with the percentage of completion method of accounting for our Transportation Systems revenues could result in a reduction or reversal of +previously +recorded revenues and profits. A portion of Transportation Systems revenues are measured and recognized using the percentage of completion method of accounting. +Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs +expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could +occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program +management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including +reductions or reversals of previously recorded revenues and profits. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely +affected. Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial +reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to +obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis +and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +16 +Table of Contents +A +control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of +a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control +systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations +include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of +some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future +events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in +conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may +occur and not be detected. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could +cause +our stock price to decline. Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number +of factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as +increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• our ability to raise additional capital; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• seasonality due to winter weather conditions; +• seasonality with respect to revenues from our ClearPath Weather and related weather forecasting services due to the decrease in revenues +generated for such services during the spring and summer time periods; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely +manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +17 +Table of Contents +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +We may be subject to traffic related litigation. The traffic industry in general is subject to litigation claims due to the +nature of personal +injuries that result from traffic accidents. As a provider of traffic engineering services, products and solutions, we have been, and could in the future continue to be, from time to time, subject to +litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not +be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or +more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims +could cause us to incur significant expenses and result in a diversion of management's attention. +We rely on outside suppliers that could experience supply shortages or may experience production gaps that could materially and adversely impact our sales and financial +results. It is possible that we could experience unforeseen quality control issues or part shortages as we adjust production to meet current demand for our +products. We have historically used single suppliers for certain significant components in our products, and have had to reengineer products from time to time to address obsolete components, +especially in our Roadway Sensors products. Should any such delay or disruption occur, or should a key supplier discontinue operations, our future sales will likely be materially and adversely +affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we +believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many +of our products, if necessary, we could experience a production gap if for any reason our contract manufacturers were unable to meet our production requirements and our cost of goods sold could +increase, adversely affecting our margins. +We may engage in acquisitions of companies or technologies that may require us to undertake significant capital infusions and could result in disruptions of our business and +diversion of +resources and management +18 +Table of Contents +attention. We have completed two acquisitions since November 2011 and, in the future, we may acquire additional complementary businesses, products, and +technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information +system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits anticipated from any acquisition. +Our international business operations may be threatened by many factors that are outside of our control. While we historically +have had limited +international sales, revenues and operations experience, we have had transportation systems contracts in the United Arab Emirates ("UAE"), for which approximately $535,000 in performance bonds are yet +to be released by the UAE Department of Transportation. We also have been expanding our distribution capabilities for our Roadway Systems segment internationally, particularly in Canada, Australia, +New Zealand and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to +various inherent risks including, among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S. and each other country in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but +not limited to the U.S. Foreign Corrupt Practices Act; +19 +Table of Contents +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. We have +historically +experienced volatility in our earnings and cash flows from operations from year to year. Should the credit markets further tighten or our business declines, we may need or choose to raise additional +capital to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you +that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• potential acquisitions of businesses and product lines; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +20 +Table of Contents +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common +stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms, we may +be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The trading price of our common stock is highly volatile. The trading price of our common stock has been subject to wide +fluctuations in the past. +From April 1, 2014 through May 22, 2017, our common stock has traded at prices as low as $1.48 per share and as high as $6.15 per share. The market price of our common stock could +continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. +This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, +companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action +lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Certain provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common +stock. Certain provisions of our certificate of incorporation could make it difficult for a third party to acquire us, even though an acquisition might be +beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of +incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior +to those of our common stock. In August 2009, we adopted a new stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. Generally, the stockholder rights +plan provides that if a person or group acquires 15% or more of our common stock, subject to certain exceptions and under certain +21 +Table of Contents +circumstances, +the rights may be exchanged by us for common stock or the holders of the rights, other than the acquiring person or group, could acquire additional shares of our capital stock at a +discount off of the then current market price. Such exchanges or exercise of rights could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The +mere existence of a stockholder rights plan often delays or makes a merger, tender offer or other acquisition of the company more difficult. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 41,000 square feet of leased office, manufacturing and warehouse space +located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 9 of Notes to Consolidated Financial +Statements, included in Part IV, Item 15 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 9 of Notes to Consolidated Financial +Statements, included in Part IV, Item 15 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +22 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information and Holders +Our common stock is traded on the NASDAQ Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock +traded on the NYSE MKT under the same symbol. The following table sets forth, for the periods indicated, the highest and lowest sales prices for our common stock: +High +Low +Fiscal 2017 +Quarter Ended June 30, 2016 +$ +2.99 +$ +2.20 +Quarter Ended September 30, 2016 +4.04 +2.81 +Quarter Ended December 31, 2016 +3.79 +3.20 +Quarter Ended March 31, 2017 +5.64 +3.52 +Fiscal 2016 +Quarter Ended June 30, 2015 +$ +1.91 +$ +1.64 +Quarter Ended September 30, 2015 +2.96 +1.62 +Quarter Ended December 31, 2015 +2.65 +2.00 +Quarter Ended March 31, 2016 +2.65 +1.89 +On +June 5 , 2017, the last reported sales price of our common stock on the NASDAQ Capital Market was $6.11. As of June 5, 2017, we had 344 holders of record of our common +stock according to information furnished by our transfer agent. +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We +currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon +a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business +conditions, the consent of our lender and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to +$3.0 million of our outstanding common stock from time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of +$1.3 million. On August 9, 2012, our Board of Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new +stock repurchase program pursuant to which we may acquire up to $3.0 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares +from time to time in open-market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to an existing or future 10b5-1 trading plan to facilitate repurchases +during our closed trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. +On November 6, 2014, our Board of Directors approved a $3.0 million increase to our existing stock +23 +Table of Contents +repurchase +program, pursuant to which we may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +From +inception of the original stock repurchase program in August 2011 through March 31, 2017, we repurchased approximately 3,422,000 shares of our common stock for an aggregate +repurchase price of approximately $5.6 million at an average purchase price of $1.63 per share. We did not repurchase any shares of our common stock during Fiscal 2017. All repurchased shares +from prior periods have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2017, there was approximately $1.7 million of +remaining funds available under the stock repurchase program. +ITEM 6. SELECTED FINANCIAL DATA +Per the Securities and Exchange Commission ("SEC"), Financial Reporting Manual, Section 5120.1(c), an issuer that no longer qualifies as +a smaller reporting company at the determination date may continue to use the scaled disclosures permitted for a smaller reporting company through its annual report on Form 10-K and begin +providing non-scaled larger company disclosure in the first Form 10-Q of the next fiscal year. Although the Compnay is filing as an accelerated filer, the aforementioned SEC rule allows the +Company to continue reporting as a smaller reporting company in this Form 10-K. As such, we are not required to make any disclosure pursuant to this Item 6. +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and +related Notes thereto included in Part IV, Item 15 of this report and the "Risk Factors" section in Item 1A, as well as the other cautionary statements and risks described +elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview* +General. We are a provider of information solutions for the intelligent traffic systems ("ITS") and the precision agriculture +("PA") markets. In the +ITS market, we are focused on the development and application of advanced technologies and software-based information systems that reduce traffic congestion, provide measurement, management and +analytics, and that improve the efficiency and safety of surface transportation systems infrastructure. We believe our products, services and solutions, in conjunction with sound traffic management, +minimize the environmental impact of traffic congestion and enhance the adoption of advanced ITS solutions that are required for the deployment of connected and autonomous vehicles. In the PA market, +we have combined our unique intellectual property with enhanced soil, land surface, and agronomy modeling techniques utilizing our extensible EMPower hybrid computing architecture to create a set of +ClearAg™ solutions that provide weather, water, soil and agronomic analytics products to large and small, public and private, enterprises in the global agriculture market. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +In connection with the Asset Sale, we are entitled to additional consideration in the form of certain performance and royalty-related earn-outs through December 31, 2017. From the date of the +Asset Sale through March 31, 2017, we received approximately $2.1 million in connection with such royalty-related earn- out provisions. We also had +24 +Table of Contents +approximately +$240,000 in royalty-related receivables included in the prepaid expenses and other current assets in the accompanying consolidated balance sheet as of March 31, 2017. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment, and we determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, for additional +discussion regarding the Asset Sale. +Business Segments. Subsequent to the Asset Sale and our acquisition of BTS, we have operated in three reportable segments: +Roadway Sensors, +Transportation Systems and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides hardware and software products to multiple segments of the ITS market. These products primarily consist of various vehicle detection and information +systems used for traffic intersection control, communication and roadway traffic data collection applications. These include, among other products, our Vantage, VantageNext, VantageLive!, Vantage +Vector, VersiCam, Vantage Vector, SmartCycle, PedTrax, SmartSpan, Pegasus, Velocity, and P-series, products. +The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. As of April 1, 2016, our performance measurement and information management solution, iPeMS, and related traffic analytics consulting services, previously included in Agriculture +and Weather segment, were reassigned to the Transportation Systems segment to better align our traffic analytics capabilities, resources and initiatives. Prior segment information has been +reclassified to reflect this change. +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road-maintenance applications, and ClearAg, our precision agriculture platform. ClearPath Weather provides +winter road maintenance recommendations for state agencies, municipalities and for commercial companies. Our ClearAg platform provides access to a comprehensive database of weather, soil and agronomic +information combined with proprietary land-surface modeling and machine learning are essential to making informed agricultural decisions and is delivered through our ClearAg solutions, including our +ClearAg APIs and components, WeatherPlot mobile application, and ClearAg Insights applications. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements +included herein, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires management to make +estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the +reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to revenue recognition, the +collectability of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for stock-based +compensation, the valuation of equity instruments, warranty reserves and other contingencies. We base these estimates on historical experience and on various other factors that we believe to be +reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These +estimates and assumptions by their nature involve risks and uncertainties, and may +25 +Table of Contents +prove +to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assets and +liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Product revenues and related costs of sales are recognized when all of the following criteria are met: +(i) persuasive +evidence of an arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of +the receivable is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until receipt or acceptance by the customer. +Accordingly, at the date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Agriculture and Weather Analytics revenues are also derived from +long-term contracts with governmental agencies, as well as contracts with commercial companies. ClearAg revenues that are derived from contracts with commercial companies are from subscription revenue +that we typically invoice our customers at the beginning of the term, in multiyear, annual, semi-annual or quarterly installments and revenue is recognized ratably over the period of the subscription +beginning once all requirements for revenue recognition have been met, including provisioning the service so that it is available to our customers. When appropriate, revenues are recognized using the +percentage of completion method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. +Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final +contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues when their +realization is reasonably assured. Certain of our revenues are recognized as services are performed and amounts are earned, which is measured by time incurred or other contractual milestones or output +measures. Revenues accounted for in this manner generally relate to certain fixed fee professional services, cost-plus fixed fee or time-and-materials contracts. Revenues for ongoing operations and +maintenance services contracts are generally accounted for ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are deferred +and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent purchased intangible assets including +26 +Table of Contents +developed +technology, customer relationships, trade names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method +that reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight- line amortization +method over the estimated useful life of the asset. +We +evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. We have determined that our reporting units for +purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. We first assess qualitative factors to determine whether it is more likely than +not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, +we conduct a goodwill impairment test. The impairment test involves comparing the fair values of the applicable reporting units with their carrying values. We determine the fair values of our +reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. +In +Fiscal 2017, we adopted the provisions issued by the Financial Accounting Standards Board ("FASB") that were intended to simplify goodwill impairment testing. This guidance permits us +to eliminate the second step of the goodwill impairment test, and eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. If the +carrying amount of a reporting unit exceeds the reporting unit's fair value, the amount by which the +carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long-lived assets +and purchased intangible assets. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This +estimation process can result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so +that the year-to-date provision reflects the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall +effective tax rate from quarter to quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than- not threshold are reversed +in the first subsequent financial reporting period in which that threshold is no longer met. +27 +Table of Contents +The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are +subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be +materially different from our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the +estimated grant date fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our stock option awards as it does not consider certain factors important to those awards to employees, such as +continued employment and periodic vesting requirements, as well as limited transferability of the awards. The fair value of our restricted stock units is based on the closing market price of our +common stock on the grant date. If there are any modifications or +cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock- based compensation expense. +Recent Accounting Pronouncements +Refer to Note 1 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report for a discussion +of recent accounting pronouncements. +Results of Operations +The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated. +Year Ended March 31, +2017 +2016 +2015 +Total revenues +100.0 +% +100.0 +% +100.0 +% +Cost of revenues +61.0 +60.6 +61.0 +Gross profit +39.0 +% +39.4 +% +39.0 +% +Operating expenses: +Selling, general and administrative +34.6 +34.4 +33.8 +Research and development +7.2 +8.9 +7.5 +Amortization of intangible assets +0.3 +0.5 +0.6 +Change in fair value of contingent consideration +— +— +0.0 +Loss on impairment of goodwill +2.3 +— +— +Total operating expenses +44.4 +43.8 +41.9 +Operating loss +(5.4 +) +(4.4 +) +(2.9 +) +Non-operating income (expense): +Other (expense) income, net +(0.0 +) +0.0 +(0.0 +) +Interest income, net +0.0 +0.0 +0.0 +Loss from continuing operations before income taxes +(5.4 +) +(4.4 +) +(2.9 +) +Benefit (provision) for income taxes +0.0 +(11.7 +) +1.1 +Loss from continuing operations +(5.4 +) +(16.1 +) +(1.8 +) +Gain on sale of discontinued operation, net of tax +0.4 +0.3 +0.3 +Net loss +(5.0 +)% +(15.8 +)% +(1.5 +)% +28 +Table of Contents +Analysis of Fiscal 2017, Fiscal 2016 and Fiscal 2015 Results of Operations +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics +segments. The following table's present details of total revenues for Fiscal 2017 compared to Fiscal 2016, and Fiscal 2016 compared to Fiscal 2015: +Year Ended +March 31, +$ +Increase +% +Change +2017 +2016 +(In thousands, except percentages) +Total revenues +$ +95,982 +$ +77,748 +$ +18,234 +23.5 +% +Year Ended +March 31, +$ +Increase +% +Change +2016 +2015 +(in thousands, except percentages) +Total revenues +$ +77,748 +$ +72,251 +$ +5,497 +7.6 +% +Total +revenues for Fiscal 2017 increased approximately 23.5% to $96.0 million, compared to $77.7 million in Fiscal 2016, due primarily to increases of approximately 45% in +Transportation Systems revenues, approximately 5% in Roadway Sensors revenues, and approximately 34% in Agriculture and Weather Analytics revenues. +Total +revenues for Fiscal 2016 increased approximately 7.6% to $77.7 million, compared to $72.3 million in Fiscal 2015, due primarily to an increase of approximately 11% in +Roadway Sensors revenues and approximately 7% in Transportation Systems revenues. The increases in revenues were partially offset by a decrease of approximately 8% in Agriculture and Weather Analytics +revenues in Fiscal 2016. +Roadway +Sensors revenues in Fiscal 2017 increased approximately 5% compared to Fiscal 2016, primarily due to higher unit sales of our legacy Roadway Sensors products, slightly offset by +a decrease in our distribution of certain original equipment manufacturer ("OEM") products for the traffic intersection market. Revenue generated through the distribution of certain third party +products was approximately $4.8 million and approximately $5.3 million for Fiscal 2017 and Fiscal 2016, respectively. Roadway Sensors revenues in Fiscal 2016 increased approximately 11% +compared to Fiscal 2015, primarily due to higher unit sales of our legacy Roadway Sensors products, and to a lesser extent, due to increases in our distribution of certain original equipment +manufacturer ("OEM") products for the traffic intersection market. Revenue generated through the distribution of certain third party products was approximately $5.3 million and approximately +$5.0 million for Fiscal 2016 and Fiscal 2015, respectively. While OEM products generally have lower gross margins than our core video detection products, we believe the offering of OEM products +can benefit sales of our core products by providing a more comprehensive suite of traffic solutions for our customers. Going forward, we plan to grow revenues by focusing on our core domestic +intersection market, and refine and deliver products that address the needs of this market, primarily our Vantage processors and camera systems and our Vantage Vector video/radar hybrid sensor, as +well as our SmartCycle, Velocity, PedTrax and SmartSpan products. +Transportation +Systems revenues in Fiscal 2017 increased approximately 45% compared to Fiscal 2016, primarily as a result of one large contract win during the fourth quarter of Fiscal +2017 and two large contract wins during the third quarter of Fiscal 2016, which was a key contributor to positively impacting revenue growth in Fiscal 2017, as well as timing of backlog fulfilment on +certain other projects. Transportation Systems revenues in Fiscal 2016 increased approximately 7% compared to Fiscal 2015, primarily as a result of two large contract wins during the third quarter of +Fiscal 2016, which positively impacted revenue growth in our fourth quarter of Fiscal 2016, as well as timing of +29 +Table of Contents +backlog +fulfilment on certain other projects. While one of the aforementioned large contracts is expected to be near completion by the second quarter of our fiscal year ending March 31, 2018, +we plan to continue to pursue larger contracts that may contain significant sub-consulting content. While we believe larger contacts will contribute to overall revenue growth, the mix of +sub-consulting content will likely affect the related gross profit from period to period, as revenues derived from sub-consultants generally have lower gross margins than revenues generated by our +professional services. +Agriculture +and Weather Analytics revenues in Fiscal 2017 increased approximately 34% compared to Fiscal 2016, primarily due to increases in both ClearPath Weather and ClearAg solutions +under newly signed contracts during Fiscal 2017. Agriculture and Weather Analytics revenues in Fiscal 2016 increased approximately 8% compared to Fiscal 2015, primarily due to increases in both +ClearPath Weather and ClearAg solutions under newly signed contracts during Fiscal 2016. Going forward, we plan to continue investing in this segment, particularly in the research and development and +sales and marketing of the ClearAg and ClearPath Weather solutions. We also plan to pursue commercial opportunities in the precision agriculture technology markets by offering software applications, +content, and modeling services that provide analytics and decision support services that leverage our precision weather, soil and agronomic content and applications. +Gross Profit. The following tables present details of our gross profit for Fiscal 2017 compared to Fiscal 2016, and Fiscal 2016 +compared to Fiscal +2015: +Year Ended +March 31, +$ +Increase +% +Change +2017 +2016 +(In thousands, except percentages) +Gross profit +$ +37,402 +$ +30,669 +$ +6,733 +22.0 +% +Gross profit as a % of total revenues +39.0 +% +39.4 +% +Year Ended +March 31, +$ +Increase +% +Change +2016 +2015 +(in thousands, except percentages) +Gross profit +$ +30,669 +$ +28,182 +$ +2,487 +8.8 +% +Gross profit as a % of total revenues +39.4 +% +39.0 +% +Our +total gross profit as a percentage of total revenues for Fiscal 2017 decreased approximately 40 basis points compared to Fiscal 2016 primarily due to higher revenues derived +from our Transportation Systems segment, which has generally experienced lower gross profits than our other segments and which increased to approximately 51.3% of our total revenues for Fiscal 2017, +as compared to 43.9% for Fiscal 2016. Transportations Systems revenues generally carry lower gross margins than Roadway Sensors and Agriculture and Weather Analytics revenues. Therefore, the increase +in Transportation Systems revenues, as a percentage of our overall revenue mix, decreased our overall margin. +Our +total gross profit as a percentage of total revenues for Fiscal 2016 increased approximately 40 basis points compared to Fiscal 2015 primarily due to higher revenues derived +from our Roadway Sensors segment, which has generally experienced higher gross profits than our other segments and which increased to approximately 51.8% of our total revenues for Fiscal 2016, as +compared to 50.3% for Fiscal 2015. Roadway Sensors revenues generally carry higher gross margins than Transportation Systems and Agriculture and Weather Analytics revenues. Therefore, the increase in +Roadway Sensors revenues had a positive impact on our overall margin. The increase in gross profit as a percentage of total revenues was also attributable to an increase in Transportation Systems +gross profit percentage, primarily due to timing of revenue recognition on certain projects and an increase in the percentage of revenue generated by internal labor compared to revenue generated by +our sub-consultants, which typically generates lower profit margins. +30 +Table of Contents +We +recognize a portion of our Transportation Systems and Agriculture and Weather Analytics revenues and related gross profit using percentage of completion contract accounting, and the +underlying mix of contract activity affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future +periods due to our contract mix and the amount of related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could +cause fluctuations in our margins from period to period. +Selling, General and Administrative Expense +The following table presents selling, general and administrative expense for Fiscal 2017 and Fiscal 2016: +Year Ended March 31, +2017 +2016 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +23,025 +24.0 +% +$ +18,546 +23.9 +% +$ +4,479 +24.2 +% +Facilities, insurance and supplies +3,233 +3.4 +2,727 +3.5 +506 +18.6 +Travel and conferences +2,503 +2.6 +2,136 +2.7 +367 +17.2 +Professional and outside services +4,407 +4.6 +2,658 +3.4 +1,749 +65.8 +Other +145 +0.2 +779 +1.0 +(634 +) +(81.4 +) +Selling, general and administrative +$ +33,313 +34.8 +% +$ +26,846 +34.5 +% +$ +6,467 +24.1 +The +overall increase in selling, general and administrative expense for Fiscal 2017, as compared to Fiscal 2016, was primarily due to planned headcount increases in corporate +headquarters general and administrative positions, as well as planned investments in Agriculture and Weather Analytics sales and marketing, including an increase in the salesforce headcount, which +resulted in higher salary and personnel-related costs. The increases in general and administrative expense were also due to legal costs incurred to reach a proxy contest settlement during our second +quarter of Fiscal 2017 and legal costs incurred for the recent stockholder litigation (refer to Note 9 of Notes to Consolidated Financial Statements). The increases in general and +administrative were also attributable to additional costs for internal control framework to comply with Sarbanes-Oxley standards as an accelerated filer. These increases were partially offset by a +reversal of certain bad debt reserves that were placed on specific accounts receivable that were collected during Fiscal 2017. +The +following table presents selling, general and administrative expense for Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2016 +2015 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +18,546 +23.9 +% +$ +15,896 +22.0 +% +$ +2,650 +16.7 +% +Facilities, insurance and supplies +2,727 +3.5 +2,522 +3.5 +205 +8.1 +Travel and conferences +2,136 +2.7 +1,681 +2.3 +455 +27.1 +Professional and outside services +2,658 +3.4 +3,982 +5.5 +(1,324 +) +(33.2 +) +Other +779 +1.0 +344 +0.5 +435 +126.5 +Selling, general and administrative +$ +26,846 +34.5 +% +$ +24,425 +33.8 +% +$ +2,421 +9.9 +31 +Table of Contents +The +overall increase in selling, general and administrative expense for Fiscal 2016, as compared to Fiscal 2015, was primarily due to planned investments in Agriculture and Weather +Analytics sales and marketing, including an increase in the salesforce headcount, as well as increased headcount in general and administrative positions, which resulted in higher salary and +personnel-related costs. The overall increase for Fiscal 2016 was also attributable to certain transition costs relating to the Company's previous CEO and interim CEO. These increases in sales, +marketing, general and administrative expenses were offset by decreases in professional and outside services for audit fees incurred during Fiscal 2015 in connection with the audit of our financial +statements for Fiscal 2014. As previously disclosed, the Company delayed its Fiscal 2014 earnings release and the filing of its Annual Report on Form 10-K for Fiscal 2014 until +September 3, 2014, due to additional procedures performed by its auditors related to contract revenue testing. As a result of these additional procedures and related delays, we incurred an +increase of approximately $940,000 in audit fees during the first and second +quarters of Fiscal 2015. We also incurred an increase of approximately $175,000 in service fees for the review of our Fiscal 2015 quarters. In addition, in Fiscal 2015, we incurred approximately +$770,000 of outside professional consulting costs to assist with the completion of the Fiscal 2014 annual audit and the Fiscal 2015 quarterly reviews. +Research and Development Expense. +The following table presents research and development expense for Fiscal 2017 and Fiscal 2016: +Year Ended March 31, +2017 +2016 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +(Decrease) +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +3,949 +4.1 +% +$ +3,325 +4.3 +% +$ +624 +18.8 +% +Facilities, development and supplies +2,278 +2.4 +2,404 +3.1 +(126 +) +(5.2 +) +Other +650 +0.7 +1,204 +1.5 +(554 +) +(46.0 +) +Research and development +$ +6,877 +7.2 +% +$ +6,933 +8.9 +% +$ +(56 +) +(0.8 +) +Research +and development expense for Fiscal 2017 compared to Fiscal 2016, was relatively consistent as the Company continues to invest in research, discovery, and development. +In +the Agriculture and Weather Analytics segment, we continued to invest in the development of ClearAg and ClearPath Weather solutions. ClearAg products include historical, real-time and +forecast weather content, soil and crop growth information, and other useful crop health information to provide solutions in the precision agriculture technology markets. We successfully released +generally available versions of a set of ClearAg products during the first half of Fiscal 2016, as well as our iOS Mobile Application that launched in our fourth quarter of Fiscal 2016. We also +released a number of generally available advisory applications during Fiscal 2017, including our Harvest Advisory and Nitrogen Advisory. Certain development costs were capitalized into intangible +assets in the consolidated balance sheets; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect +to continue to invest in our Agriculture and Weather Analytics segment to enhance the ClearAg and ClearPath Weather solutions. This continued investment may result in increases in research and +development costs in future periods. +32 +Table of Contents +The +following table presents research and development expense for Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2016 +2015 +Amount +% of +Revenues +Amount +% of +Revenues +$ +Increase +% +Change +(In thousands, except percentages) +Salary and personnel-related +$ +3,325 +4.3 +% +$ +2,674 +3.7 +% +$ +651 +24.3 +% +Facilities, development and supplies +2,404 +3.1 +1,543 +2.1 +861 +55.8 +Other +1,204 +1.5 +1,179 +1.6 +25 +2.1 +Research and development +$ +6,933 +8.9 +% +$ +5,396 +7.5 +% +$ +1,537 +28.5 +The +overall increase in research and development expense for Fiscal 2016 compared to Fiscal 2015, was primarily due to an increase in headcount, which resulted in higher salary and +personnel-related costs. The increases were also attributable to research costs for certain software and application developments in the Agriculture and Weather Analytics segment and investments in +securing intellectual property rights. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2017, we determined the fair value of the Agriculture and Weather Analytics reporting unit +was less than its carrying amount and resulted in approximately $2.2 million impairment charge in the consolidated result of operations. We also determined our Roadway Sensors and +Transportation Systems reporting units had no impairment, as their estimated fair values exceeded their respective carrying values. Based on our goodwill impairment testing for Fiscal 2016 and 2015, +we believe the carrying value of our goodwill was not impaired, as the estimated fair values of our reporting units exceeded their carrying values at the end of such fiscal years. If our actual +financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill +impairment charges in the future. +Interest Income (Expense), Net +Net interest income was approximately $13,000 in Fiscal 2017. Net interest expense was approximately $12,000 and $6,000 in Fiscal 2016 and +Fiscal 2015, respectively. +Income Taxes +The following table presents our (benefit) provision for income taxes for Fiscal 2017, Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2017 +2016 +2015 +(In thousands, except +percentages) +(Benefit) provision for income taxes +$ +(44 +) +$ +9,079 +$ +(816 +) +Effective tax rate +0.8 +% +(262.6 +)% +39.0 +% +For +Fiscal 2017, the difference between the statutory and the effective tax rate is primarily attributable to the valuation allowance maintained against our deferred tax assets. +For +Fiscal 2016, the difference between the statutory and the effective tax rate was primarily attributable to the recording of a valuation allowance against our deferred tax assets. +33 +Table of Contents +For +Fiscal 2015, the difference between the statutory and the effective tax rate was primarily attributable to state income taxes. Additionally, the effective tax rate for Fiscal 2015 +was favorably impacted by the recognition of approximately $233,000 of tax credits, partially offset by permanent non-deductible tax items, including share-based payments and other permanent +differences amounting to approximately $156,000. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As of December 31, 2015, the Company had generated a cumulative pre-tax loss over the trailing three +years. As such, we considered it appropriate to record a valuation allowance of approximately $10.1 million in our third quarter of +Fiscal 2016 against our deferred tax assets. We continuously reassess the appropriateness of maintaining a valuation allowance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective +tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to +the extent that we believe these assets will more likely than not be realized. +At +March 31, 2017, we had $5.6 million of federal net operating loss carryforwards and $1.4 million of state net operating loss carryforwards that begin to expire in +2022 and 2031, respectively. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax +payments, that would otherwise be higher using statutory tax rates. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations, borrowings under credit facilities and the sale +of equity securities. We currently rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least the next +twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to +the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may +experience significant dilution and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure funding on a +timely basis, on terms acceptable to us, or at all. +At +March 31, 2017, we had $22.7 million in working capital, which included $18.2 million in cash and cash equivalents and reflected no borrowings on our line of +credit, which expired on October 1, 2016 and was +not renewed. This compares to working capital of $24.3 million at March 31, 2016, which included no borrowings on our line of credit and $16.0 million in cash and cash +equivalents. +The +following table summarizes our cash flows for Fiscal 2017, Fiscal 2016 and Fiscal 2015: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +2,903 +$ +(4,110 +) +$ +3,577 +Investing activities +(1,343 +) +(978 +) +(844 +) +Financing activities +612 +(844 +) +(1,186 +) +34 +Table of Contents +Operating Activities. Cash provided by our operations during Fiscal 2017 was primarily the result of approximately +$3.6 million of working +capital provided and offset by our net loss of approximately $4.8 million, adjusted by approximately $4.2 million in non-cash items for deferred income taxes, depreciation, stock-based +compensation, amortization, gain on sales of discontinued operations, loss on disposal of equipment and loss on impairment of goodwill. +Cash +used in our operations during Fiscal 2016 was primarily the result of our net loss of approximately $12.3 million, adjusted by approximately $10.5 million in non-cash +items, of which approximately $9.0 million related to the change in our deferred income taxes and related valuation allowance recorded against our federal net operating loss carryforwards. Such +non-cash items also included higher stock-based compensation primarily due to the recent large equity grant to our new CEO, as well as depreciation, amortization, gain on the sale of discontinued +operation and loss on disposal of property and equipment. Cash used in our operations was also driven by approximately $2.3 million used in working capital. +Cash +provided by our operations in Fiscal 2015 was primarily the result of approximately $4.6 million provided by improvements in our accounts receivables, unbilled accounts +receivable and deferred revenue, net, and accounts payable and accrued expenses. Cash provided by operations was also attributable to approximately $1.5 million of non-cash items for +depreciation, amortization and stock-based compensation expense. This was offset by a decrease of approximately $0.5 million used in working capital for inventories. +Investing Activities. Cash used in our investing activities during Fiscal 2017 consisted of approximately $1.2 million of +capitalized software +development in the Agriculture and Weather Analytics and Roadway Sensors business segments related to ClearAg assets and VantageLive! development, respectively, and approximately $668,000 for +purchases of property and equipment, primarily related to computers and related equipment which were offset by approximately $495,000 in proceeds from the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2016 consisted of approximately $856,000 for purchases of property and equipment, primarily related to computers and related equipment +and approximately $490,000 of capitalized software development in the Agriculture and Weather Analytics business segment related to ClearAg assets, which were offset by approximately $368,000 in +proceeds from the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2015 consisted of approximately $986,000 for purchases of property and equipment, primarily related to leasehold improvements on our +headquarters facility, which was offset by approximately $142,000 in proceeds from the sale of the Vehicle Sensors segment. +Financing Activities. Net cash provided by financing activities during Fiscal 2017 was primarily the result of approximately +$612,000 of cash +proceeds received from the exercises of stock options. +Net +cash used in financing activities during Fiscal 2016 was primarily the result of approximately $1.2 million in cash used to repurchase shares of our common stock under our +stock repurchase program, which was offset by approximately $383,000 of cash proceeds received from the exercises of stock options. +Net +cash used in financing activities during Fiscal 2015 was primarily the result of approximately $863,000 in cash used to repurchase shares of our common stock under our stock +repurchase program and approximately $336,000 in cash used for the final deferred payment for the prior acquisition of BTS. +35 +Table of Contents +Borrowings +We previously had a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expired on +October 1, 2016. We were obligated to pay an unused line fee of 0.15% per annum applied to the average unused portion of the revolving line of credit during the preceding month. We chose not to +renew our line of credit as we do not foresee a need to utilize credit within the next twelve months, and we will avoid paying an unused line fee. +Off-Balance Sheet Arrangements +Other than our operating leases, which are further described at Note 9 of Notes to Consolidated Financial Statements, included in +Part IV, Item 15 of this report, we do not have any other material off-balance sheet arrangements at March 31, 2017. +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such sales in +our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally +impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal quarter due to +the increased number of holidays, causing a reduction in available billable hours. In addition, we have experienced seasonality related to certain ClearPath Weather services, which adversely impacts +such sales in our first and second fiscal quarters, mainly because these services are generally not required during Spring and Summer when weather conditions are comparatively milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +Our exposure to interest rate risk was limited to our line of credit, which expired on October 1, 2016 and was not renewed. +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The financial statements and supplementary data required by Regulation S- X are included in Part IV, Item 15 of this +report. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and +Chief Executive Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the +Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure +controls and procedures were effective as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized +and +36 +Table of Contents +reported +in a timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, +to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2017 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated +Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2017. The +effectiveness of our internal control over financial reporting as of March 31, 2017 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as +stated in their report, which is included herein. +ITEM 9B. OTHER INFORMATION +None. +37 +Table of Contents +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +(a) Identification of Directors. The information under the caption "Election of Directors," appearing in our +proxy statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +(b) Identification of Executive Officers. The information under the caption "Executive Compensation and Other +Information—Executive Officers," appearing in our proxy statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +(c) Compliance with Section 16(a) of the Exchange Act. The information under the caption +"Section 16(a) Beneficial Ownership Reporting Compliance," appearing in our proxy statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +(d) Corporate Governance. The information under the caption "Corporate Governance," appearing in our proxy +statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +(e) Audit Committee. The information under the caption "Board Meetings and Committees—Audit +Committee," appearing in our proxy statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 11. EXECUTIVE COMPENSATION +The information under the caption "Executive Compensation and Other Information," appearing in our proxy statement for the 2017 Annual Meeting +of Stockholders, is incorporated herein by reference. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information under the captions "Equity Compensation Plans" and "Principal Stockholders and Common Stock Ownership of Certain Beneficial +Owners and Management," appearing in our proxy statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in our proxy +statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information under the caption "Fees Paid to Independent Registered Public Accounting Firm," appearing in our proxy statement for the 2017 +Annual Meeting of Stockholders, is incorporated herein by reference. +38 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. The following financial statements of Iteris, Inc. are included in a separate +section of this Annual Report on Form 10-K commencing on the pages referenced below: +Report of Independent Registered Public Accounting Firm +43 +Consolidated Balance Sheets as of March 31, 2017 and 2016 +46 +Consolidated Statements of Operations for the fiscal years ended March 31, 2017, 2016 and 2015 +47 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2017, 2016 and 2015 +48 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2017, 2016 and 2015 +49 +Notes to Consolidated Financial Statements +50 +2. Exhibits . +The +exhibits listed on the accompanying Exhibit Index immediately following the financial statements are filed or furnished as part of, or hereby incorporated by reference into, this +report. +39 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to +be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 13, 2017 +ITERIS, INC. +(Registrant) +By +/s/ JOE BERGERA +JOE BERGERA +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Andrew C. Schmidt, +and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to +sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said +attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all +intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause +to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ JOE BERGERA +Joe Bergera +Director, President and Chief Executive Officer (principal executive officer) +June 13, 2017 +/s/ ANDREW C. SCHMIDT +Andrew C. Schmidt +Chief Financial Officer (principal financial and accounting officer) +June 13, 2017 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Chairman of the Board +June 13, 2017 +/s/ D. KYLE CERMINARA +D. Kyle Cerminara +Director +June 13, 2017 +40 +Table of Contents +Signature +Title +Date +/s/ KEVIN C. DALY +Kevin C. Daly, Ph.D +Director +June 13, 2017 +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 13, 2017 +/s/ MIKEL WILLIAMS +Mikel Williams +Director +June 13, 2017 +/s/ SCOTT E. DEETER +Scott E. Deeter +Director +June 13, 2017 +41 +Table of Contents +Iteris, Inc. +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm +43 +Consolidated Balance Sheets as of March 31, 2017 and 2016 +46 +Consolidated Statements of Operations for the fiscal years ended March 31, 2017, 2016 and 2015 +47 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2017, 2016 and 2015 +48 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2017, 2016 and 2015 +49 +Notes to Consolidated Financial Statements +50 +42 +Table of Contents +Report of Independent Registered Public Accounting Firm +To +the Board of Directors and Stockholders +Iteris, Inc. +We +have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiary (the "Company") as of March 31, 2017 and 2016, and the related consolidated +statements of operations, stockholders' equity, and cash flows for the years ended March 31, 2017 and 2016. We also have audited the Company's internal control over financial reporting as of +March 31, 2017, based on criteria +established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal +control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated +financial statements and an opinion on the Company's internal control over financial reporting based on our audits. The consolidated financial statements of the Company for the year ended +March 31, 2015 were audited by other auditors whose report, dated June 17, 2015, expressed an unqualified opinion on those statements. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material +respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting +principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an +understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control +based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our +opinions. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +43 +Table of Contents +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Iteris, Inc. and +subsidiary as of March 31, 2017 and 2016, and the consolidated results of their operations and their cash flows for the years ended March 31, 2017 and 2016, in conformity with accounting +principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of +March 31, 2017, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of +Sponsoring Organizations of the Treadway Commission. +/s/ Deloitte & Touche LLP +Costa Mesa, California +June 13, 2017 +44 +Table of Contents +Report of Independent Registered Public Accounting Firm +To +the Board of Directors and Stockholders +Iteris, Inc. +We +have audited the accompanying consolidated statements of operations, stockholders' equity, and cash flows for the year ended March 31, 2015, of Iteris, Inc. and +subsidiaries (the Company) (collectively, the financial statements). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these +financial statements based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audit provides a reasonable basis for our opinion. +In +our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations of Iteris, Inc. and subsidiaries and +their cash flows for the year ended March 31, 2015, in conformity with U.S. generally accepted accounting principles. +/s/ RSM US LLP +Irvine, California +June 17, 2015 +45 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2017 +2016 +Assets +Current assets: +Cash and cash equivalents +$ +18,201 +$ +16,029 +Trade accounts receivable, net of allowance for doubtful accounts of $389 and $714 at March 31, 2017 and March 31, 2016, +respectively +14,299 +13,241 +Unbilled accounts receivable +6,456 +5,250 +Inventories +2,250 +3,153 +Prepaid expenses and other current assets +2,108 +1,505 +Total current assets +43,314 +39,178 +Property and equipment, net +2,064 +2,139 +Intangible assets, net +1,498 +951 +Goodwill +15,150 +17,318 +Other assets +319 +434 +Total assets +$ +62,345 +$ +60,020 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +7,886 +$ +5,469 +Accrued payroll and related expenses +6,443 +5,719 +Accrued liabilities +2,201 +1,445 +Deferred revenue +4,049 +2,294 +Total current liabilities +20,579 +14,927 +Deferred rent +649 +750 +Deferred income taxes +707 +685 +Unrecognized tax benefits +186 +196 +Total liabilities +22,121 +16,558 +Commitments and contingencies (Note 9) +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 +Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2017 and March 31, 2016 Issued and outstanding shares—32,488 at March 31, 2017 and 32,048 +at March 31, 2016 +3,249 +3,205 +Additional paid-in capital +136,968 +135,424 +Accumulated deficit +(99,993 +) +(95,167 +) +Total stockholders' equity +40,224 +43,462 +Total liabilities and stockholders' equity +$ +62,345 +$ +60,020 +See accompanying notes. +46 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2017 +2016 +2015 +Total revenues +$ +95,982 +$ +77,748 +$ +72,251 +Cost of revenues +58,580 +47,079 +44,069 +Gross profit +37,402 +30,669 +28,182 +Operating expenses: +Selling, general and administrative +33,313 +26,846 +24,425 +Research and development +6,877 +6,933 +5,396 +Amortization of intangible assets +281 +360 +431 +Change in fair value of contingent consideration +— +— +9 +Loss on impairment of goodwill +2,168 +— +— +Total operating expenses +42,639 +34,139 +30,261 +Operating loss +(5,237 +) +(3,470 +) +(2,079 +) +Non-operating income (expense): +Other (expense) income, net +(7 +) +2 +(20 +) +Interest income, net +13 +12 +6 +Loss from continuing operations before income taxes +(5,231 +) +(3,456 +) +(2,093 +) +Benefit (provision) for income taxes +44 +(9,079 +) +816 +Loss from continuing operations +(5,187 +) +(12,535 +) +(1,277 +) +Gain on sale of discontinued operation, net of tax +361 +214 +207 +Net loss +$ +(4,826 +) +$ +(12,321 +) +$ +(1,070 +) +Loss per share from continuing operations—basic and diluted +$ +(0.16 +) +$ +(0.39 +) +$ +(0.04 +) +Gain per share from sale of discontinued operation—basic and diluted +$ +0.01 +$ +0.01 +$ +0.01 +Net loss per share—basic and diluted +$ +(0.15 +) +$ +(0.38 +) +$ +(0.03 +) +Shares used in basic per share calculations +32,174 +32,049 +32,595 +Shares used in diluted per share calculations +32,174 +32,049 +32,595 +See accompanying notes. +47 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at March 31, 2014 +32,788 +$ +3,280 +$ +135,986 +$ +(81,776 +) +$ +57,490 +Stock option exercises +24 +2 +31 +— +33 +Stock-based compensation +— +— +398 +— +398 +Issuance of shares pursuant to vesting of restricted stock units +72 +7 +(27 +) +— +(20 +) +Repurchases of common stock +(473 +) +(47 +) +(816 +) +— +(863 +) +Net loss +— +— +— +(1,070 +) +(1,070 +) +Balance at March 31, 2015 +32,411 +3,242 +135,572 +(82,846 +) +55,968 +Stock option exercises +243 +24 +359 +— +383 +Stock-based compensation +— +— +659 +— +659 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +50 +5 +(37 +) +— +(32 +) +Repurchases of common stock +(656 +) +(66 +) +(1,129 +) +— +(1,195 +) +Net loss +(12,321 +) +(12,321 +) +Balance at March 31, 2016 +32,048 +3,205 +135,424 +(95,167 +) +43,462 +Stock option exercises +388 +40 +628 +— +668 +Stock-based compensation +— +— +976 +— +976 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +52 +4 +(60 +) +— +(56 +) +Repurchases of common stock +— +— +— +— +— +Net loss +(4,826 +) +(4,826 +) +Balance at March 31, 2017 +32,488 +$ +3,249 +$ +136,968 +$ +(99,993 +) +$ +40,224 +See accompanying notes. +48 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Year Ended March 31, +2017 +2016 +2015 +Cash flows from operating activities +Net loss +$ +(4,826 +) +$ +(12,321 +) +$ +(1,070 +) +Adjustments to reconcile net loss to net cash provided by (used in) operating activities: +Deferred income taxes +12 +8,859 +(749 +) +Depreciation of property and equipment +729 +649 +525 +Stock-based compensation +976 +659 +398 +Amortization of intangible assets +623 +526 +597 +Change in fair value of contingent consideration +— +— +9 +Gain on sale of discontinued operation, net of tax +(361 +) +(214 +) +(207 +) +Loss on disposal of equipment +14 +58 +17 +Loss on impairment of goodwill +2,168 +— +— +Changes in operating assets and liabilities, net of effects of discontinued operation: +Accounts receivable +(1,058 +) +(2,035 +) +1,143 +Unbilled accounts receivable and deferred revenue, net +549 +(239 +) +1,705 +Inventories +903 +(91 +) +(516 +) +Prepaid expenses and other assets +(408 +) +(407 +) +9 +Accounts payable and accrued expenses +3,582 +446 +1,716 +Net cash provided by (used in) operating activities +2,903 +(4,110 +) +3,577 +Cash flows from investing activities +Purchases of property and equipment +(668 +) +(856 +) +(986 +) +Capitalized software development costs +(1,170 +) +(490 +) +— +Net proceeds from sale of business segment +495 +368 +142 +Net cash used in investing activities +(1,343 +) +(978 +) +(844 +) +Cash flows from financing activities +Deferred payment for prior business combination +— +— +(336 +) +Repurchases of common stock +— +(1,195 +) +(863 +) +Proceeds from stock option exercises +668 +383 +33 +Tax withholding payments for net share settlements of restricted stock units +(56 +) +(32 +) +(20 +) +Net cash provided by (used in) financing activities +612 +(844 +) +(1,186 +) +Increase (decrease) in cash and cash equivalents +2,172 +(5,932 +) +1,547 +Cash and cash equivalents at beginning of period +16,029 +21,961 +20,414 +Cash and cash equivalents at end of period +$ +18,201 +$ +16,029 +$ +21,961 +Supplemental cash flow information: +Cash paid during the year for: +Interest +$ +14 +$ +18 +$ +30 +Income taxes +166 +177 +141 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units +5 +5 +7 +Landlord contribution for tenant improvements +— +— +328 +See accompanying notes. +49 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its subsidiary in these consolidated financial statements as "Iteris," the "Company," "we," +"our" and "us") is a provider of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application of advanced +technologies and software-based information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface +transportation systems infrastructure. By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, +we offer a broad range of Intelligent Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. In the agribusiness markets, we have combined our intellectual +property with enhanced soil, land surface and agronomy modeling techniques to create a set of ClearAg solutions. These solutions provide analytical software solutions to large and small enterprises in +the global agriculture market. We continue to make significant investments to leverage our existing technologies and further expand our software-based information systems to offer solutions to the +precision agriculture technology markets. Iteris was incorporated in Delaware in 1987. +In +March 2017, our subsidiary, Iteris Michigan LLC, was dissolved as a legal entity and ceased operating as a wholly-owned subsidiary of the Company. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and its subsidiary and have been prepared in accordance with +generally accepted accounting principles in the United States of America ("GAAP"). All intercompany accounts and transactions have been eliminated in consolidation. +The +results of continuing operations for all periods presented in the consolidated financial statements exclude the financial impact of a discontinued operation. See Note 3, "Sale +of Vehicle Sensors," for further discussion related to the discontinued operation presentation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions +that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses +during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the collectability of +accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves, costs to complete long-term +contracts, indirect cost rates used in cost-plus contracts, contract reserves, the valuation of purchased intangible assets and goodwill, the valuation of equity instruments and estimates of future +cash flows used to assess the recoverability of long-lived assets and the impairment of goodwill and fair value of our stock option awards used to calculate the stock-based compensation. +50 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Revenue Recognition +Product revenues and related costs of sales are recognized when all of the following criteria are met: (i) persuasive evidence of an +arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the receivable +is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until receipt or acceptance by the customer. Accordingly, at the +date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Agriculture and Weather Analytics revenues are also derived from +long-term contracts with governmental agencies, as well as contracts with commercial companies. Agriculture and Weather Analytics revenues that are derived from contracts with commercial companies are +from subscription revenue that we typically invoice our customers at the beginning of the term, in multiyear, annual, semi-annual or quarterly installments and revenue is recognized ratably over the +period of the subscription beginning once all requirements for revenue recognition have been met, including provisioning the service so that it is available to our customers. When appropriate, +revenues are +recognized using the percentage of completion method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the relationship of costs incurred to +total estimated costs. Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, including those arising from contract +penalty provisions and final contract settlements, may result in revisions to costs and revenues, and are recognized in the period in which the revisions are determined. Profit incentives are included +in revenues, when their realization is reasonably assured. Certain of our revenues are recognized as services are performed and amounts are earned, which is measured by time incurred or other +contractual milestones or output measures. Revenues accounted for in this manner generally relate to certain fixed fee professional services, cost plus fixed fee or time and materials contracts. +Revenues for ongoing operations and maintenance services contracts are generally accounted for ratably as the services are performed throughout the term of the contract. Payments received in advance +of services performed are deferred and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple element arrangement where neither vendor +specific objective evidence ("VSOE") nor third party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +51 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Unbilled Accounts Receivable +Unbilled accounts receivable in the accompanying consolidated balance sheets represent unbilled amounts earned and reimbursable under services +sales arrangements, including approximately $362,000 of costs and estimated earnings in excess of billings on uncompleted contracts accounted for under Financial Accounting Standards Board ("FASB") +Accountind Standards Codification ("ASC") 605-35, Construction-Type and Production-Type Contracts . At any given period-end, a large portion of the +balance in this account represents the accumulation of labor, materials and other costs that have not been billed due to timing, whereby the accumulation of each month's costs and earnings are not +administratively billed until the subsequent month. Also included in this account are amounts that will become billable according to contract terms, which usually require the consideration of the +passage of time, achievement of milestones or completion of the project. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of cash collected from customers and billings to customers on +contracts in advance of work performed, advance payments negotiated as a contract condition, estimated losses on uncompleted contracts, project-related legal liabilities and other project-related +reserves, including approximately $798,000 of billings in excess of costs and estimated earnings on uncompleted contracts accounted for under FASB ASC 605-35. The unearned amounts are expected to be +earned within the next twelve months. +We +record provisions for estimated losses on uncompleted contracts in the period in which such losses become known. The cumulative effects of revisions to contract revenues and estimated +completion costs are recorded in the accounting period in which the amounts become evident and can be reasonably estimated. These revisions can include such items as the effects of change orders and +claims, warranty claims, liquidated damages or other contractual penalties and adjustments for contract closeout settlements. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade +accounts receivable. +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in the Middle East, Europe, South America and Asia. We generally +do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within +management's expectations. +52 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +We +have historically had a diverse customer base. For the fiscal year ended March 31, 2017 ("Fiscal 2017"), one individual customer represented greater than 10% of our total +revenues. For the fiscal year ended March 31, 2016 ("Fiscal 2016") and the fiscal year ended March 31, 2015 ("Fiscal 2015"), no individual customer represented more than 10% of our total +revenues. +Fair Values of Financial Instruments +The fair value of cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of the short period of +time to maturity. +Cash and Cash Equivalents +Cash and cash equivalents consist of cash and short-term investments with initial maturities of ninety days or less. +Prepaid Expenses and Other Current Assets +Prepaid expenses and other current assets were $2.1 million as of March 31, 2017 and $1.5 million as of March 31, +2016 and included approximately $535,000 of cash designated as collateral on performance bonds, as required under certain of our Transportation Systems contracts in the Middle East. The performance +bonds require us to maintain 100% cash value of the bonds as collateral in a bank that is local to the purchasing agency. The performance bond collateral is required throughout the delivery of our +services and is maintained in the local bank until the contract is closed by the purchasing agency. We expect these requirements, and the related cash collateral restrictions, to be released during +2017. +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or market. Cost is determined using +the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging from three +to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +53 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Goodwill and Long-Lived Assets +We evaluate goodwill on an annual basis in our fourth fiscal quarter or more frequently if we believe indicators of impairment exist. We have +determined that our reporting units for purposes of testing for goodwill impairment are identical to our reportable segments for financial reporting purposes. We first assess qualitative factors to +determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting +unit is less than its carrying amount, we conduct a goodwill impairment test. The impairment test involves comparing the fair values of the applicable reporting units with their carrying values. We +determine the fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. +In +Fiscal 2017, we adopted the provisions issued by the FASB that were intended to simplify goodwill impairment testing. This guidance permits us to eliminate the second step of the +goodwill impairment test, and eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. If the carrying amount of a reporting unit +exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators +for goodwill impairment testing between annual tests. As of March 31, 2017, we determined the carrying amount of the goodwill in the Agriculture and Weather Analytics reporting unit exceeded +it's implied fair value, and as a result, recognized an approximate $2.2 million impairment loss in the accompanying consolidated financial statements. We also determinted that no adjustments +to the carrying value of its goodwill and intangible assets were required in the Roadway Sensors and Transportation Systems reporting units. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets +and purchased intangible assets. As of March 31, 2017, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary +differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation +allowance is recorded when it is more-likely-than-not +that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. As such, we determined it was appropriate to record a +valuation allowance of approximately $10.1 million in the third quarter of our Fiscal 2016 against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a +valuation allowance. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in +54 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +the +first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first +subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of +our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock units. The +fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our common stock option awards as it does not consider certain factors important to those awards to employees, +such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common +stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned +stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Advertising Expenses +Advertising costs are expensed in the period incurred and totaled $146,000, $164,000 and $134,000 in Fiscal 2017, Fiscal 2016 and Fiscal 2015, +respectively. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to +various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. +55 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to +one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and +maintenance costs are charged to expense as incurred. +Comprehensive Income +Comprehensive income equals net income for all periods presented. +Recent Accounting Pronouncements +In May 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with +Customers ("ASU 2014-09"), which establishes principles for reporting revenue and cash flows arising from an entity's contracts with customers. This new revenue recognition +standard will replace most of the recognition guidance within GAAP. This guidance was deferred by ASU No. 2015-14, Revenue from Contracts with Customers (Topic +606): Deferral of the Effective Date, issued by the FASB in August 2015, and is now effective for fiscal years beginning on or after December 15, 2017 with early +adoption permitted as of the original effective date. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus +Agent Considerations , which further clarifies the implementation guidance in ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): +Identifying Performance Obligations and Licensing , to expand the guidance on identifying performance +obligations and licensing within ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical +Expedients , which amends the guidance in the new revenue standard on collectability, noncash consideration, presentation of sales tax, and transition. The amendments are +intended to address implementation issues that were raised by stakeholders and provide additional practical expedients to reduce the cost and complexity of applying the new revenue standard. These +standards are effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. We anticipate that these standards will have an impact on our +consolidated financial statements and we are still evaluating the significance of the impact. +In +July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11") to simplify the +guidance on the measurement of inventory. Under the new standard, an entity should measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices +in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The standard is effective for interim and annual periods beginning after +December 15, 2016. We do not anticipate a significant impact on our consolidated financial statements upon adoption of ASU 2015-11. +In +November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17") to simplify the +presentation of deferred taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. ASU 2015-17 is effective for public companies for annual reporting +periods beginning after December 15, 2016, and interim periods within those fiscal years. The standard may be adopted prospectively or retrospectively and early adoption is +56 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +permitted. +We early adopted ASU 2015-17, prospectively, in our fourth quarter of Fiscal 2016, which did not have a material impact on our consolidated financial statements. +In +February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). The pronouncement requires an entity to recognize assets +and liabilities for the rights and obligations created by leases on the entity's balance sheet for both finance and operating leases. For leases with a term of 12 months or less, an entity can +elect to not recognize lease assets and lease liabilities and expense the lease over a straight-line basis for the term of the lease. ASU 2016-02 will require new disclosures that depict the amount, +timing, and uncertainty of cash flows pertaining to an entity's leases. Companies are required to adopt the new standard using a modified retrospective approach for annual and interim periods +beginning after December 15, 2018. Early adoption of ASU 2016-02 is permitted. We are currently evaluating the impact of ASU 2016-02 on our consolidated financial statements. +In +March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based +Payment Accounting ("ASU 2016-09"), which is intended to simplify several aspects of accounting for share-based compensation arrangements, including the income tax impact, +classification on the statement of cash flows and forfeitures. The guidance will be effective for the fiscal year beginning after December 15, 2016, including interim periods within that year. +We are currently evaluating the impact of ASU 2016-09 on our consolidated financial statements. +In +August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash +Payments ("ASU 2016-15"), which clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new standard is +effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. We are currently evaluating the impact of +ASU 2016-15 on our consolidated financial statements. +In +November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash ("ASU 2016-18"), requiring +restricted cash and cash equivalents to be included with cash and cash equivalents on the statement of cash flows. The new standard is effective for fiscal years, and interim periods within those +years, beginning after December 15, 2017, with early adoption permitted. We are currently evaluating the impact of ASU 2016-18 on our consolidated financial statements. +In +December 2016, the FASB issued ASU No. 2016-19, Technical Corrections and Improvements ("ASU 2016-19"), which clarifies +guidance, corrects errors and makes minor improvements affecting a variety of topics in the ASC. The new standard is effective upon issuance (December 14, 2016) for amendments that do not have +transition guidance, with all other amendments effective for fiscal years, and interim +periods within those years, beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of ASU 2016-19 on our consolidated financial statements. +In +December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with +Customers ("ASU 2016-20"), which allows entities not to make quantitative disclosures about remaining performance obligations in certain cases and requires entities that use +any of the new or previously existing optional exemptions to expand their qualitative +57 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +disclosures. +The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted. We are currently +evaluating the impact of ASU 2016-20 on our consolidated financial statements. +In +January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill +Impairment ("ASU 2017-04"), eliminating the second step of the goodwill impairment test, and eliminating the requirements for any reporting unit with a zero or negative +carrying amount to perform a qualitative assessment. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early +adoption permitted. We chose to early adopt ASU 2017-04 in our fourth quarter of Fiscal 2017, which had an impact on our consolidated financial statements, as we recognized a goodwill impairment loss +in our Agriculture and Weather Analytics reporting unit. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2017 +2016 +(In thousands) +Materials and supplies +$ +887 +$ +1,754 +Work in process +298 +217 +Finished goods +1,065 +1,182 +$ +2,250 +$ +3,153 +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2017 +2016 +(In thousands) +Equipment +$ +7,078 +$ +6,530 +Leasehold improvements +2,494 +2,463 +Accumulated depreciation +(7,508 +) +(6,854 +) +$ +2,064 +$ +2,139 +Depreciation +expense was approximately $729,000, $649,000 and $525,000 in Fiscal 2017, Fiscal 2016 and Fiscal 2015, respectively. Approximately $269,000, $252,000 and $225,000 of the +depreciation expense was recorded to cost of revenues, and approximately $460,000, $397,000 and $300,000 was recorded to operating expenses Fiscal 2017, Fiscal 2016 and Fiscal 2015, respectively, in +the consolidated statement of operations. +58 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +2. Supplementary Financial Information (Continued) +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, +2017 +2016 +Gross +Carrying +Amount +Accumulated +Amortization +Gross +Carrying +Amount +Accumulated +Amortization +(In thousands) +Technology +$ +1,856 +$ +(1,828 +) +$ +1,856 +$ +(1,708 +) +Customer contracts / relationships +750 +(726 +) +750 +(622 +) +Trade names and non-compete agreements +1,110 +(1,066 +) +1,110 +(1,008 +) +Capitalized software development costs +2,158 +(756 +) +988 +(415 +) +Total +$ +5,874 +$ +(4,376 +) +$ +4,704 +$ +(3,753 +) +Amortization +expense for intangible assets subject to amortization was approximately $623,000, $526,000 and $597,000 for Fiscal 2017, Fiscal 2016 and Fiscal 2015, respectively. +Approximately $342,000, $166,000 and $166,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $281,000, $360,000 and $431,000 was recorded to amortization +expense for Fiscal 2017, Fiscal 2016 and Fiscal 2015, respectively, in the consolidated statement of operations. +We +do not have any intangible assets with indefinite useful lives. As of March 31, 2017, the future estimated amortization expense of approximately $1.5 million is +associated with our Agriculture and Weather Analytics and Roadway Sensors business segments, as follows: +Year Ending March 31, +(In thousands) +2018 +$ +650 +2019 +571 +2020 +277 +$ +1,498 +Refer +to Note 4 for additional information regarding intangible assets acquired during the last three fiscal years. +59 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +2. Supplementary Financial Information (Continued) +Goodwill +The following table presents the activity related to the carrying value of our goodwill by reportable segment for Fiscal 2015, Fiscal 2016 and +Fiscal 2017: +Roadway +Sensors +Transportation +Systems +Ag & Weather +Analytics +Total +(In thousands) +Balance—March 31, 2015 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +6,936 +$ +2,168 +$ +17,318 +Balance—March 31, 2016 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +8,214 +6,936 +2,168 +17,318 +Balance—March 31, 2017 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Balance at beginning of fiscal year +$ +193 +$ +181 +$ +184 +Additions charged to cost of sales +382 +236 +134 +Warranty claims +(297 +) +(224 +) +(137 +) +Balance at end of fiscal year +$ +278 +$ +193 +$ +181 +60 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +2. Supplementary Financial Information (Continued) +Earnings Per Share +The following table sets forth the computation of basic and diluted loss from continuing operations per share: +Year Ended March 31, +2017 +2016 +2015 +(In thousands, except +per share amounts) +Numerator: +Loss from continuing operations +$ +(5,187 +) +$ +(12,535 +) +$ +(1,277 +) +Denominator: +Weighted average common shares used in basic computation +32,174 +32,049 +32,595 +Dilutive stock options +— +— +— +Dilutive restricted stock units +— +— +— +Dilutive warrants +— +— +— +Weighted average common shares used in diluted computation +32,174 +32,049 +32,595 +Loss from continuing operations per share: +Basic +$ +(0.16 +) +$ +(0.39 +) +$ +(0.04 +) +Diluted +$ +(0.16 +) +$ +(0.39 +) +$ +(0.04 +) +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted loss per share from continuing operations as +their effect would have been anti-dilutive: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Stock options +3,491 +3,220 +2,252 +Restricted stock units +179 +186 +198 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial Vehicle +Systems LLC ("Bendix"), a member of Knorr-Bremse Group. In connection with the asset sale, we are entitled to additional consideration in the form of the following performance and +royalty-related earn-outs: Bendix is obligated to pay us an amount in cash equal to 85% of revenue associated with royalties received under our license and distribution agreements with Audiovox +Electronics Corporation and Valeo Schalter and Sensoren GmbH through December 31, 2017, subject to certain reductions and limitations set forth in the asset purchase agreement. From the +date of the asset sale, through March 31, 2017, we received +61 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +3. Sale of Vehicle Sensors (Continued) +approximately +$2.1 million in connection with royalty-related earn-outs provisions for a total of $17.4 million in cash from the asset sale. +In +accordance with applicable accounting guidance, we determined that the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a discontinued operation. +For the fiscal year ended March 31, 2017, 2016 and 2015, we recorded a gain on sale of discontinued operation of approximately $361,000, $214,000 and $207,000, respectively, net of tax, related +to the earn-out provisions of the asset purchase agreement. +4. Acquisitions +Berkeley Transportation Systems, Inc. +In the fiscal year ended March 31, 2012 ("Fiscal 2012"), we acquired all of the outstanding capital stock of Berkeley Transportation +Systems, Inc. ("BTS"). BTS was a privately-held company based in Berkeley, California, which specialized in transportation performance measurement. BTS' Performance Measurement System leverages +its real-time data collection, diagnostic, fusion and warehousing platform to aggregate and compute performance measures. This information is used to analyze how a transportation system is performing +based on pre-determined measures of effectiveness such as stops, delays and travel time. Our primary reasons for the acquisition were to add key +technologies to complement our iPeMS solutions and strengthen our performance measurement and management initiative as a whole. +Our +consolidated financial statements for Fiscal 2017, Fiscal 2016 and Fiscal 2015 include the results of operations of BTS. On or shortly after the acquisition date, we paid a total of +approximately $840,000 in cash to the shareholders of BTS. On December 17, 2012, the Company entered into an amendment to the BTS stock purchase agreement, which modified certain earn out +provisions, and as a result, the Company paid $700,000 in cash to the former BTS shareholders for achievement of those modified earn-out provisions in our fourth quarter of the fiscal year ended +March 31, 2013 ("Fiscal 2013"). The amendment did not have a material impact on previous estimated amounts accrued in connection with the earn-out provisions. This payment completed the +Company's obligation under the earn- out provisions of the agreement. During the third quarter of the fiscal year ended March 31, 2014 ("Fiscal 2014"), the Company paid $250,000 pursuant to +certain holdback provisions. Additionally, the Company paid the BTS shareholders approximately $336,000 in November 2014 pursuant to certain deferred payment provisions. These payments completed all +of the Company's obligations under the purchase agreement. +5. Impairment of Goodwill +As discussed in Note 1, goodwill is tested for impairment on an annual basis in our fourth fiscal quarter or more frequently if indicators of impairment exist. +Based +on our goodwill impairment testing for Fiscal 2017, we believe the carrying value of our goodwill in our Agriculture and Weather Analytic reporting unit was impaired as of +March 31, 2017, and resulted in approximately $2.2 million impairment charge. We also determined our Roadway Sensors and Transportation Systems reporting units were not impaired as of +March 31, 2017. Based on our goodwill impairment testing for Fiscal 2016 and 2015, we believe the carrying value of our goodwill +62 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +5. Impairment of Goodwill (Continued) +was +not impaired, as the estimated fair values of our reporting units exceeded their carrying values at the end of such fiscal years. If our actual financial results, or the plans and estimates used +in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +6. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets and liabilities; Level 2, defined as observable inputs +other than Level 1 prices such as quoted prices for similar assets or liabilities or prices quoted in inactive markets; and Level 3, defined as unobservable inputs that are significant +to the fair value of the asset or liability, and for which little or no market data exists, therefore requiring management to utilize its own assumptions to provide its best estimate of what market +participants would use in valuing the asset or liability. +We +did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2017 or 2016. Our +non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets +such as a purchase transaction, a business combination or an adjustment for impairment. In Fiscal 2017, Level 3 inputs were used to evaluate the fair value of our goodwill in our three +reporting units. As a result of our impairment testing, we recorded an adjustment for impairment of approximately $2.2 million in our Agriculture and Weather Analytics reporting unit. No other +non- financial assets were measured at fair value during the fiscal years ended March 31, 2017, 2016, and 2015. +7. Credit Facility +We had a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expired on October 1, 2016. We chose not to renew our line of credit as +we do not foresee a need to utilize credit within the next twelve months. As of March 31, 2016, no amounts were outstanding under the credit facility with CB&T. +63 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +8. Income Taxes +The components of current and deferred federal and state income tax (benefits) provision are as follows: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Current income tax provision: +Federal +$ +71 +$ +170 +$ +3 +State +62 +50 +49 +Deferred income tax provision (benefit): +Federal +(166 +) +8,289 +(655 +) +State +(11 +) +570 +(213 +) +Net income tax (benefit) provision +$ +(44 +) +$ +9,079 +$ +(816 +) +The +components of income tax (benefit) expense consist of the following: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Current income tax expense +$ +133 +$ +220 +$ +52 +Deferred income tax expense (benefit) +1,061 +1,232 +(781 +) +Benefit of operating loss carryforwards +(1,238 +) +(1,316 +) +(87 +) +Recording of valuation allowance +— +8,943 +— +Net income tax (benefit) provision +$ +(44 +) +$ +9,079 +$ +(816 +) +The +reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +(Benefit) for income taxes at statutory rates +$ +(1,778 +) +$ +(1,175 +) +$ +(712 +) +State income taxes net of federal benefit +(124 +) +(184 +) +(108 +) +Impairment charges +737 +— +— +Tax credits +(125 +) +(258 +) +(148 +) +Change in fair value of contingent acquisition consideration +— +— +3 +Compensation charges +29 +91 +88 +Change in valuation allowance +1,148 +10,557 +— +Other +69 +48 +61 +(Benefit) provision for income taxes +$ +(44 +) +$ +9,079 +$ +(816 +) +64 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +8. Income Taxes (Continued) +The components of deferred tax assets and liabilities are as follows: +March 31, +2017 +2016 +(In thousands) +Deferred tax assets: +Net operating losses +$ +830 +$ +2,468 +Capitalized R&D +5,003 +3,557 +Credit carry forwards +2,387 +2,130 +Deferred compensation and payroll +2,064 +1,306 +Bad debt allowance and other reserves +820 +665 +Deferred rent +313 +335 +Property and equipment +521 +— +Other, net +255 +242 +Total deferred tax assets +12,193 +10,703 +Valuation allowance +(11,726 +) +(10,561 +) +Total deferred tax assets, net of valuation allowance +467 +142 +Deferred tax liabilities: +Property and equipment +— +(71 +) +Acquired intangibles +(467 +) +(71 +) +Goodwill +(707 +) +(685 +) +Total deferred tax liabilities +(1,174 +) +(827 +) +Net deferred tax liabilities +$ +(707 +) +$ +(685 +) +At +March 31, 2017, we had $1.1 million in federal alternative minimum tax credit carryforwards that can be carried forward indefinitely, and $922,000 in federal research +credits that begin to expire in 2031. We also had $555,000 in state tax credits that begin to expire in 2023. We had $5.6 million of federal net operating loss carryforwards at +March 31, 2017 that begin to expire in 2022. We also had $1.4 million of state net operating loss carryforwards at March 31, 2017 that begin to expire in 2031. +Our +deferred tax assets at March 31, 2017 do not include approximately $1.1 million of excess tax benefits from employee stock option exercises that are a component of our +net operating loss carryforwards. If and when such excess tax benefits are realized, stockholders' equity will be increased. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As of December 31, 2015, the Company had generated a cumulative pre-tax loss over the trailing three +years. As such, we considered it appropriate to record a valuation allowance of approximately $10.1 million in our third quarter of Fiscal 2016 against our deferred tax assets. We will +continuously reassess the appropriateness of maintaining a valuation allowance. +65 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +8. Income Taxes (Continued) +Unrecognized Tax Benefits +As of March 31, 2017 and 2016, our gross unrecognized tax benefits were $426,000 and $394,000, respectively, of which $286,000 and +$251,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are $359,000 and $328,000, respectively. +We +recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31, 2017 and 2016, we had accrued cumulatively $46,000 and $52,000, +respectively, for the payment of potential interest and penalties. The total amount of interest and penalties recognized in the consolidated statements of operations for the fiscal years ended +March 31, 2017 and 2016 was $(6,000) and $5,000, respectively. +A +reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +394 +$ +319 +$ +281 +Increases for tax positions taken in prior years +18 +22 +14 +Decreases for tax positions taken in prior years +(8 +) +— +(3 +) +Increases for tax positions taken in the current year +59 +68 +46 +Lapse in statute of limitations +(37 +) +(15 +) +(19 +) +Gross unrecognized tax benefits at March 31 +$ +426 +$ +394 +$ +319 +We +do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We +are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2014 or later, and state and local income tax examination for fiscal tax years ended March 31, 2013 or +later. However, if NOL carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +9. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural +industries, the Company has in the past been, and may in the future be from time to time, involved in litigation relating to claims arising out of its operations in the normal course of business. +While the Company cannot accurately predict the outcome of any such litigation, except as described below, the Company is not a party to any legal proceeding, the outcome of which, in management's +opinion, individually or in the aggregate, would have a material effect on the Company's consolidated results of operations, financial position or cash flows. +On +September 15, 2016, a stockholder class action and derivative action (captioned Ionni v. Bergera, et al., Case +No. 16-cv00807-RGA) was filed in the United States District Court for the District +66 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +9. Commitments and Contingencies (Continued) +of +Delaware (the "Court") against certain of the Company's current and former directors and officers (the "Individual Defendants") and the Company as a nominal defendant (together with the Individual +Defendants, the "Defendants"). The complaint asserts claims for breach of fiduciary duty and unjust enrichment. Plaintiff contends that, in 2014 and 2015, the Individual Defendants caused the Company +to issue purportedly false and misleading proxy statements in connection with the Company's annual +meeting of stockholders in 2014 and 2015 (collectively, the "Proxy Statements"). In those Proxy Statements, the Company's stockholders were asked to approve amendments (the "Amendments") to increase +the number of shares of the Company's common stock reserved for issuance under the Iteris, Inc. 2007 Omnibus Incentive Plan (the "2007 Plan"). Among other things, Plaintiff alleges that the +Proxy Statements were materially false and misleading because they affirmatively represented that no person could receive more than 500,000 stock options or SARs under the 2007 Plan in any fiscal year +(the "Share Limit") and failed to disclose that the Compensation Committee had the discretion to approve an annual grant to a 2007 Plan participant in excess of that amount. Plaintiff contends that, +in voting to approve the Amendments, the Company's stockholders were not fully informed and, therefore, the Amendments were not valid. Plaintiff seeks rescission of any stock options granted pursuant +to the Amendments, including the option to purchase up to 1,350,000 shares of the Company's common stock that was granted in September 2015 to Mr. Bergera (the "CEO Option") in connection with +his appointment to serve as President and Chief Executive Officer of the Company. +The +Individual Defendants deny that they breached their fiduciary duties and the Company believes the Amendments were properly approved and that all of the options granted pursuant to +the Amendments, including the CEO Option, were valid. Nonetheless, to eliminate the burden, expense and uncertainty of the litigation, on November 8, 2016, the parties entered into a Memorandum +of Understanding ("MOU") setting forth their agreement in principle to resolve the litigation. In consideration for a release of claims and dismissal of this litigation with prejudice, the Company +agreed to submit a proposal at its 2016 Annual Meeting of Stockholders seeking stockholder approval for that portion of the CEO Option that exceeds the Share Limit (i.e., the 850,000 options +above the Share Limit (the "Excess Shares")). The Company submitted a proposal of the Excess Shares for approval by the Company stockholders at the 2016 Annual Meeting of Stockholders. On +December 15, 2016, the Company's stockholders approved the Excess Shares. +On +April 28, 2017, the parties entered into a Stipulation of Settlement and Compromise (the "Stipulation") that provides for, among other things, a release of claims against +Defendants. Under the Stipulation, Defendants agreed not to oppose any award of attorneys' fees and expenses to Plaintiff up to $215,000. On May 2, 2017, the parties filed a motion for +preliminary approval of the settlement. On May 11, 2017, the Court issued an order requesting briefing from the parties regarding the scope of the proposed release in the settlement, and on +May 22, 2017, Defendants and Plaintiff each filed a letter brief to the Court in response to the order. On June 2, 2017, the Court issued an Order granting the motion for preliminary +approval, approving notice of the settlement, and scheduling a settlement approval hearing for September 8, 2017. We recorded an immaterial accrued liability for the settlement in the +accompanying consolidated balance sheet as of March 31, 2017. +67 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +9. Commitments and Contingencies (Continued) +Operating Leases +In May 2007, we entered into an agreement to lease 52,000 square feet of office space in Santa Ana, California for a term of +88 months. In September 2007, we relocated our headquarters and principal operations into this space. The monthly lease rate was $102,000 during the first year of the lease and increased each +year thereafter, to $120,000 per month during the last year of the lease. In February 2014, we entered into an amendment to the lease, which reduced our office space by approximately 11,000 square +feet and changed the lease term to 96 months, commencing on April 1, 2014. The monthly lease rate is approximately $76,000 during the first year of the amended term and increases each +year thereafter, up to a maximum of approximately $90,000 during the last year of the term. Additionally, the lease amendment provided for approximately $328,000 in incentives in the form of tenant +improvement allowances, which we recorded as fixed assets and deferred rent in our consolidated balance sheet. The leasehold improvements were capitalized into fixed assets during Fiscal 2015 and will +be depreciated over the estimated useful life of the improvements, or the term of the lease amendment, whichever is shorter. The corresponding deferred rent amount will reduce monthly rent expense +over the term of the lease amendment. On January 23, 2017, we entered into an amendment to the lease, which added approximately 5,980 square feet and will expire after 60 months, +commencing on April 1, 2017. The monthly lease rate is approximately $14,000 during the first year of the term and increase each year thereafter, up to a maximum of approximately $16,000 during +the last year of the term. Additionally, the lease amendment provided for approximately $119,000 in incentives in the form of tenant improvement allowances. +We +have lease commitments for facilities in various locations throughout the U.S., as well as for certain equipment. Future minimum rental payments under these non-cancelable operating +leases at March 31, 2017 were as follows: +Year Ending March 31, +(In thousands) +2018 +$ +1,906 +2019 +2,100 +2020 +1,872 +2021 +1,813 +2022 +1,725 +Thereafter +288 +$ +9,704 +Rent +expense totaled approximately $1.7 million for each of Fiscal 2017, Fiscal 2016 and Fiscal 2015. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. +The sublease terminated in September 2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated on +July 23, 2013. The amended and restated note bears +68 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +9. Commitments and Contingencies (Continued) +interest +at a rate of 6% per annum, compounded annually, with accrued interest payable quarterly on the first business day of each calendar quarter. Maxxess continues to pay down the balance of this +note by providing consulting services to Iteris, although we have previously fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of +March 31, 2017, approximately $146,000 of the original principal balance was outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes one former Iteris +director, who has not been a director of Iteris since September 2013, and one existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +Inventory Purchase Commitments +At March 31, 2017, we had firm commitments to purchase approximately $6.7 million of inventory, operating assets and other +supplies, which are expected to occur primarily during the first and second quarters of the fiscal year ended March 31, 2018. +10. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to +issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or +restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2017 and 2016, there were no outstanding shares of +preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior +Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between +Iteris and Computershare Trust Company, N.A., as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of Designations, which +created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred +stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. +69 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +10. Stockholders' Equity (Continued) +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2017: +Number of Shares +(In thousands) +Stock options outstanding +3,776 +Restricted stock units outstanding +232 +Authorized for future issuance under stock incentive plans +2,443 +6,451 +11. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares +of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date +of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. The 2007 Plan also allows for +the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to satisfy stock +option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for +issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized +and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of +shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the +2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December 2016, our +stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs", cash incentive awards and +other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options +expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. Stock appreciation rights, restricted stock, RSUs +and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. +We +currently maintain both the 2007 Plan and the 2016 Plan. Of these plans, we may only grant future awards from the 2016 Plan. As of the 2016 Annual Meeting of Stockholders, no future +shares could be granted under the 2007 Plan. At March 31, 2017, there were approximately 2.4 million shares +70 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +11. Employee Benefit Plans (Continued) +of +common stock available for grant under the 2016 plan. As of March 31, 2017, options to purchase approximately 2,942,000 shares of common stock, as well as 93,000 RSUs, were outstanding under +the 2007 Plan and options to purchase approximately 835,000 shares of common stock, as well as 139,000 RSUs, were outstanding under the 2016 Plan. +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2017 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2016 +3,309 +$ +2.07 +Granted +905 +4.81 +Exercised +(388 +) +1.72 +Forfeited +(37 +) +2.25 +Expired +(13 +) +2.06 +Options outstanding at March 31, 2017 +3,776 +$ +2.76 +8.0 +$ +10,115 +Options exercisable at March 31, 2017 +1,396 +$ +1.99 +6.4 +$ +4,822 +Vested and expected to vest at March 31, 2017 +3,406 +$ +2.66 +7.8 +$ +9,483 +Options exercisable at March 31, 2017 pursuant to a change-in-control +3,776 +$ +2.76 +8.0 +$ +10,115 +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under +the 2007 Plan vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs +granted under the 2016 Plan vest at varying terms between one and four anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. +The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +71 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +11. Employee Benefit Plans (Continued) +A +summary of activity with respect to our RSUs for Fiscal 2017 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2016 +173 +$ +2.00 +Granted +141 +4.98 +Vested +(68 +) +1.93 +Forfeited +(14 +) +2.05 +RSUs outstanding at March 31, 2017 +232 +$ +3.84 +1.8 +$ +477 +Expected to vest at March 31, 2017 +180 +$ +3.83 +1.7 +$ +377 +Common stock issuable (for RSUs) at March 31, 2017 upon a change-in-control +232 +$ +3.84 +1.8 +$ +477 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of +operations: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Cost of revenues +$ +51 +$ +42 +$ +21 +Selling, general and administrative expense +858 +567 +315 +Research and development expense +67 +50 +62 +Total stock-based compensation +$ +976 +$ +659 +$ +398 +At +March 31, 2017, there was approximately $2.8 million and $700,000 of unrecognized compensation expense related to unvested stock options and RSUs, respectively. This +expense is currently expected to be recognized over a weighted average period of approximately 2.8 years for stock options and 1.8 years for RSUs. If there are any modifications or +cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based compensation expense +and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +72 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +11. Employee Benefit Plans (Continued) +The +grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended +March 31, +2017 +2016 +2015 +Expected life—years +6.5 +7.2 +7.7 +Risk-free interest rate +2.2 +% +1.9 +% +2.0 +% +Expected volatility of common stock +40 +% +47 +% +50 +% +Dividend yield +— +% +— +% +— +% +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2017 +2016 +2015 +(In thousands, except per +share amounts) +Weighted average grant date fair value per share of options granted +$ +2.11 +$ +1.19 +$ +1.01 +Intrinsic value of options exercised +$ +1,061 +$ +135 +$ +9 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No +contributions were made during the fiscal years ended March 31, 2017, 2016 and 2015. +We +sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible associates voluntarily contribute to the plan, up to IRS maximums, through +payroll deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the +401(k) Plan were approximately $881,000, $716,000 and $495,000 for the fiscal years ended March 31, 2017, 2016 and 2015, respectively. +12. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no +73 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +12. Stock Repurchase Program (Continued) +guarantee +as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of +Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from +time to time for an unspecified length of time. +For +our fiscal year ended March 31, 2017, we did not repurchase any shares. For our fiscal year ended March 31, 2016 and 2015, we repurchased approximately 656,000 and +473,000 shares of our common stock, respectively. From inception of the program in August 2011 through March 31, 2017, we repurchased approximately 3,422,000 shares of our common stock for an +aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2017, all repurchased shares have been retired and returned to their status as +authorized and unissued shares of our common stock. As of March 31, 2017, approximately $1.7 million remains available for the repurchase of our common stock under our current program. +13. Business Segments, Significant Customer and Geographic Information +Business Segments +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics (formerly +known as Performance Analytics). +The +Roadway Sensors segment provides hardware and software products to multiple segments of the ITS market. These products primarily consist of various vehicle detection and information +systemse used for traffic intersection control, communication and roadway traffic data collection applications. These include, among other products, our Vantage, VantageNext, VersiCam, Vantage Vector, +SmartCycle, PedTrax, SmartSpan, Pegasus, Velocity, and P-series, products. +The +Transportation Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the +ITS industry. As of April 1, 2016, our performance measurement and information management solution, iPeMS, and related traffic analytic consulting services, previously included in Agriculture +and Weather segment, were reassigned to the Transportation Systems segment to better align our traffic analytics capabilities, resources and initiatives. Prior segment information has been recast to +reflect this change. +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road-maintenance applications, and ClearAg, our precision agriculture solutions. ClearPath Weather provides +winter road maintenance recommendations for state agencies, municipalities and for commercial companies. Our +ClearAg platform provides access to a comprehensive database of weather, soil and agronomic information combined with proprietary land-surface modeling and machine learning are essential to making +informed agricultural decisions and is delivered through ClearAg solutions, including our ClearAg APIs and components, WeatherPlot mobile application, and ClearAg Insights applications. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate general and +administrative expenses, including general overhead functions such as information systems, accounting, human +74 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +13. Business Segments, Significant Customer and Geographic Information (Continued) +resources, +marketing, compliance costs and certain administrative expenses, as well as interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are +each managed separately because they manufacture and distribute distinct products or provide services with different processes. All reported segment revenues are derived from external customers. Our +Chief Executive Officer, who is our chief operating decision maker ("CODM"), reviews financial information at the operating segment level. Our CODM does not review assets by segment in his resource +allocation, and therefore assets by segment are not disclosed below. +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2017, 2016 and 2015 is as follows: +Roadway +Sensors +Transportation +Systems +Agriculture +and Weather +Analytics +Total +(In thousands) +Year Ended March 31, 2017 +Revenues +$ +42,170 +$ +49,270 +$ +4,542 +$ +95,982 +Depreciation +180 +191 +131 +502 +Loss on impairment of goodwill +— +— +2,168 +2,168 +Segment income (loss) +9,799 +8,482 +(9,557 +) +8,724 +Year Ended March 31, 2016 +Revenues +$ +40,259 +$ +34,096 +$ +3,393 +$ +77,748 +Depreciation +152 +175 +122 +449 +Segment income (loss) +8,401 +4,170 +(6,140 +) +6,431 +Year Ended March 31, 2015 +Revenues +$ +36,370 +$ +32,832 +$ +3,049 +$ +72,251 +Depreciation +119 +151 +106 +376 +Segment income (loss) +6,840 +3,620 +(2,822 +) +7,638 +The +following table reconciles total segment income to consolidated income from continuing operations before income taxes: +Year Ended March 31, +2017 +2016 +2015 +(In thousands) +Segment income: +Total income from reportable segments +$ +8,724 +$ +6,431 +$ +7,638 +Unallocated amounts: +Corporate and other expenses +(13,680 +) +(9,541 +) +(9,277 +) +Amortization of intangible assets +(281 +) +(360 +) +(431 +) +Change in fair value of contingent acquisition consideration +— +— +(9 +) +Other (expense) income, net +(7 +) +2 +(20 +) +Interest income, net +13 +12 +6 +Loss from continuing operations before income taxes +$ +(5,231 +) +$ +(3,456 +) +$ +(2,093 +) +75 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +13. Business Segments, Significant Customer and Geographic Information (Continued) +Significant Customer and Geographic Information +We currently have, and historically have had, a diverse customer base. For Fiscal 2017, one individual customer represented approximately 22% of +our total revenues and no other individual customer represented greater than 10% of our total revenues. For Fiscal 2016, no individual customer represented approximately 10% of our total revenues. For +Fiscal 2015, one individual customer represented approximately 10% of our total revenues and no other individual customer represented greater than 10% of our total revenues. +No +individual customer or government agency had a receivable balance at March 31, 2017 or 2016 greater than 10% of our total trade accounts receivable balances as of +March 31, 2017 and 2016, respectively. +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended +March 31, +2017 +2016 +2015 +Canada +1 +% +— +% +— +% +Europe +1 +— +— +Middle East +— +1 +3 +2 +% +1 +% +3 +% +Substantially +all of our long-lived assets are held in the U.S. +76 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2017 +14. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross Profit +Net Loss +Basic Net +Loss per +Share +Diluted Net +Loss per +Share +(In thousands, except per share amounts) +June 30, 2016 +$ +23,927 +$ +9,409 +$ +(38 +) +$ +(0.00 +) +$ +(0.00 +) +September 30, 2016 +24,060 +9,455 +(40 +) +(0.00 +) +(0.00 +) +December 31, 2016 +22,691 +8,620 +(1,380 +) +(0.04 +) +(0.04 +) +March 31, 2017 +25,304 +9,918 +(3,368) +* +(0.10 +) +(0.10 +) +$ +95,982 +$ +37,402 +$ +(4,826 +) +$ +(0.15) +** +$ +(0.15) +** +June 30, 2015 +$ +18,365 +$ +7,637 +$ +(192 +) +$ +(0.01 +) +$ +(0.01 +) +September 30, 2015 +20,573 +7,883 +(395 +) +(0.01 +) +(0.01 +) +December 31, 2015 +19,014 +7,211 +(10,442 +) +(0.33 +) +(0.33 +) +March 31, 2016 +19,796 +7,938 +(1,292 +) +(0.03 +) +(0.03 +) +$ +77,748 +$ +30,669 +$ +(12,321 +) +$ +(0.38) +** +$ +(0.38) +** +* Net +Loss includes a goodwill impairment charge of approximately $2.2 million related to our Agriculture and Weather Analytics reporting unit. Refer to +Note 5 for additional discussion regarding the goodwill impairment charge. +** Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +77 +Table of Contents +Exhibit Index +Exhibit +Number +Description +Reference +2.2 ++ +Asset Purchase Agreement by and between Iteris, Inc. and Bendix Commercial Vehicle Systems LLC, dated as of July 25, 2011 +Exhibit 2.1 to the registrant's Current Report on Form 8- K/A as filed with the SEC on November 1, 2011 +3.1 +Restated Certificate of Incorporation of the registrant +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.2 +Certificate of Designations of Series A Junior Participating Preferred Stock +Exhibit 3.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.3 +Bylaws of the registrant, as amended +Exhibit 4.2 to the registrant's Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993 +3.4 +Certificates of Amendment to Bylaws of the registrant dated April 24, 1998 and August 10, 2001 +Exhibit 3.4 to the registrant's Annual Report on Form 10- K/A for the year ended March 31, 2003 as filed with the SEC on July 29, 2003 +3.5 +Certificate of Amendment to Bylaws of registrant dated September 9, 2004 +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 as filed with the SEC on November 15, 2004 +3.6 +Certificate of Amendment to Bylaws of registrant effective September 16, 2005 +Exhibit 3.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2007 +3.7 +Certificate of Amendment to Bylaws of registrant effective December 7, 2007 +Exhibit 3.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 13, 2007 +3.8 +Certificate of Amendment to Bylaws of registrant, effective August 20, 2009 +Exhibit 3.3 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +4.1 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +4.2 +Rights Agreement dated August 20, 2009 between the registrant and Computershare Trust Company, N.A., which includes the form of Certificate of Designations for the Series A Junior Participating Preferred Stock, +the form of Right Certificate, and Summary of Rights to Purchase Preferred Stock as exhibits thereto +Exhibit 4.1 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +78 +Table of Contents +Exhibit +Number +Description +Reference +4.3 +Amendment No. 1 to Rights Agreement, entered into as of August 8, 2012 by and between Iteris, Inc. and Computershare Trust Company, N.A. +Exhibit 4.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 10, 2012 +10.1 +Form of Indemnity Agreement entered into by the registrant and certain of its officers and directors +Exhibit 19.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 +10.2 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +* +1997 Stock Incentive Plan (the "1997 Plan") as amended on May 3, 2003, as further amended on December 15, 2004 +Exhibit 10.32 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2005 as filed with the SEC on July 14, 2005 +10.4 +* +Form of Notice of Grant of Stock Option for 1997 Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.5 +* +Form of Stock Option Agreement for the 1997 Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.6 +* +Form of Addendum to Stock Option Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction or Change in Control +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.7 +* +Form of Stock Issuance Agreement for 1997 Plan +Exhibit 99.6 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Addendum to Stock Issuance Agreement for 1997 Plan—Involuntary Termination Following Corporate Transaction/Change in Control +Exhibit 99.7 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.8 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Initial Grant +Exhibit 99.8 to Exhibit 99.8 to registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.10 +* +Form of Notice of Grant of Automatic Stock Option for 1997 Plan—Annual Grant +Exhibit 99.9 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 14, 2000 +10.11 +* +Form of Automatic Stock Option Agreement for 1997 Plan +Exhibit 99.10 to the registrant's Registration Statement on Form S-8 (File No. 333-30396) as filed with the SEC on February 19, 2000 +79 +Table of Contents +Exhibit +Number +Description +Reference +10.15 +* +Form of 1997 Stock Option Agreements +Exhibit 99.4 to the registrant's Registration Statement on Form S-8 (File No. 333-126834) as filed with the SEC on July 22, 2005 +10.17 +Office Lease, dated May 24, 2007, by and between Crown Carnegie Associates, LLC and Iteris, Inc. +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.18 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.19 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.20 +Amended and Restated Loan and Security Agreement dated February 4, 2009 by and between California Bank & Trust and the registrant +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2008 as filed with the SEC on February 13, 2009 +10.21 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.22 +Modification Agreement dated September 30, 2010 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 6, 2010 +10.23 +Modification Agreement dated September 28, 2012 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8- K as filed with the SEC on October 3, 2012 +10.24 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.25 +* +Employment Agreement, dated July 29, 2013, by and between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.26 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +80 +Table of Contents +Exhibit +Number +Description +Reference +10.27 +Modification Agreement dated September 23, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q as filed with the SEC on November 12, 2014 +10.28 +Modification Agreement dated November 18, 2014 by and between Iteris, Inc. and California Bank & Trust +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on November 24, 2014 +10.29 +Separation Agreement and Release of Claims dated February 25, 2015 between Iteris, Inc. and Abbas Mohaddes +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.30 +Modification Agreement dated February 24, 2015 between the Iteris, Inc. and California Bank & Trust +Exhibit 10.2 to the registrant's Current Report on Form 8-K as filed with the SEC on February 27, 2015 +10.31 +Employment Agreement dated March 9, 2015 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on March 15, 2015 +10.32 +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.33 +Amendment 1 to Employment Agreement dated June 12, 2017 between Iteris, Inc. and Andrew Schmidt +Filed herewith +16.1 +Letter from McGladrey LLP dated October 16, 2015 regarding change in certifying accountant +Exhibit 16.1 to the registrant's Current Report on Form 8-K as filed with the SEC on October 14, 2015 +23.1 +Consent of Independent Registered Public Accounting Firm, dated June 17, 2016 +Filed herewith +23.2 +Consent of Independent Registered Public Accounting Firm, dated June 17, 2016 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +81 +Table of Contents +Exhibit +Number +Description +Reference +101.INS +XBRL Instance Document +Filed herewith +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. ++ Confidential +treatment has been previously granted by the SEC for certain portions of the referenced exhibit pursuant to Rule 24b-2 of the Securities Exchange +Act of 1934, as amended. In accordance with Rule 24b- 2, these confidential portions have been omitted from the exhibit and filed separately with the SEC. +# Pursuant +to Rule 406T of Regulation S-T, these interactive data files i) are not deemed filed or part of a registration statement or prospectus +for purposes of Sections 11 or 12 of the Securities Act of 1933, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, irrespective of any general +incorporation language included in any such filings, and otherwise are not subject to liability under these sections; and ii) are deemed to have complied with Rule 405 of +Regulation S-T ("Rule 405") and are not subject to liability under the anti-fraud provisions of the Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the +Securities Exchange Act of 1934 or under any other liability provision if we have made a good faith attempt to comply with Rule 405 and, after we become aware that the interactive data files +fail to comply with Rule 405, we promptly amend the interactive data files. +82 \ No newline at end of file diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/filing_metadata.csv b/raw/filings/0000350868/2016/0001047469-17-003975/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b640248acff9c3a0a4cfd80c70ec6580c2a03643 --- /dev/null +++ b/raw/filings/0000350868/2016/0001047469-17-003975/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2017-06-13,2017-03-31,2017-06-13T21:27:43.000Z,0001047469-17-003975,a2232390z10-k.htm,10-K,9357863,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746917003975/a2232390z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746917003975/,2016,2016,1 diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/item1.txt b/raw/filings/0000350868/2016/0001047469-17-003975/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..3eceba73eabe0aa8f072777e68241af0c47f4fde --- /dev/null +++ b/raw/filings/0000350868/2016/0001047469-17-003975/item1.txt @@ -0,0 +1,247 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its subsidiary in this report as "Iteris," the "Company," "we," "our" and "us") is a provider +of intelligent information solutions for both the traffic management and global agribusiness markets. We are focused on the development and application of advanced technologies and software-based +information systems that reduce traffic congestion, provide measurement, management and predictive traffic and weather analytics, and improve the safety of surface transportation systems +infrastructure. By combining our unique intellectual property, products, decades of experience in traffic management, weather forecasting solutions and information technologies, we offer a broad range +of Intelligent Transportation Systems ("ITS") solutions to customers throughout the U.S. and internationally. We believe our products, services and solutions, in conjunction with sound traffic +management, minimize the environmental impact of traffic congestion. +In +the agribusiness markets, we have combined our unique intellectual property with enhanced soil, land surface and agronomy modeling techniques to create a set of ClearAg solutions. +These solutions provide analytical support to large enterprises in the agriculture market and field-specific advisories to individual producers. We continue to make significant investments to leverage +our existing technologies and further expand our software-based information systems to offer solutions to the precision agriculture technology markets. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that location +is (949) 270-9400. Our Internet website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any +information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to +these reports, are available on the "Investors" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the +Securities and Exchange Commission ("SEC"). +Recent Developments +In March 2017, our subsidiary, Iteris Michigan LLC, was dissolved as a legal entity and ceased operating as a wholly-owned subsidiary of +the Company. +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Agriculture and Weather Analytics (formerly known +as our Performance Analytics segment). On April 1, 2016, certain operations that were previously within the Agriculture and Weather Analytics segment, specifically our performance measurement +and information management solution, iPeMS, and related traffic analytic consulting services, were reassigned to the Transportation Systems segment to better align our traffic analytics capabilities, +resources and initiatives. All prior segment information presented in this report has been reclassified to reflect this change. +The +Roadway Sensors segment provides various vehicle detection and information systems and products for traffic intersection control, incident detection and roadway traffic data +collection applications. The Transportation Systems segment includes transportation engineering and consulting services, iPeMS, our specialized transportation performance measurement and traffic +analytics solutions, as well as the development of transportation management and traveler information systems for the ITS industry. The Agriculture and Weather Analytics segment includes ClearPath +Weather, our road maintenance applications, and ClearAg, our precision agriculture solutions. See Note 13 of Notes to +4 +Table of Contents +Consolidated +Financial Statements, included in Part IV, Item 15 of this report, for further details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image processing technology and other techniques to capture and analyze sensor data +through sophisticated algorithms, enabling vehicle detection and transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among other +products, our Vantage, VantageLive!, VantageNext, VersiCam, Vantage Vector, SmartCycle, SmartSpan, PedTrax, Pegasus, P-series and Velocity products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radars. Our Vantage systems give traffic managers the ability to mitigate roadway congestion by +modifying traffic signal timing or detecting incidents quickly. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection +assets remotely over a network connection. +• Our Vantage Vector video/radar hybrid product is an all-in-one vehicle detection sensor with a wide range of capabilities, including stop bar +detection, advanced-zone detection and sensing, which enable advanced safety and adaptive control applications. It includes all of the proven benefits of Iteris video detection, including high +accuracy, high availability remote viewing of video images, bicycle and pedestrian detection capability and high precision for dilemma zone detection, by integrating the video field-of-view with radar +sensing. Enhanced information, including vehicle counts, speed and distance in user configurable zones that is available for use in special applications. +• Our Vantage systems equipped with SmartCycle capability can effectively differentiate between bicycles and other vehicles with a single video +detection camera, enabling more efficient signalized intersections and improved traffic throughput. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection zones that can +be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +• Our Vantage systems equipped with PedTrax capability provides bi-directional counting and speed tracking of pedestrians within the cross-walk +to help improve signal timing efficiency and provides additional data stream to existing vehicle and bicycle counts. PedTrax is included with all new Vantage video detection systems, field-upgradable +for the latest Vantage hardware platforms, and utilizes previously installed non-intrusive sensor systems. +• Our VantageLive! is a cloud-based subscription service release that was announced on May 2, 2017. Our VantageLive! service allows users +to collect, process and analyze advanced intersection data, and to view and understand intersection activity. +We +believe that future growth domestically and internationally, particularly in developing countries, will be dependent in part on the continued adoption of above-ground video detection +technologies, instead of traditional in-pavement loop technology, to manage traffic. +We +also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, intersection controllers and +component cabinets. +5 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes transportation engineering and consulting services focused on the planning, design, development and +implementation of software and hardware-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and +direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and +management of surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and +identify mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and information management solution, iPeMS. iPeMS is a state-of-the-art information management software +suite that provides big data and software analytics solutions that help determine current and future traffic patterns, permitting the effective performance analysis and management of traffic +infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and +management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how +a transportation network is performing and to identify potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics and easy-to-use visualization and +animation features based on historical traffic conditions. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent, on federal governmental funding. As such, our Transportation +Systems business has been adversely affected by governmental budgetary issues. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, +including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future +will continue to be dependent at least in part on the federal government's use of funds under the federal highway bill. Delays in the allocation of funds may prolong uncertainty regarding the +allotment of transportation funds in federal, state and local budgets. We believe that prolonged uncertainty regarding such matters has adversely impacted in the past, and may continue to adversely +impact in the future, our Transportation Systems revenues and our overall financial performance in future periods. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearAg solutions and our ClearPath Weather management tools. Our ClearPath Weather tools provide winter road maintenance recommendations for state agencies, municipalities and for commercial +companies that allow such users to create solutions to meet roadway maintenance decision needs. +Our +Weather Analytics business is a market leader in performance management solutions for federal and state organizations. We intend to use our strong brand and deep experience in the +traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook a focused development activity to supplement our intellectual property, technology base and product suites to provide products and services for the +emerging precision agriculture ("PA") market. This activity included market research into the needs of the PA market, scientific modeling and forecasting development, computing infrastructure +development to support both the required big data acquisition and processing and the distributed delivery vehicles required to service the commercial PA market, as well as the development of several +products +6 +Table of Contents +specifically +intended for the PA market. We refer to our products for the PA market generically as our ClearAg solutions. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems. By using our ClearAg digital +platform, growers, researchers and other agribusinesses can access and use a comprehensive database of historical, real-time and forecasted weather content, soil and plant health information, as well +as other useful crop growing information to make better agricultural decisions and improve the efficiency and sustainability of farmlands. Companies use our ClearAg platform to simulate field +conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers leverage ClearAg solutions to determine the best times to plant, spray, fertilize and +harvest their crops. +We +currently offer our ClearAg solutions on an enterprise basis using our modeling solutions and ClearAg application programming interfaces ("APIs"), which can allow the integration of +ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. The APIs facilitate the integration of such companies' processes and solutions with the +ClearAg modeling and forecasting engine. We commenced commercial sales of our ClearAg platform and the related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). +We +also offer our ClearAg solutions to individual agriculture producers or growers who can benefit from the advisories based on our platform that are tailored for their specific location +of interest. These solutions can be accessed in a web based-product or pursuant to our mobile applications. Our first mobile application, ClearAg Mobile, was introduced in the first quarter of our +fiscal year ended March 31, 2016 ("Fiscal 2016"). ClearAg Mobile is an analytics application for individual growers that leverages weather, water, soil and crop growth information to provide +growers with field local specific advisories that help improve the management of crop production operations. Our harvest advisory tools of our ClearAg mobile application help growers better understand +up-to-the-minute environmental impact of weather, water and soil on crop growth and health, and to plan their harvest operations accordingly. Our ClearAg WeatherPlot and ClearAg Insights are +applications that help agronomists and crop consultants identify ideal environmental conditions for treatments and make recommendations based on forecasted or historical weather, water and soil +analytics. +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, largely for +expanded sales and marketing resources, through internally generated cash flow from our Roadway Sensors and Transportation Systems operations, as well as revenues from our Agriculture and Weather +Analytics segment and our available cash on hand, if necessary. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell direct, we use +a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, who sell integrated systems and related products to the traffic management market. Our independent distributors are trained +in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers and sell directly to +government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products +for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold +technical training classes for our distributors and end users and maintain a full-time +7 +Table of Contents +staff +of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to +accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions, and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +We +currently market and sell our ClearAg products as a subscription-based service to seed and crop protection companies, allied providers and agriculture integrators, as well as to +growers and retailers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically involve long lead times. We generally sell directly to +customers interested in the ClearAg API products, but typically sell through selling partners for our ClearAg applications. Versions of ClearAg Mobile and WeatherPlot are currently available in the +Apple app store and on Google Play. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +from qualified suppliers, both locally and globally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components +are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing, +MoboTrex, Inc., and Sony Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume +at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for our fiscal year ended March 31, 2017 ("Fiscal 2017"), Fiscal 2016 and Fiscal 2015. We believe customer support is a key competitive +factor. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $64.5 million as of March 31, 2017, which included +$54.4 million related to Transportation Systems. We typically recognize approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and +currently expect that trend to continue for the near future for both Transportation Systems and Agriculture and Weather Analytics. Substantially the entire backlog for +Roadway Sensors as of March 31, 2017 is expected to be recognized as revenue in the fiscal year ending March 31, 2018. At +8 +Table of Contents +March 31, +2016, we had backlog of approximately $63.3 million, which included $53.3 million related to Transportation Systems. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are conducted at our Agriculture and Weather Analytics facilities in Grand Forks, North Dakota and Berkeley, +California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $6.9 million for both Fiscal 2017 and 2016, and +$5.4 million for Fiscal 2015. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Agriculture and Weather +Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to focus our development efforts in the near future in our Agriculture +and Weather Analytics segment on our ClearAg products for the PA market; however, since 2014, our Roadway Sensors segment has introduced our VantageNext, Vantage Vector, PedTrax, SmartCycle, +SmartSpan, Pegasus, Velocity, and P-series, products. Additionally, during Fiscal 2016 and Fiscal 2017, we engaged in development activities of our ClearAg precision agriculture solutions, including +WeatherPlot and ClearAg mobile applications. We believe that developing new offerings across our segments and +enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather products. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, planning +and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that market +such as IBM/The Weather Company, MeteoGroup and agronomic analytics companies such as FBN and Famer's Edge. +In +the market for our Roadway Sensors vehicle detection products, we compete with manufacturers and distributors of other above ground video camera detection systems and manufacturers +and distributors and other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant +9 +Table of Contents +vehicle +detection system in this market. Additionally, products such as Velocity and Pegasus compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced Transportation Systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation +engineering, planning and design include major regional ITS engineering firms, as well as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of thirty-one issued U.S. patents, +including: (i) nine relating to our Roadway Sensors technologies, four of which issued in fiscal year 2017, (ii) seventeen relating to our Agriculture and Weather Analytics technologies, +five of which issued in fiscal year 2017, and (iii) six relating specifically to our Transportation Systems technologies, two of which issued in fiscal year 2017. We have a total of +twenty-three pending patent applications in the U.S. and nine pending foreign patent applications. We intend to pursue additional patent protection to the extent we believe it would be beneficial and +cost effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +10 +Table of Contents +Employees +As of March 31, 2017, we employed 397 full-time employees and 35 part-time employees, for a total of 432 employees. None of our employees +are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not +involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds +in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the +near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on +our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/item13.txt b/raw/filings/0000350868/2016/0001047469-17-003975/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9260309b7b7984f0016dec722041b18e362524a9 --- /dev/null +++ b/raw/filings/0000350868/2016/0001047469-17-003975/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information under the captions "Corporate Governance—Director Independence" and "Certain Transactions," appearing in our proxy +statement for the 2017 Annual Meeting of Stockholders, is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/item9a.txt b/raw/filings/0000350868/2016/0001047469-17-003975/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..94e5129bf59346cd12116735df830bee1fb96514 --- /dev/null +++ b/raw/filings/0000350868/2016/0001047469-17-003975/item9a.txt @@ -0,0 +1,32 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities +Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and +Chief Executive Officer, and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the +Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure +controls and procedures were effective as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized +and +36 +Table of Contents +reported +in a timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, +to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2017 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated +Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2017. The +effectiveness of our internal control over financial reporting as of March 31, 2017 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as +stated in their report, which is included herein. \ No newline at end of file diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/rp_note.txt b/raw/filings/0000350868/2016/0001047469-17-003975/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2016/0001047469-17-003975/rpt_disclosure.txt b/raw/filings/0000350868/2016/0001047469-17-003975/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/filing.txt b/raw/filings/0000350868/2017/0001047469-18-004333/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..348b697c4c8ad1bcf7596479232727f4bb520ee6 --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/filing.txt @@ -0,0 +1,4697 @@ +10-K +1 +a2235930z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2018 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California +(Address of Principal Executive Offices) +92705 +(Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, $0.10 par value +The NASDAQ Stock Market LLC +Securities +registered pursuant to Section 12(g) of the Act. None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities +Act"). Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act +of 1934, as amended (the "Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to +such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to +be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes ý No o +Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this +Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an +emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange +Act. (Check one): +Large accelerated filer o +Accelerated filer ý +Non accelerated filer o +(Do not check if a +smaller reporting company) +Smaller reporting company o +Emerging growth company o +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting +standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2017 was approximately +$147,100,000. For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of +affiliate status is not necessarily a conclusive determination for other purposes. As of May 29, 2018, there were 33,203,740 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2018 Annual Meeting of +Stockholders, which will be filed with the Securities and Exchange Commission. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2018 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +3 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +23 +ITEM 2. +PROPERTIES +23 +ITEM 3. +LEGAL PROCEEDINGS +23 +ITEM 4. +MINE SAFETY DISCLOSURES +23 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +24 +ITEM 6. +SELECTED FINANCIAL DATA +26 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +27 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +39 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +40 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +77 +ITEM 9A. +CONTROLS AND PROCEDURES +77 +ITEM 9B. +OTHER INFORMATION +78 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +78 +ITEM 11. +EXECUTIVE COMPENSATION +78 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +78 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +78 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +78 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +79 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiary, ClearAg, Inc. CheckPoint™, +ClearAg®, ClearPath Weather®, CVIEW-Plus™, Edge®, EdgeConnect™, EMPower®, EvapoSmart™, IMFocus™, +inspect™, iPeMS®, Iteris®, Next®, P10™, P100™, PedTrax®, Pegasus™, SmartCycle®, +SmartSpan®, TransitHelper®, UCRLink™, Vantage®, VantageLive!™, VantageNext®, VantagePegasus®, +VantageRadius™, Vantage Vector®, VantageView™, Velocity®, VersiCam™ and WeatherPlot™ are among, but not all of, the trademarks +of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of +the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and +certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words +"expect(s)," "feel(s)," "believe(s)," "intend(s)," "plan(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are +intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, +capital needs, backlog, manufacturing capabilities, the market acceptance of our products, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, +the applications for and acceptance of our products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to +certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these +forward-looking statements that speak only as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect +our business, including in "Risk Factors" set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake +no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of +unanticipated events. +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris," the "Company," +"we," "our," and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, farmers and +agronomists use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products, software-as-a-service offerings and weather +forecasting systems offer a comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +In +the agribusiness markets, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content solutions that +provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service +providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the entire value chain in the agriculture market with our smart content and digital farming platform. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is +3 +Table of Contents +(949) 270-9400. +Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or +accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are +available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities +and Exchange Commission ("SEC"). +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +in the agribusiness markets. +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Transportation Systems segment provides engineering and consulting services, performance measurement, regulatory compliance, and traffic analytics solutions, as well as the +development of traveler information systems for the ITS industry. The Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital +agriculture platform. +See +Note 13 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report, for further details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image and signal processing technology and other techniques to capture and analyze sensor +data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our +Roadway Sensors products include, among others, Vantage, VantageLive!, VantageNext, VantageRadius, VantagePegasus, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, +PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +4 +Table of Contents +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +We +also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and +traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services focused on the planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and management solution, iPeMS—a state-of-the-art information management software suite that +provides prescriptive data insights to help determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. iPeMS +utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and management of traffic +infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of improvement. iPeMS is +also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This +segment also includes our commercial vehicle operations and vehicle safety compliance platforms, known as "CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." +5 +Table of Contents +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. As such, our Transportation +Systems business has been adversely affected by governmental budgetary issues. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, +including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future +will continue to be dependent at least in part on the federal and local government's use of funds. Delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation +funds in federal, state and local budgets. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearPath Weather and Clear Ag solutions. +Our +ClearPath Weather is a web-based system that has a suite of tools that enable users to assess historical weather conditions and analyze short-term and long-range weather forecasts, +to customize route/site weather and pavement forecast tools, which provide winter road maintenance recommendations for state agencies, municipalities and enable commercial companies to create +solutions for the management of roadway maintenance. +Our +Weather Analytics business is a market leader in performance management solutions for federal and state organizations. We intend to use our strong brand and deep experience in the +traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For our ClearAg solutions, we developed additional scientific and agronomic models and forecasts, expanded our computing +infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems, which results in the increased +efficiency and sustainability of farmlands. The ClearAg Platform delivers product validation, irrigation and harvest solutions giving growers, researchers and other agribusinesses access to a +comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as other information on crop growth. Companies use the ClearAg Platform to simulate +field conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers leverage the ClearAg Platform to determine the best times to plant, spray, +fertilize, irrigate, and harvest crops. +We +currently offer our ClearAg solutions on an enterprise basis combining our modeling solutions with ClearAg application programming interfaces ("APIs"). These APIs facilitate the +integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. We commenced commercial sales of the ClearAg solutions and related APIs in +the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). We also developed the ClearAg WeatherPlot and ClearAg Insights applications, which provide analytics on forecasted +historical weather, water and soil temperatures to help agronomists and crop consultants identify and make recommendations for treatments at ideal environmental conditions to maximize crop quality and +yield. +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, through cash flow +generated from our Roadway Sensors and Transportation Systems operations, revenues from our +6 +Table of Contents +Agriculture +and Weather Analytics segment, and our available cash on hand, as needed. We may also elect to raise additional equity for these investments. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell direct, we use +a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues, and support our products. Our indirect sales channel is comprised of a +network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our +fiscal year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors +are trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when +needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions, and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +We +currently market and sell our ClearAg solutions as a subscription-based service to seed and crop protection companies, allied providers and agriculture integrators, as well as to +growers and retailers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically involve long lead times. We generally sell directly to +customers interested in the ClearAg API products, but typically sell through selling partners for our ClearAg applications. Mobile versions of WeatherPlot are currently available in the Apple app +store and on Google Play. +We +have historically had a diverse customer base. For Fiscal 2018, one individual customer represented greater than 10% of our total revenues. For the fiscal year ended March 31, +2017 ("Fiscal 2017"), one individual customer represented greater than 10% of our total revenues. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility, where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris Manufacturing, MoboTrex, Inc. and Sony Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa +Ana, California facility. Production volume at +7 +Table of Contents +our +subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2018, Fiscal 2017 and the fiscal year ended March 31, 2016 ("Fiscal 2016"). We believe customer support is a key competitive +factor for our company. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $47.5 million as of March 31, 2018, which included +$37.7 million related to Transportation Systems. We typically recognize approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and +currently expect that trend to continue for the near future for both Transportation Systems and Agriculture and Weather Analytics. Substantially the entire backlog for Roadway Sensors as of +March 31, 2018 is expected to be recognized as revenue in the fiscal year ending March 31, 2019. At March 31, 2017, we had backlog of approximately $64.5 million, which +included $54.4 million related to Transportation Systems. The decline in backlog in the current fiscal year was largely due to the completion of a large Transportation Systems contract in the +current fiscal year. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our Agriculture and Weather Analytics facilities in Grand Forks, North Dakota and +Oakland, California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $7.9 million for Fiscal 2018 and +$6.9 million for both Fiscal 2017 and Fiscal 2016. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our +Agriculture and Weather Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to focus our development efforts in the near future in our Agriculture +and Weather Analytics segment on our ClearAg solutions and to developing further enhancements and functionality in our Vantage products family. We believe that developing new and enhanced product +8 +Table of Contents +offerings +across our segments and enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that +market, such as IBM/The Weather Company, MeteoGroup and agronomic analytics companies such as FBN and Farmer's Edge. +In +the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems such as Econolite, and +manufacturers and distributors of other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement +inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity and VantagePegasus +compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced transportation systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation engineering, planning and design include major regional ITS engineering firms, as well +as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of +9 +Table of Contents +40 +issued U.S. patents, including: (i) 10 relating to our Roadway Sensors technologies, one of which was issued in Fiscal 2018, (ii) 23 relating to our Agriculture and Weather Analytics +technologies, six of which were issued in Fiscal 2018, and (iii) seven relating specifically to our Transportation Systems technologies, one of which was issued in Fiscal 2018. We have a total +of 22 pending patent applications in the U.S. and 15 pending foreign patent applications. The expiration dates of our patents range from 2026 to 2037. We intend to pursue additional patent protection +to the extent we believe it would be beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, +rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2018, we employed 414 full-time employees and 33 part-time employees, for a total of 447 employees. None of our employees +are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. +10 +Table of Contents +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in +this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our +other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not +the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks +actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part +of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including +budgetary issues and fixed price contracts. A significant portion of our revenues are derived from contracts with governmental agencies, either as a general +contractor, subcontractor or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject +to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, delays in the +expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the +new administration; +• performance bond requirements; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestones; +• adverse weather conditions may cause delays, such as, evacuations and flooding due to hurricanes can result in our inability to perform work in +affected areas; and +• international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from +transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and +income to drop substantially or to fluctuate significantly between fiscal periods. +11 +Table of Contents +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs would adversely +affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could +result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously +harm our business, financial condition and results of operations. +We recently expanded our Agriculture and Weather Analytics capabilities to address a new market segment, the agricultural market, which may not broadly accept our +technologies and new products. The application of digital analytics to the agricultural market is a relatively new development that has required us to invest, and +is expected to continue to require us to invest, in additional research and development, and sales and marketing without any guarantee of a commensurate increase in revenues. The introduction of any +new Agriculture and Weather Analytics products and services could have longer than expected sales cycles, which could adversely impact our operating results. We cannot assure you that growers or other +companies in this market will perceive the value proposition of our Agriculture and Weather Analytics or that our new ClearAg products for this market will achieve broad market acceptance in the near +future or at all. If the agricultural market fails to understand and appreciate the benefit of our Agriculture and Weather Analytics products or chooses not to adopt our technologies, our business, +financial condition and results of operations will be adversely affected. +We may not be able to achieve profitability on a quarterly or annual basis in the future. For Fiscal 2018 and Fiscal 2017, we had +net losses of +$3.5 million and $4.8 million, respectively, and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by +governmental budgetary constraints, government and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from certain of our +business segments to fund investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely +support those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or +decrease in anticipated revenues or increases in planned investments. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund +our operations and achieve our business plan, and could cause the market price of our common stock to decline. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our Transportation Systems workforce. The cost +of providing our Transportation Systems engineering and consulting services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our +workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• the timing of new contract awards or the completion of large contract; +• availability of funding or other budget issues; +12 +Table of Contents +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An +inability to properly and fully utilize our Transportation Systems workforce could have an adverse effect on our results of operations. +We recently entered into the software development market and may be subject to additional challenges and additional costs and delays. We have only +been in the business of software development for a few years and may experience development and technical challenges. Our business and results of operations could also be seriously harmed by any +significant delays in our software development and updates. Despite testing and quality control, we cannot be certain that errors will not be found in our software after its release. Any faults or +errors in our existing products or in any new products may cause delays in product introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of +which could adversely affect our business and competitive position. In addition, the software development industry frequently experiences litigation concerning intellectual property disputes, which +could be costly and distract our management. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely +decline. Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in the marketplace as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements successfully and in a cost-effective and timely manner, or are unable to achieve market acceptance +of our +new products, our operating results would be adversely affected. We believe our revenue growth and future operating results will depend on our ability to complete +development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production +costs. During the past two fiscal years, we have introduced both new and enhanced products across all segments. We cannot guarantee the success of these products, and we may not be able to introduce +any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our +existing products. +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and +analysis in response to evolving customer requirements. We cannot assure you that we will be able to adequately +13 +Table of Contents +manage +product transition issues. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer +requirements or if we cannot adequately manage inventory issues typically related to new product +transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +If our security measures are breached and unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our web-based and mobile application +services, we may incur significant liabilities, our services may be perceived as not being secure and customers may curtail or stop using our services, we could incur significant liability to our +customers and to individuals or businesses whose information was being stored, our business may suffer and our reputation will be damaged. Because techniques used +to obtain unauthorized access to, or to sabotage, systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to +implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose +sales and customers. +The markets in which we operate are highly competitive and have many more established competitors than us, which could adversely affect our revenues or the market acceptance of +our +products. We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many smaller +regional engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a portion of the traffic intersection market has +adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry +make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result +in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local regional firms. +The +markets in which our Agriculture and Weather Analytics segment operates vary from public sector customers who focus on snow and ice management for state and county roadways, to +commercial sector customers who employ our environmental content and agronomic models. Our competitors include divisions of large, international weather companies, as well as a variety of small +providers in the road weather market. In the commercial agriculture sector, we compete with a variety of public and private entities that currently market software, agronomic analytics and weather +forecast capabilities to the agribusiness. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +14 +Table of Contents +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. If we are not able +to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations +will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure +agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products +that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the +laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or abroad. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse +outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or +using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is +determined that we have infringed upon or misappropriated another party's intellectual property. Our recent expansion into software development activities may subject us to increased possibility of +litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, +including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, +financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profitability. Our +business depends on +our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. Contract proposals and negotiations are complex and frequently involve a lengthy +bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. For example, a customer may require us +to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions continue, or if we fail to secure adequate +financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue particular projects, which could reduce or eliminate our +profitability. +We may continue to be subject to traffic related litigation. The traffic industry in general is subject to litigation claims due +to the nature of +personal injuries that result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject +to litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may +not be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or +more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims +could cause us to incur significant expenses and result in a diversion of management's attention. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. Due +to the specialized +nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical +15 +Table of Contents +personnel. +We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team and our ability to retain existing business and generate new +business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations +(e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering +and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, +which may adversely affect our growth in the current fiscal year and in future years. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled +personnel, we may not be able to +attract and retain these employees and therefore could impair our ability to perform our contractual obligations efficiently and timely meet our customers' needs and win new business, which could +adversely affect our future results. The future success of our Transportation Systems segment will depend on our ability to hire additional qualified engineers, planners and technical personnel. The +future success of our Agriculture and Weather Analytics segment will depend on our ability to hire additional software developers, qualified engineers and technical personnel. Competition for +qualified employees, particularly development engineers and software developers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. +Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +Our management information systems and databases could be disrupted by system security failures, cyber threats or by the failure of, or lack of access to, our Enterprise Resource +Planning system. These disruptions could negatively impact our sales, increase our expenses and/or harm our reputation. Internal users and computer programmers may +be able to penetrate, aka "hack", our network security and create system disruptions, cause shutdowns and/or misappropriate our confidential information or that of our employees and third parties. +Therefore, we could incur significant expenses addressing problems created by security breaches to our network. We must, and do, take precautions to secure customer information and prevent +unauthorized access to our databases and systems containing confidential information. Any data loss or information security lapses resulting in the compromise of personal information or the improper +use or disclosure of confidential, sensitive or classified information could result in claims, remediation costs, regulatory sanctions against us, loss of current and future contracts and serious harm +to our reputation. We operate our Enterprise Resource Planning system on a software-as-a-service platform, and we use this system for reporting, planning, sales, audit, customer relationship +management, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on this system, and the third-party provide of this service, for a number of +aspects of our operations. If this service provider or this system fails, or if we are unable to continue to have access to this system on commercially reasonable terms, or at all, operations would be +severely disrupted until an equivalent system could be identified, licensed or developed, and integrated into our operations. This disruption would have a material adverse effect on our business. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in +our +operating results. Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past +expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these +activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +16 +Table of Contents +Our use of estimates in conjunction with the percentage of completion method of accounting for our Transportation Systems revenues could result in a reduction or reversal of +previously +recorded revenues and profits. A portion of Transportation Systems revenues are measured and recognized using the percentage of completion method of accounting. +Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs +expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could +occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program +management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including +reductions or reversals of previously recorded revenues and profits. +Uncertainties in the interpretation and application of the new revenue recognition standard ASC 606 could materially affect our revenue +recognition. As discussed in Note 1 to the Consolidated Financial Statements (Description of Business and Summary of Significant Accounting +Policies—Recent Accounting Pronouncements), effective March 1, 2018, we adopted the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, +Revenue from Contracts with Customers ("ASC 606"). We believe that ASC 606 and related revenue recognition policies will not result in a material change to our consolidated financial statements, and +will not cause any significant changes to the amount and timing of our recognition of future revenue and cost. However, uncertainties in future guidance of the interpretation and application of ASC +606 could materially affect our revenue and cost recognition. +Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax +rate. The 2017 Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017, and significantly affected U.S. tax law by changing how the U.S. +imposes income tax on multinational corporations. The U.S. Department of Treasury has broad authority to issue regulations and interpretative guidance that may significantly impact how we will apply +the law and impact our results of operations in the period issued. The Tax Act requires complex computations not previously provided in U.S. tax law. As such, the application of accounting guidance +for such items is currently uncertain. Further, compliance with the Tax Act and the accounting for such provisions require accumulation of information not previously required or regularly produced. As +a result, we have provided a provision on the effect of the Tax Act in our financial statements. As additional regulatory guidance is issued by the applicable taxing authorities, and the accounting +treatment is clarified, we plan to perform additional analysis on the application of the law, and may need to refine +our estimates in calculating the impact of such further guidance. As such, our final analysis may be different from our current provisional amounts, which could materially affect our tax obligations +and effective tax rate. +Declines in the value of securities held in our investment portfolio can affect us negatively. As of March 31, 2018, the +value of securities +available for sale and held to maturity within our investment portfolio was $9.0 million, which is generally determined based upon market values available from third-party sources, may +fluctuate as a result of market volatility and economic or financial market conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and +liquidity. Further, to the extent that we experience unrealized losses in our portfolio of investment securities from declines in securities values that management determines to be other than +temporary, the book value of those securities will be adjusted to their estimated recovery value and we will recognize a charge to earnings in the quarter during which we make that determination. +Although we have policies and procedures in place to assess and mitigate potential impacts of market risks, including hedging-related strategies, those policies and procedures are inherently limited +because they cannot anticipate the existence or future development of currently +17 +Table of Contents +unanticipated +or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage these risks properly. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely +affected. Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial +reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to +obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis +and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A +control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of +a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control +systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations +include the realities that +judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of +two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure +you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in +the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. If we +are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could +cause +our stock price to decline. Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number +of factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as +increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• our ability to raise additional capital; +18 +Table of Contents +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• seasonality due to winter weather conditions; +• seasonality with respect to revenues from our ClearPath Weather and related weather forecasting services due to the decrease in revenues +generated for such services during the spring and summer time periods; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely +manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +We rely on outside suppliers that could experience supply shortages or may experience production gaps that could materially and adversely impact our sales and financial +results. It is possible that we could experience unforeseen quality control issues or part shortages as we adjust production to meet current demand for our +products. We have historically used single suppliers for certain significant components in our products, and have had to reengineer products from time to time to address obsolete components, +especially in our Roadway Sensors products. Should any such delay or disruption occur, or should a key supplier discontinue operations, our future sales will likely be materially and adversely +affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we +believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many +of our products, if necessary, we could experience a production gap if for any reason our contract +19 +Table of Contents +manufacturers +were unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. +We may engage in acquisitions of companies or technologies that may require us to undertake significant capital infusions and could result in disruptions of our business and +diversion of +resources and management attention. We have completed two acquisitions since November 2011 and, in the future, we may acquire additional complementary businesses, +products, and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information +system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits anticipated from any acquisition. +Our international business operations may be threatened by many factors that are outside of our control. While we historically +have had limited +international sales, revenues and operational experience, we previously had Transportation Systems contracts in the United Arab Emirates ("UAE"), for which approximately $130,000 in performance bonds +have not yet been released by the UAE Department of +Transportation. We also have been expanding our distribution capabilities for our Roadway Sensors segment internationally, particularly in Canada, Australia, New Zealand, Europe and in South America. +We plan to continue to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to various inherent risks including, +among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S. and each other country in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +20 +Table of Contents +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but +not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. We have +historically +experienced volatility in our earnings and cash flows from operations from year to. On September 1, 2017, we filed a registration statement on a Form S-3, utilizing a "shelf" +registration process, and may consider a new equity financing in the future. Should the credit markets further tighten or our business declines, we may need or choose to raise additional capital to +fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot +assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• potential acquisitions of businesses and product lines; +• our relationships with customers and suppliers; +21 +Table of Contents +• government budgets, political agendas and other funding issues, including potential delays in government contract awards; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such +securities may have rights, preferences and privileges senior to our common stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If +adequate funds are not available or are not available on acceptable terms, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing +programs, take advantage of future opportunities or respond to competitive pressures. +The trading price of our common stock is highly volatile. The trading price of our common stock has been subject to wide +fluctuations in the past. +From August 1, 2015 through May 31, 2018, our common stock has traded at prices as low as $1.77 per share and as high as $8.17 per share. The market price of our common stock could +continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. +This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, +companies that have experienced volatility in the market price of their securities have been the subject of securities +class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +22 +Table of Contents +Certain provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common +stock. Certain provisions of our certificate of incorporation could make it difficult for a third party to acquire us, even though an acquisition might be +beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of +incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior +to those of our common stock. In August 2009, we adopted a stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. Generally, the stockholder rights +plan provides that if a person or group acquires 15% or more of our common stock, subject to certain exceptions and under certain circumstances, the rights may be exchanged by us for common stock or +the holders of the rights, other than the acquiring person or group, could acquire additional shares of our capital stock at a discount off of the then current market price. Such exchanges or exercise +of rights could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a +merger, tender offer or other acquisition of the company more difficult. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 41,000 square feet of leased office, manufacturing and warehouse space +located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 8 of Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 8 of Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +23 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information and Holders +Our common stock is traded on the NASDAQ Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock +traded on the NYSE MKT under the same symbol. The following table sets forth, for the periods indicated, the highest and lowest sales prices for our common stock: +High +Low +Fiscal 2018 +Quarter Ended June 30, 2017 +$ +6.50 +$ +4.88 +Quarter Ended September 30, 2017 +6.91 +5.68 +Quarter Ended December 31, 2017 +8.17 +5.30 +Quarter Ended March 31, 2018 +7.88 +4.43 +Fiscal 2017 +Quarter Ended June 30, 2016 +$ +2.99 +$ +2.20 +Quarter Ended September 30, 2016 +4.04 +2.81 +Quarter Ended December 31, 2016 +3.79 +3.20 +Quarter Ended March 31, 2017 +5.64 +3.52 +On +May 29, 2018, the last reported sales price of our common stock on the NASDAQ Capital Market was $5.16. As of May 29, 2018, we had 331 holders of record of our common +stock according to information furnished by our transfer agent. The actual number of stockholders is greater than this +number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain +Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We +currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon +a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business +conditions, the consent of our lender and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to +$3.0 million of our outstanding common stock from time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of +$1.3 million. On August 9, 2012, our Board of Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new +stock repurchase program pursuant to which we may acquire up to $3 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares +24 +Table of Contents +from +time to time in open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no +guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of +Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from +time to time for an unspecified length of time. +For +our fiscal years ended March 31, 2018 and 2017, we did not repurchase any shares. For our fiscal year ended March 31, 2016, we repurchased approximately 656,000 shares +of our common stock. From inception of the program in August 2011 through March 31, 2018, we repurchased approximately 3,422,000 shares of our common stock for an aggregate price of +approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2018, all repurchased shares have been retired and returned to their status as authorized and unissued +shares of our common stock. As of March 31, 2018, approximately $1.7 million remains available for the repurchase of our common stock under our current program. +Performance Graph +The following performance graph compares the cumulative total stockholder return of the Company's common stock for the five-year period ended +March 31, 2018 to the total returns of (i) the NASDAQ Composite Index and (ii) the NASDAQ Telecommunications Index. This comparison assumes in each case that $100 was invested at +the close of market on March 29, 2013, the last trading day immediately preceding the Company's fifth preceding fiscal year, and that any dividends were reinvested. Stockholder returns over the +indicated period should not be considered indicative of future stockholder returns. +2013 +2014 +2015 +2016 +2017 +2018 +Iteris +$ +100.00 +$ +108.79 +$ +100.00 +$ +134.07 +$ +298.90 +$ +272.53 +NASDAQ Composite +$ +100.00 +$ +130.18 +$ +153.76 +$ +154.62 +$ +189.99 +$ +229.43 +NASDAQ Telecommunications +$ +100.00 +$ +120.57 +$ +133.29 +$ +131.52 +$ +162.03 +$ +188.13 +25 +Table of Contents +The foregoing performance graph shall not be deemed "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under +that section and shall not be deemed to be incorporated by reference into any of our filings under the Securities Act or the Exchange Act. +ITEM 6. SELECTED FINANCIAL DATA +The selected consolidated financial data for the five-year period ended March 31, 2018 has been derived from our consolidated financial +statements. The historical results are not necessarily indicative of the results to be expected in any future period. The following selected consolidated financial data should be read in conjunction +with, and are qualified in their entirety by reference to, the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated audited +financial statements and the related notes included elsewhere in this Annual Report. The consolidated statements of operations data for the years ended March 31, 2015 and 2014 and the +consolidated balance sheet data as of March 31, 2016, 2015 and 2014 have been derived from consolidated financial statements not included herein +In +July 2011, we completed the sale of substantially all of the assets used in connection with our prior Vehicle Sensors business. As a result, the results of operations of this business +are all reflected as a discontinued operation for all periods presented below. See Note 3 (Sale of Vehicle Sensors) of the Notes to Consolidated Financial Statements included in this Annual +Report. +For the Years Ended March 31, +2018 +2017 +2016 +2015 +2014 +(in thousands except share and per share data) +Selected Consolidated Statement of Operations Data: +Total revenues +$ +103,729 +$ +95,982 +$ +77,748 +$ +72,251 +$ +68,228 +Gross profit +39,831 +37,402 +30,669 +28,182 +25,974 +Income (loss) from continuing operations +(3,768 +) +(5,187 +) +(12,535 +) +(1,277 +) +1,320 +Gain on sale of discontinued operation, net of tax +242 +361 +214 +207 +89 +Net income (loss) +(3,526 +) +(4,826 +) +(12,321 +) +(1,070 +) +1,409 +Earnings (loss) per share (basic and diluted): +(Loss) income per share from continuing operations +$ +(0.12 +) +$ +(0.16 +) +$ +(0.39 +) +$ +(0.04 +) +$ +0.04 +Gain per share on sale of discontinued operation, net of tax +$ +0.01 +$ +0.01 +$ +0.01 +$ +0.01 +$ +0.00 +Net (loss) income per share +$ +(0.11 +) +$ +(0.15 +) +$ +(0.38 +) +$ +(0.03 +) +$ +0.04 +Weighted average common shares used in basic per share calculations +32,776 +32,174 +32,049 +32,595 +32,665 +Weighted average common shares used in diluted per share calculations +32,776 +32,174 +32,049 +32,595 +32,847 +Selected Consolidated Balance Sheet Data: +Total assets +$ +62,886 +$ +62,345 +$ +60,020 +$ +70,632 +$ +70,607 +Long-term liabilities +871 +1,542 +1,631 +1,009 +199 +Stockholders' equity +39,521 +40,224 +43,462 +55,968 +57,490 +(1) See +Note 2 to our accompanying consolidated financial statements in Part II, Item 8 of this Annual Report for a description of the method used +to compute basic and diluted net loss per common share +26 +Table of Contents +ITEM 7. MANAGEMENT's DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and +related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Item 1A, as well as the other cautionary statements and risks described +elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General. We are a provider of essential applied informatics that enable smart transportation and digital agriculture. +Municipalities, government +agencies, crop science companies, farmers and agronomists use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +In connection with the Asset Sale, we were entitled to additional +consideration in the form of certain performance and royalty-related earn-outs through December 31, 2017. From the date of the Asset Sale through March 31, 2018, we received +approximately $2.6 million in connection with such royalty-related earn-out provisions. We also had approximately $106,000 in royalty-related receivables included in the prepaid expenses and +other current assets in the accompanying consolidated balance sheet as of March 31, 2018. We do not anticipate any further payments from Bendix. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment. We determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report, for additional +discussion regarding the Asset Sale. +Business Segments. We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadways Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, VantageNext, VantagePegasus, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +The +Transportation Systems segment includes engineering and consulting services, performance measurement and traffic analytics solutions, as well as the development of transportation +management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, implementation, operation and management of surface transportation +infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to +reduce traffic congestion. Our Transportation Systems product line includes: iPeMS, our performance measurement and information management solution, as well as our commercial vehicle operations and +vehicle safety compliance platforms, known as "CVIEW-Plus," "CheckPoint," "UCRLink," and "inspect." +27 +Table of Contents +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. Our ClearPath Weather suite of +tools, such as tools for assessing historical weather conditions to both short-term and long-range weather forecasts and customizable route/site weather and pavement forecast tools, provide winter +road maintenance recommendations for state agencies, municipalities and for commercial companies that allow such users to create solutions to meet roadway maintenance decision needs. Our ClearAg +solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems. Our ClearAg solutions include our ClearAg applications, +ClearAg APIs and components, WeatherPlot mobile application and ClearAg Insights applications. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements +included herein, which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires management +to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and +the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to revenue recognition, the +collectability of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for stock-based +compensation, the valuation of equity instruments, warranty reserves and other contingencies. We base these estimates on historical experience and on various other factors that we believe to be +reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These +estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any material respect, +it could have a material adverse effect on our reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting +period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Product revenues and related costs of sales are recognized when all of the following criteria are met: +(i) persuasive +evidence of an arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of +the receivable is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until receipt or acceptance by the customer. +Accordingly, +at the date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Agriculture and Weather Analytics revenues are also derived from +long-term contracts with governmental agencies, as well as contracts with commercial companies. ClearAg revenues that are derived from contracts with commercial companies are from subscription revenue +that we typically invoice our customers at the beginning of the term, in multiyear, annual, semi-annual or quarterly installments, and revenue is recognized ratably over the period of the subscription +beginning once all requirements for revenue recognition have been met, including provisioning the service so that it is available to our customers. When appropriate, revenues are recognized using the +percentage of completion method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the relationship of costs incurred to total estimated costs. +Any anticipated losses on contracts are charged to earnings when identified. Changes in job +28 +Table of Contents +performance +and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and revenues and are recognized in +the period in which the revisions are determined. Profit incentives are included in revenues when their realization is reasonably assured. Certain of our revenues are recognized as services are +performed and amounts are earned, which is measured by time incurred or other contractual milestones or output measures. Revenues accounted for in this manner generally relate to certain fixed fee +professional services, cost-plus fixed fee or time-and-materials contracts. Revenues for ongoing operations and maintenance services contracts are generally accounted for ratably as the services are +performed throughout the term of the contract. Payments received in advance of services performed are deferred and recognized when the related services are performed. +We +recognize revenue from the sale of deliverables that are part of a multiple-element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement where neither vendor +specific objective evidence ("VSOE") nor third-party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple-element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent internally developed and purchased intangible assets including developed technology, +customer relationships, trade names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method that reflects the pattern +in which the economic benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method over the estimated +useful life of the asset. +We +perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, such as an adverse +change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, +including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further +testing is required. If further testing is required, we perform a two-step process. The first step involves comparing the fair value of our reporting unit to its carrying value, including goodwill. If +the carrying value of the reporting unit exceeds its fair value, the second step of the test is performed by comparing the carrying value of the goodwill in the reporting unit to its implied fair +value. An impairment charge is recognized for the excess of the carrying value of goodwill over its implied fair value. We determine the fair values of our reporting units using the income valuation +approach, as well as other generally accepted valuation methodologies. +In +Fiscal 2017, we adopted the provisions issued by the FASB that were intended to simplify goodwill impairment testing. This guidance permits us to eliminate the second step of the +goodwill impairment test, and eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. If the carrying amount of a reporting unit +exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators +for goodwill impairment testing between annual tests. +29 +Table of Contents +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long-lived assets +and purchased intangible assets. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This +estimation process can result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so +that the year-to-date provision reflects the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall +effective tax rate from quarter to quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are reversed in +the first subsequent financial reporting period in which that threshold is no longer met. +The +application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a +result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from +our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +In +relation to the Tax Act, we determine reasonable provisional estimate on our existing deferred tax balances and the one-time transition tax under the SEC Staff Accounting Bulletin +No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"). Actual future operating results and the underlying amount and type of income could differ materially +from our estimates, assumptions and judgments, thereby impacting our consolidated financial position and results of operations. +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the grant +date estimated fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative +of the actual fair values of our stock option awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements, as +well as the limited transferability of the awards. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any +modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +30 +Table of Contents +Recent Accounting Pronouncements +Refer to Note 1 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for a discussion +of recent accounting pronouncements. +Results of Operations +The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated. +Year Ended March 31, +2018 +2017 +2016 +Product revenues +44.8 +% +45.6 +% +53.7 +% +Service revenues +55.2 +54.4 +46.3 +Total revenues +100.0 +100.0 +100.0 +Cost of product revenues +25.7 +24.8 +30.0 +Cost of service revenues +35.9 +36.2 +30.5 +Cost of revenues +61.6 +61.0 +60.6 +Gross profit +38.4 +39.0 +39.4 +Operating expenses: +Selling, general and administrative +36.0 +34.6 +34.4 +Research and development +7.7 +7.2 +8.9 +Amortization of intangible assets +0.1 +0.3 +0.5 +Loss on impairment of goodwill +— +2.3 +— +Total operating expenses +43.8 +44.4 +43.8 +Operating loss +(5.4 +) +(5.4 +) +(4.4 +) +Non-operating income (expense): +Other (expense) income, net +(0.0 +) +(0.0 +) +0.0 +Interest income, net +0.0 +0.0 +0.0 +Loss from continuing operations before income taxes +(5.4 +) +(5.4 +) +(4.4 +) +Benefit (provision) for income taxes +1.8 +0.0 +(11.7 +) +Loss from continuing operations +(3.6 +) +(5.4 +) +(16.1 +) +Gain on sale of discontinued operation, net of tax +0.2 +0.4 +0.3 +Net loss +(3.4 +)% +(5.0 +)% +(15.8 +)% +Analysis of Fiscal 2018, Fiscal 2017 and Fiscal 2016 Results of Operations +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics +segments. The following table's present details of total revenues for Fiscal 2018 compared to Fiscal 2017, and Fiscal 2017 compared to Fiscal 2016: +Year Ended +March 31, +$ +Increase +% +Change +2018 +2017 +(In thousands, except percentages) +Product revenues +$ +46,464 +$ +43,735 +$ +2,729 +6.2 +% +Service revenues +57,265 +52,247 +5,018 +9.6 +% +Total revenues +$ +103,729 +$ +95,982 +$ +7,747 +8.1 +% +31 +Table of Contents +Year Ended +March 31, +$ +Increase +% +Change +2017 +2016 +(in thousands, except percentages) +Product revenues +$ +43,735 +$ +41,733 +$ +2,002 +4.8 +% +Service revenues +52,247 +36,015 +16,232 +45.1 +% +Total revenues +$ +95,982 +$ +77,748 +$ +18,234 +23.5 +% +Product +revenues for Fiscal 2018 increased approximately 6.2% to $46.5 million, compared to $43.7 million in Fiscal 2017, primarily due to increases in unit sales of our +core Roadway Sensors products, Roadway Sensors OEM sales, as well as our Transportation Systems third-party product sales. Service revenues for Fiscal 2018 increased approximately 9.6% to +$57.3 million, compared to $52.2 million in Fiscal 2017, primarily due to higher Transportation Systems traffic engineering service revenue for government agencies. Total revenues for +Fiscal 2018 increased approximately 8.1% to $103.7 million, compared to $96.0 million in Fiscal 2017, primarily due to an approximate 11% increase in Transportation Systems revenues, an +approximate 5% increase in Roadway Sensors revenues, and an approximate 8% increase in Agriculture and Weather Analytics revenues. +Roadway +Sensors revenues in Fiscal 2018 included approximately $44.2 million in product revenues and approximately $194,000 of service revenues, reflecting an increase in total +revenues of approximately $2.2 million or 5%, compared to Fiscal 2017. The increase was primarily due to higher unit sales of our core Roadway Sensors video detection products aided by a +corresponding increase of in our distribution of certain OEM products for the traffic intersection market. Revenue generated through the distribution of certain third party products was approximately +$5.3 million and approximately $4.8 million for Fiscal 2018 and Fiscal 2017, respectively. Roadway Sensors revenues in Fiscal 2017 included approximately $42.1 million in product +revenues and $111,000 of service revenues, reflecting an increase in total revenues of approximately $1.9 million or 5%, compared to Fiscal 2016. The increase was primarily due to higher unit +sales of our Roadway Sensors products, slightly offset by a decrease in our distribution of OEM products for the traffic intersection market. Revenue generated through the distribution of certain +third party products was approximately $4.8 million and approximately $5.3 million for Fiscal 2017 and Fiscal 2016, respectively. Going forward, we plan to grow revenues by focusing on +our core domestic intersection market, and refine and deliver products that address the needs of this market, primarily our Vantage processors and camera systems, and our Vantage Vector video/radar +hybrid sensor, as well as our SmartCycle, Velocity, PedTrax and SmartSpan products. +Transportation +revenues in Fiscal 2018 included approximately $52.2 million of service revenues and approximately $2.3 million of sales of third-party products purchased +for installation under certain construction-type contracts, reflecting an increase in total revenues of approximately $5.2 million or 11%, compared to Fiscal 2017. The increase was primarily a +result of extensions granted on certain large contracts, new contract awards, and the timing of backlog fulfilment on certain other projects. Transportation revenues in Fiscal 2017 included +approximately $47.6 million of service revenues and approximately $1.7 million of sales of third-party products purchased for installation under certain construction-type contracts, +reflecting an increase in total revenues of approximately $15.2 million or 45%, compared to Fiscal 2016. The increase was primarily due as a result of one large contract win during the fourth +quarter of Fiscal 2017 and two large contract wins during the third quarter of Fiscal 2016, which was a key contributor to positively impacting revenue growth in Fiscal 2017, as well as timing of +backlog fulfilment on certain other projects. While one of the aforementioned large contracts is expected to be near completion by the first quarter of our fiscal year ending March 31, 2019, we +plan to continue to pursue larger contracts that may contain significant sub-consulting content. While we believe larger contacts will contribute to overall revenue growth, the mix of sub-consulting +content will +32 +Table of Contents +likely +affect the related gross profit from period to period, as revenues derived from sub-consultants generally have lower gross margins than revenues generated by our professional services. +Agriculture +and Weather Analytics revenues in Fiscal 2018 included no product revenue and approximately $4.9 million of service revenues, largely consisting of subscription +revenues, reflecting an increase in total revenues of approximately $351,000 or 8%, compared to Fiscal 2017. The increase was primarily due to an increase in ClearAg solutions under newly signed +contracts during Fiscal 2018 and Fiscal 2017. Agriculture and Weather Analytics revenues in Fiscal 2017 included no product revenue and approximately $4.5 million of service revenues, largely +consisting of subscription revenues, reflecting an increase in total revenues of approximately $1.1 million or 34%, compared to Fiscal 2016. The increase was primarily due to increases in both +ClearPath Weather and ClearAg solutions under newly signed contracts during Fiscal 2017. Going forward, we plan to continue investing in this segment, particularly in the research and development and +sales and marketing of the ClearAg and ClearPath Weather solutions. We also plan to pursue commercial opportunities in the precision agriculture technology markets by offering software applications, +content, and modeling services that provide analytics and decision support services that leverage our precision weather, soil and agronomic content and applications. +Gross Profit. The following tables present details of our gross profit for Fiscal 2018 compared to Fiscal 2017, and Fiscal 2017 +compared to Fiscal +2016: +Year Ended +March 31, +$ +Increase +(Decrease) +% +Change +2018 +2017 +(In thousands, except percentages) +Product gross margin +$ +19,831 +$ +19,858 +$ +(27 +) +(0.1 +)% +Service gross margin +20,000 +17,544 +2,456 +14.0 +% +Total gross margin +$ +39,831 +$ +37,402 +$ +2,429 +6.5 +% +Product gross margin as a % of product revenues +42.7 +% +45.4 +% +Service gross margin as a % of service revenues +34.9 +% +33.6 +% +Total gross margin as a % of total revenues +38.4 +% +39.0 +% +Year Ended +March 31, +$ +Increase +% +Change +2017 +2016 +(in thousands, except percentages) +Product gross margin +$ +19,858 +$ +18,393 +$ +1,465 +8.0 +% +Service gross margin +17,544 +12,276 +5,268 +42.9 +% +Total gross margin +$ +37,402 +$ +30,669 +$ +6,733 +22.0 +% +Product gross margin as a % of product revenues +45.4 +% +44.1 +% +Service gross margin as a % of service revenues +33.6 +% +34.1 +% +Total gross margin as a % of total revenues +39.0 +% +39.4 +% +Our +product gross profit as a percentage of product revenues for Fiscal 2018 decreased approximately 270 basis points compared to Fiscal 2017 primarily due an increase in our Roadway +Sensors OEM sales, as well as our Transportation Systems third-party product sales, both of which typically yield lower gross margins than our Roadway Sensors core video detection products. Our +service gross profit as a percentage of service revenues for Fiscal 2018 increased 130 basis points compared to Fiscal 2017 primarily due to the timing of certain extension contracts, the contract mix +and a decrease in the amount of related sub-consulting content of such contracts. Sub-consulting content generally results in +lower gross margins than our workforce. Our total gross profit as a percentage of total revenues for Fiscal 2018 decreased 60 basis points compared to Fiscal 2017 +33 +Table of Contents +primarily +as a result of the revenue mix between the Roadway Sensors and Transportation Systems segments, as Roadway Sensors revenues generally yield higher total gross margins than our other +segments. As such, the increase in our Transportation Systems total revenues from approximately 51% of total revenues for Fiscal 2017 to approximately 53% of total revenues for Fiscal 2018 was a +primary contributor to our decline in total gross margin. Roadway Sensors revenue decreased as a percentage of total revenues from approximately 44% for Fiscal 2017 to approximately 43% for Fiscal +2018. +Our +product gross profit as a percentage of product revenues for Fiscal 2017 increased approximately 130 basis points compared to Fiscal 2016 primarily due an increase in unit sales of +our core Roadway Sensors products, coupled with a decrease in our Transportation Systems third-party product sales in Fiscal 2017, both of which typically yield lower gross margins than our Roadway +Sensors core video detection products. Our service gross profit as a percentage of service revenues for Fiscal 2017 decreased 50 basis points compared to Fiscal 2016 primarily due to the timing of +certain extension contracts, the contract mix and an increase in the amount of related sub-consulting content of such contracts. Sub-consulting content generally results in lower gross margins than +our workforce. Our total gross profit as a percentage of total revenues for Fiscal 2017 decreased approximately 40 basis points compared to Fiscal 2016 primarily due to higher revenues derived from +our Transportation Systems segment in Fiscal 2017, which has generally experienced lower gross profits than our other segments and which increased to approximately 51% of our total revenues for Fiscal +2017, as compared to 44% for Fiscal 2016. Therefore, the increase in Transportation Systems revenues, as a percentage of our overall revenue mix, decreased our overall margin. +Roadway +Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix between core products and third party OEM products, +competitive pricing requirements, product warranty costs and provisions for our excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining +activities, which we record as cost of goods sold. +We +recognize a portion of our Transportation Systems revenues and related gross profit using percentage of completion contract accounting, and the underlying mix of contract activity +affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future periods due to our contract mix and +the amount of related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could cause fluctuations in our margins from +period to period. +Selling, General and Administrative Expense +Selling, +general and administration expense for Fiscal 2018 increased approximately 12.3% to $37.4 million, compared to $33.3 million in Fiscal 2017. The overall increase +was primarily due to an increase in business development costs aimed at the pursuit of large contracts in the Transportations Systems segment. In addition, there were higher personnel compensation +costs driven by higher revenues. This increase in personnel also drove an increase in facilities costs. The overall increase was also attributable to an increase in other selling, general and +administrative expenses, primarily due to a reversal of certain bad debt reserves on specific accounts receivable that were subsequently collected during Fiscal 2017, which did not reoccur in Fiscal +2018. +Selling, +general and administration expense for Fiscal 2017 increased approximately 24.1% to $33.3 million, compared to $26.8 million in Fiscal 2016. The overall increase +was primarily due to planned headcount increases in corporate headquarters general and administrative positions, as well as planned investments in Agriculture and Weather Analytics sales and +marketing, including an increase in the salesforce headcount, which resulted in higher salary and personnel-related costs. The increases in general and administrative expense were also due to legal +costs incurred (i) to reach a proxy contest settlement during our second quarter of Fiscal 2018 and (ii) for recent stockholder litigation which was +34 +Table of Contents +settles +in the first half of Fiscal 2018 (see Note 8 of Notes to Consolidated Financial Statements). The increases in general and administrative were also attributable to additional costs for +internal control framework to comply with Sarbanes-Oxley standards as an accelerated filer. These increases were partially offset by a reversal of certain bad debt reserves that were placed on +specific accounts receivable that were collected during Fiscal 2017. +Research and Development Expense +Research and development expense for Fiscal 2018 increased approximately 15.5% to $7.9 million, compared to $6.9 million in Fiscal +2017. The overall increase was primarily due to continued investment in research, discovery, and development largely focused on our software related product offerings. +We +continued to invest in the development of our iPeMS software offering as well as our ClearAg and ClearPath Weather solutions. In addition, we invested in further enhancements and +functionality in our Vantage products family. During Fiscal 2018, we successfully released Iteris SPM, our cloud-based signal performance measures application. During Fiscal 2017, we released our +VantageLive! platform as well as a number of generally available advisory applications, including our Harvest Advisory and Nitrogen Advisory. Certain development costs were capitalized into intangible +assets in the consolidated balance sheets; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect +to continue to invest in our solutions. This continued investment may result in increases in research and development costs in future periods. +Research +and development for Fiscal 2017 and Fiscal 2016 was relatively consistent at $6.9 million for both periods as the Company continued to invest in research, discovery, and +development. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2018, we believe the carrying value of our goodwill was not impaired, as the estimated fair +values of our reporting units exceeded their carrying values at the end of Fiscal 2018. Based on our goodwill impairment testing for Fiscal 2017, we determined the fair value of the Agriculture and +Weather Analytics reporting unit was less than its carrying amount and resulted in approximately $2.2 million impairment charge in the consolidated statement of operations for Fiscal 2017. We +also determined our Roadway Sensors and Transportation Systems reporting units had no impairment, as their estimated fair values exceeded their respective carrying values. Based on our goodwill +impairment testing for Fiscal 2016, we believe the carrying value of our goodwill was not impaired, as the estimated fair values of our reporting units exceeded their carrying values at the end of +such fiscal year. If our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our +goodwill, we could incur goodwill impairment charges in the future. +Amortization of Intangible Assets +Amortization of intangible assets was approximately $88,000, $281,000 and $360,000 in Fiscal 2018, Fiscal 2017 and +Fiscal 2016, respectively. The decrease in amortization was primarily due to the completion of amortization on certain older intangible assets. +Interest Income, Net +Net interest income was approximately $32,000, $13,000 and $12,000 in Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively. +35 +Table of Contents +Income Taxes +The following table presents our (benefit) provision for income taxes for Fiscal 2018, Fiscal 2017 and Fiscal 2016: +Year Ended March 31, +2018 +2017 +2016 +(In thousands, except +percentages) +(Benefit) provision for income taxes +$ +(1,818 +) +$ +(44 +) +$ +9,079 +Effective tax rate +32.5 +% +0.8 +% +(262.6 +)% +For +Fiscal 2018, the difference between the statutory and the effective tax rate was primarily attributable to an increase in tax expense resulting from the impact of the change in the +U.S. federal tax rate on the Company's deferred tax assets, offset by a corresponding change to the valuation allowance maintained against the deferred tax assets and a benefit for research tax +credits generated during the current fiscal year. The effective tax rate for Fiscal 2018 was also favorably impacted by the reversal of the valuation allowance related to Alternative Minimum Tax +credit carryforwards, which were made refundable by the tax legislation discussed below. +For +Fiscal 2017 and 2016, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against the Company's deferred +tax assets. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it +appropriate to maintain valuation allowances of $9.8 million and $11.7 million against our deferred tax assets at March 31, 2018 and 2017, respectively. We will continue to +reassess the appropriateness of maintaining a valuation allowance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective +tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to +the extent that we believe these assets will more likely than not be realized. +At +March 31, 2018, we had $6.8 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes and $5.6 million of +federal net operating loss carryforwards that begin to expire in 2022. We also had $4.4 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact +cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using +statutory tax rates. +The +Tax Act was enacted on December 22, 2017 and reduced U.S. corporate income tax rates to 21.0% as of January 1, 2018. The rate change became effective during Fiscal 2018 +resulting in a blended statutory tax rate of 30.8% for Fiscal 2018. As a consequence of the tax legislation, the Company recorded a decrease in its net deferred tax assets of $4.1 million and a +decrease in the valuation allowance maintained against its deferred tax assets of $5.8 million. The estimated impact of the tax legislation was an income tax benefit of $1.7 million, of +which $1.1 million was due to the release of valuation allowance that had been maintained against Alternative Minimum Tax credit carryforwards, which were made refundable by the tax +legislation, and $640,000 was due to the remeasurement of a deferred tax liability related to indefinite-lived assets. +36 +Table of Contents +On +December 22, 2017, the SEC issued guidance under SAB 118 directing taxpayers to consider the impact of the tax legislation as "provisional" when it does not have the +necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, the income +tax effects discussed above represent the Company's best estimate based on its current interpretation of this tax legislation. The Company is accumulating data to finalize the underlying calculations +and evaluate other aspects of this tax legislation, or in certain cases, the U.S. Treasury is expected to issue further guidance on the application of certain provisions of the tax legislation. In +accordance with SAB 118, the income tax effects of the tax legislation discussed above are considered provisional and will be finalized in Fiscal 2019. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We have +historically relied, and expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least +the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt +securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing +stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure +additional funding on a timely basis, on terms acceptable to us, or at all. +At +March 31, 2018, we had $17.4 million in working capital, which included $10.2 million in cash and cash equivalents, as well as $5.3 million in short term +investments. This compares to working capital of $22.7 million at March 31, 2017, which included $18.2 million in cash and cash equivalents. +The +following table summarizes our cash flows for Fiscal 2018, Fiscal 2017 and Fiscal 2016: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +(268 +) +$ +2,903 +$ +(4,110 +) +Investing activities +(8,823 +) +(1,343 +) +(978 +) +Financing activities +1,042 +612 +(844 +) +Operating Activities. Cash used in our operations during Fiscal 2018 was primarily the result of our net loss of approximately +$3.5 million, +adjusted by approximately $2.4 million in non-cash items for deferred income taxes, depreciation, stock-based compensation, amortization, gain on sales of discontinued operations, and loss on +disposal of equipment. The net loss was offset in part by approximately $819,000 of working capital provided in Fiscal 2018. +Cash +provided by our operations during Fiscal 2017 was primarily the result of approximately $3.6 million of working capital provided and offset by our net loss of approximately +$4.8 million, adjusted by approximately $4.2 million in non-cash items for deferred income taxes, depreciation, stock-based compensation, amortization, gain on sales of discontinued +operations, loss on disposal of equipment and loss on impairment of goodwill. +Cash +used in our operations during Fiscal 2016 was primarily the result of our net loss of approximately $12.3 million, adjusted by approximately $10.5 million in non-cash +items, of which +37 +Table of Contents +approximately +$9.0 million related to the change in our deferred income taxes and related valuation allowance recorded against our federal net operating loss carryforwards. Such non-cash items +also included higher stock-based compensation primarily due to the recent large equity grant to our new CEO, as well as depreciation, amortization, gain on the sale of discontinued operation and loss +on disposal of equipment. Cash used in our operations was also driven by approximately $2.3 million used in working capital. +Investing Activities. Cash used in our investing activities during Fiscal 2018 consisted of approximately $5.3 million in +investment +purchases, approximately $1.1 million for purchases of property and equipment primarily related to leasehold improvement to our corporate headquarters, and $2.9 million of capitalized +software development primarily related to the development of our new Oracle ERP system, and to a lesser extent, in the Agriculture and Weather Analytics and Roadway Sensors business segments related +to ClearAg assets and VantageLive! developments. These investments were partially offset by approximately $511,000 in proceeds from the earn-out provision included in the sale of the Vehicle Sensors +segment. +Cash +used in our investing activities during Fiscal 2017 consisted of approximately $1.2 million of capitalized software development in the Agriculture and Weather Analytics and +Roadway Sensors business segments related to ClearAg assets and VantageLive! development, respectively, and approximately $668,000 for purchases of property and equipment, primarily related to +computers and related equipment which were offset by approximately $495,000 in proceeds from the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2016 consisted of approximately $856,000 for purchases of property and equipment, primarily related to computers and related equipment +and approximately $490,000 of capitalized software development in the Agriculture and Weather Analytics business segment related to ClearAg assets, which were offset by approximately $368,000 in +proceeds from the sale of the Vehicle Sensors segment. +Financing Activities. Net cash provided by financing activities during Fiscal 2018 and Fiscal 2017 was primarily the result of +approximately +$1.0 million and $612,000, respectively, of cash proceeds received from the exercises of stock options. +Net +cash used in financing activities during Fiscal 2016 was primarily the result of approximately $1.2 million in cash used to repurchase shares of our common stock under our +stock repurchase program, which was offset in part by approximately $383,000 of cash proceeds received from the exercises of stock options. +Borrowings +We previously had a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expired on +October 1, 2016. We were obligated to pay an unused line fee of 0.15% per annum applied to the average unused portion of the revolving line of credit. We chose not to renew our line of credit +as we do not foresee a need to utilize credit within the next twelve months, and we will avoid paying an unused line fee. +Off-Balance Sheet Arrangements +Other than our operating leases, which are further described at Note 8 of Notes to Consolidated Financial Statements, included in +Part II, Item 8 of this report, we do not have any other material off-balance sheet arrangements at March 31, 2018. +38 +Table of Contents +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such sales in +our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally +impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal quarter due to +the increased number of holidays, causing a reduction in available billable hours. In addition, we have experienced seasonality related to certain +ClearPath Weather services, which adversely impacts such sales in our first and second fiscal quarters, mainly because these services are generally not required during Spring and Summer when weather +conditions are comparatively milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our +investment activities is to preserve principal and liquidity while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our investments +portfolio in a variety of available-for-sale fixed debt securities, including both government and corporate obligations and money market funds. Investments in fixed rate interest bearing instruments +carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in prevailing interest rates. Due in part to these factors, we may suffer +losses in principal if we need the funds prior to maturity and choose to sell securities that have declined in market value due to changes in interest rates or perceived credit risk related to the +securities' issuers. +39 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Consolidated Financial Statement +Report of Independent Registered Public Accounting Firm +41 +Consolidated Balance Sheets as of March 31, 2018 and 2017 +43 +Consolidated Statements of Operations for the fiscal years ended March 31, 2018, 2017 and 2016 +44 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2018, 2017 and 2016 +45 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2018, 2017 and 2016 +46 +Notes to Consolidated Financial Statements +47 +40 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiary (the "Company") as of March 31, 2018 +and 2017, the related consolidated statements of operations, stockholders' equity, and cash flows, for each of the three years in the period ended +March 31, 2018, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company's internal control over financial reporting as of +March 31, 2018, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring +Organizations of the Treadway Commission (COSO). +In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2018 and 2017, and the +results of their operations and their cash flows for each of the three years in the period ended March 31, 2018, in conformity with accounting principles generally accepted in the United States +of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2018, based on criteria established in Internal +Control—Integrated Framework (2013) issued by COSO. +Basis for Opinions +The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and +for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility +is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with +the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the +applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We +conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the +financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our +audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and +performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also +included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal +control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the +design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe +that our audits provide a reasonable basis for our opinions. +41 +Table of Contents +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting +includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets +of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting +principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable +assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ +Deloitte & Touche LLP +Costa Mesa, CA +June 7, 2018 +We +have served as the Company's auditor since fiscal 2016. +42 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2018 +2017 +Assets +Current assets: +Cash and cash equivalents +$ +10,152 +$ +18,201 +Short-term investments +5,319 +— +Trade accounts receivable, net of allowance for doubtful accounts of $333 and $389 at March 31, 2018 and March 31, 2017, +respectively +12,866 +14,299 +Unbilled accounts receivable +7,473 +6,456 +Inventories +2,921 +2,250 +Prepaid expenses and other current assets +1,165 +2,108 +Total current assets +39,896 +43,314 +Property and equipment, net +2,333 +2,064 +Intangible assets, net +3,751 +1,498 +Goodwill +15,150 +15,150 +Other assets +1,756 +319 +Total assets +$ +62,886 +$ +62,345 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +7,838 +$ +7,886 +Accrued payroll and related expenses +7,398 +6,443 +Accrued liabilities +2,358 +2,201 +Deferred revenue +4,900 +4,049 +Total current liabilities +22,494 +20,579 +Deferred rent +638 +649 +Deferred income taxes +65 +707 +Unrecognized tax benefits +168 +186 +Total liabilities +23,365 +22,121 +Commitments and contingencies (Note 9) +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 +Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2018 and March 31, 2017 +Issued and outstanding shares—33,186 at March 31, 2018 and 32,488 at March 31, 2017 +3,318 +3,249 +Additional paid-in capital +139,722 +136,968 +Accumulated deficit +(103,519 +) +(99,993 +) +Total stockholders' equity +39,521 +40,224 +Total liabilities and stockholders' equity +$ +62,886 +$ +62,345 +See accompanying notes. +43 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2018 +2017 +2016 +Product revenues +$ +46,464 +$ +43,735 +$ +41,733 +Service revenues +57,265 +52,247 +36,015 +Total revenues +103,729 +95,982 +77,748 +Cost of product revenues +26,633 +23,877 +23,340 +Cost of service revenues +37,265 +34,703 +23,739 +Cost of revenues +63,898 +58,580 +47,079 +Gross profit +39,831 +37,402 +30,669 +Operating expenses: +Selling, general and administrative +37,400 +33,313 +26,846 +Research and development +7,945 +6,877 +6,933 +Amortization of intangible assets +88 +281 +360 +Loss on impairment of goodwill +— +2,168 +— +Total operating expenses +45,433 +42,639 +34,139 +Operating loss +(5,602 +) +(5,237 +) +(3,470 +) +Non-operating income (expense): +Other (expense) income, net +(16 +) +(7 +) +2 +Interest income, net +32 +13 +12 +Loss from continuing operations before income taxes +(5,586 +) +(5,231 +) +(3,456 +) +Benefit (provision) for income taxes +1,818 +44 +(9,079 +) +Loss from continuing operations +(3,768 +) +(5,187 +) +(12,535 +) +Gain on sale of discontinued operation, net of tax +242 +361 +214 +Net loss +$ +(3,526 +) +$ +(4,826 +) +$ +(12,321 +) +Loss per share from continuing operations—basic and diluted +$ +(0.12 +) +$ +(0.16 +) +$ +(0.39 +) +Gain per share from sale of discontinued operation—basic and diluted +$ +0.01 +$ +0.01 +$ +0.01 +Net loss per share—basic and diluted +$ +(0.11 +) +$ +(0.15 +) +$ +(0.38 +) +Shares used in basic per share calculations +32,776 +32,174 +32,049 +Shares used in diluted per share calculations +32,776 +32,174 +32,049 +See accompanying notes. +44 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at March 31, 2015 +32,411 +$ +3,242 +$ +135,572 +$ +(82,846 +) +$ +55,968 +Stock option exercises +243 +24 +359 +— +383 +Stock-based compensation +— +— +659 +— +659 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +50 +5 +(37 +) +— +(32 +) +Repurchases of common stock +(656 +) +(66 +) +(1,129 +) +— +(1,195 +) +Net loss +(12,321 +) +(12,321 +) +Balance at March 31, 2016 +32,048 +$ +3,205 +$ +135,424 +$ +(95,167 +) +$ +43,462 +Stock option exercises +388 +40 +628 +— +668 +Stock-based compensation +— +— +976 +— +976 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +52 +4 +(60 +) +— +(56 +) +Net loss +(4,826 +) +(4,826 +) +Balance at March 31, 2017 +32,488 +$ +3,249 +$ +136,968 +$ +(99,993 +) +$ +40,224 +Stock option exercises +591 +59 +1,131 +— +1,190 +Stock-based compensation +— +— +1,781 +— +1,781 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +107 +10 +(158 +) +— +(148 +) +Net loss +(3,526 +) +(3,526 +) +Balance at March 31, 2018 +33,186 +$ +3,318 +$ +139,722 +$ +(103,519 +) +$ +39,521 +See accompanying notes. +45 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Year Ended March 31, +2018 +2017 +2016 +Cash flows from operating activities +Net loss +$ +(3,526 +) +$ +(4,826 +) +$ +(12,321 +) +Adjustments to reconcile net loss to net cash (used in) provided by operating activities: +Deferred income taxes +(660 +) +12 +8,859 +Depreciation of property and equipment +819 +729 +649 +Stock-based compensation +1,781 +976 +659 +Amortization of intangible assets +726 +623 +526 +Gain on sale of discontinued operation, net of tax +(242 +) +(361 +) +(214 +) +Loss on disposal of equipment +16 +14 +58 +Loss on impairment of goodwill +— +2,168 +— +Changes in operating assets and liabilities, net of effects of discontinued operation: +Accounts receivable +1,433 +(1,058 +) +(2,035 +) +Unbilled accounts receivable and deferred revenue, net +(166 +) +549 +(239 +) +Inventories +(671 +) +903 +(91 +) +Prepaid expenses and other assets +(693 +) +(408 +) +(407 +) +Accounts payable and accrued expenses +915 +3,582 +446 +Net cash (used in) provided by operating activities +(268 +) +2,903 +(4,110 +) +Cash flows from investing activities +Purchases of property and equipment +(1,079 +) +(668 +) +(856 +) +Capitalized software development costs +(2,936 +) +(1,170 +) +(490 +) +Purchase of short term investments +(5,319 +) +— +— +Net proceeds from sale of business segment +511 +495 +368 +Net cash used in investing activities +(8,823 +) +(1,343 +) +(978 +) +Cash flows from financing activities +Repurchases of common stock +— +— +(1,195 +) +Proceeds from stock option exercises +1,190 +668 +383 +Tax withholding payments for net share settlements of restricted stock units +(148 +) +(56 +) +(32 +) +Net cash provided by (used in) financing activities +1,042 +612 +(844 +) +(Decrease) increase in cash and cash equivalents +(8,049 +) +2,172 +(5,932 +) +Cash and cash equivalents at beginning of period +18,201 +16,029 +21,961 +Cash and cash equivalents at end of period +$ +10,152 +$ +18,201 +$ +16,029 +Supplemental cash flow information: +Cash paid during the year for: +Interest +$ +— +$ +14 +$ +18 +Income taxes +130 +166 +177 +Supplemental schedule of non-cash investing and financing activities: +Capitalized software development costs included in accounts payable and accrued expenses +$ +102 +$ +— +$ +— +Issuance of common stock for vested restricted stock units +10 +5 +5 +Landlord contribution for tenant improvements +145 +— +— +See accompanying notes. +46 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris", the "Company", +"we", "our", and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, farmers and +agronomists use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +We +offer a comprehensive range of intelligent transportation systems ("ITS") technology solutions to our customers throughout the U.S. and internationally through a combination +intellectual property, products, and decades of experience in traffic management, weather forecasting solutions and information technologies. +In +the agribusiness markets, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content solutions that +provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service +providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the entire value chain in the agriculture market with our smart content and digital farming platform. +Iteris +was incorporated in Delaware in 1987. +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +in the agribusiness markets. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and its subsidiary and have been prepared in accordance with +generally accepted accounting principles in the United States of America ("GAAP"). All intercompany accounts and transactions have been eliminated in consolidation. +The +results of continuing operations for all periods presented in the consolidated financial statements exclude the financial impact of a discontinued operation. See Note 3, "Sale +of Vehicle Sensors," for further discussion related to the discontinued operation presentation. +47 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions +that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses +during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the collectability of +accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves, costs to complete long-term +contracts, indirect cost rates used in cost plus contracts, the +valuation of purchased intangible assets and goodwill, the valuation of equity instruments, estimates of future cash flows used to assess the recoverability of long-lived assets and the impairment of +goodwill, and fair value of our stock option awards used to calculate the stock-based compensation. +Revenue Recognition +Product revenues and related costs of sales are recognized when all of the following criteria are met: (i) persuasive evidence of an +arrangement exists, (ii) delivery under the terms of the arrangement has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the receivable +is reasonably assured. These criteria are typically met at the time of product shipment but, in certain circumstances, may not be met until receipt or acceptance by the customer. Accordingly, at the +date revenue is recognized, the significant obligations or uncertainties concerning the sale have been resolved. +Transportation +Systems revenues are derived primarily from long-term contracts with governmental agencies. Certain Agriculture and Weather Analytics revenues are also derived from +long-term contracts with governmental agencies, as well as contracts with commercial companies. Agriculture and Weather Analytics revenues that are derived from contracts with commercial companies are +generally from subscription revenue that we typically invoice our customers at the beginning of the term, in multiyear, annual, semi-annual or quarterly installments, and revenue is recognized ratably +over the period of the subscription beginning once all requirements for revenue recognition have been met, including provisioning the service so that it is available to our customers. When +appropriate, revenues are recognized using the percentage of completion method of accounting, whereby revenue is recognized as contract performance progresses and is determined based on the +relationship of costs incurred to total estimated costs. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract +settlements, may result in revisions to costs and revenues, and are recognized in the period in which the revisions are determined. Profit incentives are included in revenues, when their realization +is reasonably assured. Certain of our revenues are recognized as services are performed and amounts are earned, which is measured by time incurred or other contractual milestones or output measures. +Revenues accounted for in this manner generally relate to certain fixed fee professional services, cost plus fixed fee, or time and materials contracts. Revenues for ongoing operations and maintenance +services contracts are generally accounted for ratably as the services are performed throughout the term of the contract. Payments received in advance of services performed are deferred and recognized +when the related services are performed. +48 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +We +recognize revenue from the sale of deliverables that are part of a multiple element arrangement in accordance with applicable accounting guidance that establishes a relative selling +price hierarchy permitting the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple element arrangement where neither vendor +specific objective evidence ("VSOE") nor third party evidence ("TPE") of fair value is available for that deliverable. In the absence of VSOE or TPE of the stand-alone selling price for one or more +delivered or undelivered elements in a multiple element arrangement, we are required to estimate the selling prices of those elements. Overall arrangement consideration is allocated to each element +(both delivered and undelivered items) that has stand-alone value based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on our +estimated selling prices. +We +record provisions for estimated losses on uncompleted contracts in the period in which such losses become known. The cumulative effects of revisions to contract revenues and estimated +completion costs are recorded in the accounting period in which the amounts become evident and can be reasonably estimated. These revisions can include such items as the effects of change orders and +claims, warranty claims, liquidated damages or other contractual penalties and adjustments for contract closeout settlements. +Unbilled Accounts Receivable +Unbilled accounts receivable in the accompanying audited consolidated balance sheets represent unbilled amounts earned and reimbursable under +services sales arrangements, including approximately $1.5 million of costs and estimated earnings in excess of billings on uncompleted contracts as of March 31, 2018, accounted for under +Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 605-35, Construction-Type and Production-Type Contracts +("ASC 605-35"). At any given period-end, a large portion of the balance in this account represents the accumulation of labor, materials and other costs that have not been billed due to timing, +whereby the accumulation of each month's costs and earnings are not administratively billed until the subsequent month. Also included in this account are amounts that will become billable according to +contract terms, which usually require the consideration of the passage of time, achievement of milestones or completion of the project. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of cash collected from customers and billings to customers on +contracts in advance of work performed, advance payments negotiated as a contract condition, estimated losses on uncompleted contracts, +project-related legal liabilities and other project-related reserves, including approximately $1.5 million of billings in excess of costs and estimated earnings on uncompleted contracts +accounted for under FASB ASC 605-35. The unearned amounts are expected to be earned within the next twelve months. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade +accounts receivable. +49 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in the Middle East, Europe, South America and Asia. We generally +do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within +management's expectations. +We +currently have, and historically have had, a diverse customer base. For the fiscal years ended March 31, 2018 ("Fiscal 2018") and March 31, 2017 ("Fiscal 2017"), one +individual customer represented approximately 22% of our total revenues, respectively, and no other individual customer represented greater than 10% of our total revenues. . For the fiscal year ended +March 31, 2016 ("Fiscal 2016"), no individual customer represented greater than 10% of our total revenues. +Fair Values of Financial Instruments +The fair value of cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of the short period of +time to maturity. Our investments are measured at fair value on a recurring basis. +The +framework for measuring fair value and related disclosure requirements about fair value measurements are provided in ASC 820, Fair Value +Measurements ("ASC 820"). This pronouncement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most +advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy proscribed by ASC 820 contains three levels as +follows: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +Cash and Cash Equivalents +Cash and cash equivalents consist of cash and short-term investments with initial maturities of ninety days or less. +50 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Investments +The Company's investments are classified as either held-to-maturity, available-for-sale or trading, in accordance with FASB ASC 320. +Held-to-maturity securities are those securities that the Company has the positive intent and ability to hold until maturity. Trading securities are those securities that the Company intends to sell +in the near term. All other securities not included in the held-to-maturity or trading category are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost which +approximates fair market value. Trading securities are carried at fair value with unrealized gains and losses charged to earnings. Available-for-sale securities are carried at fair value with +unrealized gains and losses recorded within accumulated other comprehensive loss as a separate component of stockholders' equity. FASB ASC 820 defines fair value as the price that would be received to +sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an +entity to maximize the use of observable inputs, where available (see Note 5). Under FASB ASC 320-10-35, a security is considered to be other-than-temporarily impaired if the present value of +cash flows expected to be collected are less than the security's amortized cost basis (the difference being defined as the "Credit Loss") or if the fair value of the security is less than the +security's amortized cost basis and the investor intends, or will be required, to sell the security before recovery of the security's amortized cost basis. If an other-than-temporary impairment +exists, the charge to earnings is limited to the amount of Credit Loss if the investor does not intend to sell the security, and will not be required to sell the security, before recovery of the +security's amortized cost basis. Any remaining difference between fair value and amortized cost is recognized in other comprehensive loss, net of applicable taxes. The Company evaluates whether the +decline in fair value of its investments is other-than-temporary at each quarter-end. This evaluation consists of a review by management, and includes market pricing information and maturity dates for +the securities held, market and economic trends in the industry and information on the issuer's financial condition and, if applicable, information on the guarantors' financial condition. Factors +considered in determining whether a loss is temporary include the length of time and extent to which the investment's fair value has been less than its cost basis, the financial condition and +near-term prospects of the issuer and guarantors, including any specific events which may influence the operations of the issuer and the Company's intent and ability to retain the investment for a +reasonable period of time sufficient to allow for any anticipated recovery of fair value. +Prepaid Expenses and Other Current Assets +Prepaid expenses and other current assets were $1.2 million as of March 31, 2018 and $2.1 million as of March 31, +2017 and included approximately $130,000 of cash designated as collateral on performance bonds, as required under certain of our Transportation Systems contracts in the Middle East. The performance +bonds require us to maintain 100% cash value of the bonds as collateral in a bank that is local to the purchasing agency. The performance bond collateral is required throughout the delivery of our +services and is maintained in the local bank until the contract is closed by the purchasing agency. We expect these requirements, and the related cash collateral restrictions, to be released during +calendar year 2018. +51 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or net realizable value. Cost is +determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging from three +to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Goodwill and Long-Lived Assets +We perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or +circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting +unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to +be impaired and no further testing is required. If further testing is required, we perform a two-step process. The first step involves comparing the fair value of our reporting unit to its carrying +value, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the second step of the test is performed by comparing the carrying value of the goodwill in the reporting +unit to its implied fair value. An impairment charge is recognized for the excess of the carrying value of goodwill over its implied fair value. We determine the fair values of our reporting units +using the income valuation approach, as well as other generally accepted valuation methodologies. +In +Fiscal 2017, we adopted the provisions issued by the FASB that were intended to simplify goodwill impairment testing. This guidance permits us to eliminate the second step of the +goodwill impairment test, and eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. If the carrying amount of a reporting unit +exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators +for goodwill impairment testing between annual tests. As of March 31, 2018, we determined that no adjustments to the carrying value of goodwill and intangible assets were required. As of +March 31, 2017, we +52 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +determined +the carrying amount of the goodwill in the Agriculture and Weather Analytics reporting unit exceeded its implied fair value, and as a result, recognized an approximate $2.2 million +impairment loss in the accompanying consolidated financial statements. We also determined that no adjustments to the carrying value of goodwill and intangible assets were required in the Roadway +Sensors and Transportation Systems reporting units for any year presented. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets +and purchased intangible assets. As of March 31, 2018, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary +differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation +allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. +As such, we determined it was appropriate to record a valuation allowance of approximately $10.1 million in the third quarter of Fiscal 2016 against our deferred tax assets. We will +continuously reassess the appropriateness of maintaining a valuation allowance. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are +derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of +our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock units. The +fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our common stock option awards as it does not consider certain factors important to those awards to employees, +such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common +stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned +stock-based compensation expense. +53 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Advertising Expenses +Advertising costs are expensed in the period incurred and totaled $148,000, $146,000, and $164,000 in Fiscal 2018, Fiscal 2017 and Fiscal 2016, +respectively. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to +various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to +one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and +maintenance costs are charged to expense as incurred. +Comprehensive Loss +The +difference between net loss and comprehensive loss was de minimis for Fiscal 2018. Comprehensive loss equaled net loss for Fiscal 2017 and Fiscal 2016. +Recent Accounting Pronouncements +In May 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with +Customers ("ASU 2014-09"). The new revenue recognition standard ("ASC 606") provides a five-step analytical framework for transactions to determine when and how revenue is +recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the +54 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +entity +expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method or the modified retrospective +method. We are required to adopt this standard effective April 1, 2018. +We +plan to adopt this standard using the modified retrospective method with an immaterial adjustment to accumulative deficit for the cumulative effect of adoption. Our assessment process +has consisted of reviewing current accounting policies and practices to identify potential differences that would result from applying the requirements of the new standard to our revenue contracts. We +have reviewed individual customer contracts and purchase orders related to these revenues streams as well as identified appropriate changes to our business processes, systems and controls to support +the revenue recognition and disclosure requirements under the new standard. We believe that the new standard and related revenue recognition policies will not result in a material change to our +consolidated financial statements, but will require additional disclosures in our financial statements as to the nature, amount and timing of revenue and cash flows arising from contracts with +customers. +In +December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with +Customers ("ASU 2016-20"), which allows entities not to make quantitative disclosures about remaining performance obligations in certain cases and requires entities that use +any of the new or previously existing optional exemptions to expand their qualitative disclosures. The new standard is effective for fiscal years, and interim periods within those years, beginning +after December 15, 2017, with early adoption permitted. The adoption of ASU 2016-20 is not expected to have a material impact on our consolidated financial statements. +In +January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial +Liabilities ("ASU 2016-01"). This standard revises an entity's accounting related to (1) the classification and measurement of investments in equity securities and +(2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial +instruments. Under the new guidance, entities will have to measure certain equity investments at fair value and recognize any changes in fair value in net income unless the investments qualify for a +new practicality exception. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. We are +currently evaluating the impact of ASU 2016-01 on our consolidated financial statements. +In +February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). The pronouncement requires an entity to recognize assets +and liabilities for the rights and obligations created by leases on the entity's balance sheet for both finance and operating leases. For leases with a term of 12 months or less, an entity can +elect to not recognize lease assets and lease liabilities and expense the lease over a straight-line basis for the term of the lease. ASU 2016-02 will require new disclosures that depict the amount, +timing, and uncertainty of cash flows pertaining to an entity's leases. Companies are required to adopt the new standard using a modified retrospective approach for annual and interim periods +beginning after December 15, 2018. Early adoption of ASU 2016-02 is permitted. The Company expects adoption to increase the assets and liabilities recorded on its consolidated balance sheet and +increase the level of disclosures related to leases. We are currently evaluating the impact of ASU 2016-02 on our consolidated financial statements. +55 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +In +August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash +Payments ("ASU 2016-15"), which clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new standard is effective +for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. The adoption of ASU 2016-15 is not expected to have a material +impact on our consolidated financial statements. +In +November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash ("ASU 2016-18"), requiring +restricted cash and cash equivalents to be included with cash and cash equivalents on the statement of cash flows. The new standard is effective for fiscal years, and interim periods within those +years, beginning after December 15, 2017, with early adoption permitted. The adoption of ASU 2016-18 is not expected to have a material impact on our consolidated financial statements. +In +May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation: Scope of Modification Accounting ("ASU +2017-09"). The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC 718 +Compensation—Stock Compensation. The adoption of ASU 2017-09, which will become effective for annual periods beginning after December 15, 2017, is not expected to have a +material impact on our consolidated financial statements. +In +March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740), Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin +No. 118 ("ASU 2018-05"). ASU 2018-05 adds various Securities and Exchange Commission ("SEC") paragraphs pursuant to the issuance of the December 2017 SEC Staff +Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), which was effective immediately. The SEC issued SAB 118 to address +concerns about reporting entities' ability to timely comply with the accounting requirements to recognize all of the effects of the Tax Cuts and Jobs Act in the period of enactment. SAB 118 +allows disclosure that timely determination of some or all of the income tax effects from the Tax Cuts and Jobs Act are incomplete by the due date of the financial statements and if possible to +provide a reasonable estimate. The Company has accounted for the tax effects of the Tax Cuts and Jobs Act under the guidance of SAB 118, on a provisional basis. The Company's accounting for +certain income tax effects is incomplete, but the Company has determined reasonable estimates for those effects and has recorded provisional amounts in its consolidated financial statements as of +March 31, 2018. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2018 +2017 +(In thousands) +Materials and supplies +$ +1,745 +$ +887 +Work in process +232 +298 +Finished goods +944 +1,065 +$ +2,921 +$ +2,250 +56 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +2. Supplementary Financial Information (Continued) +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2018 +2017 +(In thousands) +Equipment +$ +6,053 +$ +7,078 +Leasehold improvements +2,880 +2,494 +Accumulated depreciation +(6,600 +) +(7,508 +) +$ +2,333 +$ +2,064 +Depreciation +expense was approximately $819,000, $729,000, and $649,000 in Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively. Approximately $288,000, $269,000, and $252,000 of the +depreciation expense was recorded to cost of revenues, and approximately $531,000, $397,000 and $300,000 was recorded to operating expenses in Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively, +in the consolidated statements of operations. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, +2018 +2017 +Gross +Carrying +Amount +Accumulated +Amortization +Gross +Carrying +Amount +Accumulated +Amortization +(In thousands) +Technology +$ +1,856 +$ +(1,856 +) +$ +1,856 +$ +(1,828 +) +Customer contracts / relationships +750 +(750 +) +750 +(726 +) +Trade names and non-compete agreements +1,110 +(1,102 +) +1,110 +(1,066 +) +Capitalized software development costs +5,108 +(1,365 +) +2,158 +(756 +) +Total +$ +8,824 +$ +(5,073 +) +$ +5,874 +$ +(4,376 +) +Amortization +expense for intangible assets subject to amortization was approximately $726,000, $623,000, and $526,000 for Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively. +Approximately $638,000, $342,000, and $166,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $88,000, $281,000, and $360,000 was recorded to amortization +expense for Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively, in the consolidated statements of operations. +We +do not have any intangible assets with indefinite useful lives. As of March 31, 2018, our net capitalized software development costs of approximately $3.8 million is +associated with our Oracle ERP development of approximately $2.3 million, which has a useful life of 10 years beginning Fiscal 2019; as +57 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +2. Supplementary Financial Information (Continued) +well +as our Agriculture and Weather Analytics and Roadway Sensors segments, which have an average useful life of three years. The future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2019 +$ +1,076 +2020 +807 +2021 +339 +2022 +244 +2023 +244 +Thereafter +1,041 +$ +3,751 +Goodwill +The following table presents the activity related to the carrying value of our goodwill by reportable segment for Fiscal 2016, Fiscal 2017 and +Fiscal 2018: +Roadway +Sensors +Transportation +Systems +Ag & Weather +Analytics +Total +(In thousands) +Balance—March 31, 2016 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +— +(7,970 +) +$ +8,214 +$ +6,936 +$ +2,168 +$ +17,318 +Balance—March 31, 2017 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +8,214 +6,936 +— +15,150 +Balance—March 31, 2018 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +58 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +2. Supplementary Financial Information (Continued) +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Balance at beginning of fiscal year +$ +278 +$ +193 +$ +181 +Additions charged to cost of sales +623 +382 +236 +Warranty claims +(498 +) +(297 +) +(224 +) +Balance at end of fiscal year +$ +403 +$ +278 +$ +193 +Earnings Per Share +The following table sets forth the computation of basic and diluted loss from continuing operations per share: +Year Ended March 31, +2018 +2017 +2016 +(In thousands, +except per share amounts) +Numerator: +Loss from continuing operations +$ +(3,768 +) +$ +(5,187 +) +$ +(12,535 +) +Denominator: +Weighted average common shares used in basic computation +32,776 +32,174 +32,049 +Dilutive stock options +— +— +— +Dilutive restricted stock units +— +— +— +Dilutive warrants +— +— +— +Weighted average common shares used in diluted computation +32,776 +32,174 +32,049 +Loss from continuing operations per share: +Basic +$ +(0.12 +) +$ +(0.16 +) +$ +(0.39 +) +Diluted +$ +(0.12 +) +$ +(0.16 +) +$ +(0.39 +) +59 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +2. Supplementary Financial Information (Continued) +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted loss per share from continuing operations as +their effect would have been anti-dilutive: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Stock options +3,917 +3,491 +3,220 +Restricted stock units +228 +179 +186 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial Vehicle +Systems LLC ("Bendix"), a member of Knorr-Bremse Group. In connection with the asset sale, we are entitled to additional consideration in the form of the following performance and +royalty-related earn-outs: Bendix is obligated to pay us an amount in cash equal to 85% of revenue associated with royalties received under our license and distribution agreements with Audiovox +Electronics Corporation and Valeo Schalter and Sensoren GmbH through December 31, 2017, subject to certain reductions and limitations set forth in the asset purchase agreement. From the date of +the asset sale, through March 31, 2018, we received approximately $2.6 million in connection with royalty-related earn-outs provisions for a total of $17.9 million in cash from +the asset sale. +In +accordance with applicable accounting guidance, we determined that the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a discontinued operation. +For the fiscal year ended March 31, 2018, 2017 and 2016, we recorded a gain on sale of discontinued operation of approximately $242,000, $361,000, and $214,000, respectively, net of tax, +related to the earn-out provisions of the asset purchase agreement. +4. Impairment of Goodwill +As discussed in Note 1, goodwill is tested for impairment on an annual basis in our fourth fiscal quarter or more frequently if indicators of impairment exist. +Based +on our goodwill impairment testing for Fiscal 2018, we determined our Roadway Sensors and Transportation Systems reporting units were not impaired as of March 31, 2018, as +the estimated fair values of our reporting units exceeded their carrying values at the end of such fiscal years. Based on our goodwill impairment testing for Fiscal 2017, we believe the carrying value +of our goodwill in our Agriculture and Weather Analytic reporting unit was impaired as of March 31, 2017, and resulted in approximately $2.2 million impairment charge. We also determined +our Roadway Sensors and Transportation Systems reporting units were not impaired as of March 31, 2017. Based on our goodwill impairment testing for Fiscal 2016, we believe the carrying value of +our goodwill was not impaired. If our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment +of our goodwill, we could incur goodwill impairment charges in the future. +60 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +5. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +We +did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2018 or 2017. Our +non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets +such as a purchase transaction, a business combination or an adjustment for impairment. In Fiscal 2018, Level 3 inputs were used to evaluate the fair value of our goodwill in our two reporting +units that had goodwill balances. In Fiscal 2017, Level 3 inputs were used to evaluate the fair value of our goodwill in our three reporting units. As a result of our impairment testing, we recorded +an adjustment for impairment of approximately $2.2 million in our Agriculture and Weather Analytics reporting unit. No other non- financial assets were measured at fair value during the fiscal years +ended March 31, 2018, 2017, and 2016. +The +following tables present the Company's financial assets that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +As of March 31, 2018 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair +Value +(In thousands) +Level 1: +Money market funds +666 +— +— +666 +Subtotal +666 +— +— +666 +Level 2: +Commercial paper +1,891 +— +— +1,891 +Corporate notes and bonds +2,008 +(2 +) +— +2,006 +US Treasuries +1,500 +(1 +) +— +1,499 +US Government agencies +2,950 +(1 +) +— +2,949 +Subtotal +8,349 +(4 +) +— +8,345 +Total +9,015 +(4 +) +— +9,011 +61 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +6. Credit Facility +We had a $12.0 million revolving line of credit with California Bank & Trust ("CB&T"), which expired on October 1, 2016. We chose not to renew our line of credit as +we do not foresee a need to utilize credit within the next twelve months. +7. Income Taxes +The components of current and deferred federal and state income tax (benefits) provision are as follows: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Loss from continuing operations before income taxes +$ +(5,586 +) +$ +(5,231 +) +$ +(3,456 +) +Current income tax provision: +Federal +$ +3 +$ +71 +$ +170 +State +45 +62 +50 +Total current tax provision +48 +133 +220 +Deferred income tax (benefit) provision: +Federal +(1,849 +) +(166 +) +8,289 +State +(17 +) +(11 +) +570 +Total deferred tax (benefit) provision +(1,866 +) +(177 +) +8,859 +(Benefit) provision for income taxes on continuing operations +(1,818 +) +(44 +) +9,079 +Loss from continuing operations, net of tax +$ +(3,768 +) +$ +(5,187 +) +$ +(12,535 +) +The +reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +(Benefit) for income taxes at statutory rates +$ +(1,720 +) +$ +(1,778 +) +$ +(1,175 +) +Change in federal tax rate +4,134 +— +— +State income taxes net of federal benefit +(255 +) +(124 +) +(184 +) +Impairment charges +— +737 +— +Tax credits +(567 +) +(125 +) +(258 +) +Compensation charges +(324 +) +29 +91 +Change in valuation allowance +(3,153 +) +1,148 +10,557 +Other +67 +69 +48 +(Benefit) provision for income taxes +$ +(1,818 +) +$ +(44 +) +$ +9,079 +62 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +7. Income Taxes (Continued) +The +components of deferred tax assets and liabilities are as follows: +March 31, +2018 +2017 +(In thousands) +Deferred tax assets: +Net operating losses +$ +2,853 +$ +830 +Capitalized R&D +2,734 +5,003 +Credit carry forwards +2,043 +2,387 +Deferred compensation and payroll +1,603 +2,064 +Bad debt allowance and other reserves +567 +820 +Deferred rent +235 +313 +Property and equipment +844 +521 +Other, net +203 +255 +Total deferred tax assets +11,082 +12,193 +Valuation allowance +(9,814 +) +(11,726 +) +Total deferred tax assets, net of valuation allowance +1,268 +467 +Deferred tax liabilities: +Acquired intangibles +(866 +) +(467 +) +Goodwill +(467 +) +(707 +) +Total deferred tax liabilities +(1,333 +) +(1,174 +) +Net deferred tax liabilities +$ +(65 +) +$ +(707 +) +At +March 31, 2018, we had $1.1 million in federal Alternative Minimum Tax credit carryforwards that were reclassified from a deferred tax asset to a noncurrent income tax +receivable as we expect this amount to be refunded over the next four years. We also had $1.5 million in federal research credits that begin to expire in 2031 and $703,000 in state tax credits +that begin to expire in 2023. We had $6.8 million of federal net operating loss carryforwards at March 31, 2018 that do not expire as a result of recent tax law changes. We had +$5.6 million of federal net operating loss carryforwards at March 31, 2018 that begin to expire in 2022. We also had $4.4 million of state net operating loss carryforwards at +March 31, 2018 that begin to expire in 2031. +Our +deferred tax assets at March 31, 2017 did not include approximately $1.1 million of excess tax benefits from employee stock option exercises that were a component of +our net operating loss carryforwards. Due to the adoption of ASU 2016-09 in Fiscal 2018, this amount was recognized through accumulated deficit, offset by a corresponding amount of valuation +allowance, resulting in no net impact to accumulated deficit. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it +appropriate to maintain valuation allowances of $9.8 million and $11.7 million against our deferred tax assets at March 31, 2018 and +63 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +7. Income Taxes (Continued) +2017, +respectively. We will continuously reassess the appropriateness of maintaining a valuation allowance. +The +Tax Cuts and Jobs Act ("tax legislation") was enacted on December 22, 2017 and reduced U.S. corporate income tax rates to 21.0% as of January 1, 2018. The rate change +became effective during Fiscal 2018 resulting in a blended statutory tax rate of 30.8% for Fiscal 2018. As a consequence of the tax legislation, the Company recorded a decrease in its net deferred tax +assets of $4.1 million and a decrease in the valuation allowance maintained against its deferred tax assets of $5.8 million. The estimated impact of the tax legislation was an income tax +benefit of $1.7 million, of which $1.1 million was due to the release of valuation allowance that had been maintained against Alternative Minimum Tax credit carryforwards, which were +made refundable by the tax legislation, and $640,000 was due to the remeasurement of a deferred tax liability related to indefinite-lived assets. +On +December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118") +directing taxpayers to consider the impact of the tax legislation as "provisional" when it does not have the necessary information available, +prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, the income tax effects discussed above +represent the Company's best estimate based on its current interpretation of this tax legislation. The Company is accumulating data to finalize the underlying calculations and evaluate other aspects +of this tax legislation, or in certain cases, the U.S. Treasury is expected to issue further guidance on the application of certain provisions of the tax legislation. In accordance with +SAB 118, the income tax effects of the tax legislation discussed above are considered provisional and will be finalized in Fiscal 2019. +Unrecognized Tax Benefits +As of March 31, 2018 and 2017, our gross unrecognized tax benefits were $586,000 and $426,000, respectively, of which $461,000 and +$286,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are $513,000 and $359,000, respectively. +We +recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31, 2018 and 2017, we had accrued cumulatively $43,000 and $46,000, +respectively, for the payment of potential interest and penalties. The total amount of interest and penalties recognized in the consolidated statements of operations for the fiscal years ended +March 31, 2018 and 2017 was $(3,000) and $(6,000), respectively. +64 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +7. Income Taxes (Continued) +A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +426 +$ +394 +$ +319 +Increases for tax positions taken in prior years +62 +18 +22 +Decreases for tax positions taken in prior years +— +(8 +) +— +Increases for tax positions taken in the current year +122 +59 +68 +Lapse in statute of limitations +(24 +) +(37 +) +(15 +) +Gross unrecognized tax benefits at March 31 +$ +586 +$ +426 +$ +394 +We +do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We +are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2015 or later, and state and local income tax examination for fiscal tax years ended March 31, 2014 or +later. However, if NOL carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +8. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural +industries, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company +cannot accurately predict the outcome of any such litigation, except as described below, the Company is not a party to any legal proceeding, the outcome of which, in management's opinion, individually +or in the aggregate, would have a material effect on the Company's consolidated results of operations, financial position or cash flows. +On +September 15, 2016, a stockholder class action and derivative action (captioned Ionni v. Bergera, et al., Case +No. 16-cv00807-RGA) was filed in the United States District Court for the District of Delaware (the "Court") against certain of the Company's current and former directors and officers (the +"Individual Defendants") and the Company as a nominal defendant (together with the Individual Defendants, the "Defendants"). The complaint asserted claims for breach of fiduciary duty and unjust +enrichment. Plaintiff contended that, in 2014 and 2015, the Individual Defendants caused the Company to issue purportedly false and misleading proxy statements in connection with the Company's annual +meeting of stockholders in 2014 and 2015 (collectively, the "Proxy Statements"). In those Proxy Statements, the Company's stockholders were asked to approve amendments (the "Amendments") to increase +the number of shares of the Company's common stock reserved for issuance under the Iteris, Inc. 2007 Omnibus Incentive Plan (the "2007 Plan"). Among other things, Plaintiff alleged that the +Proxy Statements were materially false and misleading because they affirmatively represented that no person could receive more than 500,000 stock options or SARs under the 2007 Plan in any fiscal +65 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +8. Commitments and Contingencies (Continued) +year +(the "Share Limit") and failed to disclose that the Compensation Committee had the discretion to approve an annual grant to a 2007 Plan participant in excess of that amount. Plaintiff contended +that, the Amendments were not valid and sought rescission of any stock options granted pursuant to the Amendments, including the option to purchase up to 1,350,000 shares of the Company's common stock +that was granted in September 2015 to Mr. Bergera (the "CEO Option") in connection with his appointment to serve as President and Chief Executive Officer of the Company. +The +Individual Defendants denied that they breached their fiduciary duties and the Company believed (and still believes) the Amendments were properly approved and that all of the options +granted pursuant to the Amendments, including the CEO Option, were valid. Nonetheless, to eliminate the burden, expense and uncertainty of the litigation, on November 8, 2016, the parties +entered into a Memorandum of Understanding setting forth their agreement in principle to resolve the litigation. In consideration for a release of claims and dismissal of this litigation with +prejudice, the Company agreed to submit a proposal at its 2016 Annual Meeting of Stockholders seeking stockholder approval for that portion of the CEO Option that exceeds the Share Limit +(i.e., the 850,000 options above the Share Limit (the "Excess Shares")). The Company submitted a proposal of the Excess Shares for approval by the Company stockholders at the 2016 Annual +Meeting of Stockholders. On December 15, 2016, the Company's stockholders approved the Excess Shares. +On +April 28, 2017, the parties entered into a Stipulation of Settlement and Compromise (the "Stipulation") that provides for, among other things, a release of claims against +Defendants. Under the Stipulation, Defendants agreed not to oppose any award of attorneys' fees and expenses to Plaintiff up to $215,000. The Court approved the settlement and entered a final judgment +dismissing the action with prejudice on September 8, 2017, and the settlement became effective on October 10, 2017. Pursuant to the settlement terms, Defendants paid $215,000 in October +2017. An immaterial accrued liability for the settlement was included in the accompanying consolidated balance sheet as of March 31, 2017, which was sufficient to cover the settlement payment. +Operating Leases +In May 2007, we entered into an agreement to lease 52,000 square feet of office space in Santa Ana, California for a term of 88 months. +In September 2007, we relocated our headquarters and principal operations into this space. The monthly lease rate was $102,000 during the first year of the lease and increased each year thereafter, to +$120,000 per month during the last year of the lease. In February 2014, we entered into an amendment to the lease, which reduced our office space by approximately 11,000 square feet and changed the +lease term to 96 months, commencing on April 1, 2014. The monthly lease rate is approximately $76,000 during the first year of the amended term and increases each year thereafter, up to +a maximum of approximately $90,000 during the last +year of the term. Additionally, the lease amendment provided for approximately $328,000 in incentives in the form of tenant improvement allowances, which we recorded as fixed assets and deferred rent +in our consolidated balance sheet. The leasehold improvements were capitalized into fixed assets during Fiscal 2015 and will be depreciated over the estimated useful life of the improvements, or the +term of the lease amendment, whichever is shorter. The corresponding deferred rent amount will reduce monthly rent expense over the term of the lease amendment. On January 23, 2017, we entered +into an amendment to the lease, which added approximately 5,980 square feet and will expire after 60 months, +66 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +8. Commitments and Contingencies (Continued) +commencing +on April 1, 2017. The monthly lease rate is approximately $14,000 during the first year of the term and increase each year thereafter, up to a maximum of approximately $16,000 during +the last year of the term. Additionally, the lease amendment provided for approximately $119,000 in incentives in the form of tenant improvement allowances. +We +have lease commitments for facilities in various locations throughout the U.S., as well as for certain equipment. Future minimum rental payments under these non-cancelable operating +leases at March 31, 2018 were as follows: +Year Ending March 31, +(In thousands) +2019 +$ +2,185 +2020 +1,936 +2021 +1,836 +2022 +1,725 +2023 +295 +Thereafter +— +$ +7,977 +Rent +expense totaled approximately $1.8 million for Fiscal 2018, and $1.7 million for each of Fiscal 2017 and Fiscal 2016. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. +The sublease terminated in September 2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated on +July 23, 2013 and on August 11, 2016. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with accrued interest payable annually on the first +business day of each calendar year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to Iteris. We have previously fully reserved for +amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of March 31, 2018, approximately $146,000 of the original principal balance was outstanding and +payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director of Iteris since September 2013, and one existing +director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +9. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to +issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the +designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the +67 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +9. Stockholders' Equity (Continued) +dividend, +conversion, voting, redemption and liquidation rights. As of March 31, 2018 and 2017, there were no outstanding shares of preferred stock, and we do not currently have plans to issue +any shares of preferred stock. +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior +Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between +Iteris and Computershare Trust Company, N.A., as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of Designations, which +created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred +stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2018: +Number of Shares +(In thousands) +Stock options outstanding +4,124 +Restricted stock units outstanding +144 +Authorized for future issuance under stock incentive plans +1,496 +5,764 +10. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares +of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date +of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common +stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of +our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the +number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment +of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our +stockholders approved an +68 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +10. Employee Benefit Plans (Continued) +amendment +of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December +2016, our stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs", cash incentive +awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of +grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. Stock appreciation rights, +restricted stock, RSUs and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. +We +currently maintain both the 2007 Plan and the 2016 Plan. Of these plans, we may only grant future awards from the 2016 Plan. As of the 2016 Annual Meeting of Stockholders, no future +shares could be granted under the 2007 Plan. At March 31, 2018, there were approximately 1.5 million shares of common stock available for grant under the 2016 plan. As of +March 31, 2018, options to purchase approximately 2,309,000 shares of common stock, as well as 45,000 RSUs, were outstanding under the 2007 Plan and options to purchase approximately 1,816,000 +shares of common stock, as well as 99,000 RSUs, were outstanding under the 2016 Plan. +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2018 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2017 +3,776 +$ +2.76 +Granted +1,103 +5.59 +Exercised +(591 +) +2.02 +Forfeited +(164 +) +4.00 +Expired +— +— +Options outstanding at March 31, 2018 +4,124 +$ +3.58 +8.1 +$ +6,394 +Options exercisable at March 31, 2018 +1,616 +$ +2.45 +7.0 +$ +4,049 +Vested and expected to vest at March 31, 2018 +4,124 +$ +3.58 +8.1 +$ +6,394 +Options exercisable at March 31, 2018 pursuant to a change-in-control +4,124 +$ +3.58 +8.1 +$ +6,394 +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under +the 2007 Plan vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined +69 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +10. Employee Benefit Plans (Continued) +by +the 2007 Plan) as of the vesting date. RSUs granted under the 2016 Plan vest at varying terms between one and four anniversaries of the grant date provided that the holder remains in service (as +defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A +summary of activity with respect to our RSUs for Fiscal 2018 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2017 +232 +$ +3.84 +Granted +73 +6.40 +Vested +(134 +) +4.06 +Forfeited +(27 +) +4.88 +RSUs outstanding at March 31, 2018 +144 +$ +4.72 +1.9 +$ +167 +Expected to vest at March 31, 2018 +144 +$ +4.72 +1.9 +$ +167 +Common stock issuable (for RSUs) at March 31, 2018 upon a change-in-control +144 +$ +4.72 +1.9 +$ +167 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of +operations: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Cost of revenues +$ +71 +$ +51 +$ +42 +Selling, general and administrative expense +1,558 +858 +567 +Research and development expense +152 +67 +50 +Total stock-based compensation +$ +1,781 +$ +976 +$ +659 +At +March 31, 2018, there was approximately $4.6 million and $578,000 of unrecognized compensation expense related to unvested stock options and RSUs, respectively. This +expense is currently expected to be recognized over a weighted average period of approximately 2.8 years for stock options and 1.8 years for RSUs. If there are any modifications or +cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based compensation expense +and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +70 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +10. Employee Benefit Plans (Continued) +The grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2018 +2017 +2016 +Expected life—years +6.5 +6.5 +7.2 +Risk-free interest rate +2.7 +% +2.2 +% +1.9 +% +Expected volatility of common stock +43 +% +40 +% +47 +% +Dividend yield +— +% +— +% +— +% +Expected Life : The Company's expected life represents the weighted-average period that the Company's stock options are expected to be +outstanding. +The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral +patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate : The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of +grant for the +expected term of the option. +Expected Volatility : The Company uses historical volatility as it provides a reasonable estimate of the +expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2018 +2017 +2016 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted +$ +2.59 +$ +2.11 +$ +1.19 +Intrinsic value of options exercised +$ +2,469 +$ +1,061 +$ +135 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No +contributions were made during the fiscal years ended March 31, 2018, 2017 and 2016. +We +sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible associates voluntarily contribute to the plan, up to IRS maximums, through +payroll deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the +401(k) Plan were approximately $1,067,000, $881,000, and $716,000 for the fiscal years ended March 31, 2018, 2017 and 2016, respectively. +71 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +10. Employee Benefit Plans (Continued) +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company offers an Employee Stock Purchase Plan ("ESPP") which allows employees to have a percentage of +their base compensation withheld to purchase the Company's common stock at 95% of the fair market on the last trading day of the offering period. There are two offering periods during a calendar year, +which consist of the six months beginning each January 1 and July 1. Employees may contribute 1-15% of their eligible gross pay up to a $25,000 annual stock value limit. There were no +share purchases in Fiscal 2018. The ESPP is considered a non-compensatory plan and accordingly no compensation expense is recorded in connection with this benefit. +11. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be +repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the +Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For +our fiscal years ended March 31, 2018 and 2017, we did not repurchase any shares. For our fiscal year ended March 31, 2016, we repurchased approximately 656,000 shares +of our common stock. From inception of the program in August 2011 through March 31, 2018, we repurchased approximately 3,422,000 shares of our common stock for an aggregate price of +approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2018, all repurchased shares have been retired and returned to their status as authorized and unissued +shares of our common stock. As of March 31, 2018, approximately $1.7 million remains available for the repurchase of our common stock under our current program. +72 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +12. Investments +Our investments consisted of the following: +As of March 31, 2018 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair +Value +(In thousands) +Cash and cash equivalents +$ +3,692 +$ +— +$ +— +$ +3,692 +Short term investments +5,323 +(4 +) +— +5,319 +Long term investments +— +— +— +— +Total +$ +9,015 +$ +(4 +) +$ +— +$ +9,011 +Unrealized +losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than +not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, +2018. +The +following table summarizes the contractual maturities of our investments at March 31, 2018: +As of March 31, 2018 +Maturity break out: +Amortized +Cost +Fair Value +(In thousands) +Due within one year +$ +9,015 +$ +9,011 +Due within two years +— +— +Total +$ +9,015 +$ +9,011 +13. Business Segments, Significant Customer and Geographic Information +Business Segments +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadways Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, VantageNext, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +The +Transportation Systems segment provides engineering and consulting services, performance measurement and traffic analytics solutions, as well as the development of transportation +management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, implementation, operation and management of surface transportation +infrastructure +73 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +13. Business Segments, Significant Customer and Geographic Information (Continued) +systems. +We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic +congestion. Our Transportation Systems product line includes: iPeMS, our performance measurement and information management solution as well as our commercial vehicle operations and vehicle safety +compliance platforms known as CVIEW Plus, CheckPoint, UCRLink and inspect. +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. Our ClearPath Weather suite of +tools, such as tools for assessing historical weather conditions to both short-term and long-range weather forecasts and customizable route/site weather and pavement forecast tools, provide winter +road maintenance recommendations for state agencies, municipalities and for commercial companies that allow such users to create solutions to meet roadway maintenance decision needs. Our ClearAg +solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems. Our ClearAg solutions include our ClearAg applications, +ClearAg APIs and components, WeatherPlot mobile application, and ClearAg Insights applications. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate general and +administrative expenses, including general overhead functions such as information systems, accounting, human resources, marketing, compliance costs and certain administrative expenses, as well as +interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or +provide services with different processes. All reported segment revenues are derived from external customers. Our Chief Executive Officer, who is our chief operating decision maker ("CODM"), reviews +financial information at the operating segment level. Our CODM does not review assets by segment in his resource allocation, and therefore, assets by segment are not disclosed below. +74 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +13. Business Segments, Significant Customer and Geographic Information (Continued) +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2018, 2017 and 2016 is as follows: +Roadway +Sensors +Transportation +Systems +Agriculture +and Weather +Analytics +Total +(In thousands) +Year Ended March 31, 2018 +Product revenues +$ +44,163 +$ +2,301 +$ +— +$ +46,464 +Service revenues +194 +52,180 +4,891 +57,265 +Revenues +44,357 +54,481 +4,891 +103,729 +Depreciation +221 +204 +109 +534 +Segment income (loss) +8,825 +8,639 +(8,048 +) +9,416 +Year Ended March 31, 2017 +Product revenues +42,059 +1,676 +— +43,735 +Service revenues +111 +47,594 +4,542 +52,247 +Revenues +42,170 +49,270 +4,542 +95,982 +Depreciation +180 +191 +131 +502 +Loss from continuing operations before income taxes +— +— +2,168 +2,168 +Segment income (loss) +9,799 +8,482 +(9,557 +) +8,724 +Year Ended March 31, 2016 +Product revenues +39,923 +1,810 +— +41,733 +Service revenues +336 +32,286 +3,393 +36,015 +Revenues +40,259 +34,096 +3,393 +77,748 +Depreciation +152 +175 +122 +449 +Segment income (loss) +$ +8,401 +$ +4,170 +$ +(6,140 +) +$ +6,431 +The +following table reconciles total segment income to consolidated income from continuing operations before income taxes: +Year Ended March 31, +2018 +2017 +2016 +(In thousands) +Segment income: +Total income from reportable segments +$ +9,416 +$ +8,724 +$ +6,431 +Unallocated amounts: +Corporate and other expenses +(14,930 +) +(13,680 +) +(9,541 +) +Amortization of intangible assets +(88 +) +(281 +) +(360 +) +Other (expense) income, net +(16 +) +(7 +) +2 +Interest income, net +32 +13 +12 +Loss from continuing operations before income taxes +$ +(5,586 +) +$ +(5,231 +) +$ +(3,456 +) +75 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2018 +13. Business Segments, Significant Customer and Geographic Information (Continued) +Significant Customer and Geographic Information +One individual customer who is also a government agency had a receivable balance of 13% of our total trade accounts receivable balance as of +March 31, 2018. No individual customer or government agency had a receivable balance at March 31, 2017 or 2016 greater than 10% of our total trade accounts receivable balances as of +March 31, 2017 and 2016, respectively. +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended +March 31, +2018 +2017 +2016 +Canada +1 +% +1 +% +— +% +Europe +1 +1 +— +Middle East +— +— +1 +2 +% +2 +% +1 +% +Substantially +all of our long-lived assets are held in the U.S. +14. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross Profit +Net (Loss) +Income +Basic Net +Income/Loss +per Share +Diluted Net +Income/Loss +per Share +(In thousands, except per share amounts) +June 30, 2017 +$ +27,183 +$ +9,905 +$ +(470 +) +$ +(0.02 +) +$ +(0.02 +) +September 30, 2017 +25,248 +9,968 +(984 +) +(0.03 +) +(0.03 +) +December 31, 2017 +26,025 +9,943 +343 +0.01 +0.01 +March 31, 2018 +25,273 +10,015 +(2,415 +) +(0.07 +) +(0.07 +) +$ +103,729 +$ +39,831 +$ +(3,526 +) +$ +(0.11 +)** +$ +(0.11 +)** +June 30, 2016 +$ +23,927 +$ +9,409 +$ +(38 +) +$ +(0.00 +) +$ +(0.00 +) +September 30, 2016 +24,060 +9,455 +(40 +) +(0.00 +) +(0.00 +) +December 31, 2016 +22,691 +8,620 +(1,380 +) +(0.04 +) +(0.04 +) +March 31, 2017 +25,304 +9,918 +(3,368 +)* +(0.10 +) +(0.10 +) +$ +95,982 +$ +37,402 +$ +(4,826 +) +$ +(0.15 +)** +$ +(0.15 +)** +* Net +Loss includes a goodwill impairment charge of approximately $2.2 million related to our Agriculture and Weather Analytics reporting unit. Refer to +Note 4 for additional discussion regarding the goodwill impairment charge. +** Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +76 +z Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the date +of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and +(2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions +regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2018 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework (2013) issued by the Committee of +Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework +(2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2018. The effectiveness of +77 +Table of Contents +our +internal control over financial reporting as of March 31, 2018 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in +their report, which is included herein. +ITEM 9B. OTHER INFORMATION +On June 5, 2018, the Board of Directors amended the Bylaws by adding a Section 5 to Article VI (General Provisions) in +order to adopt the necessary provisions relating to professional engineers required by the state of Washington. +The +information set forth above is included herewith for the purpose of providing the disclosure required under "Item 5.03—Amendments to Articles of Incorporation or +Bylaws; Change in Fiscal Year" of Form 8-K. The foregoing description of the amendment to the Bylaws is only a summary and is qualified in its entirety by reference to the full Restated Bylaws, +which are filed as Exhibit 3.3 to this Annual Report on Form 10-K and incorporated by reference herein. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K ("the +Form 10-K Amendment) or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2018 Annual Meeting of Stockholders (the "2018 +Proxy Statement") under the headings "Executive Compensation and Other Information—Executive Officers," "Election of Directors," "Corporate Governance," and "Section 16(a) +Beneficial Ownership Reporting Compliance." +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2018 +Proxy Statement under the heading "Executive Compensation and Other Information—Executive Officers." +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2018 +Proxy Statement under the heading "Equity Compensation Plan Information" and "Principal Stockholders and Common Stock Ownership of Certain Beneficial Owners and Management." +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2018 +Proxy Statement under the heading "Corporate Governance" and "Certain Transactions." +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2018 +Proxy Statement under the heading "Fees Paid to Independent Registered Public Accounting Firm." +78 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. +Our +consolidated financial statements are listed in the "Index to Consolidated Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All +financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our consolidated financial statements or +the notes thereto. +3. Exhibits . +The +following financial statements of Iteris, Inc. are included in a separate section of this Annual Report on Form 10-K commencing on the pages referenced below: +Exhibit Index +Exhibit +Number +Description +Reference +2.2 ++ +Asset Purchase Agreement by and between Iteris, Inc. and Bendix Commercial Vehicle Systems LLC, dated as of +July 25, 2011 +Exhibit 2.1 to the registrant's Current Report on Form 8- K/A as filed with the SEC on November 1, 2011 +3.1 +Restated Certificate of Incorporation of the registrant +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.2 +Certificate of Designations of Series A Junior Participating Preferred Stock +Exhibit 3.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on October 30, 2009 +3.3 +Restated Bylaws of the registrant, as amended through June 5, 2018 +Filed herewith +4.1 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +4.2 +Rights Agreement dated August 20, 2009 between the registrant and Computershare Trust Company, N.A., which includes +the form of Certificate of Designations for the Series A Junior Participating Preferred Stock, the form of Right Certificate, and Summary of Rights to Purchase Preferred Stock as exhibits thereto +Exhibit 4.1 to the registrant's Current Report on Form 8-K as filed with the SEC on August 21, 2009 +79 +Table of Contents +Exhibit +Number +Description +Reference +4.3 +Amendment No. 1 to Rights Agreement, entered into as of August 8, 2012 by and between Iteris, Inc. and +Computershare Trust Company, N.A. +Exhibit 4.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 10, 2012 +10.1 +Form of Indemnity Agreement entered into by the registrant and certain of its officers and directors +Exhibit 19.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 +10.2 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and +directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the +successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +* +Iteris, Inc. Employee Stock Purchase Plan +Filed herewith +10.5 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.6 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.7 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.8 +* +2016 Omnibus Incentive Plan +Filed herewith +10.9 +* +Form of Restricted Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.10 +* +Form of Form of Notice of Grant of Stock Option and form of Stock Option Agreement for use with 2016 Omnibus Incentive +Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.11 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor +of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.12 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, +Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +80 +Table of Contents +Exhibit +Number +Description +Reference +10.13 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway +Acquisitions, LLC) and Iteris, Inc. +Filed herewith +10.14 +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Filed herewith +10.15 +* +Employment Agreement dated March 9, 2015 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on March 15, 2015 +10.16 +* +Amendment 1 to Employment Agreement dated June 12, 2017 between Iteris, Inc. and Andrew +Schmidt +Exhibit 10.33 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2016 as filed with the SEC on June 13, 2017. +10.17 +* +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.18 +Seperation Agreement and General Release dated March 29, 2018 between Iteris, Inc. and Thomas N. +Blair +Exhibit 99.1 to Amendment No. 1 tothe registrant's Current Report on Form 8-K as filed with the SEC on April 5, 2018 +21 +List of Subsidiaries +Filed herewith +23 +Consent of Independent Registered Public Accounting Firm, dated June 7, 2018 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS +XBRL Instance Document +Filed herewith +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +81 +Table of Contents +Exhibit +Number +Description +Reference +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. ++ Confidential +treatment has been previously granted by the SEC for certain portions of the referenced exhibit pursuant to Rule 24b-2 of the Securities Exchange +Act of 1934, as amended. In accordance with Rule 24b- 2, these confidential portions have been omitted from the exhibit and filed separately with the SEC. +# Pursuant +to Rule 406T of Regulation S-T, these interactive data files i) are not deemed filed or part of a registration statement or prospectus +for purposes of Sections 11 or 12 of the Securities Act of 1933, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, irrespective of any general +incorporation language included in any such filings, and otherwise are not subject to liability under these sections; and ii) are deemed to have complied with Rule 405 of +Regulation S-T ("Rule 405") and are not subject to liability under the anti-fraud provisions of the Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the +Securities Exchange Act of 1934 or under any other liability provision if we have made a good faith attempt to comply with Rule 405 and, after we become aware that the interactive data files +fail to comply with Rule 405, we promptly amend the interactive data files. +82 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to +be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 7, 2018 +ITERIS, INC. +(Registrant) +By +/s/ JOE BERGERA +JOE BERGERA +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Andrew C. Schmidt, and each +of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and +all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said +attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all +intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause +to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ JOE BERGERA +Joe Bergera +Director, President and Chief Executive Officer (principal executive officer) +June 7, 2018 +/s/ ANDREW C. SCHMIDT +Andrew C. Schmidt +Chief Financial Officer (principal financial and accounting officer) +June 7, 2018 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Chairman of the Board +June 7, 2018 +/s/ LAURA L. SIEGAL +Laura L. Siegal +Director +June 7, 2018 +83 +Table of Contents +Signature +Title +Date +/s/ KEVIN C. DALY, PH.D +Kevin C. Daly, Ph.D +Director +June 7, 2018 +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 7, 2018 +/s/ SCOTT E. DEETER +Scott E. Deeter +Director +June 7, 2018 +/s/ MIKEL WILLIAMS +Mikel Williams +Director +June 7, 2018 +84 \ No newline at end of file diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/filing_metadata.csv b/raw/filings/0000350868/2017/0001047469-18-004333/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..570d1d6eae58ef2f1acc7049bc532e7ff39a2377 --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2018-06-07,2018-03-31,2018-06-07T21:24:34.000Z,0001047469-18-004333,a2235930z10-k.htm,10-K,11255259,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746918004333/a2235930z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746918004333/,2017,2017,1 diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/item1.txt b/raw/filings/0000350868/2017/0001047469-18-004333/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..b6d71c661a6c305eb3b0472795e51ce6b093f4c7 --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/item1.txt @@ -0,0 +1,254 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris," the "Company," +"we," "our," and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, farmers and +agronomists use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products, software-as-a-service offerings and weather +forecasting systems offer a comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +In +the agribusiness markets, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content solutions that +provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service +providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the entire value chain in the agriculture market with our smart content and digital farming platform. +Iteris +was incorporated in Delaware in 1987. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that +location is +3 +Table of Contents +(949) 270-9400. +Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or +accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are +available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities +and Exchange Commission ("SEC"). +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +in the agribusiness markets. +Products and Services +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Transportation Systems segment provides engineering and consulting services, performance measurement, regulatory compliance, and traffic analytics solutions, as well as the +development of traveler information systems for the ITS industry. The Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital +agriculture platform. +See +Note 13 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report, for further details on our reportable segments. +Roadway Sensors +Our Roadway Sensors segment product line uses advanced image and signal processing technology and other techniques to capture and analyze sensor +data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our +Roadway Sensors products include, among others, Vantage, VantageLive!, VantageNext, VantageRadius, VantagePegasus, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, +PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +4 +Table of Contents +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +We +also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and +traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services focused on the planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and management solution, iPeMS—a state-of-the-art information management software suite that +provides prescriptive data insights to help determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. iPeMS +utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and management of traffic +infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of improvement. iPeMS is +also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This +segment also includes our commercial vehicle operations and vehicle safety compliance platforms, known as "CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." +5 +Table of Contents +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. As such, our Transportation +Systems business has been adversely affected by governmental budgetary issues. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, +including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future +will continue to be dependent at least in part on the federal and local government's use of funds. Delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation +funds in federal, state and local budgets. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearPath Weather and Clear Ag solutions. +Our +ClearPath Weather is a web-based system that has a suite of tools that enable users to assess historical weather conditions and analyze short-term and long-range weather forecasts, +to customize route/site weather and pavement forecast tools, which provide winter road maintenance recommendations for state agencies, municipalities and enable commercial companies to create +solutions for the management of roadway maintenance. +Our +Weather Analytics business is a market leader in performance management solutions for federal and state organizations. We intend to use our strong brand and deep experience in the +traffic management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For our ClearAg solutions, we developed additional scientific and agronomic models and forecasts, expanded our computing +infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems, which results in the increased +efficiency and sustainability of farmlands. The ClearAg Platform delivers product validation, irrigation and harvest solutions giving growers, researchers and other agribusinesses access to a +comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as other information on crop growth. Companies use the ClearAg Platform to simulate +field conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers leverage the ClearAg Platform to determine the best times to plant, spray, +fertilize, irrigate, and harvest crops. +We +currently offer our ClearAg solutions on an enterprise basis combining our modeling solutions with ClearAg application programming interfaces ("APIs"). These APIs facilitate the +integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. We commenced commercial sales of the ClearAg solutions and related APIs in +the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). We also developed the ClearAg WeatherPlot and ClearAg Insights applications, which provide analytics on forecasted +historical weather, water and soil temperatures to help agronomists and crop consultants identify and make recommendations for treatments at ideal environmental conditions to maximize crop quality and +yield. +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, through cash flow +generated from our Roadway Sensors and Transportation Systems operations, revenues from our +6 +Table of Contents +Agriculture +and Weather Analytics segment, and our available cash on hand, as needed. We may also elect to raise additional equity for these investments. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories where we sell direct, we use +a combination of our own sales personnel and outside sales organizations to sell, oversee installations and set-up issues, and support our products. Our indirect sales channel is comprised of a +network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our +fiscal year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors +are trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when +needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions, and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +We +currently market and sell our ClearAg solutions as a subscription-based service to seed and crop protection companies, allied providers and agriculture integrators, as well as to +growers and retailers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically involve long lead times. We generally sell directly to +customers interested in the ClearAg API products, but typically sell through selling partners for our ClearAg applications. Mobile versions of WeatherPlot are currently available in the Apple app +store and on Google Play. +We +have historically had a diverse customer base. For Fiscal 2018, one individual customer represented greater than 10% of our total revenues. For the fiscal year ended March 31, +2017 ("Fiscal 2017"), one individual customer represented greater than 10% of our total revenues. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility, where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris Manufacturing, MoboTrex, Inc. and Sony Electronics, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa +Ana, California facility. Production volume at +7 +Table of Contents +our +subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. We typically do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2018, Fiscal 2017 and the fiscal year ended March 31, 2016 ("Fiscal 2016"). We believe customer support is a key competitive +factor for our company. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $47.5 million as of March 31, 2018, which included +$37.7 million related to Transportation Systems. We typically recognize approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and +currently expect that trend to continue for the near future for both Transportation Systems and Agriculture and Weather Analytics. Substantially the entire backlog for Roadway Sensors as of +March 31, 2018 is expected to be recognized as revenue in the fiscal year ending March 31, 2019. At March 31, 2017, we had backlog of approximately $64.5 million, which +included $54.4 million related to Transportation Systems. The decline in backlog in the current fiscal year was largely due to the completion of a large Transportation Systems contract in the +current fiscal year. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our Agriculture and Weather Analytics facilities in Grand Forks, North Dakota and +Oakland, California, as well as at our principal facility in Santa Ana, California. Our research and development costs and expenses were approximately $7.9 million for Fiscal 2018 and +$6.9 million for both Fiscal 2017 and Fiscal 2016. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our +Agriculture and Weather Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to focus our development efforts in the near future in our Agriculture +and Weather Analytics segment on our ClearAg solutions and to developing further enhancements and functionality in our Vantage products family. We believe that developing new and enhanced product +8 +Table of Contents +offerings +across our segments and enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that +market, such as IBM/The Weather Company, MeteoGroup and agronomic analytics companies such as FBN and Farmer's Edge. +In +the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems such as Econolite, and +manufacturers and distributors of other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and installers of in-pavement +inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity and VantagePegasus +compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced transportation systems include large, national corporations that generally offer +expertise in traveler information, integration and transportation management. Our competitors in transportation engineering, planning and design include major regional ITS engineering firms, as well +as many smaller local engineering firms. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of +9 +Table of Contents +40 +issued U.S. patents, including: (i) 10 relating to our Roadway Sensors technologies, one of which was issued in Fiscal 2018, (ii) 23 relating to our Agriculture and Weather Analytics +technologies, six of which were issued in Fiscal 2018, and (iii) seven relating specifically to our Transportation Systems technologies, one of which was issued in Fiscal 2018. We have a total +of 22 pending patent applications in the U.S. and 15 pending foreign patent applications. The expiration dates of our patents range from 2026 to 2037. We intend to pursue additional patent protection +to the extent we believe it would be beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, +rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2018, we employed 414 full-time employees and 33 part-time employees, for a total of 447 employees. None of our employees +are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. +10 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/item13.txt b/raw/filings/0000350868/2017/0001047469-18-004333/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..22a9cf031f71f215bb67c5bc5a89af367604342c --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2018 +Proxy Statement under the heading "Corporate Governance" and "Certain Transactions." \ No newline at end of file diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/item9a.txt b/raw/filings/0000350868/2017/0001047469-18-004333/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..38451fdb1cd851cb8efccff40bce6c3320ebc9a7 --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/item9a.txt @@ -0,0 +1,31 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the date +of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and +(2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions +regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2018 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework (2013) issued by the Committee of +Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework +(2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2018. The effectiveness of +77 +Table of Contents +our +internal control over financial reporting as of March 31, 2018 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in +their report, which is included herein. \ No newline at end of file diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/rp_note.txt b/raw/filings/0000350868/2017/0001047469-18-004333/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2017/0001047469-18-004333/rpt_disclosure.txt b/raw/filings/0000350868/2017/0001047469-18-004333/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..131e46c98673d04060079f29a9c38a8541e24f85 --- /dev/null +++ b/raw/filings/0000350868/2017/0001047469-18-004333/rpt_disclosure.txt @@ -0,0 +1,18 @@ +Transactions with Related Persons +Since April 1, 2015, other than the agreements and transactions described in "Item 11. Executive Compensation" in the Annual +Report and the transactions described below, there has not been, nor is there any proposed transaction, where we (or any of our subsidiaries) were or will be a party in which the amount involved +exceeded or will exceed the lesser of $120,000 or the average of our total assets at year-end for the last two fiscal years and in which any director, director nominee, executive officer, holder of +more than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest. +We +previously subleased office space to Maxxess Systems, Inc. (" Maxxess "), one of our former subsidiaries that we sold in September +2003. The sublease terminated in September 2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated +on July 23, 2013, and extended on August 11, 2016 and +55 +Table of Contents +August 13, +2018. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with accrued interest payable annually on the first business day of each calendar +year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to Iteris. We have previously fully reserved for amounts owed to us by Maxxess and +the outstanding principal balance remains fully reserved. As of March 31, 2018, approximately $146,000 of the original principal balance was outstanding and payable to Iteris. The note +currently matures +August 20, 2020. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director of Iteris since September 2013, and one +existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. \ No newline at end of file diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/filing.txt b/raw/filings/0000350868/2018/0001047469-19-003522/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..0da86812c436a476ecd39f8fdd5157a80c072d4e --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/filing.txt @@ -0,0 +1,5912 @@ +10-K +1 +a2238952z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2019 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California +(Address of Principal Executive Offices) +92705 +(Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common Stock, $0.10 par value +ITI +The NASDAQ Stock Market LLC +Securities +registered pursuant to Section 12(g) of the Act. None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act"). +Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of +1934, as amended (the "Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such +filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of +Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). +Yes ý No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an +emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.: +Large accelerated filer o +Accelerated filer ý +Non-accelerated filer o +Smaller reporting company ý +Emerging growth company o +If +an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting +standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2018 was approximately $132,700,000. +For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate +status is not necessarily a conclusive determination for other purposes. As of May 31, 2019, there were 33,388,696 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +None. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2019 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +24 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +24 +ITEM 4. +MINE SAFETY DISCLOSURES +24 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +25 +ITEM 6. +SELECTED FINANCIAL DATA +25 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +26 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +41 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +42 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +81 +ITEM 9A. +CONTROLS AND PROCEDURES +81 +ITEM 9B. +OTHER INFORMATION +82 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +83 +ITEM 11. +EXECUTIVE COMPENSATION +88 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +100 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +103 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +104 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +106 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiary, ClearAg, Inc. CheckPoint™, +ClearAg®, ClearPath Weather®, CVIEW-Plus™, Edge®, EdgeConnect™, EMPower®, EvapoSmart™, IMFocus™, +inspect™, iPeMS®, Iteris®, Iteris SPM™, Next®, P10™, P100™, PedTrax®, Pegasus™, Reverse +511®, SmartCycle®, SmartCycle Bike Indicator™, SmartSpan®, SPM™ (logo), TransitHelper®, UCRLink™, +Vantage®, VantageLive!™, VantagePegasus®, VantageRadius®, Vantage Vector®, Velocity®, and +VersiCam™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of +the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and +certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words +"expect(s)," "feel(s)," "believe(s)," "intend(s)," "plan(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are +intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, +capital needs, backlog, manufacturing capabilities, the market acceptance of our products, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, +the applications for and acceptance of our products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to +certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these +forward-looking statements that speak only as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect +our business, including in "Risk Factors" set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake +no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of +unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris," the "Company," +"we," "our," and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, agriculture +service providers and other agribusinesses use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products, software-as-a-service ("SaaS") offerings and weather +forecasting systems offer a comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +In +the digital agriculture market, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and +analytic solutions that provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment +manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the agriculture market with our smart content and digital agriculture platform, and always exploring strategic alternatives intended to optimize +the value of all of our businesses. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, +California 92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or +incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on +Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is +electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +to the agriculture markets. +Products and Services +We currently operate in three reporting segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Transportation Systems segment provides traffic engineering and consulting services, as well as +4 +Table of Contents +performance +measurement, traffic analytics, traveler information and commercial vehicle operating software solutions. The Agriculture and Weather Analytics segment includes ClearPath Weather, our road +maintenance applications, and ClearAg, our digital agriculture platform. +See +Note 11 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on our reporting segments. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage +Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +5 +Table of Contents +In +select territories, we also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic +signal controllers and traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services focused on the planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and management solutions, Iteris Signal Performance Measures (SPM) and iPeMS—a state-of-the-art +information management software suite that provides prescriptive data insights to help determine current and future traffic patterns, permitting the effective performance analysis and management of +traffic infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance +analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify +potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +We +recently launched our comprehensive signal performance measures solution offering, Iteris SPM, a cloud-based application that provides proactive operations and signal maintenance with +business process outsourcing and managed services. This offering is expected to be priced on a per intersection per month basis. +This +segment also includes our advanced traveler information system solutions, as well as our commercial vehicle operations and vehicle safety compliance platforms, known as +"CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." These platforms support state-based commercial vehicle operations by storing and distributing intrastate and interstate commercial vehicle +information for local, state and federal agencies' roadside and enforcement operations. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding +mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We +believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, +our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the +allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearPath Weather and ClearAg solutions. +Our +ClearPath Weather is a web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess weather conditions for customizable +route/site weather +6 +Table of Contents +and +pavement forecasting, and render winter road maintenance recommendations for state agencies, municipalities and commercial companies to improve roadway maintenance decisions. +Our +ClearPath Weather business is a market leader in performance management solutions for state organizations. We intend to use our strong brand and deep experience in the traffic +management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For our ClearAg solutions, we developed additional scientific and agronomic models and forecasts, expanded our computing +infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to increase the efficiency and +sustainability of farmlands. The ClearAg Platform delivers validation tools for ag inputs, irrigation, field readiness, and harvest solutions giving growers, researchers and other agribusinesses +access to a comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as +other information on crop growth. Companies use the ClearAg Platform to simulate field conditions and determine how new products may perform on a crop given certain weather and soil conditions. +Growers and agribusinesses leverage the ClearAg Platform to determine the best times to plant, spray, fertilize, irrigate, and harvest crops. +Currently, +we offer our ClearAg solutions on a subscription basis, with customers consuming ClearAg through our visualization component application programming interfaces ("APIs"). These +APIs facilitate the integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. We commenced commercial sales of the ClearAg solutions +and related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, through cash flow +generated from our Roadway Sensors and Transportation Systems operations, revenues from our Agriculture and Weather Analytics segment, and our available cash on hand, as needed. We may also elect to +raise additional equity for these investments. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct +channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our fiscal +year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when +needed. When +7 +Table of Contents +appropriate, +we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +Currently, +we market and sell our ClearAg solutions on a subscription basis, under a SaaS license, to seed and crop protection companies, agriculture equipment manufacturers, irrigation +solution providers, allied providers and other agriculture service providers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically +involve long lead times. Although we sell directly to all of our customers, some of these customers include ClearAg into their solutions which are ultimately used by growers. +We +have a small dedicated software solutions sales team that serves as an overlay to our regionally aligned customer management team. +We +have historically had a diverse customer base. For the fiscal year ended March 31, 2019 ("Fiscal 2019") and Fiscal 2018, one individual customer represented greater than 10% of +our total revenues. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris Manufacturing, MoboTrex, Inc. and Sony Electronics, Inc. Our manufacturing activities are conducted in +approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to +control inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production +facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2019, Fiscal 2018 and the fiscal year ended March 31, 2017 ("Fiscal 2017"). We believe customer support is a key competitive +factor for our company. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +8 +Table of Contents +Backlog +Our total backlog of unfulfilled firm orders was approximately $55.4 million as of March 31, 2019, which included +$44.5 million related to Transportation Systems, $6.2 million related to Roadway Sensors, and $4.7 million related to Agriculture and Weather Analytics. Typically, we recognize +approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and currently expect that trend to continue for the near future. Substantially the +entire backlog for Roadway Sensors and Agriculture and Weather Analytics as of March 31, 2019 is expected to be recognized as revenue in the fiscal year ending March 31, 2020 ("Fiscal +2020"). At March 31, 2018, we had backlog of approximately $47.5 million, which included $37.7 million related to Transportation Systems, $5.6 million related to Roadway +Sensors and $4.2 million related to Agriculture and Weather Analytics. The increase in backlog in the current fiscal year was largely due to increased sales and marketing efforts in our +Transportation Systems segment during the current fiscal year. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Grand +Forks, North Dakota and Oakland, California. Our research and development costs and expenses were approximately $7.8 million for Fiscal 2019, $7.9 million for Fiscal 2018, and +$6.9 million for Fiscal 2017. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Agriculture and Weather +Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of our ClearAg and ClearPath +Weather solutions, and our Iteris SPM, iPeMS, and commercial vehicle operations software offerings. In addition, we intend to continue to invest in further enhancements and functionality in our +Vantage products family. We believe that developing new and enhanced product offerings across our segments and enhancing, refining and marketing our existing products are key components for strong +organic growth and profitability. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that +market, such as IBM/The Weather Company and DTN. +9 +Table of Contents +In the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems such +as Econolite, and manufacturers and distributors of other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and +installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as +Velocity and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and +international engineering services firms. Our competitors in the software business line, which includes performance measurement and management, advance traveler information systems, and our commercial +vehicle operations and vehicle safety compliance platforms include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and +software corporations. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 53 issued U.S. patents, including: +(i) 10 relating to our Roadway Sensors technologies, two of which was issued in Fiscal 2019, (ii) 36 relating to our Agriculture and Weather Analytics technologies, ten of which were +issued in Fiscal 2019, and (iii) 7 relating to our Transportation Systems technologies, one of which was issued in Fiscal 2019. We have a total of 14 pending patent applications in the U.S. and +15 pending foreign patent applications. The expiration dates of our patents range from 2026 to 2038. We intend to pursue additional patent protection to the extent we believe it would be +beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +10 +Table of Contents +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2019, we employed 362 full-time employees and 31 part-time employees, for a total of 393 employees. None of our employees +is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in +this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in +this report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties +described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If +any of these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you +may lose all or part of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting +with federal, state and local governments, including budgetary issues and fixed price contracts. +A significant portion of our revenues is derived from contracts with governmental agencies, either as a general contractor, subcontractor or +supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and +challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, delays in the +expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +11 +Table of Contents +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the +new administration and repeal of government purchasing programs; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone +requirements; +• performance bond requirements; +• adverse weather conditions may cause delays, such as, evacuations and flooding due to hurricanes can result in our inability to perform work in +affected areas; and +• international relations and international conflicts or other military operations that could cause the temporary or permanent diversion of +government funding from transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and +income to drop substantially or to fluctuate significantly between fiscal periods. +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the +convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any +material government contract could seriously harm our business, financial condition and results of operations. +We recently expanded our Agriculture and Weather Analytics capabilities to address a new market segment, the +digital agricultural market, which might not broadly accept our technologies and new products. +The application of data analytics to the agricultural market is a relatively new development that has required us to invest, and is expected to +continue to require us to invest, in additional research and development, and sales and marketing without any guarantee of a commensurate increase in revenues. The introduction of any new Agriculture +and Weather Analytics products and services could have longer than expected sales cycles, which could adversely impact our operating results. We cannot assure +12 +Table of Contents +you +that growers or other agribusinesses in this market will appreciate the value proposition of our offering or that our new ClearAg products for this market will achieve broad market acceptance in +the near future or at all. If the agricultural market fails to understand and appreciate the benefit of our offering or chooses not to adopt our technologies, the financial results of our Agriculture +and Weather Analytics segment will be adversely affected. +We may not be able to achieve profitability on a quarterly or annual basis in the future. +For Fiscal 2019, Fiscal 2018, and Fiscal 2017, we had net losses of approximately $7.8 million, $3.5 million and +$4.8 million, respectively, and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by governmental budgetary +constraints, government and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from certain of our business segments to fund +investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those +investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in +anticipated revenues or increases in planned investments. As a result, we may continue to experience operating losses and net losses in the future, which would make it difficult to fund our operations +and achieve our business plan, and could cause the market price of our common stock to decline. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our +Transportation Systems workforce. +The cost of providing our Transportation Systems engineering and consulting services, including the extent to which we utilize our workforce, +affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• the timing of new contract awards or the completion of large contract; +• availability of funding or other budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An +inability to properly and fully utilize our Transportation Systems workforce would reduce our profitability and could have an adverse effect on our results of operations. +We may engage in acquisitions of companies or technologies that may require us to undertake significant +capital infusions and could result in disruptions of our business and diversion of resources and management attention. +We may acquire additional complementary businesses, products, services, and technologies. Acquisitions may require significant capital infusions +and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +13 +Table of Contents +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information +system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits anticipated from any acquisition. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, +or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. We have filed a registration +statement on a Form S-3, utilizing a "shelf" registration process, and may consider a new equity financing in the future. Should the credit markets further tighten or our business declines, we +may need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank +borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may +result in further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +14 +Table of Contents +• government budgets, political agendas and other funding issues, including potential delays in government contract awards; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common +stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms, we may +be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +We participate in the software development market which may be subject to various technical and commercial +challenges. +We have only been in the business of software development for a few years and have in the past and may in the future experience development and +technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we +cannot be certain that errors will not be found in our software after its release. Any faults or errors in our existing products or in any new products may cause delays in product introduction and +shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies +are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able +to remain competitive, and the demand for our products will likely decline. +Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +15 +Table of Contents +If we are unable to develop and introduce new products and product enhancements in a cost-effective and +timely manner, or are unable to achieve market acceptance of our new products, our operating results would be adversely affected. +We believe our revenue growth and future operating results will depend on our ability to complete development of new products and enhancements, +introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production costs. During the past two fiscal years, we +have introduced both new and enhanced products across all segments. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our +existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and +analysis in response to evolving customer requirements. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be +adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to +new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +If our security measures are breached and unauthorized access is obtained to our customer's personal and/or +proprietary data in connection with our web-based and mobile application services, we may suffer various negative impacts, including a loss of customer and market confidence, loss of customer loyalty, +and significant liability to our customers and to individuals or businesses whose information was being stored. +Because techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and generally are not recognized until +launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception +of the effectiveness of our security measures could be harmed and we could lose sales and customers. +The markets in which we operate are highly competitive with many companies more established than Iteris. +We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many +smaller regional engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a portion of the traffic intersection market has +adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry +make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result +in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +16 +Table of Contents +The +markets in which our Agriculture and Weather Analytics segment operates vary from public sector customers who focus on snow and ice management for state and county roadways, to +commercial sector customers who employ our environmental content and agronomic models. Our competitors include divisions of large, international weather companies, as well as a variety of small +providers in the road weather market. In the commercial agriculture sector, we compete with a variety of public and private entities that currently market software, agronomic analytics and weather +forecast capabilities to agribusinesses. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our +competitive position. +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary +technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, +trademark and trade secret laws, employee and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or +systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some +foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse +outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or +using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is +determined that we have infringed upon or misappropriated another party's intellectual property. Our recent expansion into software development activities may subject us to increased possibility of +litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, +including legal fees and expenses, and the diversion of +management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and +profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. +Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing +arrangements and required governmental approvals. For +17 +Table of Contents +example, +a customer may require us to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions +materialize, or if we fail to secure adequate financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue particular projects, +which could reduce or eliminate our profitability +We may continue to be subject to traffic related litigation. +The traffic industry in general is subject to frequent litigation claims due to the nature of personal injuries that can result from traffic +accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, +even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not be covered by insurance or the damages +resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by +insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant +expenses and result in a diversion of management's attention. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm +our business. +Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key +management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing +business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of +operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified +engineering and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely +manner, which may adversely affect our growth in the current fiscal year and in future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for +highly skilled employees are on the rise. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled personnel, we may not be able to attract and +retain such employees, that could impair our ability to perform our contractual obligations, meet our customers' needs, win new business, and adversely affect our future results. Likewise, the future +success of our Transportation Systems segment will depend on our ability to hire additional qualified engineers, planners and technical personnel. The future success of our Agriculture and Weather +Analytics segment will depend on our ability to hire additional software developers, qualified engineers and technical personnel. Competition for qualified employees, particularly development +engineers and software developers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional +key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +Our management information systems and databases could be disrupted by system security failures, cyber +threats or by the failure of, or lack of access to, our Enterprise Resource Planning ("ERP") system. These disruptions could negatively impact our sales, increase our expenses and/or significantly +harm our reputation. +Internal users and computer programmers may be able to penetrate, aka "hack", our network security and create system disruptions, cause +shutdowns and/or misappropriate our confidential +18 +Table of Contents +information +or that of our employees and third parties. Therefore, we could incur significant expenses addressing problems created by security breaches to our network. We must, and do, take +precautions to secure customer information and prevent unauthorized access to our databases and systems containing confidential information. Any data loss or information security lapses resulting in +the compromise of personal information or the improper use or disclosure of confidential, sensitive or classified information could result in claims, remediation costs, regulatory sanctions against +us, loss of current and future contracts and serious harm to our reputation. We operate our Enterprise Resource Planning system on a SaaS platform, and we use this system for reporting, planning, +sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on this system, and the third-party provider of this service, for a number +of aspects of our operations. If this service provider or this system fails, or if we are unable to continue to have access to this system on commercially reasonable terms, or at all, operations would +be severely disrupted until an equivalent system could be identified, licensed or developed, and integrated into our operations. This disruption would have a material adverse effect on our business. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable +to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past +expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these +activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +Our use of estimates in conjunction with the input method of measuring progress to completion of performance +obligations for our Transportation Systems revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of Transportation Systems revenues are measured and recognized over time using the input method of measuring progress to completion. +Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs +expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could +occur in any period and their effects could be +material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction +contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenues +and profits. +Declines in the value of securities held in our investment portfolio can affect us negatively. +As of March 31, 2019, the value of securities available for sale within our investment portfolio was $1.9 million, which is +generally determined based upon market values available from third-party sources. The value of our investment portfolio may fluctuate as a result of market volatility and economic or financial market +conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and liquidity. Further, to the extent that we experience unrealized losses in +our portfolio of investment securities from declines in securities values that management determines to be other than temporary, the book value of those securities will be adjusted to their estimated +recovery value and we will recognize a charge to earnings in the quarter during which we make that determination. Although we have policies and procedures in place to assess and +19 +Table of Contents +mitigate +potential impacts of market risks, including hedging-related strategies, those policies and procedures are inherently limited because they cannot anticipate the existence or future +development of currently unanticipated or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage these risks properly. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley +Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial +reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to +obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis +and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A +control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of +a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control +systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations +include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of +some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future +events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in +conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may +occur and not be detected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or +exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of +factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as +increased price competition in general; +• the long lead times associated with government contracts; +20 +Table of Contents +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• our ability to raise additional capital; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• seasonality due to winter weather conditions (as well as the adverse impact on revenues in certain regions impacted from time to time by +hurricanes and other extreme conditions); +• seasonality with respect to revenues from our ClearPath Weather and related weather forecasting services due to the decrease in revenues +generated for such services during the spring and summer time periods; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely +manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have in the past experienced, and may from time to time in the future continue to experience parts shortages or unforeseen quality control +issues by our suppliers that may impact our ability to meet demand for our products. We have historically used and continue to use single suppliers for certain significant components in our products, +and have had to reengineer products from time to time to address obsolete components, especially in our Roadway Sensors products. Our Roadway Sensors +21 +Table of Contents +products +are also included with other traffic intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should +any such supply delay or disruption occur, or should a key supplier discontinue operations, our future sales will likely be materially and adversely affected. Additionally, we rely heavily on select +contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient +capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience +a production gap if for any reason our contract manufacturers were unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. Further, the +federal government has created the potential for significant changes in trade policies, including tariffs and government regulations affecting trade between the U.S. and other countries where we +source components for our Roadway Sensors products. Any such actions could increase the cost to us of such products and cause increases in the prices at which we sell such products, which could +adversely affect the financial performance of our Roadway Sensors business. Similarly, these actions could result in cost increases or supply chain delays that impact third party products +(e.g. steel poles) which could lead our customers to delay or cancel planned purchases by our products. +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution +capabilities for our Roadway Sensors and subscription customer base for our Agriculture and Weather Analytics segments internationally, particularly in Europe and in South America. We plan to continue +to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to various inherent risks including, among +others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S. and each other country in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but +not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +22 +Table of Contents +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has been subject to wide fluctuations in the past. From March 31, 2016 through March 31, +2019, our common stock has traded at prices as low as $2.20 per share and as high as $8.17 per share. The market price of our common stock could continue to fluctuate in the future in response to +various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other possible strategic transactions or dispositions; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. +This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, +companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action +lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Certain provisions of our charter documents may discourage a third party from acquiring us and may adversely +affect the price of our common stock. +Certain provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that +might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For +23 +Table of Contents +example, +under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, +conversion and other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make +nominations for directors, and we recently eliminated cumulative voting for directors and implemented majority voting for the election of directors of the company. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 47,000 square feet of leased office, manufacturing and warehouse space +located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 6 of Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 6 of Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +24 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock is traded on the NASDAQ Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock +traded on the NYSE MKT under the same symbol. +As +of May 31, 2019, we had 322 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than +this number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain +Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We +currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon +a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business +conditions, and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +On August 9, 2012, our Board of Directors approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan is in place. There is no guarantee +as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors +approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to +time for an unspecified length of time. +In +Fiscal 2019, Fiscal 2018 and Fiscal 2017, we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2019, we repurchased approximately +3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2019, all repurchased shares have been +retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2019, approximately $1.7 million remains available for the repurchase of our +common stock under our current program. +ITEM 6. SELECTED FINANCIAL DATA +The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information +required under this Item. +25 +Table of Contents +ITEM 7. MANAGEMENT's DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and +related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Part I, Item 1A, as well as the other cautionary statements and risks +described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General. We are a provider of essential applied informatics that enable smart transportation and digital agriculture. +Municipalities, government +agencies, crop science companies, agriculture service providers, and other agribusinesses use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, +healthy and productive. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +In connection with the Asset Sale, we were entitled to additional consideration in the form of certain performance and royalty-related earn-outs through December 31, 2017. From the date of the +Asset Sale, through March 31, 2019, we received approximately $2.7 million in connection with royalty-related earn-outs provisions for a total of $18 million in cash received from +the Asset Sale. We also had approximately $0 and $106,000 in royalty-related receivables included in the prepaid expenses and other current assets in the accompanying consolidated balance sheet as of +March 31, 2019 and 2018, respectively. We do not anticipate any further payments from Bendix. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment. We determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report, for additional +discussion regarding the Asset Sale. +Business Segments. We currently operate in three reportable segments: Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadways Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, VantagePegasus, Vantage Next, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. In select territories, +our Roadway Sensors segment also resells OEM products for the traffic intersection markets, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +Our +Transportation Systems segment includes engineering and consulting services focused on the planning, design, development and implementation of software and hardware-based ITS systems +that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of +emergency crews, and distribute real-time information about traffic conditions. Our Transportation Systems services include planning, design, implementation, operation and management of surface +transportation +26 +Table of Contents +infrastructure +systems. We perform analysis and study goods movement, provide commercial vehicle safety solutions, provide travel demand forecasting and systems engineering, and identify mitigation +measures to reduce traffic congestion. Our Transportation Systems product line includes Iteris SPM and iPeMS, our performance measurement and information management solutions as well as our advanced +traveler information system solutions, and our commercial vehicle operations and vehicle safety compliance platforms known as CVIEW-Plus, CheckPoint, UCRLink, and inspect. +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. ClearPath Weather is a +web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess weather conditions for customizable route/site weather and pavement forecasting, +and render winter road maintenance recommendations for state agencies, municipalities and commercial companies to improve roadway maintenance decisions. Our ClearAg solutions combine weather and +agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to increase the efficiency and sustainability of farmlands. We currently offer our +ClearAg solutions to companies in +the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. Our ClearAg solutions provide weather, +environment, soil and plant growth modeling to deliver environmental intelligence through ClearAg APIs and components, IMFocus APIs and ClearAg web applications. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements +included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts +of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting +period. On an ongoing basis, we evaluate these estimates and assumptions, include those related to revenue recognition, the collectability of accounts receivable and related allowance for doubtful +accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves and other contingencies, costs to complete long-term contracts, indirect cost rates used +in cost plus contracts, the valuation of inventories, the valuation of purchased intangible assets and goodwill, the valuation of investments, estimates of future cash flows used to assess the +recoverability of long-lived assets and the impairment of goodwill, and fair value of our stock option awards used to calculate stock-based compensation. We base these estimates on historical +experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and +liabilities that are not readily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of +our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assets and liabilities at the date of the financial statements +and the reported amounts of revenues and expenses during the reporting period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Revenues are recognized when control of the promised goods or services are transferred to our customers, in +a gross amount that +reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +27 +Table of Contents +Product +revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase +orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this +method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service +revenues, primarily derived from the Transportation Systems and Agriculture and Weather Analytics segments, are primarily from long-term engineering and consulting service +contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using +the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as +the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") +contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the +Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon +inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to +consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service +revenues also consist of revenues derived from maintenance support and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from +fees for maintenance support, monthly active user fees, SaaS fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised +of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of +progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services as the +customer obtains equal benefit from the service throughout the service period. +The +Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the +products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer which combines the software functionality, maintenance +and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each constituting a separate performance obligation. +We +generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We +include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the +variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our +anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +28 +Table of Contents +The +Company's typical performance obligations include the following: +Performance Obligation +When Performance +Obligation is +Typically Satisfied +When Payment is +Typically Due +How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product +Upon shipment (point in time) +Within 30 days of delivery +Observable transactions +Engineering services where the deliverable is considered a product +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +SaaS +Over the course of the SaaS service once the system is available for use (over time) +At the beginning of the contract period +Estimated using a cost-plus margin approach +Disaggregation of Revenue +The +Company disaggregates revenue from contracts with customers into reportable segments and the nature of the products and services. See Note 11 of Notes to +Consolidated Financial Statements in Part II, Item 8 of this report for our revenue by reportable segment. +Trade Accounts Receivable and Contract Balances +We +classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is +unconditional (i.e. only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in our consolidated balance sheet at their net +estimated realizable value. The Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is +increased by the Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of +receivables are deducted from the allowance. +A +contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable on the +accompanying balance sheet. For example, we would record a contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified +milestones. +Our +contract assets and liabilities are reported in a net position on a contract basis at the end of each reporting period. +29 +Table of Contents +Contract Fulfillment Costs +The +Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of +other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be +recovered. As of March 31, 2019, we capitalized approximately $172,000 of contract fulfillment costs which are presented in the accompanying consolidated balance sheet as prepaid and other +current assets. These costs primarily relate to the satisfaction of performance obligations related to the set up of SaaS platforms. These costs are amortized on a straight-line basis over the +estimated useful life of the SaaS platform. +Transaction Price Allocated to the Remaining Performance Obligations +As +of March 31, 2019, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial primarily as a result of +termination provisions within our contracts which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions. T&M and CPFF contracts are considered variable consideration. However, performance +obligations with an +underlying fee type of T&M or CPFF qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable +consideration upon inception of the contract and reassess the estimate each reporting period. +The +Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected +duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The +Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC +340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have +recognized is one year or less. +The +Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping +and handling costs are included as cost of revenues in the period during which the products ship. +The +Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing +transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net +basis (excluded from revenues) in the Company's consolidated statements of operations. +Deferred Revenue. Deferred revenue in the accompanying consolidated balance sheets is comprised of refund liabilities related to +billings and +consideration received in advance of the satisfaction of performance obligations. +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent internally developed and purchased intangible assets including developed technology, +customer relationships, trade names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method that reflects the pattern +in which the economic benefits of the intangible asset are +30 +Table of Contents +consumed +or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method over the estimated useful life of the asset. +We +perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, such as an adverse +change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, +including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further +testing is required, if otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit's +fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We determine the +fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long-lived assets +and purchased intangible assets. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This +estimation process can result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so +that the year-to-date provision reflects the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall +effective tax rate from quarter to quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are reversed in +the first subsequent financial reporting period in which that threshold is no longer met. +The +application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a +result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from +our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +In +relation to the Tax Cuts and Jobs Act ("TCJA"), we determine reasonable provisional estimate on our existing deferred tax balances and the one-time transition tax under the SEC Staff +Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"). +31 +Table of Contents +Actual +future operating results and the underlying amount and type of income could differ materially from our estimates, assumptions and judgments, thereby impacting our consolidated financial +position and results of operations. +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the grant +date estimated fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our stock option awards as it does not consider certain factors important to those awards to employees, such as +continued employment and periodic vesting requirements, as well as the limited transferability of the awards. The fair value of our restricted stock units is based on the closing market price of our +common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining +unearned stock-based compensation expense. +Recent Accounting Pronouncements +Refer to Note 1 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for a discussion +of recent accounting pronouncements. +32 +Table of Contents +Results of Operations +The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated. +Year Ended March 31, +2019 +2018 +2017 +Product revenues +48.7 +% +44.8 +% +45.6 +% +Service revenues +51.3 +55.2 +54.4 +Total revenues +100.0 +100.0 +100.0 +Cost of product revenues +28.7 +25.7 +24.8 +Cost of service revenues +32.4 +35.9 +36.2 +Cost of revenues +61.1 +61.6 +61.0 +Gross profit +38.9 +38.4 +39.0 +Operating expenses: +Selling, general and administrative +38.7 +36.0 +34.6 +Research and development +7.9 +7.7 +7.2 +Amortization of intangible assets +0.3 +0.1 +0.3 +Loss on impairment of goodwill +— +— +2.3 +Total operating expenses +46.9 +43.8 +44.4 +Operating loss +(7.9 +) +(5.4 +) +(5.4 +) +Non-operating income (expense): +Other income (expense), net +0.1 +(0.0 +) +0.0 +Interest income, net +0.1 +0.0 +0.0 +Loss from continuing operations before income taxes +(7.8 +) +(5.4 +) +(5.4 +) +(Provision) benefit for income taxes +(0.0 +) +1.8 +— +Loss from continuing operations +(7.9 +) +(3.6 +) +(5.4 +) +Gain on sale of discontinued operation, net of tax +— +0.2 +0.4 +Net loss +(7.9 +)% +(3.4 +)% +(5.0 +)% +Analysis of Fiscal 2019, Fiscal 2018 and Fiscal 2017 Results of Operations +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics +segments. The following tables present details of total revenues for Fiscal 2019 as compared to Fiscal 2018, and Fiscal 2018 as compared to Fiscal 2017: +Year Ended March 31, +$ +Increase +(decrease) +% +Change +2019 +2018 +(In thousands, except percentages) +Product revenues +$ +48,227 +$ +46,464 +$ +1,763 +3.8 +% +Service revenues +50,896 +57,265 +(6,369 +) +(11.1 +)% +Total revenues +$ +99,123 +$ +103,729 +$ +(4,606 +) +(4.4 +)% +33 +Table of Contents +Year Ended March 31, +$ +Increase +% +Change +2018 +2017 +(in thousands, except percentages) +Product revenues +$ +46,464 +$ +43,735 +$ +2,729 +6.2 +% +Service revenues +57,265 +52,247 +5,018 +9.6 +% +Total revenues +$ +103,729 +$ +95,982 +$ +7,747 +8.1 +% +Product +revenues for Fiscal 2019 increased approximately 3.8% to $48.2 million, compared to $46.5 million in Fiscal 2018, primarily due to an increase in our Transportation +Systems third-party product sales for certain construction-type contracts. This increase was offset in part by a decrease in unit sales from our distribution of certain OEM products for the traffic +intersection market, largely in our Texas markets, as a result of the delayed finalization of certain statewide purchase programs. Service revenues for Fiscal 2019 decreased approximately 11.1% to +$50.9 million, compared to $57.3 million in Fiscal 2018, primarily due to lower Transportation Systems traffic engineering service revenue for government agencies, and the transition +from being the prime contractor on certain large contracts awarded in Fiscal 2016, to the sub-contracting party. Total revenues for Fiscal 2019 decreased approximately 4.4% to $99.1 million, +compared to $103.7 million in Fiscal 2018, primarily due to an approximate 8.6% decrease in Transportation Systems revenues, an approximate 2.0% decrease in Roadway Sensors revenues, which was +in part offset by an approximate 18.9% increase in Agriculture and Weather Analytics revenues. +Roadway +Sensors revenues in Fiscal 2019 included approximately $43.3 million in product revenues and approximately $239,000 of service revenues, reflecting a decrease in total +revenues of approximately $0.9 million or 2%, compared to Fiscal 2018. The decrease in Fiscal 2019was primarily due to lower unit sales from our distribution of certain OEM products for the +traffic intersection market, resulting from the aforementioned delayed finalization of certain statewide purchase programs, as well as a slight decline in sales of our core Vantage products. Revenue +generated through the distribution of certain OEM products was approximately $4.0 million and approximately $5.3 million for Fiscal 2019 and Fiscal 2018, respectively. Roadway Sensors +revenues in Fiscal 2018 included approximately $44.2 million in product revenues and $194,000 of service revenues, reflecting an increase in total revenues of approximately $2.2 million +or 5%, compared to Fiscal 2017. The increase was primarily due to higher unit sales of our core Roadway Sensors video detection products aided by a corresponding increase in our distribution of +certain OEM products for the traffic intersection market. Revenue generated through the distribution of certain third party products was approximately $5.3 million and +approximately $4.8 million for Fiscal 2018 and Fiscal 2017, respectively. While OEM products generally have lower gross margins than our core video detection products, we believe offering OEM +products can benefit sales of our core products by providing a more comprehensive suite of traffic solutions for our customers. Going forward, we plan to grow revenues by focusing on our core domestic +intersection market, and refine and deliver products that address the needs of this market, primarily our Vantage processors and camera systems and our Vantage Vector video/radar hybrid sensor, as +well as our SmartCycle, Velocity, PedTrax and SmartSpan products. Additionally, we expect our VantageLive! solution, which is a SaaS offering that analyzes data collected by our Vantage cameras, to +further differentiate our products from competing alternatives. +Transportation +Systems revenues in Fiscal 2019 included approximately $44.8 million of service revenues and approximately $5.0 million of sales of third-party products +purchased for installation under certain construction-type contracts, reflecting a decrease in total revenues of approximately $4.7 million or 8.6%, compared to Fiscal 2018. The decrease was +primarily a result of transition from being the prime contractor to a sub-contractor on certain large contracts as mentioned above, as well as the completion of certain large contracts awarded in +previous years, and the timing of backlog fulfilment on certain other projects. Transportation revenues in Fiscal 2018 included approximately $52.2 million of service revenues and approximately +$2.3 million of sales of third-party products +34 +Table of Contents +purchased +for installation under certain construction-type contracts, reflecting an increase in total revenues of approximately $5.2 million or 11%, compared to Fiscal 2017. The increase was +primarily a result of extensions granted on certain large contracts, new contract awards, and the timing of backlog fulfilment on certain other projects. +We +plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with key agencies related to projects in their final project phases. While +we believe our ability to obtain additional large contracts will contribute to overall revenue growth, the mix of sub-consulting content and third-party product sales will likely affect the related +total gross profit from period to period, as total revenues derived from sub-consultants and third-party product sales generally have lower gross margins than revenues generated by our professional +services. +Agriculture +and Weather Analytics revenues in Fiscal 2019 included no product revenue and represented approximately $5.8 million of service revenues, largely consisting of +subscription revenues, reflecting an increase in total revenues of approximately $925,000 or 18.9%, compared to Fiscal 2018. The increase was primarily due to increases in both ClearPath Weather and +ClearAg solutions under newly signed contracts during Fiscal 2019. Agriculture and Weather Analytics revenues in Fiscal 2018 included no product revenue and approximately $4.9 million of +service revenues, largely consisting of subscription revenues, reflecting an increase in total revenues of approximately $351,000 or 7.7%, compared to Fiscal 2017. The increase was primarily due to +increases in both our ClearPath Weather and ClearAg solutions under newly signed contracts during Fiscal 2018. We plan to continue to focus +on commercial opportunities in the digital agriculture technology markets by offering APIs, software applications, content, and modeling services to provide analytics and decision support services +that leverage our digital weather, soil and agronomic content and applications. +Gross Profit. The following tables present details of our gross profit for Fiscal 2019 compared to Fiscal 2018, and Fiscal 2018 +compared to Fiscal +2017: +Year Ended March 31, +$ +Decrease +% +Change +2019 +2018 +(In thousands, except percentages) +Product gross profit +$ +19,793 +$ +19,831 +$ +(38 +) +(0.2 +)% +Service gross profit +18,813 +20,000 +(1,187 +) +(5.9 +)% +Total gross profit +$ +38,606 +$ +39,831 +$ +(1,225 +) +(3.1 +)% +Product gross margin as a % of product revenues +41.0 +% +42.7 +% +Service gross margin as a % of service revenues +37.0 +% +34.9 +% +Total gross margin as a % of total revenues +38.9 +% +38.4 +% +Year Ended March 31, +$ +Increase +(decrease) +% +Change +2018 +2017 +(in thousands, except percentages) +Product gross profit +$ +19,831 +$ +19,858 +$ +(27 +) +(0.1 +)% +Service gross profit +20,000 +17,544 +2,456 +14.0 +% +Total gross profit +$ +39,831 +$ +37,402 +$ +2,429 +6.5 +% +Product gross margin as a % of product revenues +42.7 +% +45.4 +% +Service gross margin as a % of service revenues +34.9 +% +33.6 +% +Total gross margin as a % of total revenues +38.4 +% +39.0 +% +35 +Table of Contents +Our product gross margin as a percentage of product revenues for Fiscal 2019 decreased approximately 170 basis points compared to Fiscal 2018 primarily due to an +increase in our Transportation Systems third-party product sales. Our service gross margin as a percentage of service revenues for Fiscal 2019 increased 210 basis points compared to Fiscal 2018 +primarily due to the completion of previously awarded contracts, the timing of certain extension contracts, the contract mix and a decrease in the amount of related sub-consulting content of such +contracts. Sub-consulting content generally results in lower gross margins than our direct labor content. Our total gross margin as a percentage of total revenues for Fiscal 2019 decreased 50 basis +points compared to Fiscal 2018 primarily as a result of the revenue mix between the Roadway Sensors and Transportation Systems segments, as Roadway Sensors revenues generally yield higher total gross +margins than our other segments. As such, the decrease in our Transportation Systems revenues from approximately 52.5% of total revenues for Fiscal 2018 to approximately 50.3% of total revenues for +Fiscal 2019 was a primary contributor to our increase in total gross margin. Roadway Sensors revenue increased as a percentage of total revenues from approximately 42.8% for Fiscal 2018 to +approximately 43.9% for Fiscal 2019. +Our +product gross margin as a percentage of product revenues for Fiscal 2018 decreased approximately 270 basis points compared to Fiscal 2017 primarily due to an increase in our Roadway +Sensors OEM sales, as well as our Transportation Systems third-party product sales, both of which typically yield lower gross margins than our sales of Roadway Sensors core video detection products. +Our service +gross margin as a percentage of service revenues for Fiscal 2018 increased 130 basis points compared to Fiscal 2017 primarily due to the timing of certain extension contracts, the contract mix and a +decrease in the amount of related sub-consulting content of such contracts. Sub-consulting content generally results in lower gross margins than our direct labor content. Our total gross margin as a +percentage of total revenues for Fiscal 2018 decreased 60 basis points compared to Fiscal 2017 primarily as a result of the revenue mix between the Roadway Sensors and Transportation Systems segments, +as Roadway Sensors revenues generally yield higher total gross margins than our other segments. As such, the increase in our Transportation Systems total revenues from approximately 51% of total +revenues for Fiscal 2017 to approximately 53% of total revenues for Fiscal 2018 was a primary contributor to our decline in total gross margin. Roadway Sensors revenue decreased as a percentage of +total revenues from approximately 44% for Fiscal 2017 to approximately 43% for Fiscal 2018. +Roadway +Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix between core products and third party OEM products, +competitive pricing requirements, product warranty costs and provisions for our excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining +activities, which we record as cost of goods sold. +We +recognize a portion of our Transportation Systems revenues and related gross profit using percentage of completion contract accounting, and the underlying mix of contract activity +affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future periods due to our contract mix and +the amount of related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could cause fluctuations in our margins from +period to period. +Selling, General and Administrative Expense +Selling, general and administration expense for Fiscal 2019 increased approximately 2.9% to $38.5 million, compared to +$37.4 million in Fiscal 2018. The overall increase was primarily due to an increase in business development costs aimed at the pursuit of large contracts in the Transportations Systems segment. +In addition, during Fiscal 2019, there were planned headcount increases in general and administrative positions, as well as increases in the Transportations Systems and Roadway Sensors sales force +headcount, all of which resulted in higher salary and personnel-related costs. +36 +Table of Contents +Selling, +general and administration expense for Fiscal 2018 increased approximately 12.3% to $37.4 million, compared to $33.3 million in Fiscal 2017. The overall increase +was primarily due to an increase in business development costs aimed at the pursuit of large contracts in the Transportations Systems segment. In addition, there were higher personnel compensation +costs driven by higher revenues. This increase in personnel also drove an increase in facilities costs. The overall increase was also attributable to an increase in other selling, general and +administrative expenses, primarily due to a reversal of certain bad debt reserves on specific accounts receivable that were subsequently collected during Fiscal 2017, which did not reoccur in Fiscal +2018. +Research and Development Expense +Research and development expense for Fiscal 2019 was $7.8 million, which was relatively consistent with Fiscal 2018 at +$7.9 million, as the Company continued to invest in research, discovery, and development. +We +continued to invest in the development of our iPeMS software offering as well as our ClearAg and ClearPath Weather solutions. In addition, we invested in further enhancements and +functionality in our Vantage products family. During Fiscal 2018, we successfully released Iteris SPM, our cloud-based signal performance measures application. During Fiscal 2017, we released our +VantageLive! platform as well as a number of generally available advisory applications, including our Harvest Advisory and Nitrogen Advisory. Certain development costs were capitalized into intangible +assets in the consolidated balance sheets; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect +to continue to invest in our solutions. This continued investment may result in increases in research and development costs in future periods. +Research +and development expense for Fiscal 2018 increased approximately 15.5% to $7.9 million, compared to $6.9 million in Fiscal 2017. The overall increase was primarily +due to continued investment in research, discovery, and development largely focused on our software related product offerings. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2019 and 2018, we believe the carrying value of our goodwill was not impaired, as the +estimated fair values of our reporting units exceeded their carrying values at the end of Fiscal 2019 and 2018. Based on our goodwill impairment +testing for Fiscal 2017, we determined the fair value of the Agriculture and Weather Analytics reporting unit was less than its carrying amount and resulted in approximately $2.2 million +impairment charge in the consolidated statement of operations for Fiscal 2017. We also determined our Roadway Sensors and Transportation Systems reporting units had no impairment, as their estimated +fair values exceeded their respective carrying values. If our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates +used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Amortization of Intangible Assets +Amortization expense for intangible assets subject to amortization was approximately $1.1 million, $726,000, and $623,000 for Fiscal +2019, Fiscal 2018 and Fiscal 2017, respectively. Approximately $850,000, $638,000, and $342,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $275,000, +$88,000, and $281,000 was recorded to amortization expense for Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively, in the consolidated statements of operations. The increase in amortization was +primarily due to amortization related to our Oracle ERP system design and development, which was placed in service in April 2018. +37 +Table of Contents +Interest Income, Net +Net interest income was approximately $129,000, $32,000 and $13,000 in Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively. The increase in +net interest income in the current year was primarily due to interest earned on investments purchased and held during the current Fiscal year. +Income Taxes +The following table presents our (benefit) provision for income taxes for Fiscal 2019, Fiscal 2018 and Fiscal 2017: +Year Ended March 31, +2019 +2018 +2017 +(In thousands, except percentages) +(Benefit) provision for income taxes +$ +36 +$ +(1,818 +) +$ +(44 +) +Effective tax rate +(0.5 +)% +32.5 +% +0.8 +% +For +Fiscal 2019, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +For +Fiscal 2018, the difference between the statutory and the effective tax rate was primarily attributable to an increase in tax expense resulting from the impact of the change in the +U.S. federal tax rate on the Company's deferred tax assets, offset by a corresponding change to the valuation allowance maintained against the deferred tax assets and a benefit for research tax +credits generated during the current fiscal year. The effective tax rate for Fiscal 2018 was also favorably impacted by the reversal of the valuation allowance related to alternative minimum tax +credit carryforwards, which were made refundable by the tax legislation discussed below. +For +Fiscal 2017, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against the Company's deferred tax assets. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it +appropriate to maintain valuation allowances of $12.3 million and $9.8 million against our deferred tax assets at March 31, 2019 and 2018, respectively. We will continue to +reassess the appropriateness of maintaining a valuation allowance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective +tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to +the extent that we believe these assets will more likely than not be realized. +At +March 31, 2019, we had $17.4 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes and $5.7 million of +federal net operating loss carryforwards that begin to expire in 2022. We also had $8.0 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact +cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using +statutory tax rates. +The +TCJA was enacted on December 22, 2017 and reduced U.S. corporate income tax rates to 21.0% as of January 1, 2018. The rate change became effective during Fiscal 2018 +resulting in a +38 +Table of Contents +blended +statutory tax rate of 30.8% for Fiscal 2018. As a consequence of the tax legislation, the Company recorded a decrease in its net deferred tax assets of $4.1 million and a decrease in +the valuation allowance maintained against its deferred tax assets of $5.8 million. The estimated impact of the tax legislation was an income tax benefit of $1.7 million, of which +$1.1 million was due to the release of valuation allowance that had been maintained against alternative minimum tax credit carryforwards, which were made refundable by the tax legislation, and +$640,000 was due to the remeasurement of a deferred tax liability related to indefinite-lived assets. +On +December 22, 2017, the SEC issued guidance under SAB 118 directing taxpayers to consider the impact of the tax legislation as "provisional" when it does not have the +necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, the income +tax effects recorded in Fiscal 2018 represented the Company's best estimate based on its current interpretation of this tax legislation. We completed our accounting for the tax legislation in Fiscal +2019 and did not recognize any material adjustments to the provisional amounts recorded in Fiscal 2018. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities and our prior +bank line of credit. We have historically relied, and expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund +our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by +selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt +securities, our existing stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that +we will be able to secure additional funding on a timely basis, on terms acceptable to us, or at all. +At +March 31, 2019, we had $13.5 million in working capital, which included $7.1 million in cash and cash equivalents, as well as $1.9 million in short-term +investments. This compares to working capital of $17.4 million at March 31, 2018, which included $10.2 million in cash and cash equivalents as well as $5.3 million in +short-term investments. +The +following table summarizes our cash flows for Fiscal 2019, Fiscal 2018 and Fiscal 2017: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +(5,828 +) +$ +(268 +) +$ +2,903 +Investing activities +2,345 +(8,823 +) +(1,343 +) +Financing activities +402 +1,042 +612 +Operating Activities. Cash used in our operations during Fiscal 2019 was primarily the result of our net loss of approximately +$7.8 million, +adjusted by approximately $4.1 million in non-cash items for deferred income taxes, depreciation, stock-based compensation, and amortization. The net loss was offset in part by approximately +$2.1 million of working capital used in our operations in Fiscal 2019. +Cash +used in our operations during Fiscal 2018 was primarily the result of our net loss of approximately $3.5 million, adjusted by approximately $2.4 million in non-cash +items for deferred income taxes, depreciation, stock-based compensation, amortization, gain on sales of discontinued +39 +Table of Contents +operations, +and loss on disposal of equipment. The net loss was offset in part by approximately $819,000 of working capital provided by our operations in Fiscal 2018. +Cash +provided by our operations during Fiscal 2017 was primarily the result of approximately $3.6 million of working capital provided and offset by our net loss of approximately +$4.8 million, adjusted by approximately $4.2 million in non-cash items for deferred income taxes, depreciation, stock-based compensation, amortization, gain on sales of discontinued +operations, loss on disposal of equipment and loss on impairment of goodwill. +Investing Activities. Net cash provided by our investing activities during Fiscal 2019 was primarily the result of approximately +$7.5 million +in proceeds from the maturity of short-term investments and approximately $107,000 in proceeds from the last earn-out payment related to the sale of the assets of the Vehicle Sensors segment in 2011. +These amounts were partially offset by purchases of approximately $4.1 million of short-term investments and approximately $486,000 of property and equipment as well as approximately $660,000 +of capitalized software development primarily in the Roadway Sensors business segment related to VantageLive! developments. +Cash +used in our investing activities during Fiscal 2018 consisted of approximately $5.3 million in investment purchases, approximately $1.1 million for purchases of +property and equipment primarily related to leasehold improvement to our corporate headquarters, and $2.9 million of capitalized software development primarily related to the development of our +new Oracle ERP system, and to a lesser extent, in the Agriculture and Weather Analytics and Roadway Sensors business segments related to ClearAg assets and VantageLive! developments. These investments +were partially offset by approximately $511,000 in proceeds from the earn-out provision included in the sale of the Vehicle Sensors segment. +Cash +used in our investing activities during Fiscal 2017 consisted of approximately $1.2 million of capitalized software development in the Agriculture and Weather Analytics and +Roadway Sensors business segments related to ClearAg assets and VantageLive! development, respectively, and approximately $668,000 for purchases of property and equipment, primarily related to +computers and related equipment which were offset by approximately $495,000 in proceeds from the sale of the Vehicle Sensors segment. +Financing Activities. Net cash provided by financing activities during Fiscal 2019 was primarily the result of approximately +$343,000 of cash +proceeds received from the purchases of Employee Stock Purchase +Plan ("ESPP") shares, and approximately $90,000 of cash proceeds from the exercise of stock options during Fiscal 2019. +Net +cash provided by financing activities during Fiscal 2018 and Fiscal 2017 was primarily the result of approximately $1.0 million and $612,000, respectively, of cash proceeds +received from the exercises of stock options. +Off-Balance Sheet Arrangements +Other than our operating leases, which are further described at Note 8 of Notes to Consolidated Financial Statements, included in +Part II, Item 8 of this report, we do not have any other material off-balance sheet arrangements at March 31, 2019. +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such sales in +our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally +impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which +40 +Table of Contents +adversely +impacts our third fiscal quarter due to the increased number of holidays, causing a reduction in available billable hours. In addition, we have experienced seasonality related to certain +ClearPath Weather services which adversely impacts such sales in our first and second fiscal quarters, mainly because these services are generally not required during Spring and Summer when weather +conditions are comparatively milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information +required by this Item. +41 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Consolidated Financial Statement +Report of Independent Registered Public Accounting Firm +43 +Consolidated Balance Sheets as of March 31, 2019 and 2018 +45 +Consolidated Statements of Operations for the fiscal years ended March 31, 2019, 2018 and 2017 +46 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2019, 2018 and 2017 +47 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2019, 2018 and 2017 +48 +Notes to Consolidated Financial Statements +49 +42 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiary (the "Company") as of March 31, 2019 +and 2018, the related consolidated statements of operations, stockholders' equity, and cash flows, for each of the three years in the period ended March 31, 2019, and the related notes +(collectively referred to as the "financial statements"). We also +have audited the Company's internal control over financial reporting as of March 31, 2019, based on criteria established in Internal Control—Integrated +Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In +our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2019 and 2018, and the +results of their operations and their cash flows for each of the three years in the period ended March 31, 2019, in conformity with accounting principles generally accepted in the United States +of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2019, based on criteria established in Internal +Control—Integrated Framework (2013) issued by COSO. +Basis for Opinions +The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and +for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility +is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with +the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the +applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We +conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the +financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our +audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and +performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also +included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal +control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the +design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe +that our audits provide a reasonable basis for our opinions. +43 +Table of Contents +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting +includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets +of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting +principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable +assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ +Deloitte & Touche LLP +Costa +Mesa, CA +June 6, +2019 +We +have served as the Company's auditor since fiscal 2016. +44 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2019 +2018 +Assets +Current assets: +Cash and cash equivalents +$ +7,071 +$ +10,152 +Short-term investments +1,935 +5,319 +Trade accounts receivable, net of allowance for doubtful accounts of $539 and $333 at March 31, 2019 and March 31, 2018, +respectively +16,929 +12,866 +Unbilled accounts receivable +6,487 +7,473 +Inventories +2,916 +2,921 +Prepaid expenses and other current assets +1,367 +1,165 +Total current assets +36,705 +39,896 +Property and equipment, net +1,965 +2,333 +Intangible assets, net +3,286 +3,751 +Goodwill +15,150 +15,150 +Other assets +849 +1,756 +Total assets +$ +57,955 +$ +62,886 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +9,441 +$ +7,838 +Accrued payroll and related expenses +6,536 +7,398 +Accrued liabilities +2,370 +2,358 +Deferred revenue +4,883 +4,900 +Total current liabilities +23,230 +22,494 +Deferred rent +455 +638 +Deferred income taxes +65 +65 +Unrecognized tax benefits +150 +168 +Total liabilities +23,900 +23,365 +Commitments and contingencies (Note 6) +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 +Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2019 and March 31, 2018 +Issued and outstanding shares—33,377 at March 31, 2019 and 33,186 at March 31, 2018 +3,338 +3,318 +Additional paid-in capital +142,260 +139,722 +Accumulated deficit +(111,543 +) +(103,519 +) +Total stockholders' equity +34,055 +39,521 +Total liabilities and stockholders' equity +$ +57,955 +$ +62,886 +See accompanying notes. +45 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2019 +2018 +2017 +Product revenues +$ +48,227 +$ +46,464 +$ +43,735 +Service revenues +50,896 +57,265 +52,247 +Total revenues +99,123 +103,729 +95,982 +Cost of product revenues +28,434 +26,633 +23,877 +Cost of service revenues +32,083 +37,265 +34,703 +Total cost of revenues +60,517 +63,898 +58,580 +Gross profit +38,606 +39,831 +37,402 +Operating expenses: +Selling, general and administrative +38,471 +37,400 +33,313 +Research and development +7,819 +7,945 +6,877 +Amortization of intangible assets +275 +88 +281 +Loss on impairment of goodwill +— +— +2,168 +Total operating expenses +46,565 +45,433 +42,639 +Operating loss +(7,959 +) +(5,602 +) +(5,237 +) +Non-operating income (expense): +Other income (expense), net +50 +(16 +) +(7 +) +Interest income, net +129 +32 +13 +Loss from continuing operations before income taxes +(7,780 +) +(5,586 +) +(5,231 +) +(Provision) benefit for income taxes +(36 +) +1,818 +44 +Loss from continuing operations +(7,816 +) +(3,768 +) +(5,187 +) +Gain on sale of discontinued operation, net of tax +— +242 +361 +Net loss +$ +(7,816 +) +$ +(3,526 +) +$ +(4,826 +) +Loss per share from continuing operations—basic and diluted +$ +(0.23 +) +$ +(0.12 +) +$ +(0.16 +) +Gain per share from sale of discontinued operation—basic and diluted +$ +— +$ +0.01 +$ +0.01 +Net loss per share—basic and diluted +$ +(0.23 +) +$ +(0.11 +) +$ +(0.15 +) +Shares used in basic per share calculations +33,266 +32,776 +32,174 +Shares used in diluted per share calculations +33,266 +32,776 +32,174 +See accompanying notes. +46 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at March 31, 2016 +32,048 +$ +3,205 +$ +135,424 +$ +(95,167 +) +$ +43,462 +Stock option exercises +388 +40 +628 +— +668 +Stock-based compensation +— +— +976 +— +976 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +52 +4 +(60 +) +— +(56 +) +Net loss +(4,826 +) +(4,826 +) +Balance at March 31, 2017 +32,488 +$ +3,249 +$ +136,968 +$ +(99,993 +) +$ +40,224 +Stock option exercises +591 +59 +1,131 +— +1,190 +Stock-based compensation +— +— +1,781 +— +1,781 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +107 +10 +(158 +) +— +(148 +) +Net loss +(3,526 +) +(3,526 +) +Balance at March 31, 2018 +33,186 +$ +3,318 +$ +139,722 +$ +(103,519 +) +$ +39,521 +Adoption of ASU 2014-09 (see Note 1) +(208 +) +(208 +) +Stock option exercises +43 +4 +81 +— +85 +Issuance of shares pursuant to Employee Stock Purchase Plan +92 +10 +355 +365 +Stock-based compensation +— +— +2,156 +— +2,156 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +56 +6 +(54 +) +— +(48 +) +Net loss +(7,816 +) +(7,816 +) +Balance at March 31, 2019 +33,377 +$ +3,338 +$ +142,260 +$ +(111,543 +) +$ +34,055 +See accompanying notes. +47 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Year Ended March 31, +2019 +2018 +2017 +Cash flows from operating activities +Net loss +$ +(7,816 +) +$ +(3,526 +) +$ +(4,826 +) +Adjustments to reconcile net loss to net cash (used in) provided by operating activities: +Deferred income taxes +(18 +) +(660 +) +12 +Depreciation of property and equipment +854 +819 +729 +Stock-based compensation +2,156 +1,781 +976 +Amortization of intangible assets +1,125 +726 +623 +Gain on sale of discontinued operation, net of tax +— +(242 +) +(361 +) +Loss on disposal of equipment +— +16 +14 +Loss on impairment of goodwill +— +— +2,168 +Changes in operating assets and liabilities, net of effects of discontinued operation: +Accounts receivable +(4,063 +) +1,433 +(1,058 +) +Unbilled accounts receivable and deferred revenue, net +457 +(166 +) +549 +Inventories +5 +(671 +) +903 +Prepaid expenses and other assets +902 +(693 +) +(408 +) +Accounts payable and accrued expenses +570 +915 +3,582 +Net cash (used in) provided by operating activities +(5,828 +) +(268 +) +2,903 +Cash flows from investing activities +Purchases of property and equipment +(486 +) +(1,079 +) +(668 +) +Purchase of short term investments +(4,079 +) +(5,319 +) +— +Maturities of investments +7,463 +— +— +Capitalized software development costs +(660 +) +(2,936 +) +(1,170 +) +Net proceeds from sale of business segment +107 +511 +495 +Net cash (used in) provided by investing activities +2,345 +(8,823 +) +(1,343 +) +Cash flows from financing activities +Proceeds from stock option exercises +85 +1,190 +668 +Proceeds from ESPP purchases +365 +— +— +Tax withholding payments for net share settlements of restricted stock units +(48 +) +(148 +) +(56 +) +Net cash provided by financing activities +402 +1,042 +612 +(Decrease) increase in cash and cash equivalents +(3,081 +) +(8,049 +) +2,172 +Cash and cash equivalents at beginning of period +10,152 +18,201 +16,029 +Cash and cash equivalents at end of period +$ +7,071 +$ +10,152 +$ +18,201 +Supplemental cash flow information: +Cash paid during the year for: +Interest +$ +— +$ +— +$ +14 +Income taxes +4 +130 +166 +Supplemental schedule of non-cash investing and financing activities: +Capitalized software development costs included in accounts payable and accrued expenses +$ +— +$ +102 +$ +— +Issuance of common stock for vested restricted stock units +6 +10 +5 +Landlord contribution for tenant improvements +— +145 +— +See accompanying notes. +48 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris", the "Company", +"we", "our", and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, crop +science companies, agriculture service providers and other agribusinesses use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and +productive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, we offer a comprehensive range of ITS technology solutions to our customers throughout +the U.S. and internationally through a combination intellectual property, products, SaaS offering and weather forecasting systems. +In +the digital agriculture market, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and +analytical solutions that provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment +manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the entire value chain in the agriculture market with our smart content and digital farming platform, and always exploring strategic alternatives +intended to optimize the value of all of our businesses. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +in the agribusiness markets. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and its subsidiary and have been prepared in accordance with +generally accepted accounting principles in the United States of America ("GAAP"). All intercompany accounts and transactions have been eliminated in consolidation. +The +results of continuing operations for all periods presented in the consolidated financial statements exclude the financial impact of a discontinued operation. See Note 3, "Sale +of Vehicle Sensors," for further discussion related to the discontinued operation presentation. +49 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions +that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses +during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the collectability of +accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves, costs to complete long-term +contracts, indirect cost rates used in cost plus contracts, the valuation of purchased intangible assets and goodwill, the valuation of equity instruments, estimates of future cash flows used to +assess the recoverability of long-lived assets and the impairment of goodwill, and fair value of our stock option awards used to calculate the stock-based compensation. +Revenue Recognition +Adoption of Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with +Customers (Topic 606) ("ASU 2014-09") +On +April 1, 2018, the Company adopted ASU 2014-09, including its subsequent amendments as codified under ASC Topic 606 ("ASC 606"), using the modified retrospective approach to +apply ASC 606 to all contracts that were not completed as of the beginning of Fiscal Year 2019. ASC 606 is a comprehensive new revenue recognition principle that requires a company to recognize +revenue to depict the transfer of promised goods or services to a customer at an amount that reflects the consideration it expects to be entitled to in exchange for those goods or services. Results +for reporting periods beginning after March 31, 2018 are presented under ASC 606, while prior period amounts and disclosures are not adjusted and continue to be reported under the accounting +standards in effect for the prior period. As a result, the Company recognized the cumulative effect of initially applying ASC 606 as an increase to the opening balance of accumulated deficit in +the amount of approximately $208,000 as of April 1, 2018. The impact of the adoption of the new standard is immaterial to the Company's consolidated balance sheet, statement of operations, and +cash flows. +50 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The +following table represents the impact of adopting ASC 606 on our opening consolidated balance sheet as of April 1, 2018: +March 31, 2018 +As Reported +Cumulative-Effect +Adjustments +April 1, 2018 +As Adjusted +(In thousands) +Prepaid expenses and other current assets +$ +1,165 +$ +304 +$ +1,469 +Total assets +$ +62,886 +$ +304 +$ +63,190 +Deferred revenue +$ +4,900 +$ +512 +$ +5,412 +Total liabilities +$ +23,365 +$ +512 +$ +23,877 +Accumulated deficit +$ +(103,519 +) +$ +(208 +) +$ +(103,727 +) +Total liabilities and stockholders' equity +$ +62,886 +$ +304 +$ +63,190 +Changes in Accounting Policies as a Result of Adopting ASC 606 and Nature of Goods and +Services +Revenues +are recognized when control of the promised goods or services are transferred to our customers, in a gross amount that reflects the consideration that we +expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +Product +revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase +orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this +method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service +revenues, primarily derived from the Transportation Systems and Agriculture and Weather Analytics segments, are primarily from long-term engineering and consulting service +contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using +the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as +the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") +contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the +Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon +inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to +consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +51 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Service +revenues also consist of revenues derived from maintenance support and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from +fees for maintenance support, monthly active user fees, software as a service ("SaaS") fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single +performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company +applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the +transfer of services as the customer obtains equal benefit from the service throughout the service period. +The +Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the +products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer which combines the software functionality, maintenance +and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each constituting a separate performance obligation. +We +generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We +include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the +variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our +anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +52 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The +Company's typical performance obligations include the following: +Performance Obligation +When Performance +Obligation is Typically +Satisfied +When Payment is +Typically Due +How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product +Upon shipment (point in time) +Within 30 days of delivery +Observable transactions +Engineering services where the deliverable is considered a product +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +SaaS +Over the course of the SaaS service once the system is available for use (over time) +At the beginning of the contract period +Estimated using a cost-plus margin approach +Disaggregation of Revenue +The +Company disaggregates revenue from contracts with customers into reportable segments and the nature of the products and services. See Note 11 for our revenue +by reportable segment. +Trade Accounts Receivable and Contract Balances +We +classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is +unconditional (i.e. only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in our consolidated balance sheet at their net +estimated realizable value. +The +Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is increased by the +Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are +deducted from the allowance. +A +contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable on the +accompanying balance +53 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +sheet. +For example, we would record a contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified milestones. +Our +contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in +advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The +Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of +other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be +recovered. As of March 31, 2019, we capitalized approximately $172,000 of contract fulfillment costs which are presented in the accompanying consolidated balance sheet as prepaid and other +current assets. These costs primarily relate to the satisfaction of performance obligations related to the set up of SaaS platforms. These costs are amortized on a straight-line basis over the +estimated useful life of the SaaS platform. +Transaction Price Allocated to the Remaining Performance Obligations +As +of March 31, 2019, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial primarily as a result of +termination provisions within our contracts which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF +qualify for the "Right to +Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the +estimate each reporting period. +The +Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected +duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The +Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC +340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have +recognized is one year or less. +The +Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping +and handling costs are included as cost of revenues in the period during which the products ship. +54 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The +Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing +transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net +basis (excluded from revenues) in the Company's consolidated statements of operations. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of refund liabilities related to billings and consideration +received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade +accounts receivable. +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, South America and Asia. We generally do not require +collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's +expectations. +We +currently have, and historically have had, a diverse customer base. For the fiscal year ended March 31, 2019 ("Fiscal 2019"), one individual customer represented approximately +24% of our total revenues. For the fiscal years ended March 31, 2018 ("Fiscal 2018") and March 31, 2017 ("Fiscal 2017"), one individual customer represented approximately 22% of our +total revenues. As of March 31, 2019, no individual customer represented greater than 10% of our total accounts receivable. As of March 31, 2018, one customer represented approximately +13% of our total accounts receivable, and no other individual customer represented greater than 10% of our total accounts receivable. +Fair Values of Financial Instruments +The fair value of cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of the short period of +time to maturity. Our investments are measured at fair value on a recurring basis. +The +framework for measuring fair value and related disclosure requirements about fair value measurements are provided in FASB ASC 820, Fair Value +Measurements ("ASC 820"). This +pronouncement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an +orderly +55 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +transaction +between market participants on the measurement date. The fair value hierarchy proscribed by ASC 820 contains three levels as follows: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +Cash and Cash Equivalents +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +Investments +The Company's investments are classified as either held-to-maturity, available-for-sale or trading, in accordance with FASB ASC 320. +Held-to-maturity securities are those securities that the Company has the positive intent and ability to hold until maturity. Trading securities are those securities that the Company intends to sell +in the near term. All other securities not included +in the held-to-maturity or trading category are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost which approximates fair market value. Trading securities +are carried at fair value with unrealized gains and losses charged to earnings. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded within accumulated +other comprehensive loss as a separate component of stockholders' equity. FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an +orderly transaction between market participants at the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where +available (see Note 4). As of March 31, 2019, all of our investments are available-for-sale. +Under +FASB ASC 320-10-35, a security is considered to be other-than-temporarily impaired if the present value of cash flows expected to be collected are less than the security's +amortized cost basis (the difference being defined as the "Credit Loss") or if the fair value of the security is less than the security's amortized cost basis and the investor intends, or will be +required, to sell the security before recovery of the security's amortized cost basis. If an other-than-temporary impairment exists, the charge to earnings is limited to the amount of Credit Loss if +the investor does not intend to sell the security, and will not be required to sell the security, before recovery of the security's amortized cost basis. Any remaining difference between fair value +and amortized cost is recognized in other comprehensive loss, net of applicable taxes. The Company evaluates whether the decline in fair value of its investments is other-than-temporary at each +quarter-end. This evaluation consists of a review by management, and includes market pricing information and maturity dates for the securities held, market and economic trends in the industry and +information on the issuer's financial condition and, if applicable, information on the guarantors' financial condition. Factors considered in determining whether a loss is temporary +56 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +include +the length of time and extent to which the investment's fair value has been less than its cost basis, the financial condition and near-term prospects of the issuer and guarantors, including +any specific events which may influence the operations of the issuer and the Company's intent and ability to retain the investment for a reasonable period of time sufficient to allow for any +anticipated recovery of fair value. +Prepaid Expenses and Other Current Assets +Prepaid expenses and other current assets were $1.4 million as of March 31, 2019. Prepaid expenses and other current assets were +$1.2 million as of March 31, 2018 and included approximately $130,000 of cash designated as collateral on performance bonds, as required under certain of our Transportation Systems +contracts in the Middle East. The performance bonds required us to maintain 100% cash value of the bonds as collateral in a bank that is local to the purchasing agency. +The performance bond collateral was required throughout the delivery of our services and was maintained in the local bank until the contract was closed by the purchasing agency. The requirements on +the remaining performance bonds, and the related cash collateral restrictions, were released during the quarter ended June 30, 2018. +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or net realizable value. Cost is +determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging from three +to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Goodwill and Long-Lived Assets +We perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or +circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting +unit below its carrying amount, including goodwill. If +57 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +events +or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further testing is required, if +otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the amount by +which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. As +of March 31, 2019 and March 31, 2018, we determined that no adjustments to the carrying value of goodwill and intangible assets were required. As of March 31, 2017, we determined +the carrying amount of the goodwill in the Agriculture and Weather Analytics reporting unit exceeded its implied fair value, and as a result, recognized an approximate $2.2 million impairment +loss in the accompanying consolidated financial statements. We also determined that no adjustments to the carrying value of goodwill and intangible assets were required in the Roadway Sensors and +Transportation Systems reporting units for any year presented. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets +and purchased intangible assets. As of March 31, 2019, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary +differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation +allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. +As such, we determined it was appropriate to record a full valuation allowance against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are +derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of +our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock units. The +fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this +58 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +model +meets established requirements, the estimated fair values generated by it may not be indicative of the actual fair values of our common stock option awards as it does not consider certain +factors important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is +based on the closing market price of our common stock on the grant date. If there are any modifications or +cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Advertising Expenses +Advertising costs are expensed in the period incurred and totaled $61,000, $148,000 and $146,000 in Fiscal 2019, Fiscal 2018 and Fiscal 2017, +respectively. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to +various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. We do not provide any service-type warranties. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to +one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and +maintenance costs are charged to expense as incurred. +59 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Comprehensive Loss +The difference between net loss and comprehensive loss was de minimis for Fiscal 2019 and Fiscal 2018. Comprehensive loss equaled net loss for +Fiscal 2017. +Recent Accounting Pronouncements +In February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). The +pronouncement requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. ASU 2016-02 establishes a right-of-use ("ROU") model that requires a +lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. ASU 2016-02 also requires disclosures to meet the objective of +enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for the Company beginning April 1, 2019, using a +modified retrospective approach, with early adoption permitted. An entity may choose to use either the effective date or the beginning of the earliest comparative period presented in the financial +statements as the date of initial application. The Company expects to adopt ASU 2016-02 on April 1, 2019, using a modified retrospective approach, and to choose the effective date as the date +of initial application. Consequently, financial information will not be updated, and the disclosures required under ASU 2016-02 will not be provided for dates and periods prior to April 1, +2019. ASU 2016-02 provides a number of optional practical expedients and accounting policy elections. The Company expects to elect the package of practical expedients requiring no reassessment of +whether any expired or existing contracts are or contain leases, the lease classification of any expired or existing leases, or initial direct costs for any existing leases. Further, the Company +expects to elect accounting policies not to apply the recognition requirements under ASU 2016-02 to any of the Company's short-term leases, instead recognizing the lease payments in the consolidated +statement of operations on a straight-line basis over the lease term, and to account for each separate lease and associated nonlease components as a single lease component for all of its leases. The +Company expects ASU 2016-02 will have a material effect on its consolidated balance sheets. However, the Company does not expect ASU 2016-02 will have a material effect on its consolidated statements +of operations, its consolidated statements of stockholders' equity or its consolidated statements of cash flows. While the Company continues to assess all of the effects of adoption, the most +significant effects relate to (1) the recognition of ROU assets of approximately $12.0 million to $14.0 million and lease liabilities of approximately $13.0 million to +$15.0 million, primarily resulting from leases of office space, equipment and vehicles; (2) the derecognition of deferred rent of approximately $830,000 for certain lease incentives +received; and (3) significant new disclosure requirements. +In +August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirement for Fair Value +Measurements ("ASU 2018-13"), which modifies the disclosure requirements on fair value measurements. This update +is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. We are currently evaluating the impact of ASU 2018-13 +on our consolidated financial statements. +In +August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal Use Software (subtopic 350-40): Customer's Accounting for +Implementation Costs Incurred in a Cloud +60 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Computing +Arrangement That Is a Service Contract ("ASU 2018-15"), which clarifies the accounting for implementation costs in cloud computing arrangements. This update is effective for fiscal years, +and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. We are currently evaluating the impact of ASU 2018-15 on our consolidated financial +statements. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2019 +2018 +(In thousands) +Materials and supplies +$ +1,517 +$ +1,745 +Work in process +356 +232 +Finished goods +1,043 +944 +$ +2,916 +$ +2,921 +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2019 +2018 +(In thousands) +Equipment +$ +6,444 +$ +6,053 +Leasehold improvements +2,939 +2,880 +Accumulated depreciation +(7,418 +) +(6,600 +) +$ +1,965 +$ +2,333 +Depreciation +expense was approximately $854,000, $819,000, and $729,000 in Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively. Approximately $286,000, $288,000, and $269,000 of the +depreciation expense was recorded to cost of revenues, and approximately $568,000, $531,000 and $397,000 was recorded to operating expenses in Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively, +in the consolidated statements of operations. +61 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +2. Supplementary Financial Information (Continued) +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, 2019 +March 31, 2018 +Gross +Carrying +Amount +Accumulated +Amortization +Net +Book +Value +Gross +Carrying +Amount +Accumulated +Amortization +Net +Book +Value +(In thousands) +Technology +$ +1,856 +$ +(1,856 +) +$ +— +$ +1,856 +$ +(1,856 +) +$ +— +Customer contracts / relationships +750 +(750 +) +— +750 +(750 +) +— +Trade names and non-compete agreements +1,110 +(1,110 +) +— +1,110 +(1,102 +) +8 +Capitalized software development costs +5,768 +(2,482 +) +3,286 +5,108 +(1,365 +) +3,743 +Total +$ +9,484 +$ +(6,198 +) +$ +3,286 +$ +8,824 +$ +(5,073 +) +$ +3,751 +Amortization +expense for intangible assets subject to amortization was approximately $1.1 million, $726,000, and $623,000 for Fiscal 2019, Fiscal 2018 and Fiscal 2017, +respectively. Approximately $850,000, $638,000, and $342,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $275,000, $88,000, and $281,000 was recorded to +amortization expense for Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively, in the consolidated statements of operations. +We +do not have any intangible assets with indefinite useful lives. As of March 31, 2019, our net capitalized software development costs of approximately $3.3 million is +primarily associated with our +Oracle Enterprise Resource Planning ("ERP") system design and implementation of approximately $2.2 million, which has a useful life of 10 years beginning Fiscal 2019. +As +of March 31, 2019, the future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2020 +$ +895 +2021 +542 +2022 +327 +2023 +266 +2024 +266 +Thereafter +990 +$ +3,286 +62 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +2. Supplementary Financial Information (Continued) +Goodwill +The following table presents the activity related to the carrying value of our goodwill by reportable segment for Fiscal 2017, Fiscal 2018 and +Fiscal 2019: +Roadway +Sensors +Transportation +Systems +Ag & Weather +Analytics +Total +(In thousands) +Balance—March 31, 2017 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +Balance—March 31, 2018 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +8,214 +6,936 +— +15,150 +Balance—March 31, 2019 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Balance at beginning of fiscal year +$ +403 +$ +278 +$ +193 +Additions charged to cost of sales +647 +623 +382 +Warranty claims +(587 +) +(498 +) +(297 +) +Balance at end of fiscal year +$ +463 +$ +403 +$ +278 +63 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +2. Supplementary Financial Information (Continued) +Earnings Per Share +The following table sets forth the computation of basic and diluted loss from continuing operations per share: +Year Ended March 31, +2019 +2018 +2017 +(In thousands, except per +share amounts) +Numerator: +Loss from continuing operations +$ +(7,816 +) +$ +(3,768 +) +$ +(5,187 +) +Gain on sale of discontinued operation, net of tax +— +242 +361 +Net loss +$ +(7,816 +) +$ +(3,526 +) +$ +(4,826 +) +Denominator: +Weighted average common shares used in basic computation +33,266 +32,776 +32,174 +Dilutive stock options +— +— +— +Dilutive restricted stock units +— +— +— +Dilutive warrants +— +— +— +Weighted average common shares used in diluted computation +33,266 +32,776 +32,174 +Loss from continuing operations per share: +Basic +$ +(0.23 +) +$ +(0.12 +) +$ +(0.15 +) +Diluted +$ +(0.23 +) +$ +(0.12 +) +$ +(0.15 +) +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted loss per share from continuing operations as +their effect would have been anti-dilutive: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Stock options +5,056 +3,917 +3,491 +Restricted stock units +12 +228 +179 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale (the "Asset Sale") of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial +Vehicle Systems LLC ("Bendix"), a member of Knorr Bremse Group. In connection with the Asset Sale, we are entitled to additional consideration in the form of the following performance and +royalty related earn-outs: Bendix was obligated to pay us an amount in cash equal to 85% of revenue associated with royalties received under our license and distribution agreements with Audiovox +Electronics Corporation and Valeo +64 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +3. Sale of Vehicle Sensors (Continued) +Schalter +and Sensoren GmbH through December 31, 2017, subject to certain reductions and limitations set forth in the asset purchase agreement. From the date of the Asset Sale, through +March 31, 2019, we received approximately $2.7 million in connection with royalty-related earn-outs provisions for a total of $18 million in cash received from the Asset Sale. +In +accordance with applicable accounting guidance, we determined that the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a discontinued operation. +For the fiscal years ended March 31, 2019, March 31, 2018, and 2017, we recorded a gain on sale of discontinued operation of approximately $0, $242,000 and $361,000, respectively, net of +tax, related to the earn-out provisions of the asset purchase agreement. +4. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +We +did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2019 or 2018. Our +non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets +such as a purchase transaction, a business combination or an adjustment for impairment. In Fiscal 2019 and Fiscal 2018, Level 3 inputs were used to evaluate the fair value of our goodwill in +our two reporting units that had goodwill balances. In Fiscal 2017, Level 3 inputs were used to evaluate the fair value of our goodwill in our three reporting units. As a result of our +impairment testing, we recorded an adjustment for impairment of approximately $2.2 million in our Agriculture and Weather Analytics reporting unit. No other non-financial assets were measured +at fair value during the fiscal years ended March 31, 2019, March 31, 2018 and March 31, 2017. +65 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +4. Fair Value Measurements (Continued) +The +following tables present the Company's financial assets that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +As of March 31, 2019 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair Value +(In thousands) +Level 1: +Money market funds +$ +3,338 +$ +— +$ +— +$ +3,338 +Subtotal +3,338 +— +— +3,338 +Level 2: +Corporate notes and bonds +1,434 +(1 +) +— +1,433 +US Treasuries +502 +— +— +502 +Subtotal +1,936 +(1 +) +— +1,935 +Total +$ +5,274 +$ +(1 +) +$ +— +$ +5,273 +As of March 31, 2018 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair Value +(In thousands) +Level 1: +Money market funds +$ +666 +$ +— +$ +— +$ +666 +Subtotal +666 +— +— +666 +Level 2: +Commercial paper +1,891 +— +— +1,891 +Corporate notes and bonds +2,008 +(2 +) +— +2,006 +US Treasuries +1,500 +(1 +) +— +1,499 +US Government agencies +2,950 +(1 +) +— +2,949 +Subtotal +8,349 +(4 +) +— +8,345 +Total +$ +9,015 +$ +(4 +) +$ +— +$ +9,011 +66 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +5. Income Taxes +The components of current and deferred federal and state income tax (benefits) provision are as follows: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Loss from continuing operations before income taxes +$ +(7,780 +) +$ +(5,586 +) +$ +(5,231 +) +Current income tax provision: +Federal +— +3 +71 +State +36 +45 +62 +Total current tax provision +36 +48 +133 +Deferred income tax benefit: +Federal +— +(1,849 +) +(166 +) +State +— +(17 +) +(11 +) +Total deferred benefit provision +— +(1,866 +) +(177 +) +Provision (benefit) for income taxes on continuing operations +36 +(1,818 +) +(44 +) +Loss from continuing operations, net of taxes +$ +(7,816 +) +$ +(3,768 +) +$ +(5,187 +) +The +reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Benefit for income taxes at statutory rates +$ +(1,634 +) +$ +(1,720 +) +$ +(1,778 +) +Change in federal tax rate +— +4,134 +— +State income taxes net of federal benefit +(620 +) +(255 +) +(124 +) +Impairment charges +— +— +737 +Tax credits +(343 +) +(567 +) +(125 +) +Compensation charges +199 +(324 +) +29 +Change in valuation allowance +2,385 +(3,153 +) +1,148 +Other +49 +67 +69 +Provision (benefit) for income taxes +$ +36 +$ +(1,818 +) +$ +(44 +) +67 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +5. Income Taxes (Continued) +The +components of deferred tax assets and liabilities are as follows: +March 31, +2019 +2018 +(In thousands) +Deferred tax assets: +Net operating losses +$ +5,335 +$ +2,853 +Capitalized R&D +2,347 +2,734 +Credit carry forwards +2,806 +2,043 +Deferred compensation and payroll +1,655 +1,603 +Bad debt allowance and other reserves +618 +567 +Deferred rent +202 +235 +Property and equipment +139 +844 +Other, net +309 +203 +Total deferred tax assets +13,411 +11,082 +Valuation allowance +(12,250 +) +(9,814 +) +Total deferred tax assets, net of valuation allowance +1,161 +1,268 +Deferred tax liabilities: +Acquired intangibles +(759 +) +(866 +) +Goodwill +(467 +) +(467 +) +Total deferred tax liabilities +(1,226 +) +(1,333 +) +Net deferred tax liabilities +$ +(65 +) +$ +(65 +) +At +March 31, 2019, we had $1.2 million in federal alternative minimum tax credit carryforwards, approximately $629,000 of which were classified as a current income tax +receivable included in the prepaid expenses and other current assets in the accompanying consolidated balance sheet, and approximately $551,000 of which were classified as a noncurrent income tax +receivable included in the other assets in the accompanying consolidated balance sheet as we expect this amount to be refunded over the next three years. We also had $1.8 million in federal +research credits that begin to expire in 2031 and $1.2 million in state tax credits that begin to expire in 2023. We had $17.4 million of federal net operating loss carryforwards at +March 31, 2019 that do not expire as a result of recent tax law changes. We had $5.7 million of federal net operating loss carryforwards at March 31, 2019 that begin to expire in +2022. We also had $8.0 million of state net operating loss carryforwards at March 31, 2019 that begin to expire in 2031. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it +appropriate to maintain valuation allowances of $12.3 million and $9.8 million against our deferred tax assets at March 31, 2019 and 2018, respectively. We will continuously +reassess the appropriateness of maintaining a valuation allowance. +68 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +5. Income Taxes (Continued) +The +Tax Cuts and Jobs Act ("TCJA") was enacted on December 22, 2017 and reduced U.S. corporate income tax rates to 21.0% as of January 1, 2018. The rate change became +effective during Fiscal 2018 resulting in a blended statutory tax rate of 30.8% for Fiscal 2018. As a consequence of the tax legislation, the Company recorded a decrease in its net deferred tax assets +of $4.1 million and a decrease in the valuation allowance maintained against its deferred tax assets of $5.8 million. The estimated impact of the tax legislation was an income tax +benefit of $1.7 million, of which $1.1 million was due to the release of valuation allowance that had been maintained against alternative minimum tax credit carryforwards, which were +made refundable by the tax legislation, and approximately $640,000 was due to the remeasurement of a deferred tax liability related to indefinite-lived assets. +On +December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118") +directing taxpayers to consider the impact of the tax legislation as "provisional" when it does not have the necessary information available, prepared or analyzed (including computations) in +reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, the income tax effects recorded in Fiscal 2018 represented the Company's best estimate based +on its current interpretation of this tax legislation. We completed our accounting for the tax legislation in Fiscal 2019 and did not recognize any material adjustments to the provisional amounts +recorded in Fiscal 2018. +Unrecognized Tax Benefits +As of March 31, 2019 and 2018, our gross unrecognized tax benefits were approximately $687,000 and $586,000, respectively, of which +approximately $580,000 and $461,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are approximately +$609,000 and $513,000, respectively. +We +recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31, 2019 and 2018, we had accrued cumulatively approximately $42,000 and +$43,000, respectively, for the payment of potential interest and penalties. The total amount of interest and penalties recognized in the consolidated statements of operations for the fiscal years +ended March 31, 2019 and 2018 was approximately $1,000 and $3,000, respectively. +A +reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +586 +$ +426 +$ +394 +Increases for tax positions taken in prior years +2 +62 +18 +Decreases for tax positions taken in prior years +— +— +(8 +) +Increases for tax positions taken in the current year +116 +122 +59 +Lapse in statute of limitations +(17 +) +(24 +) +(37 +) +Gross unrecognized tax benefits at March 31 +$ +687 +$ +586 +$ +426 +69 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +5. Income Taxes (Continued) +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve +months. We are subject to taxation in the U.S. and various state tax jurisdictions. We are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2016 or later, and state +and local income tax examination for fiscal tax years ended March 31, 2015 or later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the +future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +6. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural +industries, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company +cannot accurately predict the outcome of any such litigation, the Company is not a party to any legal proceeding, the outcome of which, in management's opinion, individually or in the aggregate, would +have a material effect on the Company's consolidated results of operations, financial position or cash flows. +Operating Leases +In May 2007, we entered into an agreement to lease 52,000 square feet of office space in Santa Ana, California for a term of 88 months. +In September 2007, we relocated our headquarters and principal operations into this space. The monthly lease rate was $102,000 during the first year of the lease and increased each year thereafter, to +$120,000 per month during the last year of the lease. In February 2014, we entered into an amendment to the lease, which reduced our office space by approximately 11,000 square feet and changed the +lease term to 96 months, commencing on April 1, 2014. The monthly lease rate is approximately $76,000 during the first year of the amended term and increases each year thereafter, up to +a maximum of approximately $90,000 during the last year of the term. Additionally, the lease amendment provided for approximately $328,000 in incentives in the form of tenant improvement allowances, +which we recorded as fixed assets and deferred rent in our consolidated balance sheet. The leasehold improvements were capitalized into fixed assets during Fiscal 2015 and will be depreciated over the +estimated useful life of the improvements, or the term of the lease amendment, whichever is shorter. The corresponding deferred rent amount will reduce monthly rent expense over the term of the lease +amendment. On January 23, 2017, we entered into an amendment to the lease, which added approximately 5,980 square feet and will expire after 60 months, commencing on April 1, +2017. The monthly lease rate is approximately $14,000 during the first year of the term and increases each year thereafter, up to a maximum of approximately $16,000 during the last year of the term. +Additionally, the lease amendment provided for approximately $119,000 in incentives in the form of tenant improvement allowances. +70 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +6. Commitments and Contingencies (Continued) +We +have lease commitments for facilities in various locations throughout the U.S., as well as for certain equipment. Future minimum rental payments under these non-cancelable operating +leases at March 31, 2019 were as follows: +Year Ending March 31, +(In thousands) +2020 +$ +2,408 +2021 +2,150 +2022 +1,981 +2023 +548 +2024 +177 +Thereafter +— +$ +7,264 +Rent +expense totaled approximately $1.9 million for Fiscal 2019, and $1.8 million for each of Fiscal 2018 and $1.7 million for Fiscal 2017. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. +The sublease terminated in September 2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated on +July 23, 2013, August 11, 2016 and on August 11, 2018. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with accrued interest payable +annually on the first business day of each calendar year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to Iteris. We have previously +fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of March 31, 2019, approximately $146,000 of the original principal balance was +outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director of Iteris since September 2013, +and one existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +7. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to +issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the +designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. +As of March 31, 2019 and 2018, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +71 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +7. Stockholders' Equity (Continued) +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior +Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between +Iteris and Computershare Trust Company, N.A. ("Computershare"), as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of +Designations, which created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior +participating preferred stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. Effective on September 28, 2018, an +amendment was entered into by and between Iteris and Computershare to accelerate the expiration of the Rights from August 20, 2019 to September 28, 2019, wherein all of the Rights +distributed to the holders of the Company's common stock pursuant to the Rights Agreement expired. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2019: +Number of Shares +(In thousands) +Stock options outstanding +5,035 +Restricted stock units outstanding +112 +Authorized for future issuance under stock incentive plans +2,761 +7,908 +8. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares +of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date +of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common +stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of +our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the +number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment +of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our +stockholders approved an +72 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +8. Employee Benefit Plans (Continued) +amendment +of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December +2016, our stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs, cash incentive +awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of +grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. Stock appreciation rights, +restricted stock, RSUs and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. +We +currently maintain both the 2007 Plan and the 2016 Plan. Of these plans, we may only grant future awards from the 2016 Plan. As of the 2016 Annual Meeting of Stockholders, no future +shares could be granted under the 2007 Plan. As of March 31, 2019, options to purchase approximately 2.3 million shares of common stock, as well as 7,500 RSUs, were outstanding under the +2007 Plan and options to purchase approximately 2.8 million shares of common stock, as well as 104,000 RSUs, were outstanding under the 2016 Plan. +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2019 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2018 +4,124 +$ +3.58 +Granted +1,038 +4.20 +Exercised +(43 +) +2.00 +Forfeited +(76 +) +4.93 +Expired +(8 +) +4.91 +Options outstanding at March 31, 2019 +5,035 +$ +3.70 +7.6 +$ +4,430 +Options exercisable at March 31, 2019 +2,482 +$ +2.92 +6.5 +$ +3,729 +Vested and expected to vest at March 31, 2019 +5,035 +$ +3.70 +7.6 +$ +4,430 +Options exercisable at March 31, 2019 pursuant to a change-in-control +5,035 +$ +3.70 +7.6 +$ +4,430 +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under +the 2007 Plan vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs +granted under the 2016 Plan vest at varying terms +73 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +8. Employee Benefit Plans (Continued) +between +one and four anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the +closing market price of our common stock on the grant date. +A +summary of activity with respect to our RSUs for Fiscal 2019 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2018 +144 +$ +4.72 +Granted +62 +4.21 +Vested +(69 +) +4.83 +Forfeited +(25 +) +3.61 +RSUs outstanding at March 31, 2019 +112 +$ +4.62 +1.1 +19.00 +Expected to vest at March 31, 2019 +112 +$ +4.62 +1.1 +19.00 +Common stock issuable (for RSUs) at March 31, 2019 upon a change-in-control +112 +$ +4.62 +1.1 +19.00 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of +operations: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Cost of revenues +$ +146 +$ +71 +$ +51 +Selling, general and administrative expense +1,804 +1,558 +858 +Research and development expense +206 +152 +67 +Total stock-based compensation +$ +2,156 +$ +1,781 +$ +976 +At +March 31, 2019, there was approximately $4.7 million and $364,000 of unrecognized compensation expense related to unvested stock options and RSUs, respectively. This +expense is currently expected to be recognized over a weighted average period of approximately 2.7 years for stock options and 1.1 years for RSUs. If there are any modifications or +cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based compensation expense +and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +74 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +8. Employee Benefit Plans (Continued) +The +grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2019 +2018 +2017 +Expected life—years +5.9 +6.5 +6.5 +Risk-free interest rate +2.7 +% +2.7 +% +2.2 +% +Expected volatility of common stock +43 +% +43 +% +40 +% +Dividend yield +— +% +— +% +— +% +Expected Life: The Company's expected life represents the weighted-average period that the Company's stock options are expected to be +outstanding. +The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral +patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of +grant for the +expected term of the option. +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the +expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2019 +2018 +2017 +(In thousands, except per +share amounts) +Weighted average grant date fair value per share of options granted +$ +1.89 +$ +2.59 +$ +2.11 +Intrinsic value of options exercised +$ +114 +$ +2,469 +$ +1,061 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No +contributions were made during the fiscal years ended March 31, 2019, 2018 and 2017. +We +sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible associates voluntarily contribute to the plan, up to IRS maximums, through +payroll deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the +401(k) Plan were approximately $1,185,000, $1,067,000, and $881,000 for the Fiscal 2019, Fiscal 2018 and Fiscal 2017, respectively. +75 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +8. Employee Benefit Plans (Continued) +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an Employee Stock Purchase Plan ("ESPP") which allows employees to withhold a percentage +of their base compensation to purchase the Company's common stock at 95% of the lower of the fair market at the beginning of the offering period and on the last trading day of the offering period. +There are two offering periods during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may contribute 1-15% of their eligible gross pay up +to a $25,000 annual stock value limit. During Fiscal 2019, 92,000 shares were purchased. There were no share purchases in Fiscal 2018. The ESPP is considered a non-compensatory plan and accordingly no +compensation expense is recorded in connection with this benefit. +9. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be +repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the +Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For +our fiscal years ended March 31, 2019, 2018, and 2017 we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2019, we +repurchased approximately 3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2019, all +repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2019, approximately $1.7 million remains +available for the repurchase of our common stock under our current program. +76 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +10. Investments +Our investments consisted of the following: +As of March 31, 2019 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated Fair +Value +(In thousands) +Cash and cash equivalents +$ +3,338 +$ +— +$ +— +$ +3,338 +Short term investments +1,936 +(1 +) +— +1,935 +Total +$ +5,274 +$ +(1 +) +$ +— +$ +5,273 +As of March 31, 2018 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated Fair +Value +(In thousands) +Cash and cash equivalents +$ +3,692 +$ +— +$ +— +$ +3,692 +Short term investments +5,323 +(4 +) +— +5,319 +Total +$ +9,015 +$ +(4 +) +$ +— +$ +9,011 +Unrealized +losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than +not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, +2019. +11. Business Segments, Significant Customer and Geographic Information +Business Segments +We currently operate in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadway Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. Our Roadway Sensors +segment also includes the sale of original equipment manufacturer ("OEM") products for the traffic intersection markets, which include, among other things, traffic signal controllers and traffic +signal equipment cabinets. +The +Transportation Systems segment provides engineering and consulting services, performance measurement and traffic analytics solutions, as well as the development of transportation +management +77 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +11. Business Segments, Significant Customer and Geographic Information (Continued) +and +traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, implementation, operation and management of surface transportation infrastructure +systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic +congestion. Our Transportation Systems product line includes: iPeMS, our performance measurement and information management solution as well as our commercial vehicle operations and vehicle safety +compliance platforms known as CVIEW Plus, CheckPoint, UCRLink and inspect. +The +Agriculture and Weather Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. Our ClearPath Weather is a +web-based solution, that includes a suite of tools that applies data assimilation and modeling technologies for assessing historical weather conditions for both short-term and long-range weather +forecasts and customizable route/site weather and pavement forecasting, and providing winter road maintenance recommendations for state agencies, municipalities and for commercial companies that allow +such users to create solutions to meet roadway maintenance decision needs. Our ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve +complex agricultural problems and to increase the efficiency and sustainability of farmlands. We currently offer our ClearAg solutions to companies in the agriculture industry, such as seed and crop +protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. Our ClearAg solutions provide weather, environment, soil and plant growth modeling to +deliver smart content through ClearAg APIs and components, IMFocus APIs and ClearAg web applications. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate general and +administrative expenses, including general overhead functions such as information systems, accounting, human resources, marketing, compliance costs and certain administrative expenses, as well as +interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or +provide services with different processes. All reported segment revenues are derived from external customers. Our Chief Executive Officer, who is our chief operating decision maker ("CODM"), reviews +financial information at the operating segment level. Our CODM does not review assets by segment in his resource allocation, and therefore, assets by segment are not disclosed below. +78 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +11. Business Segments, Significant Customer and Geographic Information (Continued) +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2019, 2018 and 2017 is as follows: +Roadway +Sensors +Transportation +Systems +Agriculture +and Weather +Analytics +Total +(In thousands) +Year Ended March 31, 2019 +Product revenues +$ +43,253 +$ +4,974 +$ +— +$ +48,227 +Service revenues +239 +44,841 +5,816 +50,896 +Total revenues +43,492 +49,815 +5,816 +99,123 +Depreciation +233 +195 +103 +531 +Segment income (loss) +7,011 +5,907 +(5,024 +) +7,894 +Year Ended March 31, 2018 +Product revenues +44,163 +2,301 +— +46,464 +Service revenues +194 +52,180 +4,891 +57,265 +Total revenues +44,357 +54,481 +4,891 +103,729 +Depreciation +221 +204 +109 +534 +Segment income (loss) +8,825 +8,639 +(8,048 +) +9,416 +Year Ended March 31, 2017 +Product revenues +42,059 +1,676 +— +43,735 +Service revenues +111 +47,594 +4,542 +52,247 +Total revenues +42,170 +49,270 +4,542 +95,982 +Depreciation +180 +191 +131 +502 +Loss on impairment of goodwill +— +— +2,168 +2,168 +Segment income (loss) +$ +9,799 +$ +8,482 +$ +(9,557 +) +$ +8,724 +The +following table reconciles total segment income to consolidated income from continuing operations before income taxes: +Year Ended March 31, +2019 +2018 +2017 +(In thousands) +Segment income: +Total income from reportable segments +$ +7,894 +$ +9,416 +$ +8,724 +Unallocated amounts: +Corporate and other expenses +(15,578 +) +(14,930 +) +(13,680 +) +Amortization of intangible assets +(275 +) +(88 +) +(281 +) +Other income (expense), net +50 +(16 +) +(7 +) +Interest income, net +129 +32 +13 +Loss from continuing operations before income taxes +$ +(7,780 +) +$ +(5,586 +) +$ +(5,231 +) +79 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements (Continued) +March 31, 2019 +11. Business Segments, Significant Customer and Geographic Information (Continued) +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance at March 31, 2019 greater than 10% of our total trade accounts +receivable balances as of March 31, 2019. One individual customer who is also a government agency had a receivable balance of 13% of our total trade accounts receivable balance as of +March 31, 2018. No individual customer or government agency had a receivable balance at March 31, 2017 greater than 10% of our total trade accounts receivable balances as of +March 31, 2017. +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended March 31, +2019 +2018 +2017 +Canada +— +% +1 +% +1 +% +Europe +1 +1 +1 +1 +% +2 +% +2 +% +Substantially +all of our long-lived assets are held in the U.S. +12. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross Profit +Net (Loss) +Income +Basic Net +Income (Loss) +per Share +Diluted Net +Income (Loss) +per Share +(In thousands, except per share amounts) +June 30, 2018 +$ +25,475 +$ +10,192 +$ +(1,579 +) +$ +(0.05 +) +$ +(0.05 +) +September 30, 2018 +24,417 +9,661 +(1,341 +) +(0.04 +) +(0.04 +) +December 31, 2018 +23,140 +8,892 +(2,464 +) +(0.07 +) +(0.07 +) +March 31, 2019 +26,091 +9,861 +(2,432 +) +(0.07 +) +(0.07 +) +$ +99,123 +$ +38,606 +$ +(7,816 +) +$ +(0.23) +* +$ +(0.23) +* +June 30, 2017 +$ +27,183 +$ +9,905 +$ +(470 +) +$ +(0.02 +) +$ +(0.02 +) +September 30, 2017 +25,248 +9,968 +(984 +) +(0.03 +) +(0.03 +) +December 31, 2017 +26,025 +9,943 +343 +0.01 +0.01 +March 31, 2018 +25,273 +10,015 +(2,415 +) +(0.07 +) +(0.07 +) +$ +103,729 +$ +39,831 +$ +(3,526 +) +$ +(0.11) +* +$ +(0.11) +* +* Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +80 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable +assurance level as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a +timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely +decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2019 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2019. The +effectiveness of our internal control over financial reporting as of March 31, 2019 has been audited by Deloitte & +81 +Table of Contents +Touche LLP, +an independent registered public accounting firm, as stated in their report, which is included herein. +ITEM 9B. OTHER INFORMATION +None, except as reported in Part III, Item 11. +82 +Table of Contents +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors and Executive Officers +The table and narrative below set forth information as of May 31, 2019 regarding our directors and executive officers, including, with +respect to our directors, the attributes that we believe qualify them to serve as directors. We believe that our directors also have the following additional key attributes that are important to an +effective board of directors: integrity and demonstrated high ethical standards; sound judgment; analytical skills; the ability to engage management and each other in a constructive and collaborative +fashion; diversity of experience and thought; and the commitment to devote significant time and energy to service on our Board of Directors (the "Board") and its committees. +Name +Age +Current Position(s) with Iteris +J. Joseph ("Joe") Bergera +55 +Chief Executive Officer, President and Director +Kevin C. Daly, Ph.D.(2)(3)(4) +74 +Director +Scott E. Deeter(1)(2) +55 +Director +Gerard M. Mooney(1)(3)(4) +65 +Director +Laura L. Siegal +56 +Director +Thomas L. Thomas(2)(4)(5) +70 +Chairman of the Board +Mikel H. Williams(1)(3) +62 +Director +Andrew Schmidt +57 +Chief Financial Officer, Vice President of Finance and Secretary +Joseph Boissy +55 +Chief Marketing Officer +James Chambers +52 +Senior Vice President and General Manager, Agriculture and Weather Analytics +Todd Kreter +59 +Senior Vice President and General Manager, Roadway Sensors +Ramin Massoumi +46 +Senior Vice President and General Manager, Transportation Systems +(1) Member +of the Audit Committee +(2) Member +of the Compensation Committee +(3) Member +of the Nominating and Corporate Governance Committee +(4) Member +of the Finance and Strategy Committee +(5) Our +Bylaws provide that our Chairman of the Board is also an ex-officio member of each of our Board committees. +Joe Bergera has served as our President and Chief Executive Officer and as a director since September 2015. Prior to joining us, +Mr. Bergera served as Group Vice President, Software of Roper Technologies, Inc. (formerly, Roper Industries) since September 2011 and as President of iTradeNetwork, a Roper subsidiary, +since August 2013. He was the Executive Vice President and General Manager, Tax Solutions at CCH Wolters Kluwer from March 2011 to September 2011 and served in senior executive positions with Sage +Software from 2004 to March 2011, most recently as Executive Vice President, Global CRM. Mr. Bergera holds a B.A. degree in Government from Colby College, an M.B.A. from the Booth School of +Business at the University of Chicago and an A.M. in Public Policy from the Harris School of Public Policy at the University of Chicago. Mr. Bergera has over 25 years of +experience in technology-related companies and provides extensive management and global software and service industry knowledge to the Board. +83 +Table of Contents +Kevin C. Daly, Ph.D. served as our interim Chief Executive Officer from February 2015 to September 2015. Prior to his service as our +interim CEO, Dr. Daly served as the CEO of Maxxess Systems, Inc., a provider of electronic security systems, from November 2005. Between August 2007 and August 2009, Dr. Daly also +served as CEO of iStor Networks, Inc., a manufacturer of IP SAN storage systems. Prior to that, he served as the CEO of several technology companies, including Avamar Technologies, Inc. +and ATL Products, Inc. Dr. Daly served on the board of directors of sTec, Inc., a provider of solid state disk systems, from May 2010 until the acquisition of the company in +September 2013 by Western Digital Corporation. Dr. Daly received a B.S. degree in Electrical Engineering from the University of Notre Dame and M.S., M.A. and Ph.D. degrees in Engineering from +Princeton University. He has served as a director of Iteris since 1993. Having served as the CEO of several technology companies and as a director of both private and public companies, Dr. Daly +offers to the Board a wealth of management and leadership experience, as well as an understanding of issues faced by such companies. +Scott E. Deeter has served as a director since February 23, 2017. Mr. Deeter has served as Ventria Bioscience Inc.'s +President and CEO and as a director since 2002. Ventria is the first company to commercialize recombinant proteins derived from a plant-based manufacturing system. From 1999 to 2001, he served as +President and CEO and as a director of CyberCrop.com Incorporated, a supply chain software company connecting producers with their markets to optimize quality, logistics and efficiency. From 1996 to +1998, Mr. Deeter served as Vice President of Agriculture of Koch Industries, Inc. Previously, Mr. Deeter held various positions at Cargill, Incorporated as well as started and led +a joint venture between Cargill and F. Hoffmann-La Roche, Ltd. that commercialized pharmaceutical intermediates and functional food ingredients. Earlier in his career, Mr. Deeter was a +member of the Technology and Life Sciences Group of Salomon Brothers Inc. He received a BSc degree in Economics from the University of Kansas; an M.B.A. from the University of Chicago; and an +MSc degree in Economics from the London School of Economics. Mr. Deeter is a proven leader who is widely known across entrepreneurial sectors of the agribusiness and agricultural biotech +industry. +Gerard M. Mooney retired from International Business Machines Corporation ("IBM") in March 2014, after serving in a number of senior +positions since 2000. Most recently, he served as the Vice President Strategy for IBM's Public Sector from February 2012 until his retirement, as the General Manager, Global Smarter Cities for IBM +from November 2011 to February 2012, and as the General Manager, Global Government and Education for IBM from 2008 to November 2011. He served as Vice President of IBM's Venture Capital Group from +2000 to 2008. Before joining IBM, Mr. Mooney held various management positions at Hewlett-Packard Company for six years. Mr. Mooney has extensive operational and financial experience +across a broad range of technology-based companies, from start-ups to large public companies, and has considerable experience with the major customers in the professional transportation market. He +previously served as a member of the board of directors of the Intelligent Transportation Society of America and is also active in the intelligent search technology, cognitive intelligence, AI, data +mining and visualization tools industries. Mr. Mooney currently serves as a director of inno360 and cofounder of Swarm Intelligence LLC formerly theinnovationexchange, which offers SaaS +cognitive platforms. He received a B.A. degree in Philosophy from Mount Saint Mary's College, an M.S. degree in Accounting from Georgetown University and an M.B.A. from Yale +University. Mr. Mooney has served as a director of Iteris since September 2013 and brings to the Board extensive experience in setting and implementing strategy for both large and small +technology organizations, deep category knowledge of the intelligent transportation market, and familiarity with many key customers for intelligent transportation solutions. +Laura L. Siegal has served as a director since May 15, 2018. Ms. Siegal has been the Chief Financial Officer and a member of +the board of directors at Natel Engineering Company, Inc. dba NEO Technology Solutions, a manufacturer of products in the industrial, medical, and aerospace and defense markets, since July +2013. Prior to that, Ms. Siegal served in various financial positions with +84 +Table of Contents +Kratos +Defense & Security Solutions, Inc. ("Kratos") formerly Wireless Facilities Inc. since 2000, most recently as its Principal Accounting Officer, Vice President and Corporate +Controller from April 2006 to July 2013. Kratos is a publicly-traded leading technology, intellectual property, proprietary product and system solution company which provides engineering, information +technology and other technical services to government agencies. Throughout her career, she has held a variety of financial management positions in technology and consulting companies including +Controller of MEC Analytical Systems. Ms. Siegal is a Certified Public Accountant and received a B.A. degree in Economics from the University of California, San Diego. Ms. Siegal's +extensive experience in technology and public agency markets, financial expertise, and demonstrated success with mergers and acquisitions provide important resources in her service on our Board. +Thomas L. Thomas is the managing partner of T2 Partners, a private management consulting and investment business which he founded in +January 2011. In addition, Mr. Thomas served as the Executive Chairman and CEO of International Decision Systems, a provider of software and solutions for the equipment finance market, from +September 2009 to January 2011. From 2004 to July 2008, Mr. Thomas was the President and Chief Operating Officer of Global Exchange Services, a provider of business to business EDI and supply +chain management solutions. Prior to that, Mr. Thomas served as the President and CEO at several software, analytics and technology companies, including HAHT Commerce, Ajuba Solutions, and +Vantive Corporation, and as the first Chief Information Officer for Dell Computer Corporation and 3Com Corporation. Earlier in his career, Mr. Thomas also held various senior executive +management positions at Kraft General Foods, Sara Lee Corporation and W. R. Grace. Since July 2017, Mr. Thomas has served as Chairman of the Board of Directors of VIP Software +Corporation, a provider of software solutions in the insurance industry. Since 2012, Mr. Thomas has served as a director of Accurate Group, which specializes in the appraisal and title services +business where technology has been instrumental in redefining the transaction model for the industry. He has also served on the board of directors of infoGroup, Inc. from January 2009 to July +2010, and served as a director on the boards of a wide range of technology companies, including ATL Products, Vantive Corporation, Interwoven, iManage, FrontRange Solutions, IDS International, and +Quofore International. Mr. Thomas has served as a director of Iteris since 1999 and as our Chairman of the Board of Directors since 2016. Mr. Thomas offers to our Board valuable +business, leadership and strategic insights obtained through his service as an executive and as a member of the board of +directors in a variety of industries and businesses, including a number of leading technology companies, and his experience in working with companies through several stages of their development. +Mikel H. Williams has served as the Chief Executive Officer and a director of Targus Cayman Holdco Limited, a leading global supplier that +designs, develops and sells products for the mobile worker, including laptop cases, docking stations and accessories for mobile electronic devices, since February 2016. Prior to that, +Mr. Williams served as the Chief Executive Officer and a director of JPS Industries, Inc., a manufacturer of sheet and mechanically formed glass and aramid substrate materials for the +electronics, aerospace, ballistics and general industrial applications, from May 2013 until its sale in July 2015. Mr. Williams was the President, Chief Executive Officer and a director of DDi +Corp., a leading provider of time-critical, technologically advanced electronics manufacturing services, from November 2005 to May 2012 and a Senior Vice President and Chief Financial Officer of DDi +from November 2004 to October 2005. DDi was sold in May of 2012. He has also served in various management positions with several companies in the technology and professional services related +industries. Mr. Williams began his career with PricewaterhouseCoopers as a certified public accountant in the State of Maryland. Mr. Williams also serves as Chairman of the board of +directors of Centrus Energy Corp. (formerly USEC Inc.). He was added to USEC's board of directors in October 2013 on the recommendation of certain holders of USEC's convertible senior notes as +USEC was considering a bankruptcy restructuring, which was successfully initiated and completed in 2014. Since October 2015, Mr. Williams also serves on the board of directors of B. Riley +Financial, Inc. He previously served on the boards of Lightbridge Communications Corporation until it was sold in January 2015, and +85 +Table of Contents +Tellabs, Inc. +until it was sold in December 2013. Mr. Williams received his B.S. degree in Accounting from the University of Maryland and an M.B.A. from the University of Georgetown. +Mr. Williams has served as a director of Iteris since April 2011 and provides the Board with operational and public company experience and valuable strategic insights through his many years of +leadership positions in technology-related companies with international operations, as well as valuable knowledge and insights in finance and financial reporting matters. +Andrew Schmidt has served as our Vice President of Finance, Chief Financial Officer and Secretary since March 2015. Prior to joining us, +Mr. Schmidt served as the Chief Financial Officer and Corporate Secretary of Smith Micro Software, Inc., a publicly-held provider of wireless and mobility software solutions from 2005 to +May 2014. Prior to joining Smith Micro, Mr. Schmidt held CFO roles for several other public companies, including Genius Products, an entertainment company, and Mad Catz Interactive, a provider +of console video game accessories. He also served as Vice President (Finance) of Peregrine Systems, a publicly-held provider of enterprise level software. Mr. Schmidt holds a B.B.A. degree in +Finance from the University of Texas and an M.S. degree in Accountancy from San Diego State University. +Joseph Boissy has served as our Chief Marketing Officer since January 2017. Prior to that, Mr. Boissy served as Chief Marketing +Officer of Vendavo, Inc. (acquired by Francisco Partners in October 2014), a provider of margin and profit optimization solutions, from September 2013 to November 2016. Prior to that, he served +as the Chief Marketing Officer at 3VR Inc., a video intelligence solutions provider, from October 2011 to September 2013. From February 2002 to October 2011, he served in various management +positions at ILOG, Inc. (acquired by IBM in July 2008), a provider of business rule management systems, most recently as Vice President ILOG Worldwide Marketing, then Program Director, +Go-to-Market Strategy and Industry Marketing IBM WebSphere. Mr. Boissy was Vice President Program Management, Credient at SunGard Trading & Risk Systems Inc., a provider of +financial software solutions and services, from 2000 to 2002, and from 1997 to 2000, he served in management positions in product development, support and product management, most recently as the Vice +President Product Marketing, with Infinity Financial Technology, Inc., a financial trading and risk management software solutions provider that was acquired by SunGard in October 1997. Prior to +Infinity, Mr. Boissy was Director Product Development at Diagram Financial Software, Inc. (now part of Thomson Reuters) from 1993 to 1997. Mr. Boissy holds a B.S. degree in +Electrical Engineering from the Lebanese University (Lebanon) and a M.S. degree in Computer Science and Data Analytics from the University of Paris XI (France). +James Chambers has served as our Senior Vice President and General Manager, Agriculture and Weather Analytics since August 2017. Prior to +that, Mr. Chambers served as Chief Executive Officer of Observant, Inc. (acquired by Jain Irrigation, Inc. in February 2017), a provider of agricultural in-field hardware and +cloud based applications for precision farm water management, from February 2016 to February 2017. From June 2013 to February 2016, he served as Director of Marketing at Bayer CropScience, a company +specialized in agriculture, and lifesciences. Prior to that, Mr. Chambers served in various key management positions at divisions of Deere & Company, including John Deere Water (acquired +by FIMI Opportunity Funds in June 2014), a provider of integrated Ag water management solutions, most recently as Director of Global Product Management and Marketing and then as the Director of Global +Technology Solutions, from August 2010 to May 2013, and John Deere Agri Services, Inc. (acquired by Constellation Software, Inc. in January 2011), a provider of software solutions for +the agricultural supply chain, most recently as the General Manager for the Specialty Crop Business Unit and then as the Director of Marketing, from June 2006 to August 2010. From January 2003 to June +2006, he was Global Business Manager at Valent BioSciences Corporation, a provider of technologies and products for the agricultural, public health, forestry and household markets, and from March 2001 +to January 2003, he was Director of Global Sales and Marketing with AgraQuest (acquired by Bayer CropScience in July 2012), a supplier of biological pest management +86 +Table of Contents +solutions. +From 1989 to 2001, Mr. Chambers served in various management positions at Monsanto Company, a provider of agriculture products for farmers, most recently as Business Development +Manager and Financial Analyst, then as Marketing Manager Animal Productivity and Market and Sales Manager. Mr. Chambers holds a B.S. degree in Agriculture Business Management and Economics from +The Ohio State University. +Todd Kreter has served as our Senior Vice President and General Manager, Roadway Sensors since May 2014. Mr. Kreter served as our +Senior Vice President, Sensors Development and Operations from May 2009 to May 2014 and as Vice President of Engineering from November 2007 to May 2009. Prior to joining us, Mr. Kreter served +in a number of executive positions at Quantum Corporation, most recently as the VP Global Services from 2004 to January 2007, where he managed the company's worldwide customer service organization. +Mr. Kreter holds a B.S. degree in Mechanical Engineering from California State University, Fullerton. +Ramin Massoumi has served as our Senior Vice President and General Manager, Transportation Systems since March 2015. Mr. Massoumi +joined Iteris in 1998 and served in a number of executive and managerial positions prior to the promotion to his current position, most recently as our Vice President of Business Development from June +2011 to March 2015. Throughout his career, his focus has been in the application of advanced technologies in the traffic management market, and has led projects throughout the United States and the +Middle East. Mr. Massoumi also serves as a lecturer of upper division courses on transportation engineering, ITS and multi-modal operation at University of California at Irvine. +Mr. Massoumi holds a B.S. degree in Civil Engineering from the University of California Irvine, an M.S. degree in Engineering from the University of California, Berkeley, and an M.B.A. from the +University of Southern California. +Family Relationships +There are no family relationships among any of our directors or executive officers. +Code of Ethics and Business Conduct +Our Board has adopted a Code of Ethics and Business Conduct ("Code of Ethics"), which applies to all directors, officers (including our +principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions) and employees. The full text of our Code of Ethics is +available under the "Corporate Governance" heading on the Investor Relations section of our website at www.iteris.com. We will also provide an electronic or paper copy of the Code of Ethics, free of +charge, upon request made to our corporate secretary. If any substantive amendments are made to our Code of Ethics, or if any waiver (including any implicit waiver) of any provision of the Code of +Ethics is granted that is required to be disclosed under the rules of the SEC, such amendment or waiver will be disclosed at the same location on our website, or, if required, in a current report on +Form 8-K. +Audit Committee +The current members of our Audit Committee are Messrs. Deeter, Mooney and Williams. The Board has determined that each member of the +Audit Committee is "independent" under the standards established by The Nasdaq Stock Market ("Nasdaq") and the SEC rules regarding audit committee memberships. The Board has identified +Mr. Williams as the member of the Audit Committee who qualifies as an "audit committee financial expert" under applicable SEC rules and regulations governing the composition of the Audit +Committee. +87 +Table of Contents +Changes in Nominating Procedures +There have been no material changes to the procedures by which security holders may recommend nominees to our Board that were implemented since +we last disclosed such procedures. +ITEM 11. EXECUTIVE COMPENSATION +COMPENSATION OF DIRECTORS +Compensation of directors is determined by the Compensation Committee. The Compensation Committee has approved a compensation structure for +non-employee directors consisting of a cash retainer, an annual equity award and, for Board members serving on a committee, an additional cash retainer. Directors who are our employees are not +compensated for their services as directors. +Board and Committee Retainers +For Fiscal 2019, annual cash compensation for non-employee directors was as follows: +Position +Annual Retainer +Chairman of the Board +$ +65,000 +Non-Employee Director (other than the Chairman) +$ +35,000 +Additional +retainers for each non-employee director who served on one or more Board committees in Fiscal 2019 were as follows: +Position +Annual Retainer +Audit Committee +Chair +$ +12,000 +Member +$ +6,000 +Compensation Committee +Chair +$ +9,000 +Member +$ +4,500 +Nominating and Corporate Governance Committee +Chair +$ +4,000 +Member +$ +2,000 +Finance and Strategy Committee +Chair +$ +9,000 +Member +$ +4,500 +All +directors are reimbursed for their out-of-pocket expenses incurred in attending meetings of our Board and its committees, but they do not receive separate meeting fees. +Annual Equity Compensation +Non-employee directors are also eligible to receive periodic restricted stock units ("RSUs") under the Company's equity incentive plan then in +effect. Each non-employee director shall be granted an annual RSU upon approval of the grant by the Compensation Committee as soon as reasonably practicable following the annual meeting of +stockholders at which such director is re-elected. The annual RSU grant to directors shall be worth approximately $40,000 based on the closing price of the Company's common stock on the RSU grant +date. Each RSU entitles the holder to receive shares of the Company's common stock upon vesting of those units. Each annual RSU generally vests in full upon the director's completion of one year of +service measured from the date of the grant; however, it is expected that future annual RSU grants will vest in full on the annual stockholder meeting date to which the RSU relates. If a non-employee +director joins the Board in between annual stockholder +88 +Table of Contents +meetings, +such director would receive an RSU for a pro rata portion of the annual grant, which typically vests in full one year following the grant date. +2019 Director Compensation Table +The following table sets forth a summary of the compensation earned in Fiscal 2019 by each person who served as a non-employee director during +that year: +Name +Fees Earned +or Paid in +Cash ($)(1) +Restricted +Stock Units +($)(2) +Total ($) +Kevin C. Daly, Ph.D. +$ +50,500 +39,998 +90,498 +Scott E. Deeter +45,500 +39,998 +85,498 +Gerard M. Mooney +42,250 +39,998 +82,248 +Laura L. Siegal(3) +30,722 +39,998 +70,720 +Thomas L. Thomas +78,500 +39,998 +118,498 +Mikel H. Williams +49,000 +39,998 +88,998 +(1) Represents +amounts earned by the directors based on the arrangement described above, which amounts have been prorated for directors who served on such committees for +less than a full term. +(2) The +dollar amounts shown represent the grant date fair value of restricted stock unit awards granted in Fiscal 2019 determined in accordance with ASC 718. For each +director, the number of units was determined by dividing $40,000 by $4.16, the closing sales price of the Company's common stock on the grant date. At the end of Fiscal 2019, the above-listed +directors held options for the following number of shares of common stock: Kevin C. Daly—60,000; Gerard M. Mooney—40,000; and Mikel H. Williams—60,000. At +the end of Fiscal 2019, the above listed directors held RSUs for the following number of shares of common stock: Kevin C. Daly—9,615; Scott E. Deeter—9,615; Laura L. +Siegal—9,615; Gerard M. Mooney—9,615; Thomas L. Thomas—9,615; and Mikel H. Williams—9,615. +(3) Ms. Siegal +did not join the Board until May 2018, and accordingly, earned pro-rated Board fees in Fiscal 2019. +Director Stock Ownership Guidelines +Pursuant to stock ownership guidelines adopted by the Board in February 2016 with a five-year phase-in period, members of the Board of Directors +are required to own shares of Company common stock having a value equal to or greater than three times their annual cash board retainer, which is currently set at $35,000 per year. Unexercised stock +options do not count toward fulfillment of this ownership requirement. Each director will have until the later of (i) February 2021 and (ii) five years from the time he or she is elected +to the Board, to meet the stock ownership guidelines. +Compensation Committee Interlocks and Insider Participation +None of our executive officers serves as a member of the board of directors or compensation committee (or other committee performing equivalent +functions) of any entity that has one or more executive officers serving on our Board or Compensation Committee. No interlocking relationship exists between any member of the board of directors and +any member of the compensation committee (or other committee performing equivalent functions) of any other company. Kevin C. Daly, Ph.D., a member of our Compensation Committee, previously +served as our interim Chief Executive Officer from February 2015 to September 2015. +89 +Table of Contents +EXECUTIVE COMPENSATION SUMMARY +The following is a summary of the compensation policies, plans and arrangements for our executive officers. This summary should be read in +conjunction with the Summary Compensation Table and related disclosure set forth below. We are eligible to, and have chosen to, comply with the executive compensation disclosure rules applicable to a +"smaller reporting company," as defined in the applicable SEC rules. This section discusses the principles underlying our compensation policies for our executive officers who are named in the "Summary +Compensation Table" below, who we refer to as our "named executive officers" or "NEOs" for Fiscal 2019 and who include the following executive officers: +• Joe Bergera, our Chief Executive Officer, President and Director; +• Andrew Schmidt, our Chief Financial Officer, Vice President of Finance and Secretary; and +• James Chambers, our Senior Vice President and General Manager, Agriculture and Weather Analytics. +Compensation Philosophy and Objectives +Our executive compensation plans and arrangements are overseen and administered by our Compensation Committee, which is comprised entirely of +independent directors as determined in accordance with applicable NASDAQ and SEC rules. The Compensation Committee operates under a written charter adopted and reviewed annually by our Board. A copy +of this charter is available on our website under our investor relations page on our website at www.Iteris.com under the heading "Corporate Governance." Our philosophy is to provide our named +executive officers with compensation that will motivate and retain them, provide them with meaningful incentives to achieve and exceed short-term and long-term corporate objectives set by our +Compensation Committee, and align their long-term interests with those of our shareholders. Based on this philosophy, the compensation programs for our named executive officers are designed to achieve +the following primary objectives: +• establish a compensation structure that is competitive enough to attract, retain and motivate outstanding executive talent; +• ensure that any cash incentive compensation programs for our named executive officers are aligned with our corporate strategies and business +objectives by tying the potential payouts under such programs to the achievement of key strategic, financial and operational goals; and +• utilize long-term equity awards to align interests between our named executive officers and stockholders. +Impact of 2016 Say-on-Pay Vote +The most recent stockholder advisory vote on executive officer compensation required under the federal securities laws was held on +December 15, 2016. Approximately 81.5% of the total votes cast on such proposal (which excluded broker non-votes) were in favor of the compensation of the named executive officers, as that +compensation was disclosed in the various compensation tables and narrative that appeared in the Company's proxy statement dated November 21, 2016. Based on that high level of stockholder +approval, the Compensation Committee decided not to make any material changes to the Company's compensation philosophies, policies and practices for the Fiscal 2019 compensation of the named executive +officers. Based on the voting preference of the Company's stockholders, advisory votes on executive officer compensation will be conducted every three years. Accordingly, the next advisory vote will +be conducted at the 2019 Annual Meeting of Stockholders. The Compensation Committee will continue to take into account each such advisory vote in order to determine whether any subsequent changes to +the Company's executive compensation programs and policies would be warranted to reflect any stockholder concerns reflected in those advisory votes. +90 +Table of Contents +Annual Review of Cash and Equity Compensation +We conduct an annual review of the aggregate level of our executive compensation, as well as the mix of elements used to compensate our +executive officers to ensure that compensation is structured appropriately to achieve our objectives. We review each component of compensation as related but distinct. Although the Compensation +Committee reviews total compensation, it has not adopted any formal guidelines for allocating total compensation between cash and equity compensation. We determine the appropriate level of each +compensation component based in part, but not exclusively, on our retention goals and short-term and long-term objectives. +This +review generally occurs in the first quarter of each fiscal year at which time the Compensation Committee establishes executive officer base salaries for the following fiscal year, +reviews and approves any bonus awards and programs, establishes the performance objectives for our cash based bonus plan, and may grant of equity compensation to the executive officers to ensure their +interests are aligned with our stockholders and for retention. [In Fiscal 2019, the Compensation Committee engaged and retained the services of an independent compensation consulting firm, +Frederic W. Cook & Co., Inc. ("FWC"), to assist in the review of its executive compensation with respect to our Chief +Executive Officer and our Chief Financial Officer. This consultant provided the Compensation Committee with market data and analysis of our total direct compensation for such executive officer +positions as compared with the competitive market. FWC reports only to the Compensation Committee and has not performed any other work for the Company since being retained as an independent consultant +to the Compensation Committee. As provided in its charter, the Compensation Committee has the authority to determine the scope of FWC's services and may terminate their engagement at any +time.] +In +setting executive compensation, the Compensation Committee takes into account a number of factors, including the nature and scope of the named executive officer's responsibilities, +his or her individual performance level and contribution to the achievement of our corporate objectives, the experience level of the executive, the recommendations of our Chief Executive Officer for +each individual's compensation package (other than his own) and the compensation trends in the industry. +As +part of the review process, our Chief Executive Officer provides our Compensation Committee with recommendations as to the base salary, cash bonus potential and long-term equity +incentive award for each of our executive officers other than himself based on that officer's level of responsibility, individual performance and contribution to the attainment of our strategic +corporate objectives and market data. Our Compensation Committee takes the Chief Executive Officer's recommendations into consideration in setting named executive officer compensation, but retains +complete discretionary authority to make all compensation-related decisions for our named executive officers. Our Compensation Committee makes its compensation decisions with respect to the Chief +Executive Officer on the basis of relevant market data furnished by a variety of sources and its subjective assessment of individual performance and contributions to our overall corporate performance. +Any decisions regarding our Chief Executive Officer's compensation are made without such officer present. +Compensation Components and Structure +We utilize three main components in structuring compensation programs for our named executive +officers: +• Base salary, which is the only fixed compensation element in the executive compensation program and is primarily used to recruit and retain +executive talent and provide an element of economic security from year to year; +• Performance-based cash bonuses that are primarily designed to reward achievement of financial and operational goals; and +91 +Table of Contents +• Equity incentive awards designed to ensure long-term retention of our executive talent and align their interests with those of our +stockholders. +We +view each component of compensation as related but distinct. It is the practice of our Compensation Committee to allocate a substantial portion of each named executive officer's total +compensation to performance and long-term incentive compensation as a result of the philosophy described above. While the Compensation Committee does establish specific performance criteria for its +cash-based bonus plan each year, there is no formal pre-established policy for the allocation of compensation between cash and non-cash components or between short-term and long-term components, and +there are no pre-established ratios between the compensation of our Chief Executive Officer and that of the other named executive officers. Instead, our Compensation Committee determines the +compensation of each named executive officer annually based on its review of the market data, its subjective analysis of that individual's performance and contribution to our financial performance and +the other factors identified in the "Annual Review of Cash and Equity Compensation" section above to determine the appropriate level and balance of total compensation. We believe that this approach +allows us to tailor compensation for each named executive officer to attract, retain and motivate that executive officer within the parameters of our compensation philosophy. +Base Salaries. Base salaries are set at levels that are intended to recognize the experience, skills, knowledge and +responsibilities required of all +our named executive officers. Each named executive officer's base salary level is typically reviewed on an annual basis and adjustments may be made to the individual's base salary on the basis of his +or her level of performance, the overall performance of the Company and the various compensation trends in our industry. +In +July 2018, the Compensation Committee reviewed the base salaries of the named executive officers and established the base salaries for Fiscal 2019 for such officers as is set forth +below. +Named Executive Officer +Fiscal 2019 +Annual Base +Salary +Joe Bergera +$ +416,000 +Andrew Schmidt +362,500 +James Chambers +283,750 +Fiscal 2019 Cash-Based Bonus Plan ("2019 Bonus Plan"). Our named executive officers are eligible to receive an annual cash-based +bonus under our 2019 +Bonus Plan. Each year, our Compensation Committee establishes the performance objectives to be attained and the target bonuses payable based on the level of attainment of the specified goals, which +generally include the Company's revenues and operating income for the fiscal year, the revenues and contribution margin of such officer's business unit, and personal objectives set for each officer +("MBOs"). We define "contribution margin" as the business unit's operating income without corporate expense allocations. Corporate operating income and the operating income of each business unit is +calculated on a non-GAAP basis to exclude amortization, depreciation, stock-based compensation, goodwill impairment charge, if any, and such other non-cash items that the Compensation Committee, in +its sole discretion, believes are not directly indicative of the performance of the Company and the business units. +92 +Table of Contents +The +corporate and business unit performance targets and the actual achievement of such objectives for Fiscal 2019 were as follows (dollars in thousands): +Performance Components +No Bonuses +At or Below +Target +Maximum +Actual +% +Attained +Corporate Revenue +$ +85,899 +$ +107,374 +$ +123,881 +$ +99,123 +92.3 +% +Corporate Operating Income +(200 +) +— +(201 +) +(3,575 +) +(100 +) +Roadway Sensors Revenue +41,235 +51,544 +61,853 +43,492 +84.4 +Roadway Sensors Contribution Margin +8,774 +10,968 +13,162 +7,157 +65.3 +Transportation Systems Revenue +43,585 +54,481 +65,377 +49,815 +91.4 +Transportation Systems Contribution Margin +6,390 +7,987 +9,584 +5,907 +74.0 +Agriculture and Weather Analytics Revenue +4,736 +5,920 +7,104 +5,816 +98.2 +Agriculture and Weather Analytics Contribution Margin +(8,008 +) +(6,673 +) +(5,338 +) +(5,024 +) +132.8 +If +our performance for Fiscal 2019 exceeded the Company and business unit performance targets set for bonus purposes, the NEOs could have earned an additional bonus of up to 50% of the +target bonus award that was not based upon achieving individual objectives. The full 50% additional bonus would have been earned by the NEOs if the Company had achieved the performance goals set forth +under the "Maximum" column above. If the Company had achieved performance that was less than the goals set forth under the "Maximum" column but more than the amounts set forth under the "Target" +column, the additional bonus payable would have been proportional, or based on the level of the Maximum goal achieved when measured from the Target amount. For example, if the performance had exceeded +the Target goal by 25% of the difference between the Maximum and Target amounts, then 25% of the 50% additional bonus relating to such performance goal would have been payable. +The +Compensation Committee typically meets during near the end of the first fiscal quarter of each year to evaluate each NEO's achievement of their respective MBOs and annual bonuses are +typically paid out as soon as practicable thereafter. +The +performance objectives, target bonus and actual bonus for each of our named executive officers for Fiscal 2019 were as follows: +Named Executive Officer +Performance +Objectives +Allocation +(%) +2019 +Target +Bonus ($) +2019 Actual +Bonus ($) +% of +Target +Awarded +(%) +Joe Bergera +$ +312,000 +$ +137,280 +44 +% +Corporate Revenue +40 +Corporate Operating Income +40 +MBOs +20 +Andrew Schmidt +163,125 +71,775 +44 +Corporate Revenue +40 +Corporate Operating Income +40 +MBOs +20 +James Chambers +156,063 +131,890 +85 +Agriculture and Weather Analytics Revenue +30 +Agriculture and Weather Analytics Contribution Margin +20 +Corporate Revenue +15 +Corporate Operating Income +15 +MBOs +20 +93 +Table of Contents +See "Fiscal 2019 Grant of Plan-Based Awards" below for additional information on Fiscal 2019 cash bonuses. +Equity Compensation. Our equity award program is the primary vehicle for offering long-term incentives to our named executive +officers and providing +an inducement for long-term retention. Our equity component also aligns the interests of our named executive officers with those of our stockholders and focuses their attention on the creation of +stockholder value in the form of stock price appreciation. The Compensation Committee uses both stock options and restricted stock units as part of the Company's long-term incentive program for named +executive officers, and the relative allocation of such instruments may vary from time to time. The Company believes that there are several advantages of using restricted stock units including ongoing +concerns over the dilutive effect of option grants on the Company's outstanding shares, the Company's desire to have a more direct correlation between the compensation expense it must record for +financial accounting purposes and the actual value delivered to executive officers, and the fact that the incentive and retention value of a restricted stock unit award is less affected by market +volatility than stock options. We believe that the equity-based compensation provides our named executive officers with a direct interest in our long-term performance and creates +an ownership culture that establishes a mutuality of interests between our named executive officers and our stockholders. +Typically, +the Compensation Committee provides grant guidelines to our Chief Executive Officer, who in turn will make recommendations back to the Compensation Committee regarding the +number of options to be granted to our executive officers. See "Fiscal 2019 Grant of Plan-Based Awards" below for the Fiscal 2019 awards. +Summary Compensation Table +The following table shows information regarding the compensation earned for the fiscal years ended March 31, 2019, 2018 and 2017 by +(i) our Chief Executive Officer, and (ii) our two other most highly compensated executive officers (other than our Chief Executive Officer) who were serving as executive officers as of +March 31, 2019. The officers listed below are collectively referred to as the "named executive officers" or "NEOs" in this proxy statement: +Name and Principal Position +Fiscal +Year +Salary +Bonus +Stock +Awards(1) +Non-Equity +Incentive Plan +Compensation(2) +All Other +Compensation(3) +Total +Joe Bergera +2019 +$ +412,894 +$ +— +$ +421,425 +$ +137,280 +$ +17,118 +$ +988,716 +Chief Executive Officer +2018 +396,648 +— +649,328 +180,000 +8,848 +1,234,825 +and President +2017 +399,816 +— +328,362 +354,000 +(4) +3,594 +1,085,772 +Andrew Schmidt +2019 +358,670 +— +159,205 +71,775 +12,792 +602,442 +Chief Financial Officer, +2018 +346,138 +15,000 +(4) +259,731 +94,035 +8,683 +723,587 +Vice President of Finance +2017 +346,790 +— +164,181 +161,970 +8,118 +681,059 +and Secretary +James Chambers +2019 +282,399 +— +188,085 +131,890 +10,385 +612,759 +Senior Vice President +2018 +195,322 +(5) +— +322,425 +65,541 +5,616 +589,004 +and General Manager, Agriculture and Weather Analytics +(1) The +dollar amounts shown represent the grant date fair value of stock options granted during the applicable fiscal year determined pursuant to the +Black-Scholes-Merton option pricing formula. For a discussion of valuation assumptions used in the calculations, see Note 8 of Notes to Consolidated Financial Statements, included in +Part II, Item 8 of this report. See also our discussion of stock-based compensation under "Management's Discussion and Analysis of Financial Condition and Results of +Operations—Critical Accounting Policies and Estimates" in Part II, Item 7 of this report. The options have an exercise price equal +94 +Table of Contents +to +the closing sales price of our common stock as of the grant date and vest in equal annual installments over four years and are not exercisable until vested. +(2) The +amounts shown in this column constitute the cash bonuses paid to each named executive officer based on the attainment of certain pre-established management's +objectives. These awards are discussed in further detail under "Fiscal 2019 Cash-Based Bonus Plan" below. +(3) Except +as otherwise noted, represents 401(k) plan employer contributions paid by us. +(4) Represents +a discretionary cash bonus. +(5) Mr. Chambers +was hired in August 2017 at an annual salary of $275,000. The Fiscal 2018 salary represents the amount earned by Mr. Chambers from his +hire date through the end Fiscal 2018. +Fiscal 2019 Grant of Plan-Based Awards +The table below sets forth information with respect to awards granted to the named executive officers under our annual non-equity incentive +compensation plan and our 2016 Omnibus Incentive Plan in Fiscal 2019, which constitute all of the plan-based awards granted to our named executive officers in Fiscal 2019. +Estimated Possible Payouts +Under Non-Equity +Incentive Plan Awards +Number of +Securities +Underlying +Options or +Stock Units +(#) +Grant Date +Fair Value +of +Awards +($)(2) +Name +Grant +Date +Threshold +($) +Target +($)(1) +Maximum +($)(1) +Awards +($/share) +Joe Bergera +12/10/2018 +$ +— +$ +312,000 +$ +468,000 +225,000 +$ +4.16 +$ +421,405 +Andrew Schmidt +12/10/2018 +— +163,125 +244,688 +85,000 +4.16 +159,197 +James Chambers +12/10/2018 +— +156,063 +234,095 +70,000 +4.16 +131,104 +6/11/2018 +25,000 +4.85 +56,987 +(1) Reflects +the amount payable upon achievement of the management objectives described under the heading "Fiscal 2019 Cash-Based Bonus Plan" above. +(2) The +dollar amounts shown represent the grant date fair value of stock options granted during the applicable fiscal year determined pursuant to the +Black-Scholes-Merton option pricing formula. For a discussion of valuation assumptions used in the calculations, see Note 8 of Notes to Consolidated Financial Statements, included in +Part II, Item 8 of this report. See also our discussion of stock-based compensation under "Management's Discussion and Analysis of Financial Condition and Results of +Operations—Critical Accounting Policies and Estimates" in Part II, Item 7 of this report. +95 +Table of Contents +Outstanding Equity Awards at 2019 Fiscal Year End +The following table sets forth the outstanding equity awards held by each named executive officer as of March 31, 2019. None of the NEOs +held outstanding RSUs at the end of Fiscal 2019. +Option Awards(1) +Name +Number of +Securities +Underlying +Outstanding +Options (#) +Exercisable +Number of +Securities +Underlying +Outstanding +Options (#) +Unexercisable +Option +Exercise +Price ($) +Option +Grant +Date +Option +Expiration +Date +Joe Bergera +1,012,500 +337,500 +$ +2.38 +09/23/15 +09/22/25 +Chief Executive Officer, President and +75,000 +75,000 +4.91 +03/03/17 +03/02/27 +Director +62,500 +187,500 +5.52 +02/16/18 +02/15/28 +— +225,000 +4.16 +12/10/18 +12/09/28 +Andrew Schmidt +100,000 +— +1.79 +03/16/15 +03/15/25 +Chief Financial Officer, Vice President of +56,250 +18,750 +2.37 +11/02/15 +11/01/25 +Finance and Secretary +37,500 +37,500 +4.91 +03/03/17 +03/02/27 +25,000 +75,000 +5.52 +02/16/18 +02/15/28 +— +85,000 +4.16 +12/10/18 +12/09/28 +James Chambers +25,000 +75,000 +5.90 +08/17/17 +08/16/27 +Senior Vice President and General +6,250 +25,000 +5.52 +02/16/18 +02/15/28 +Manager, Agriculture and Weather +— +25,000 +4.85 +06/11/18 +06/10/28 +Analytics +— +70,000 +4.16 +12/10/18 +12/09/28 +(1) All +options vest in four equal annual installments following the date of grant. The vesting of equity awards held by the named executive officers is subject to each +officers continued service with the Company, and is subject to acceleration under certain circumstances as discussed under the heading "Employment Agreements; Termination of Employment and Change in +Control Arrangements" below. +Fiscal 2019 Option Exercises and Stock Vesting Table +No options were exercised by the NEOs and no stock awards issued with a vesting period vested during Fiscal 2019. +Employment Contracts; Termination of Employment and Change of Control Arrangements +We do not currently have any employment contracts or change in control arrangements in effect with any of our named executive officers other +than the agreements described below. We provide incentives such as salary, benefits, option grants and RSUs to attract and retain executive officers and other key associates. The plan administrator of +the 2007 Omnibus Incentive Plan and 2016 Omnibus Incentive Plan has the discretion to determine whether outstanding equity awards held by our NEOs are to vest upon a qualifying termination of +employment following certain changes in control of the Company, or upon such change in control, but we do not provide for any automatic "single trigger" acceleration of equity awards upon a change in +control (other than the option grant received by Dr. Daly in connection with his service as a non-employee director). Other than as noted in this section, there is no agreement or policy which +would automatically entitle any named executive officer to severance payments or any other compensation as a result of such officer's termination. +96 +Table of Contents +Joe Bergera +In connection with his hiring, we entered into an employment agreement with Joe Bergera, our Chief Executive Officer, dated September 8, +2015, pursuant to which Mr. Bergera will receive an annual base salary of $385,000, which may be increased from time to time at the discretion of the Compensation Committee. Mr. Bergera +will also be eligible to participate in our executive bonus plan as then in effect and his potential bonus for each year will be established annually by the Board or a committee of the Board, provided +that the bonus potential for Fiscal 2016 was $300,000, of which $150,000 was a signing bonus payable on January 31, 2016 provided that Mr. Bergera was employed by +the Company as of such date. The agreement is for an initial term of three years and will renew for successive one year periods until September 2025 unless either we or Mr. Bergera provide +written notice of non-renewal at least 30 days prior to the end of the initial term or renewal term, as applicable. +Pursuant +to the agreement, Mr. Bergera also received an option grant under our 2007 Omnibus Incentive Plan to purchase up to 1,350,000 shares of our common stock (the "Option"). +The Option vests in equal annual installments over four years and has an exercise price equal to the closing sales price of our common stock on the date of grant of the Option. +If +during the initial term of the agreement or any renewal term, Mr. Bergera's employment with the Company is terminated without Cause (as such term is defined in the agreement), +Mr. Bergera will be entitled to receive (i) salary continuation payments for 12 months following his termination, (ii) a lump sum payment equal to the pro-rated portion of +his target bonus established by the Compensation Committee for the fiscal year in which his employment is terminated and (iii) reimbursement for the cost of COBRA coverage for a period of up to +12 months following the termination. If Mr. Bergera is terminated without Cause or resigns for Good Reason within 12 months following a Change in Control (as such terms are +defined in the agreement) (such termination or resignation, a "CIC Termination"), Mr. Bergera will be entitled to receive (i) a lump sum payment equal to 125% of his base salary as then +in effect, (ii) a lump sum payment equal to the pro-rated portion of his target bonus established by the Compensation Committee for the fiscal year in which the CIC Termination occurs, +(iii) reimbursement for the cost of COBRA coverage for a period of up to 12 months following the CIC Termination, and (iv) acceleration of the vesting of the Option. In addition, +upon termination of his employment due to death, Mr. Bergera's estate or beneficiaries will be entitled to receive salary continuation payments in the aggregate equal to 50% of his then current +base salary. +Andrew Schmidt +We entered into an employment agreement dated March 9, 2015 with Andrew Schmidt, our Chief Financial Officer, in connection with his +hiring. Pursuant to the agreement, Mr. Schmidt will receive an annual base salary of $325,000, which may be increased from time to time at the discretion of the Board or the Compensation +Committee. He will also be eligible to participate in our executive bonus plan as then in effect and his potential bonus for each year will be established annually by the Board or the Compensation +Committee, provided that the bonus potential for Fiscal 2016 was to be $125,000. The agreement will have an initial term of two years and will renew for successive one year periods until March 2025 +unless either the Company or Mr. Schmidt provides written notice of non-renewal at least 30 days prior to the end of the initial term or renewal term, as applicable. The agreement was +amended on June 12, 2017 and provides that if Mr. Schmidt's employment with the Company is terminated without Cause or in connection with a Change of Control (as such terms are defined +in the agreement), Mr. Schmidt will be entitled to salary continuation payments for twelve months following his termination of his annual base salary as then in effect. In addition, +Mr. Schmidt will be entitled to receive reimbursement for the cost of COBRA coverage for a period of up to twelve months following such termination. +97 +Table of Contents +James Chambers +We entered into a retention incentive agreement and retention bonus agreement, both effective June 4, 2019, with James Chambers, our +Senior Vice President and General Manager, Agriculture and Weather Analytics. Pursuant to the retention bonus agreement, Mr. Chambers will receive a one-time cash award of $426,000 on +June 4, 2021, if Mr. Chambers is still employed by us. The payment of the cash bonus will accelerate if Mr. Chambers' employment is terminated without cause or by +Mr. Chambers for good reason, as those terms are defined in the retention bonus agreement. In addition, pursuant to the retention incentive agreement, if we achieve certain strategic business +goals while he remains employed by us, Mr. Chambers will receive a cash award equal to 0.9 times his base salary or 1.5 times his base salary. +Iteris, Inc. Amended and Restated Executive Severance Plan +The Iteris, Inc. Executive Severance Plan (the "Severance Plan") was adopted on February 5, 2018 and amended and restated +effective on June 4, 2019 (the "Severance Plan"). Each individual employed by the Company or its subsidiary, who is an officer subject to Section 16 of the Securities Exchange Act of +1934, as amended, and who is not otherwise covered by an employment agreement that includes severance terms, is eligible to receive severance payments under the Severance Plan upon certain qualifying +terminations of employment (the "Eligible Employees"). Eligible Employees for the purposes of the Severance Plan is limited to a select group of management or highly compensated employees within the +meaning of the Employee Retirement Income Security Act of 1974, as amended. +The +Severance Plan provides Eligible Employees with severance payments in the event that an Eligible Employee's employment with the Company or its subsidiaries is terminated either +(a) by the Company without Cause not in connection with a Change of Control ("Non-CIC Qualifying Termination") or (b) if in connection with or within 12 months following a Change +of Control, which, for Eligible Employees employed by that business, includes a divestiture of a material business, by the Eligible Employee for Good Reason (as such terms are defined in the Severance +Plan) or by the Company without Cause (a "CIC Qualifying Termination"). +Non-CIC Qualifying Termination. Upon a Non-CIC Qualifying Termination, an Eligible Employee will be eligible to receive the +following: +• A cash payment equal to the Eligible Employee's annual base salary, payable in substantially equal installment payments over the one-year +period following termination, in accordance with the Company's normal payroll practices; and +• Reimbursement for the Eligible Employee's monthly COBRA premiums for the 12-month period following termination or until the Eligible Employee +receives substantially similar medical coverage from another employer. +CIC Qualifying Termination. Upon a CIC Qualifying Termination, an Eligible Employee will be eligible to receive the +following: +• A cash payment equal to the Eligible Employee's annual base salary, payable in a lump sum on the next payroll date after the 61st day +following termination; and +• Reimbursement for the Eligible Employee's monthly COBRA premiums for the 12-month period following, or until the Eligible Employee receives +substantially similar medical coverage from another employer. +The +severance payments are subject to the Eligible Employee's execution of a severance agreement within 60 days following termination that includes a release of claims and certain +non-solicitation, confidentiality, and non-disparagement restrictions. +98 +Table of Contents +The +Company may amend or terminate the Severance Plan at any time by providing at least 90 days' advance written notice to each participant, provided that no such amendment or +termination that has the effect of reducing or diminishing the right of any participant will be effective unless one year's advance written notice is provided to participants, and such amendment or +termination will not be effective if a Change of Control occurs during the one-year notice period. +Indemnification of Directors and Officers +Under Section 145 of the Delaware General Corporation Law, we can indemnify our directors and officers against liabilities they may incur +in such capacities, including liabilities under the Securities Act. Our certificate of incorporation and bylaws provide that we will indemnify our directors and officers to the fullest extent +permitted by law, and our bylaws require us to advance litigation expenses upon receipt of an undertaking by the director or officer. If it is ultimately determined that the director or officer is not +entitled to indemnification, the director or officer is required to repay such advances. The bylaws further provide that rights conferred under such bylaws do not exclude any other right such persons +may have or acquire under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise. +Our +certificate of incorporation provides that, pursuant to Delaware law, our directors shall not be liable for monetary damages for breach of the directors' fiduciary duty of care to us +and our stockholders. This provision in the certificate of incorporation does not eliminate the duty of care, and in appropriate circumstances equitable remedies such as injunctive or other forms of +non-monetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director's duty of loyalty to us or our +stockholders, for acts or omissions not in good faith or involving intentional misconduct or knowing violations of law, for actions leading to improper personal benefit to the director, and for +payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director's responsibilities under any other law, such as +the federal securities laws or state or federal environmental laws. +We +have entered into agreements to indemnify certain of our directors and officers in addition to the indemnification provided for in the certificate of incorporation and bylaws. These +agreements, among other things, indemnify such directors and officers for certain expenses (including attorneys' fees), judgments, fines and settlement amounts incurred by such person in any action or +proceeding, including any action by or in the right of the Company, on account of services as a director or officer of Iteris, or +as a director or officer of any other company or enterprise to which the person provides services at our request. +Compensation Committee Report +The Compensation Committee has reviewed and discussed with management the discussion and analysis of the compensation of our named executive +officers as disclosed in this Annual Report under the heading "Compensation Discussion and Analysis." Based on this review and discussion, the Compensation Committee has recommended to the Board that +the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the fiscal year ended March 31, 2019. +Kevin Daly, Ph.D. +Scott E. Deeter +Thomas L. Thomas ( Chairman ) +99 +Table of Contents +Compensation Risk Assessment +The Compensation Committee has evaluated our compensation programs and policies as generally applicable to our employees to ascertain any +potential material risks that may be created by the compensation programs. The Compensation Committee concluded that our compensation policies and practices, taken as a whole, are not reasonably +likely to have a material adverse impact on our business or our financial condition. The following compensation design features help minimize the incentives for excessive +risk-taking: +• Our base pay programs consist of generally competitive salary rates that represent a reasonable portion of total compensation and provide a +reliable level of income on a regular basis, which decreases incentive on the part of our executives to take unnecessary or imprudent risks; +• A portion of each executive's incentive compensation opportunity is tied to long-term incentive compensation that emphasizes sustained +performance over time. This reduces any incentive to take risks that might increase short-term compensation at the expense of longer term results; and +• Annual equity awards have multi-year vesting which aligns the long-term interests of our executives with those of our stockholders and, again, +discourages the taking of short-term risk at the expense of long-term performance. +• Each officer has multiple performance objectives, some of which relate to the Company as a whole, which is more difficult for an officer to +manipulate. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +Principal Stockholders and Common Stock Ownership of Certain Beneficial Owners and Management +The following table sets forth, as of May 31, 2019, the number and percentage ownership of our common stock by (i) all persons +known to us to beneficially own more than 5% of the outstanding common stock, (ii) each of the named executive officers, (iii) each of our directors, and (iv) all of our executive +officers and directors as a group. To our knowledge, except as otherwise indicated, each of +100 +Table of Contents +the +persons named in this table has sole voting and investment power with respect to the common stock shown as beneficially owned, subject to community property and similar laws, where applicable. +Common Stock +Name and Address of Beneficial Owner(1) +Amount and +Nature of +Beneficial +Ownership(2) +Percent of +Class(2) +BlackRock, Inc.(3) +1,956,032 +5.9 +% +Joe Bergera(4) +1,150,000 +3.3 +Andrew Schmidt(5) +218,750 +* +James Chambers(6) +31,250 +* +Todd Kreter(7) +146,111 +* +Ramin Massoumi(8) +125,425 +* +Joseph Boissy(9) +56,250 +* +Kevin C. Daly, Ph.D.(10) +497,166 +1.5 +Scott E. Deeter +12,394 +* +Gerard M. Mooney(11) +53,934 +* +Laura L. Siegal +4,180 +* +Thomas L. Thomas(12) +137,934 +* +Mikel H. Williams(13) +83,934 +* +All executive officers and directors as a group (12 persons)(13) +2,517,328 +7.2 +* Less +than 1%. +(1) The +address of each of the directors and officers is 1700 Carnegie Avenue, Suite 100, Santa Ana, CA 92705. +(2) Based +on 33,388,696 shares of common stock outstanding as of May 31, 2019. Shares of common stock subject to options or warrants which are exercisable within +60 days of May 31, 2019 are deemed to be beneficially owned by the person holding such options or warrants for the purpose of computing the percentage of ownership of such person but are +not treated as outstanding for the purpose of computing the percentage of any other person. Other than as described in the preceding sentence, shares issuable upon exercise of outstanding options and +warrants are not deemed to be outstanding for purposes of this calculation. In addition to the shares held in the individual's name, the number of shares indicated also includes shares held for the +benefit of the named person under our 401(k) plan. +(3) Pursuant +to a Schedule 13G filed on February 4, 2019 with the SEC, BlackRock, Inc. reported that through the following subsidiaries, it has sole +dispositive and voting power with respect to 1,956,032 shares: BlackRock Advisors, LLC, BlackRock Fund Advisors; BlackRock Institutional Trust Company, National Association; BlackRock Financial +Management, Inc. and BlackRock Investment Management, LLC. The address for BlackRock Inc. is 55 East 52nd Street, New York, NY 10005. +(4) Consists +of 1,150,500 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after May 31, +2019. +(5) Consists +of 218,750 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after May 31, +2019. +(6) Consists +of 31,250 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after May 31, +2019. +101 +Table of Contents +(7) Consists +of (i) 33,303 shares held directly, (ii) 308 shares held by Mr. Kreter's IRA and (iii) 112,500 shares issuable upon exercise of +options that are currently exercisable or will become exercisable within 60 days after May 31, 2019. +(8) Consists +of (i) 31,624 shares held by the Massoumi Family Trust; (ii) 2,551 shares held by Mr. Massoumi's IRA and (iii) 91,250 shares +issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after May 31, 2019. +(9) Consists +of 56,250 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after May 31, +2019. +(10) Consists +of (i) 420,165 shares held by the Daly Family Trust, of which Dr. Daly is a trustee, (ii) 10,788 shares held directly by +Dr. Daly, (iii) 6,113 shares held by Dr. Daly's IRA, (iv) 100 shares held by Dr. Daly's spouse; and (v) 60,000 shares issuable upon exercise of options that +are currently exercisable or will become exercisable within 60 days after May 31, 2019. +(11) Consists +of (i) 13,934 shares held directly by Mr. Mooney and (ii) 40,000 shares issuable upon exercise of options that are currently +exercisable or will become exercisable within 60 days after May 31, 2019. +(12) Consists +of (i) 20,788 shares held directly by Mr. Thomas and (ii) 117,146 shares held by Mr. Thomas's Trust. +(13) Consists +of (i) 10,000 shares held by Mr. Williams' IRA; (ii) 8,146 shares held by Mr. Williams' family trust, (iii) 5,788 shares +held directly by Mr. Williams and (iv) 60,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after +May 31, 2019. +(13) Includes +1,820,000 shares issuable upon exercise of options held by the executive officers and directors as a group that are currently exercisable or will become +exercisable within 60 days after May 31, 2019. +102 +Table of Contents +Equity Compensation Plans +The following table provides information as of March 31, 2019 with respect to shares of our common stock that may be issued under +existing equity compensation plans. +Plan Category +Number of +Securities to be +Issued Upon +Exercise of +Outstanding +Options +Weighted +Average +Exercise +Price of +Outstanding +Options +Number of +Securities +Remaining Available +for Future Issuance +under Equity +Compensation Plans +(excluding some +securities reflected +in first column) +Equity Compensation Plans Approved by Security Holders +2007 Omnibus Incentive Plan +2,268,750 +(1) +$ +2.22 +(2) +— +2016 Omnibus Incentive Plan +2,877,842 +(3) +$ +4.90 +(4) +2,761,082 +Equity Compensation Plans Not Approved by Security Holders +None +Total +5,146,592(1 +)(3) +$ +3.70 +(5) +2,761,082 +(1) Includes +7,500 shares of our common stock subject to RSUs that entitle each holder to one share of common stock for each such unit that vests over the holder's +period of continued service. +(2) Calculated +without taking into account the 7,500 shares of common stock subject to outstanding RSUs that become issuable as those units vest, without the payment of +any additional consideration or exercise price. +(3) Includes +104,342 shares of our common stock subject to RSUs that entitle each holder to one share of common stock for each such unit that vests over the holder's +period of continued service. +(4) Calculated +without taking into account the 104,342 shares of common stock subject to outstanding RSUs that become issuable as those units vest, without the payment +of any additional consideration or exercise price. +(5) Calculated +without taking into account the 111,842 shares of common stock subject to outstanding RSUs that become issuable as those units vest, without the payment +of any additional consideration or exercise price. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Certain Transactions +Since April 1, 2015, other than the agreements and transactions described in "Item 11. Executive Compensation" and the +transactions described below, there has not been, nor is there any proposed transaction, where we (or any of our subsidiaries) were or will be a party in which the amount involved exceeded or will +exceed the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two fiscal years and in which any director, director nominee, executive officer, holder of more +than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest. +We +previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. The sublease terminated in September +2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, +103 +Table of Contents +which +was subsequently amended and restated on July 23, 2013 and on August 11, 2016. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with +accrued interest payable annually on the first business day of each calendar year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to +Iteris. We have previously fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of March 31, 2019, approximately $146,000 of the +original principal balance was outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director +of Iteris since September 2013, and one existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +Director Independence +The Board of Directors has determined that Ms. Siegal and each of Messrs. Daly, Deeter, Mooney, Thomas and Williams satisfies the +requirements for "independence" using the +standards established by Nasdaq, except that Dr. Daly did not qualify as an independent director while he was serving as our interim Chief Executive Officer from February 2015 to September +2015. +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +Principal Accountant Fees +Deloitte & Touche LLP ("Deloitte") has been our principal independent accounting firm since October 2015. The table below reflects +the aggregate fees billed by Deloitte in Fiscal 2019 and Fiscal 2018 for the following services: +Year Ended March 31, +Fee Category +2019 +2018 +Audit fees +$ +914,000 +$ +916,000 +Audit related fees +30,000 +190,000 +Tax fees +— +— +All other fees +— +— +Total fees +$ +944,000 +$ +1,106,000 +Audit Fees. Audit fees consist of fees billed for professional services rendered in connection with the audit of our annual +consolidated financial +statements for the applicable fiscal year and review of our consolidated financial statements included in our quarterly reports on Form 10-Q, Form 10-K and other regulatory filings for +such fiscal year. +Audit Related Fees. Audit related fees consist of fees billed for assurance and related services that are reasonably related to the +performance of +the audit or review of our consolidated financial statements but are not reporting under "Audit Fees." Audit related fees for Fiscal 2019 were related to the adoption of ASC 842. Audit related fees +billed for Fiscal 2018 were related to the review our registration statements on Form S-3 and Form S-8 as well as fees related to the adoption of ASC 606. +Tax Fees. Tax fees consist of fees billed for professional services for tax compliance, tax advice and tax planning. There were no tax +fees billed by +Deloitte for Fiscal 2019 or Fiscal 2018. +All Other Fees. There were no fees were billed by Deloitte in Fiscal 2019 or Fiscal 2018 for any other services. +104 +Table of Contents +Audit Committee Pre-Approval Policies and Procedures +All engagements for services by Deloitte or other independent registered public accountants are subject to prior approval by the Audit +Committee; however, de minimis, non-audit services may instead be approved in accordance with applicable SEC rules. The prior approval of the Audit Committee was obtained for all services provided by +Deloitte for Fiscal 2019 and Fiscal 2018. +The +Audit Committee reviewed and discussed the services, in addition to the auditor services, rendered by Deloitte during Fiscal 2019, as well as the fees paid for such services, and has +determined that the provision of such other services by Deloitte, and the fees paid for such services, were compatible with maintaining Deloitte's independence. +105 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. +Our +consolidated financial statements are listed in the "Index to Consolidated Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All +financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our consolidated financial statements or +the notes thereto. +3. Exhibits. +The +following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit +Number +Description +Reference +3.1 +Restated Certificate of Incorporation of the registrant as filed with the Delaware Secretary of State on October 12, +2018 +Exhibit 3.1 to the registrant's Current Report on Form 8-K as filed with the SEC on October 15, 2018 +3.2 +Restated Bylaws of the registrant, as amended through August 6, 2018 +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q as filed with the SEC on August 7, 2018 +4.1 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +10.1 +Form of Indemnity Agreement entered into by the registrant and certain of its officers and directors +Exhibit 19.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 +10.2 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and +directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the +successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, +Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +106 +Table of Contents +Exhibit +Number +Description +Reference +10.5 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway +Acquisitions, LLC) and Iteris, Inc. +Filed herewith +10.6 +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Filed herewith +10.7 +* +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.8 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.9 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.10 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.11 +* +Amended and Restated 2016 Omnibus Incentive Plan +Exhibit 99.1 to registrant's Registration Statement on Form S-8 (File No. 333-228210) as filed with the SEC on November 6, 2018. +10.12 +* +Form of Restricted Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.13 +* +Form of Form of Notice of Grant of Stock Option and form of Stock Option Agreement for use with 2016 Omnibus Incentive +Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.14 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor +of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +10.15 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, +Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +10.16 +* +Employment Agreement dated March 9, 2015 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on March 15, 2015 +107 +Table of Contents +Exhibit +Number +Description +Reference +10.17 +* +Amendment 1 to Employment Agreement dated June 12, 2017 between Iteris, Inc. and Andrew Schmidt +Exhibit 10.33 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2016 as filed with the SEC on June 13, 2017. +10.18 +* +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.19 +Separation Agreement and General Release dated March 29, 2018 between Iteris, Inc. and Thomas N. +Blair +Exhibit 99.1 to Amendment No. 1 to the registrant's Current Report on Form 8-K as filed with the SEC on April 5, 2018 +10.20 +* +Iteris, Inc. Amended and Restated Executive Severance Plan +Filed herewith +10.21 +* +Retention Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Filed herewith. +10.22 +* +Incentive Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Filed herewith. +23 +Consent of Independent Registered Public Accounting Firm, dated June 6, 2019 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS +XBRL Instance Document +Filed herewith +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +108 +Table of Contents +Exhibit +Number +Description +Reference +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +109 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to +be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 6, 2019 +ITERIS, INC. +(Registrant) +By +/s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Andrew C. Schmidt, and each +of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and +all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said +attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all +intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause +to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ JOE BERGERA +Joe Bergera +Director, President and Chief Executive Officer (principal executive officer) +June 6, 2019 +/s/ ANDREW C. SCHMIDT +Andrew C. Schmidt +Chief Financial Officer (principal financial and accounting officer) +June 6, 2019 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Chairman of the Board +June 6, 2019 +/s/ LAURA L. SIEGAL +Laura L. Siegal +Director +June 6, 2019 +110 +Table of Contents +Signature +Title +Date +/s/ KEVIN C. DALY, PH.D +Kevin C. Daly, Ph.D +Director +June 6, 2019 +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 6, 2019 +/s/ SCOTT E. DEETER +Scott E. Deeter +Director +June 6, 2019 +/s/ MIKEL WILLIAMS +Mikel Williams +Director +June 6, 2019 +111 \ No newline at end of file diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/filing_metadata.csv b/raw/filings/0000350868/2018/0001047469-19-003522/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..fab90bbb31325e58d0146a4e0403e0bd930f4395 --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2019-06-06,2019-03-31,2019-06-06T20:38:40.000Z,0001047469-19-003522,a2238952z10-k.htm,10-K,14075356,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746919003522/a2238952z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746919003522/,2018,2018,1 diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/item1.txt b/raw/filings/0000350868/2018/0001047469-19-003522/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a8a2ea524507c0ee9ffdf190b54f0ea674bbe2b --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/item1.txt @@ -0,0 +1,254 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiary, ClearAg, Inc., in this report as "Iteris," the "Company," +"we," "our," and "us") is a provider of essential applied informatics that enable smart transportation and digital agriculture. Municipalities, government agencies, crop science companies, agriculture +service providers and other agribusinesses use our solutions to make roads safer and travel more efficient, as well as farmlands more sustainable, healthy and productive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products, software-as-a-service ("SaaS") offerings and weather +forecasting systems offer a comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +In +the digital agriculture market, we have combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and +analytic solutions that provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment +manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel and the lands we +farm. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market, while supporting the agriculture market with our smart content and digital agriculture platform, and always exploring strategic alternatives intended to optimize +the value of all of our businesses. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, +California 92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or +incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on +Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is +electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +ClearAg, Inc. +In April 2017, Iteris, Inc. formed a wholly-owned subsidiary, ClearAg, Inc., a Delaware corporation, to provide ClearAg solutions +to the agriculture markets. +Products and Services +We currently operate in three reporting segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Transportation Systems segment provides traffic engineering and consulting services, as well as +4 +Table of Contents +performance +measurement, traffic analytics, traveler information and commercial vehicle operating software solutions. The Agriculture and Weather Analytics segment includes ClearPath Weather, our road +maintenance applications, and ClearAg, our digital agriculture platform. +See +Note 11 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on our reporting segments. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage +Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +5 +Table of Contents +In +select territories, we also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic +signal controllers and traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services focused on the planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. +The +Transportations Systems segment also includes our performance measurement and management solutions, Iteris Signal Performance Measures (SPM) and iPeMS—a state-of-the-art +information management software suite that provides prescriptive data insights to help determine current and future traffic patterns, permitting the effective performance analysis and management of +traffic infrastructure resources. iPeMS utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance +analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify +potential areas of improvement. iPeMS is also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +We +recently launched our comprehensive signal performance measures solution offering, Iteris SPM, a cloud-based application that provides proactive operations and signal maintenance with +business process outsourcing and managed services. This offering is expected to be priced on a per intersection per month basis. +This +segment also includes our advanced traveler information system solutions, as well as our commercial vehicle operations and vehicle safety compliance platforms, known as +"CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." These platforms support state-based commercial vehicle operations by storing and distributing intrastate and interstate commercial vehicle +information for local, state and federal agencies' roadside and enforcement operations. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding +mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We +believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, +our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the +allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Agriculture and Weather Analytics +Our Agriculture and Weather Analytics segment, which we formed during the first quarter of our fiscal year ended March 31, 2013, consists +of our ClearPath Weather and ClearAg solutions. +Our +ClearPath Weather is a web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess weather conditions for customizable +route/site weather +6 +Table of Contents +and +pavement forecasting, and render winter road maintenance recommendations for state agencies, municipalities and commercial companies to improve roadway maintenance decisions. +Our +ClearPath Weather business is a market leader in performance management solutions for state organizations. We intend to use our strong brand and deep experience in the traffic +management market, as well as our market-specific intellectual property, to expand our leadership in data aggregation and analytics in this market. +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For our ClearAg solutions, we developed additional scientific and agronomic models and forecasts, expanded our computing +infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +Our +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to increase the efficiency and +sustainability of farmlands. The ClearAg Platform delivers validation tools for ag inputs, irrigation, field readiness, and harvest solutions giving growers, researchers and other agribusinesses +access to a comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as +other information on crop growth. Companies use the ClearAg Platform to simulate field conditions and determine how new products may perform on a crop given certain weather and soil conditions. +Growers and agribusinesses leverage the ClearAg Platform to determine the best times to plant, spray, fertilize, irrigate, and harvest crops. +Currently, +we offer our ClearAg solutions on a subscription basis, with customers consuming ClearAg through our visualization component application programming interfaces ("APIs"). These +APIs facilitate the integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. We commenced commercial sales of the ClearAg solutions +and related APIs in the first quarter of our fiscal year ended March 31, 2015 ("Fiscal 2015"). +We +expect market acceptance of our ClearAg solutions to continue to increase in upcoming quarters. We plan to continue to fund the investments in our ClearAg solutions, through cash flow +generated from our Roadway Sensors and Transportation Systems operations, revenues from our Agriculture and Weather Analytics segment, and our available cash on hand, as needed. We may also elect to +raise additional equity for these investments. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct +channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our fiscal +year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when +needed. When +7 +Table of Contents +appropriate, +we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and our ClearPath Weather services primarily to government agencies pursuant to negotiated contracts that involve +competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the +option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to +serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price +negotiations. +Currently, +we market and sell our ClearAg solutions on a subscription basis, under a SaaS license, to seed and crop protection companies, agriculture equipment manufacturers, irrigation +solution providers, allied providers and other agriculture service providers. Due to the recent consolidation of certain large companies in the agriculture market, sales to such companies typically +involve long lead times. Although we sell directly to all of our customers, some of these customers include ClearAg into their solutions which are ultimately used by growers. +We +have a small dedicated software solutions sales team that serves as an overlay to our regionally aligned customer management team. +We +have historically had a diverse customer base. For the fiscal year ended March 31, 2019 ("Fiscal 2019") and Fiscal 2018, one individual customer represented greater than 10% of +our total revenues. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris Manufacturing, MoboTrex, Inc. and Sony Electronics, Inc. Our manufacturing activities are conducted in +approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to +control inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production +facility is currently ISO 9001 certified. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2019, Fiscal 2018 and the fiscal year ended March 31, 2017 ("Fiscal 2017"). We believe customer support is a key competitive +factor for our company. +Our +ClearAg solutions are primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provide full-time support and customer +service for such ClearAg solutions. +8 +Table of Contents +Backlog +Our total backlog of unfulfilled firm orders was approximately $55.4 million as of March 31, 2019, which included +$44.5 million related to Transportation Systems, $6.2 million related to Roadway Sensors, and $4.7 million related to Agriculture and Weather Analytics. Typically, we recognize +approximately 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and currently expect that trend to continue for the near future. Substantially the +entire backlog for Roadway Sensors and Agriculture and Weather Analytics as of March 31, 2019 is expected to be recognized as revenue in the fiscal year ending March 31, 2020 ("Fiscal +2020"). At March 31, 2018, we had backlog of approximately $47.5 million, which included $37.7 million related to Transportation Systems, $5.6 million related to Roadway +Sensors and $4.2 million related to Agriculture and Weather Analytics. The increase in backlog in the current fiscal year was largely due to increased sales and marketing efforts in our +Transportation Systems segment during the current fiscal year. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Grand +Forks, North Dakota and Oakland, California. Our research and development costs and expenses were approximately $7.8 million for Fiscal 2019, $7.9 million for Fiscal 2018, and +$6.9 million for Fiscal 2017. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Agriculture and Weather +Analytics and Roadway Sensors segments, in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of our ClearAg and ClearPath +Weather solutions, and our Iteris SPM, iPeMS, and commercial vehicle operations software offerings. In addition, we intend to continue to invest in further enhancements and functionality in our +Vantage products family. We believe that developing new and enhanced product offerings across our segments and enhancing, refining and marketing our existing products are key components for strong +organic growth and profitability. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The +markets in which our Agriculture and Weather Analytics segment operates vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we compete with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. In the commercial sector, we compete with a variety of entities that currently provide weather-related data to that +market, such as IBM/The Weather Company and DTN. +9 +Table of Contents +In the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems such +as Econolite, and manufacturers and distributors of other non-intrusive detection devices, including microwave, infrared, radar, ultrasonic and magnetic detectors, as well as manufacturers and +installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as +Velocity and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +The +markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our +competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and +international engineering services firms. Our competitors in the software business line, which includes performance measurement and management, advance traveler information systems, and our commercial +vehicle operations and vehicle safety compliance platforms include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and +software corporations. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 53 issued U.S. patents, including: +(i) 10 relating to our Roadway Sensors technologies, two of which was issued in Fiscal 2019, (ii) 36 relating to our Agriculture and Weather Analytics technologies, ten of which were +issued in Fiscal 2019, and (iii) 7 relating to our Transportation Systems technologies, one of which was issued in Fiscal 2019. We have a total of 14 pending patent applications in the U.S. and +15 pending foreign patent applications. The expiration dates of our patents range from 2026 to 2038. We intend to pursue additional patent protection to the extent we believe it would be +beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +10 +Table of Contents +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2019, we employed 362 full-time employees and 31 part-time employees, for a total of 393 employees. None of our employees +is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/item13.txt b/raw/filings/0000350868/2018/0001047469-19-003522/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..3de4184c14472a28d67299b543583a1570c98d87 --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/item13.txt @@ -0,0 +1,22 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Certain Transactions +Since April 1, 2015, other than the agreements and transactions described in "Item 11. Executive Compensation" and the +transactions described below, there has not been, nor is there any proposed transaction, where we (or any of our subsidiaries) were or will be a party in which the amount involved exceeded or will +exceed the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two fiscal years and in which any director, director nominee, executive officer, holder of more +than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest. +We +previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. The sublease terminated in September +2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, +103 +Table of Contents +which +was subsequently amended and restated on July 23, 2013 and on August 11, 2016. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with +accrued interest payable annually on the first business day of each calendar year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to +Iteris. We have previously fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of March 31, 2019, approximately $146,000 of the +original principal balance was outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director +of Iteris since September 2013, and one existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +Director Independence +The Board of Directors has determined that Ms. Siegal and each of Messrs. Daly, Deeter, Mooney, Thomas and Williams satisfies the +requirements for "independence" using the +standards established by Nasdaq, except that Dr. Daly did not qualify as an independent director while he was serving as our interim Chief Executive Officer from February 2015 to September +2015. \ No newline at end of file diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/item9a.txt b/raw/filings/0000350868/2018/0001047469-19-003522/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..1f5048b371b2331895c80c6c9b76d45dcad11280 --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/item9a.txt @@ -0,0 +1,31 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable +assurance level as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a +timely manner, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely +decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2019 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted +an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective as of March 31, 2019. The +effectiveness of our internal control over financial reporting as of March 31, 2019 has been audited by Deloitte & +81 +Table of Contents +Touche LLP, +an independent registered public accounting firm, as stated in their report, which is included herein. \ No newline at end of file diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/rp_note.txt b/raw/filings/0000350868/2018/0001047469-19-003522/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2018/0001047469-19-003522/rpt_disclosure.txt b/raw/filings/0000350868/2018/0001047469-19-003522/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..3de4184c14472a28d67299b543583a1570c98d87 --- /dev/null +++ b/raw/filings/0000350868/2018/0001047469-19-003522/rpt_disclosure.txt @@ -0,0 +1,22 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Certain Transactions +Since April 1, 2015, other than the agreements and transactions described in "Item 11. Executive Compensation" and the +transactions described below, there has not been, nor is there any proposed transaction, where we (or any of our subsidiaries) were or will be a party in which the amount involved exceeded or will +exceed the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two fiscal years and in which any director, director nominee, executive officer, holder of more +than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest. +We +previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. The sublease terminated in September +2007, at which time Maxxess owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, +103 +Table of Contents +which +was subsequently amended and restated on July 23, 2013 and on August 11, 2016. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with +accrued interest payable annually on the first business day of each calendar year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to +Iteris. We have previously fully reserved for amounts owed to us by Maxxess and the outstanding principal balance remains fully reserved. As of March 31, 2019, approximately $146,000 of the +original principal balance was outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, one former Iteris director, who has not been a director +of Iteris since September 2013, and one existing director of Iteris, who currently owns less than 2% of Maxxess' capital stock. +Director Independence +The Board of Directors has determined that Ms. Siegal and each of Messrs. Daly, Deeter, Mooney, Thomas and Williams satisfies the +requirements for "independence" using the +standards established by Nasdaq, except that Dr. Daly did not qualify as an independent director while he was serving as our interim Chief Executive Officer from February 2015 to September +2015. \ No newline at end of file diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/filing.txt b/raw/filings/0000350868/2019/0001047469-20-003463/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bb1f4740da0f8799cafec6816fad803f4b0b2b7 --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/filing.txt @@ -0,0 +1,4666 @@ +10-K +1 +a2241797z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31, 2020 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +(State or Other Jurisdiction of +Incorporation or Organization) +95-2588496 +(I.R.S. Employer +Identification No.) +1700 Carnegie Ave., Santa Ana, California +(Address of Principal Executive Offices) +92705 +(Zip Code) +Registrant's +Telephone Number, Including Area Code: (949) 270-9400 +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common Stock, $0.10 par value +ITI +The NASDAQ Stock Market LLC +Securities +registered pursuant to Section 12(g) of the Act. None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act"). +Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of +1934, as amended (the "Exchange Act"). Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the +preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. +Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of +Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). +Yes ý No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an +emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.: +Large accelerated filer o +Accelerated filer ý +Non-accelerated filer o +Smaller reporting company ý +Emerging growth company o +Indicate +by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting +under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit +report. o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act +Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2019 was approximately $233,300,000. +For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate +status is not necessarily a conclusive determination for other purposes. As of May 29, 2020, there were 40,732,994 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2020 Annual Meeting of +Stockholders, which will be filed with the Securities and Exchange Commission. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2020 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +12 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +26 +ITEM 2. +PROPERTIES +26 +ITEM 3. +LEGAL PROCEEDINGS +26 +ITEM 4. +MINE SAFETY DISCLOSURES +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +27 +ITEM 6. +SELECTED FINANCIAL DATA +27 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +28 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +39 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +40 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +80 +ITEM 9A. +CONTROLS AND PROCEDURES +80 +ITEM 9B. +OTHER INFORMATION +84 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +84 +ITEM 11. +EXECUTIVE COMPENSATION +84 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +84 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +84 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +84 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +85 +Unless +otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiaries, ClearAg, Inc. and Albeck +Gerken, Inc., CheckPoint™, ClearGuide™, ClearFleet™, CVIEW-Plus™, Edge®, EdgeConnect™, inspect™, +iPeMS®, Iteris®, Iteris SPM™, Next®, P10™, P100™, P-Series™, PedTrax®, Pegasus™, Reverse +511®, SmartCycle®, SmartCycle Bike Indicator™, SmartSpan®, SPM™ (logo), UCRLink™, Vantage®, +VantageLive!™, Vantage Next®, VantagePegasus®, VantageRadius®, Vantage Vector®, Velocity® and VersiCam™ are among, +but not all of, the trademarks of +Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of +the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and +certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words +"expect(s)," "feel(s)," "believe(s)," "intend(s)," "plan(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are +intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, +capital needs, backlog, manufacturing capabilities, the market acceptance of our products, impact of planned acquisitions and dispositions, the Company's strategy for growth, competition, the impact +of the outbreak of a novel strain of coronavirus, COVID-19, the impact of any current or future litigation, the impact of recent accounting pronouncements, the applications for and acceptance of our +products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are +subject to certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that +speak only as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in +"Risk Factors" set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or +update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated +events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), +in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of essential applied informatics that enable smart transportation. Municipalities, government agencies and other +businesses use our solutions to make roads safer and travel more efficient. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products and software-as-a-service ("SaaS") offerings offer a +comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +Prior +to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling +techniques to offer smart content and analytic solutions that provided analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food +companies, and agricultural equipment manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on our roadways. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market and we are always exploring strategic alternatives intended to optimize the value of all of our Company. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California +92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by +reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, +together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically +filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net +proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately +$6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm +headquartered in Tampa, Florida (see Note 11, "Acquisition" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on +the acquisition of AGI), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +4 +Table of Contents +Coronavirus +In March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of a novel strain of +coronavirus, COVID-19 ("the Pandemic"). The Pandemic is having an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, such as travel +restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our +vendors, our employees and customers and customer sentiment in general. Continued impacts of the Pandemic have materially adversely impacted global economic conditions, and could impact our business, +results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results and volatility of our stock price will depend largely on future +developments, including the duration of the spread of the outbreak, the impact on capital and financial markets and the related impact on the +financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of this report. +Sale of Segment +On May 5, 2020, pursuant to an Asset Purchase Agreement (the "Purchase Agreement") entered in on May 2, 2020, the Company sold the +assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather product lines, to DTN, LLC ("DTN"), an operating company of TBG AG, a Swiss-based holding +company. See Note 14 "Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the sale of the +Agriculture and Weather Analytics segment. +Restructuring +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of +Iteris, Inc. approved a plan of restructuring that will involve a charge in the range of approximately $1.7 million to $1.9 million in the fiscal quarter ending June 30, +2020, of which approximately 60% relates to the sale of the Agriculture and Weather Analytics segment. The restructuring charge includes separation costs for certain employees who will not transition +to DTN and an additional 10 to 15 positions that are being eliminated to right-size the cost structure of the Company. The restructuring is expected to result in a cash expenditure of approximately +$1.7 million to $1.9 million. The annualized savings from the restructuring charges, excluding those related to the sale, are expected to be in the range of $1.2 million to +$1.3 million. The amounts stated above are preliminary and subject to change as the Company finalizes its assessment of the charges and savings associated with the above items. +Products and Services +Our reportable segments consist of: Roadway Sensors, Transportation Systems, and, prior to May 5, 2020, Agriculture and Weather +Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadway Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. The Transportation Systems segment provides traffic engineering +and consulting services, as well as managed services, performance measurement, traffic analytics, traveler information and commercial vehicle operating software solutions. The Agriculture and Weather +Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. +5 +Table of Contents +See +Note 12 "Business Segments, Significant Customer and Geographic Information" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of +this report for further details on our reporting segments. See Note 14 "Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this +report for further details on the sale of the Agriculture and Weather Analytics segment. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage +Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +In +select territories, we also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic +signal controllers and traffic signal equipment cabinets. +6 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services, performance measurement and traffic analytics solutions, as +well as the development of transportation management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 (see Note 11 "Acquisition" of the Notes to +Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisition of AGI). +The +Transportations Systems segment also includes our performance measurement and traffic analytics solutions, Iteris Signal Performance Measures (SPM), Iteris ClearGuide, and +iPeMS—a state-of-the-art analytics software suite that provides prescriptive data insights for multiple applications, including to help determine current and future traffic patterns, +permitting the effective performance analysis and management of traffic infrastructure resources. Our analytics suite of products utilizes a wide range of data resources and analytical techniques to +determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic +professionals to measure how a transportation network is performing and to identify potential areas of improvement. These applications are also capable of providing users with predictive traffic +analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This +segment also includes our advanced traveler information system solutions and services, as well as our commercial vehicle operations and vehicle safety compliance platforms, known as +"ClearFleet", "CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." These software applications support state-based commercial vehicle operations by storing and distributing intrastate and interstate +commercial vehicle information for local, state and federal agencies' roadside and enforcement operations. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding +mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We +believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, +our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the allocation of funds may prolong uncertainty regarding the allotment of +transportation funds in federal, state and local budgets. +Agriculture and Weather Analytics +The Agriculture and Weather Analytics segment, which we sold in May 2020, consisted of ClearPath Weather, a road maintenance application, and +ClearAg, a digital agriculture platform. +ClearPath +Weather is a web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess weather conditions for customizable route/site +weather and pavement forecasting, and render winter road maintenance recommendations for state agencies, municipalities and commercial companies to improve roadway maintenance decisions. +7 +Table of Contents +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For ClearAg solutions, we developed additional +scientific and agronomic models and forecasts, expanded our computing infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +The +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to increase the efficiency and +sustainability of farmlands. The ClearAg Platform delivers validation tools for ag inputs, irrigation, field readiness, and harvest solutions giving growers, researchers and other agribusinesses +access to a comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as other information on crop growth. Companies use the ClearAg Platform +to simulate field conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers and agribusinesses leverage the ClearAg Platform to determine the +best times to plant, spray, fertilize, irrigate, and harvest crops. +ClearAg +solutions were offered on a subscription basis, with customers consuming ClearAg through visualization component application programming interfaces ("APIs"). These APIs +facilitate the integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. +On +May 5, 2020, pursuant to a Purchase Agreement the Company sold the assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather +product lines, to DTN, an operating company of TBG AG, a Swiss-based holding company. As a result of the sale, we no longer operate in the Agriculture and Weather Analytics segment. See Note 14 +"Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the sale of the Agriculture and Weather Analytics +segment. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct +channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our fiscal +year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time +staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to +accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and, prior to May 2020, our ClearPath Weather services, primarily to government agencies pursuant to negotiated +contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation +or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use +8 +Table of Contents +selected +members of our engineering, science and information technology teams on a regional basis to serve in sales and business development functions. Our Transportation Systems contracts generally +involve long lead times and require extensive specification development, evaluation and price negotiations. +ClearAg +solutions were marketed and sold on a subscription basis, under a SaaS license, to seed and crop protection companies, agriculture equipment manufacturers, irrigation solution +providers, allied providers and other agriculture service providers. +We +have historically had a diverse customer base. For the fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total +revenues. For the fiscal year ended March 31, 2019 ("Fiscal 2019) and Fiscal 2018, one individual customer represented greater than 10% of our total revenues. As of March 31, 2020 and +2019, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris +Manufacturing and MoboTrex, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our +subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. Typically, we do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all +requirements of the ISO 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2020, Fiscal 2019 and Fiscal 2018. We believe customer support is a key competitive factor for our Company. +Our +ClearAg solutions were primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provided full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $67.2 million at March 31, 2020, which included +$53.4 million related to Transportation Systems, $8.7 million related to Roadway Sensors, and $5.2 million related to Agriculture and Weather Analytics. Typically, we recognize +approximately more than 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and currently expect that trend to continue for the near future. +Substantially all of the backlog for Roadway Sensors at March 31, 2020 is expected to be recognized as revenue in the fiscal year ending March 31, 2021 ("Fiscal 2021") and only a small +portion of the backlog for Agriculture and Weather Analytics was realized prior to its sale in May 2020. At March 31, 2019, we had backlog of approximately $55.4 million, which included +$44.5 million related to Transportation Systems, $6.2 million related to Roadway Sensors and $4.7 million related to Agriculture and Weather +9 +Table of Contents +Analytics. +The increase in backlog in the current fiscal year was largely due to increased sales and marketing efforts in our Transportation Systems segment during the current fiscal year. +Backlog +is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred +revenue on our consolidated balance sheets. Backlog does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given +its relevance to total orders. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Grand +Forks, North Dakota and Oakland, California. Our research and development costs and expenses were approximately $8.6 million for Fiscal 2020, $7.8 million for Fiscal 2019, and +$7.9 million for Fiscal 2018. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Roadway Sensors and +Transportation Systems segments in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of our software offerings that +include Iteris SPM, iPeMS, Iteris ClearGuide, and Iteris ClearFleet, as well as our other commercial vehicle operations software products. In addition, we intend to continue to invest in further +enhancements and functionality in our Vantage products family. We believe that developing new and enhanced product +offerings across our segments and enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +In +the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems and manufacturers and +distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity and VantagePegasus compete +against various competitors in the travel-time and data communications markets, respectively. +10 +Table of Contents +The markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety +standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, +regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and +our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary +hardware and software corporations. +The +markets in which our Agriculture and Weather Analytics segment operated vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we competed with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than we. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 21 issued U.S. patents, including: +(i) 14 relating to our Roadway Sensors technologies, four of which were issued in Fiscal 2020 and (ii) 7 relating to our Transportation Systems technologies. Prior to the sale of our +Agriculture and Weather Analytics segment in May 2020, we had a total of 36 issued U.S. patents relating to our Agriculture and Weather Analytics technologies. Prior to the sale of our Agriculture and +Weather Analytics in May 2020, we had a total of 14 pending patent applications in the U.S. and 8 total foreign patent applications. The expiration dates of our patents range from 2026 to 2038. We +intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +11 +Table of Contents +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2020, we employed 414 full-time employees and 26 part-time employees, for a total of 440 employees. As a result of the +sale of our Agriculture and Weather Analytics segment in May 2020 and related restructuring activities, we currently have approximately 348 full-time and 26 part-time employees. None of our employees +is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in +this report and in the information incorporated by reference into this +report. You should consider the following risks carefully in addition to the other information contained in this report and our other filings with the SEC, including our subsequent reports on +Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and +uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, our business, financial condition, or +results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. +Because we depend on government contracts and subcontracts, we face additional risks related to contracting +with federal, state and local governments, including budgetary issues and fixed price contracts, that could adversely impact our future revenues and profitability. +A significant portion of our revenues is derived from contracts with governmental agencies, either as a general contractor, sub-contractor or +supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and +challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, delays in the +expenditures from the federal highway bill and +12 +Table of Contents +delays +or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the +administration and repeal of government purchasing programs; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone +requirements; +• performance bond requirements; +• adverse weather conditions or other natural or medical disasters or developments, such as, the novel coronavirus COVID-19, and evacuations and +flooding due to hurricanes, can result in our inability to perform work in affected areas; and +• international relations and international conflicts or other military operations that could cause the temporary or permanent diversion of +government funding from transportation or other infrastructure projects. +Governmental +budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation +of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense +competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the +current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and +income to drop substantially or to fluctuate significantly between fiscal periods. +In +addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts +require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to +estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. +Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the +convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any +material government contract could seriously harm our business, financial condition and results of operations. +We may not be able to achieve profitability on a quarterly or annual basis in the future. +We had net losses of approximately $5.6 million in Fiscal 2020, $7.8 million in Fiscal 2019 and $3.5 million in Fiscal +2018, and we cannot assure you that we will be profitable in the future. Our ability to become profitable in future periods could be impacted by governmental budgetary constraints, +13 +Table of Contents +government +and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from certain of our business segments to fund investments +in +sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our +expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or +increases in planned investments. We may expect to continue to experience operating losses and net losses in Fiscal 2021 and may continue to do so in the future, which would make it difficult to fund +our operations and achieve our business plan, and could cause the market price of our common stock to decline. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our +Transportation Systems workforce. +The cost of providing our Transportation Systems engineering and consulting services, including the extent to which we utilize our workforce, +affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• the timing of new contract awards, the commencement of work under an awarded contract or the completion of large contracts; +• availability of funding or other budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An +inability to properly and fully utilize our Transportation Systems workforce would reduce our profitability and could have an adverse effect on our results of operations. +Our management information systems and databases have been and could in the future be disrupted by data +protection breaches, system security failures, cyber threats or by the failure of, or lack of access to, our internal operations, such as our enterprise resource planning, or ERP, system, or services +provided to our customers. These disruptions could negatively impact our sales, increase our expenses, significantly harm our reputation and/or adversely affect our stock price. +Experienced users and computer programmers may be able to penetrate, or "hack", our network security and create system disruptions, cause +shutdowns and compromise or misappropriate our confidential information or that of our employees and third parties. Computer programmers and hackers also may be able to develop and deploy viruses, +worms, and other malicious software programs that attack our internal network, any of our systems, service offerings or otherwise exploit any security vulnerabilities of our network, systems or +service offerings. In addition, sophisticated services, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, +including "bugs" and other problems that could unexpectedly interfere with the operation of a system. We could incur expenses addressing problems created by cyber or other security problems, bugs, +viruses, worms malicious software programs and security vulnerabilities, and our efforts to address these problems may not be successful. We must, and do, take precautions to secure customer +information and prevent unauthorized access to our databases and systems containing +14 +Table of Contents +confidential +information. Any data security event, such as a breach, data loss or information security lapses, whether resulting in the compromise of personal information or the improper use or +disclosure of confidential, sensitive or classified information, could result in interruptions, cessation of service(s), claims, remediation costs, regulatory sanctions against us, loss of current and +future contracts, adverse +effects to results of operations and financial condition, serious harm to our reputation and/or adverse effects to our stock price. We operate our ERP system on a SaaS platform, and we use this system +for reporting, planning, sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on this system, and the third-party provider of +this service, for a number of aspects of our operations. If this service provider or this system fails, or if we are unable to continue to have access to this system on commercially reasonable terms, +or at all, operations would be severely disrupted until an equivalent system could be identified, licensed or developed, and integrated into our operations. This disruption would have a material +adverse effect on our business. We carry insurance, including cyber insurance, commensurate with its size and the nature of its operations, although there is no certainty that such insurance will in +all cases be sufficient to fully reimburse us for all losses incurred in connection with the occurrence of any of these system security risks, data protection breaches, cyber-attacks or other events. +In +April 2020, certain internal computer systems at our headquarters in Santa Ana were breached by an intruder, which prevented them temporarily from operating. We immediately took steps +to isolate those systems and implemented measures to prevent additional systems from being affected, including taking systems offline as a precaution. The intrusion did not affect any customer-facing +systems. Third party forensic experts were engaged to assist our information technology team to restore those affected internal systems to operation. We completed our investigation on June 3, +2020 and we have not experienced, nor do we believe there has been, any material impact to our operating activities nor our controls over financial reporting. To date, we have found no evidence of +data exfiltration or misappropriation. +If unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our +web-based and mobile application solutions and services, we may suffer various negative impacts, including a loss of customer and market confidence, loss of customer loyalty, and significant liability +to our customers and to individuals or businesses whose information was being stored. +Protecting data of our customers is critical to our business, and if there is unauthorized access we may incur significant costs or liabilities. +In addition, we are required to comply with government contracting requirements and make investments in our systems to protect that data. If we are unable to do so, our customers may lose confidence +in us, which would harm our sales, and we may incur significant expenses or liabilities. +The recent coronavirus outbreak could have an adverse effect on our business. +In March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of the Pandemic. The +Pandemic is having an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, such as travel restrictions, quarantines and "stay-at-home" +orders. The uncertainties +caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our vendors, our employees and customers and customer sentiment in general. +Continued impacts of the Pandemic have materially adversely impacted global economic conditions, and have impacted our business, results of operations and financial condition, such as expense +reductions, in an effort to mitigate such impacts. The extent of the impact of the Pandemic on our business and financial results and volatility of our stock price will depend largely on future +developments, including the duration of the spread of the outbreak, the impact on capital and financial markets and the related impact on the +15 +Table of Contents +financial +circumstances of our customers, all of which are highly uncertain and cannot be predicted. This situation is changing rapidly, and additional impacts may arise that we are not aware of +currently. +Acquisitions of companies or technologies, including our acquisition of AGI, may require us to undertake +significant capital infusions and could result in disruptions of our business and diversion of resources and management attention. +In July 2019, we completed the acquisition of AGI and we plan to continue to explore acquiring additional complementary businesses, products, +services, and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, +including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information +system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our +competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies +available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation +charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully +integrate any acquisitions or realize the benefits and opportunities anticipated from any acquisition. +Acquisitions, investments and divestitures could result in operating difficulties, dilution, and other +consequences that may adversely affect our business and results of operations. +Acquisitions, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions +could be material to our financial +condition and results of operations. We expect to continue to evaluate and enter into discussions regarding potential strategic transactions. Effecting these strategic transactions could create +unforeseen operating difficulties and expenditures. We face risks that include, among other things: +• the strategic benefits and opportunities from any planned or completed acquisition or divestiture by the Company may not be realized or may +take longer to realize than expected; +• strategic benefits and opportunities related to past and ongoing restructuring actions may not be realized or may take longer to realize than +expected; +• our ability to realize the expected financial benefits of an acquisition, divestiture or other strategic transaction; +• cost reductions may not occur as expected; +16 +Table of Contents +• management time and focus may be diverted from operating our business to challenges related to acquisitions and other strategic transactions; +• cultural challenges may arise associated with integrating employees from the acquired company into our organization, and retention of employees +from the businesses we acquire; and +• we may fail to successfully further develop the acquired business or technology. +Our +failure to address the risks and other issues in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated +benefits and opportunities, including unanticipated liabilities, increased costs, and harm our business generally. +We participate in the software development market which may be subject to various technical and commercial +challenges. +We have only been in the business of software development for a few years and have in the past and may in the future experience development and +technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we +cannot be certain that errors will not be found in our software after its release. Any faults or errors in our existing products or in any new products may cause delays in product introduction and +shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies +are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able +to remain competitive, and the demand for our products will likely decline. +Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• obsolescence of certain parts and components from time to time that may require re-engineering of certain portions of our product; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our +future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad +acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements in a cost-effective and +timely manner, or are unable to achieve market acceptance of our new products, our operating results would be adversely affected. +We believe our revenue growth and future operating results will depend on our ability to complete development of new products and enhancements, +introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our +17 +Table of Contents +production +costs. During the past few fiscal years, we have introduced, and will continue to introduce this fiscal year, both new and enhanced products across all segments. We cannot guarantee the +success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new +products could adversely affect the sales of certain of our existing products. +We +believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain +competitive. We need to continue to prepare updates for existing products and develop and introduce new products that incorporate the latest technological advancements in outdoor image processing +hardware, camera technologies, software and analysis in response to evolving customer requirements. In addition, we are beginning to migrate some of our products to a new platform. We cannot assure +you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to +technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you +that any such investments in research and development will lead to any corresponding increase in revenue. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, +or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. Should the credit markets further +tighten or our business decline, we may +need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, +or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in +further dilution to our stockholders. +Our +capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards or commencement of +work for a project; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +18 +Table of Contents +If +our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the +issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common +stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms when +needed, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to +competitive pressures. +The markets in which we operate are highly competitive with many companies more established than we are. +We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many +smaller regional engineering firms. +We +compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a portion of the traffic intersection market has +adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry +make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result +in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The +Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and +breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +In +each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. +This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, +promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the +foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and +profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. +We continually bid on new contracts and negotiate contract renewals on expiring contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection +process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. As a condition to contract award, customers require us to +provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. Government entities are also taking more time between contract award and +approval to commence work under the contract, which delays our ability to recognize revenues under the contract. If negative market conditions materialize, or if we fail to secure adequate financing +arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue, obtain or perform particular projects, which could reduce or eliminate our +profitability. +19 +Table of Contents +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our +competitive position. +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary +technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, +trademark and trade secret laws, employee and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or +systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some +foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation +may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be +necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse +outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or +using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is +determined that we have infringed upon or misappropriated another party's intellectual property. Our continued expansion into software development activities may subject us to increased possibility of +litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, +including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, +financial condition and results of operations. +We may continue to be subject to traffic-related litigation. +The traffic industry in general is subject to frequent litigation claims due to the nature of personal injuries that can result from traffic +accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, +even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not be covered by insurance or the damages +resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by +insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant +expenses and result in a diversion of management's attention. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm +our business. +Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key +management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing +business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of +operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified +engineering and other highly skilled technical personnel. Particularly in highly +20 +Table of Contents +specialized +areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may adversely affect our growth in the current fiscal year and in +future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for highly skilled employees are on the rise. Although we intend to continue to +devote significant resources to recruit, train and retain qualified skilled personnel, we may not be able to attract and retain such employees, which could impair our ability to perform our +contractual obligations, meet our customers' needs, win new business, and adversely affect our future results. Likewise, the future success of our Transportation Systems segment will depend on our +ability to hire additional qualified engineers, planners and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense. We may +not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our +current key employees could adversely affect our business, financial condition and results of operations. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable +to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and +invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past +expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these +activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +Our use of estimates in conjunction with the input method of measuring progress to completion of performance +obligations for our Transportation Systems revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of Transportation Systems revenues are measured and recognized over time using the input method of measuring progress to completion. +Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs +expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or +can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards +completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to +vary materially from estimates, including reductions or reversals of previously recorded revenues and profits. +Declines in the value of securities held in our investment portfolio can affect us negatively. +As of March 31, 2020, the value of securities available for sale within our investment portfolio was $11.6 million, which is +generally determined based upon market values available from third-party sources. The value of our investment portfolio has fluctuated as a result of market volatility and economic or financial market +conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and liquidity. Further, to the extent that we experience unrealized losses in +our portfolio of investment securities from declines in securities values that management determines to be other than temporary, the book value of those securities will be adjusted to their estimated +recovery value and we will recognize a charge to earnings in the quarter during which we make that determination. Although we have policies and procedures in place to assess and mitigate potential +impacts of market risks, those policies and procedures are inherently limited because +21 +Table of Contents +they +cannot anticipate the existence or future development of currently unanticipated or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage +these risks properly. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley +Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial +reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to +obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis +and, even if we timely complete such requirements, our +independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A +control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of +a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control +systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations +include the realities that technology, decision-making and other processes can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the +individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the +likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate +because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to +error or fraud may occur and not be detected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock +price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or +exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of +factors, many of which are not within our control. Factors that could affect our revenues and operating results include, among others, the following: +• the Pandemic, which may impact our first quarter and full fiscal year 2021 operating results; +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as +increased price competition in general; +• the long lead times associated with government contracts; +22 +Table of Contents +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely +manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• timing of backlog fulfillment; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• our ability to raise additional capital; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due +to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that +happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication +of our future performance. +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have in the past experienced, and may from time to time in the future continue to experience parts shortages or unforeseen quality control +issues by our suppliers that may impact our ability to meet demand for our products. We have historically used and continue to use single suppliers for certain significant components in our products, +and have had to reengineer products from time to time to address obsolete components, especially in our Roadway Sensors products. Our Roadway Sensors products are also included with other traffic +intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should any such supply delay or disruption occur, or +should a key supplier discontinue operations, our future sales and costs will likely be materially and adversely affected. Additionally, we rely heavily on select contract +23 +Table of Contents +manufacturers +to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to +meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a +production gap should for any reason our contract manufacturers become unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. Further, +foreign imports of components in our products subject the Company to risks of changes in, or the imposition of new, export/import requirements, tariffs, work stoppages, delays in shipment, product +cost increases due to component shortages, public health issues that could lead to temporary closures of facilities or shipping ports, such as the Pandemic and other economic uncertainties, affecting +trade between the U.S. and other countries where we source components for our Roadway Sensors products. Any such actions could increase the cost to us of such products and cause increases in the +prices at which we sell such products, which could adversely affect the financial performance of our Roadway Sensors business. Similarly, these actions could result in cost increases or supply chain +delays that +impact third party products (e.g. steel poles) which could lead our customers to delay or cancel planned purchases of our products. +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution +capabilities for our Roadway Sensors segment internationally, particularly in Europe and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we +will be successful in such efforts. International operations subject us to various inherent risks including, among others: +• the Pandemic and related government responses, including travel restrictions, quarantines and "stay-at-home" orders; +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S., as well as requirements and restrictions in the other countries in which +we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but +not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially +all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive +and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +24 +Table of Contents +Any +of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, +as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face +local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, +our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the +world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has been subject to wide fluctuations in the past. From March 31, 2017 through March 31, +2020, our common stock has traded at prices as low as $2.08 per share and as high as $8.17 per share. The market price of our common stock could continue to fluctuate in the future in response to +various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other strategic transactions or dispositions; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The +stock market is currently experiencing and has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of +many technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common +stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of +a class action lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Provisions of our charter documents may discourage a third party from acquiring us and may adversely affect +the price of our common stock. +Provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that might be +beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For example, +25 +Table of Contents +under +the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and +other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make nominations for +directors. We may also adopt provisions and agreements from time to time that could make it harder for a potential acquirer. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 47,000 square feet of leased office, manufacturing and warehouse space +located in Santa Ana, California, pursuant to a lease which terminates in March 2022. For additional information regarding our lease obligations, see Note 7 "Right-of-Use Assets and Lease +Liabilities" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 6 of Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +26 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock is traded on the NASDAQ Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock +traded on the NYSE MKT under the same symbol. +As +of May 29, 2020, we had 318 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than +this number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain +Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We +currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon +a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business +conditions, and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +On August 9, 2012, our Board of Directors approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan is in place. There is no guarantee +as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors +approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to +time for an unspecified length of time. +In +Fiscal 2020, Fiscal 2019, and Fiscal 2018, we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2020, we repurchased approximately +3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2020, all repurchased shares have been +retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2020, approximately $1.7 million remains available for the repurchase of our +common stock under our current program. +ITEM 6. SELECTED FINANCIAL DATA +The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information +required under this Item. +27 +Table of Contents +ITEM 7. MANAGEMENT's DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and +related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Part I, Item 1A, as well as the other cautionary statements and risks +described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General. We are a provider of smart mobility infrastructure management solutions. Municipalities, government agencies, and other +transportation +infrastructure providers use our solutions to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +Sale of Vehicle Sensors. On July 29, 2011, we completed the sale of substantially all of our assets used in connection with +our former Vehicle +Sensors segment to Bendix Commercial Vehicle Systems LLC ("Bendix"), a member of Knorr-Bremse Group, pursuant to an Asset Purchase Agreement signed on July 25, 2011 (the "Asset Sale"). +In connection with the Asset Sale, we were entitled to additional consideration in the form of certain performance and royalty-related earn-outs through December 31, 2017. From the date of the +Asset Sale, through March 31, 2020, we received approximately $2.7 million in connection with royalty-related earn-outs provisions for a total of $18 million in cash received from +the Asset Sale. We do not anticipate any further payments from Bendix. +As +a result of the Asset Sale, we no longer operate in the Vehicle Sensors segment. We determined that the Vehicle Sensors segment, which previously constituted one of our operating +segments, qualified as a discontinued operation. The applicable financial results of our former Vehicle Sensors segment through the closing of the Asset Sale have been reclassified as a discontinued +operation for all periods presented in this report. Refer to Note 3 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report, for additional +discussion regarding the Asset Sale. +Business Segments. Our reportable segments consist of: Roadway Sensors, Transportation Systems, and, prior to May 5, 2020, +Agriculture and +Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadways Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. In select +territories, our Roadway Sensors segment also sells OEM products for the traffic intersection markets, which include, among other things, traffic signal controllers and traffic signal equipment +cabinets. +The +Transportation Systems segment includes engineering and consulting services, managed services, performance measurement and traffic analytics solutions, as well as the development of +transportation management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, development and implementation of software and +hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in +the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of surface +transportation +28 +Table of Contents +infrastructure +systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to +reduce traffic congestion. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 (see Note 11 "Acquisition" of the Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report for further details on the acquisition of AGI). The Transportations Systems segment product line includes: Iteris Signal +Performance Measures ("SPM"), Iteris ClearGuide, and iPeMS, our performance measurement and analytics solution, our advanced traveler information system solutions ClearPath 511 and Reverse 511, as +well as our commercial vehicle operations and vehicle safety compliance platforms known as ClearFleet, CVIEW-Plus, CheckPoint, UCRLink and inspect. +The +Agriculture and Weather Analytics segment consisted of ClearPath Weather, a road maintenance application, and ClearAg, a digital agriculture platform. ClearPath Weather is a +web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess historical weather conditions for both short-term and long-range weather forecasts +and customizable +route/site weather and pavement forecasting, and providing winter road maintenance recommendations for state agencies, municipalities and commercial companies that allow such users to create solutions +to meet roadway maintenance decision needs. ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to +increase the efficiency and sustainability of farmlands. ClearAg solutions were offered to companies in the agriculture industry, such as seed and crop protection companies, integrated food companies, +and agricultural equipment manufacturers and service providers. ClearAg solutions provided weather, environment, soil and plant growth modeling to deliver environmental intelligence through ClearAg +APIs and components, IMFocus APIs and ClearAg web applications. +On +May 5, 2020, pursuant to an Asset Purchase Agreement (the "Purchase Agreement") entered in on May 2, 2020, the Company sold the assets of its Agriculture and Weather +Analytics segment, composed of its ClearAg and ClearPath Weather product lines, to DTN, LLC ("DTN"), an operating company of TBG AG, a Swiss-based holding company. As a result of the sale, we +no longer operate in the Agriculture and Weather Analytics segment. See Note 14 "Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 +of this report for further details on the sale of the Agriculture and Weather Analytics segment. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements +included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts +of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting +period. On an ongoing basis, we evaluate these estimates and assumptions, include those related to revenue recognition, the collectability of accounts receivable and related allowance for doubtful +accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves and other contingencies, costs to complete long-term contracts, indirect cost rates used +in cost plus contracts, the valuation of inventories, the valuation of purchased intangible assets and goodwill, the valuation of investments, estimates of future cash flows used to assess the +recoverability of long-lived assets and the impairment of goodwill, and fair value of our stock option awards used to calculate stock-based compensation. We base these estimates on historical +experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and +liabilities that are not readily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of +29 +Table of Contents +our +estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assets and liabilities at the date of the financial statements +and the reported amounts of revenues and expenses during the reporting period. +The +following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Revenues are recognized when control of the promised goods or services are transferred to our customers, in +a gross amount that +reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenues from contracts with our customers. +Product +revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase +orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this +method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service +revenues, primarily derived from the Transportation Systems and Agriculture and Weather Analytics segments, are primarily from long-term engineering and consulting service +contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using +the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as +the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") +contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the +Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon +inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to +consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service +revenues also consist of revenues derived from maintenance support and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from +fees for maintenance support, monthly active user fees, SaaS fees, and hosting fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series +of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the +total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services as the customer obtains +equal benefit from the service throughout the service period. The Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires +significant judgment based upon knowledge of the products and/or services, the solutions provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer +which combines the software functionality, maintenance and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each +constituting a separate performance obligation. +We +generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We +include +30 +Table of Contents +estimated +amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable +consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our +anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +The +Company's typical performance obligations include the following: +Performance Obligation +When Performance +Obligation is +Typically Satisfied +When Payment is +Typically Due +How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product +Upon shipment (point in time) +Within 30 days of delivery +Observable transactions +Engineering services where the deliverable is considered a product +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +SaaS +Over the course of the SaaS service once the system is available for use (over time) +At the beginning of the contract period +Estimated using a cost-plus margin approach +Goodwill and Other Long-Lived Assets. Goodwill is recorded as the difference, if any, between the aggregate consideration paid +for an acquisition and +the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent internally developed and purchased intangible assets including developed technology, +customer relationships, trade names and patents. We currently amortize our intangible assets with definitive lives over periods ranging from one to seven years using a method that reflects the pattern +in which the economic benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method over the estimated +useful life of the asset. +The +Company has the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value. +However, the Company may elect to bypass the qualitative assessment and proceed directly to the quantitative impairment tests. The first step of the impairment test involves comparing the fair value +of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, the Company would perform the second step of the goodwill impairment test to determine +the amount of the impairment loss. We perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, +such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its +carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and +no further testing is required, if otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds the +reporting unit's fair value, the amount by which the +31 +Table of Contents +carrying +value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We determine the fair values of our reporting units using the income valuation approach, as +well as other generally accepted valuation methodologies. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long-lived assets +and purchased intangible assets. +Income Taxes. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are +determined based on the +temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A +valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +determination is made. +On +an interim basis, we estimate what our anticipated annual effective tax rate will be, while also separately considering applicable discrete and other non-recurring items, and record a +quarterly income +tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and financial results during the year. This estimation process +can result in significant changes to our expected effective tax rate. When this occurs, we adjust our income tax provision during the quarter in which our estimates are refined so that the +year-to-date provision reflects the expected annual effective tax rate. These changes, along with adjustments to our deferred taxes, among others, may create fluctuations in our overall effective tax +rate from quarter to quarter. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are reversed in +the first subsequent financial reporting period in which that threshold is no longer met. +The +application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a +result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from +our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. +In +relation to the Tax Cuts and Jobs Act ("TCJA"), we determined reasonable provisional estimates on our existing deferred tax balances and the one-time transition tax under the SEC +Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"). Actual future operating results and the underlying amount and type of +income could differ materially from our estimates, assumptions and judgments, thereby impacting our consolidated financial position and results of operations. +On +March 27, 2020, the Coronavirus Aid, Relief and Economic Security (CARES) Act was enacted and signed into U.S. law to provide economic relief to individuals and businesses +facing economic hardship as a result of the COVID-19 pandemic. Changes in tax laws or rates are accounted for in the period of enactment. The income tax provisions of the CARES Act had an immaterial +impact on our current taxes, deferred taxes, and uncertain tax positions of the Company. +32 +Table of Contents +Stock-Based Compensation. We record stock-based compensation in the statements of operations as an expense, based on the grant +date estimated fair +value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock +units. The fair value of our stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our stock option awards as it does not consider certain factors important to those awards to employees, such as +continued employment and periodic vesting requirements, as well as the limited transferability of the awards. The fair value of our restricted stock units is based on the closing market price of our +common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining +unearned stock-based compensation expense. +Recent Accounting Pronouncements +Refer to Note 1 "Description of Business and Summary of Significant Accounting Policies" of the Notes to Consolidated Financial +Statements, included in Part II, Item 8 of this report for a discussion of recent accounting pronouncements. +Analysis of Fiscal 2020 and Fiscal 2019 Results of Operations +For a comparison of the 2019 to 2018 fiscal years, see Part II, Item 7. Management's Discussion and +Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2019." +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors, Transportation Systems and Agriculture and +Weather Analytics +segments. The following tables present details of total revenues for Fiscal 2020 as compared to Fiscal 2019: +Year Ended March 31, +2020 +2019 +$ Increase +% Change +(In thousands, except percentages) +Product revenues +$ +55,007 +$ +48,227 +$ +6,780 +14.1 +% +Service revenues +59,110 +50,896 +8,214 +16.1 +% +Total revenues +$ +114,117 +$ +99,123 +$ +14,994 +15.1 +% +Product +revenues primarily consist of Roadway Sensors product sales, but also include OEM products for the traffic signal markets, as well as Transportation Systems third-party product +sales for installation under certain construction-type contracts. Product revenues for Fiscal 2020 increased approximately 14.1% to $55.0 million, compared to $48.2 million in Fiscal +2019, primarily due to an increase in sales of our core Roadway Sensors video detection products, and to a lesser extent, increases in both unit sales from our distribution in Texas of certain OEM +products for the traffic intersection market and Transportation Systems third-party product sales for installation under certain construction-type contracts. +Service +revenues primarily consist of Transportation Systems engineering services, but also includes service revenues generated by our Roadway Sensors segment and the Agriculture and +Weather Analytics segment. Service revenues for Fiscal 2020 increased approximately 16.1% to $59.1 million, compared to $50.9 million in Fiscal 2019, primarily due to approximately +$6.4 million of revenues from the operations of AGI as well as higher Transportation Systems traffic engineering service revenues and to a lesser extent higher Agriculture and Weather Analytics +revenues. Total revenues for Fiscal 2020 increased approximately 15.1% to $114.1 million, compared to $99.1 million in Fiscal 2019. The increase in total revenues was primarily due to an +approximate 16.5% increase in Transportation +33 +Table of Contents +Systems +revenues, an approximate 13.5% increase in Roadway Sensors revenues, and an approximate 15.5% increase in Agriculture and Weather Analytics revenues. +Roadway +Sensors revenues in Fiscal 2020 included approximately $49.1 million in product revenues and approximately $0.3 million of service revenues, reflecting an increase +in total revenues of approximately $5.9 million or 13.5%, compared to Fiscal 2019, primarily due to higher sales from our core video detection products, as well as higher unit sales from our +distribution in Texas of certain OEM products for the traffic intersection market, which increased approximately $2.0 million or 54.1% to approximately $5.8 million. While OEM products +generally have lower gross margins than our core video detection products, we believe the offering of OEM products can benefit sales of our core products in Texas by providing a more comprehensive +suite of traffic solutions for our customers. Going forward, we plan to grow revenues by focusing on our core domestic traffic intersection market, and refining and delivering products that address +the needs of this market, primarily our Vantage processors and camera systems and our Vantage Vector video/radar hybrid sensor, as well as our SmartCycle, Velocity, PedTrax and SmartSpan products. +Transportation +Systems revenues in Fiscal 2020 included approximately $52.1 million of service revenues and approximately $5.9 million of sales of third-party products +purchased for installation under certain construction-type contracts, reflecting an increase in total revenues of approximately $8.2 million or 16.5%, compared to Fiscal 2019, primarily due to +approximately $6.4 million of revenues from the operations of AGI and an increase in Transportation Systems traffic engineering service revenues of approximately $1.1 million. +Transportation Systems added approximately $68.7 million of new backlog during the Fiscal 2020. Transportation Systems backlog increased to approximately $53.4 million as of +March 31, 2020, compared to approximately $44.5 million as of March 31, 2019. +We +plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with key agencies related to projects in their final project phases. While +we believe our ability to obtain additional large contracts will contribute to overall revenue growth, the mix of sub-consulting content and third-party product sales will likely affect the related +total gross profit from period to period, as total revenues derived from sub-consultants and third-party product sales generally have lower gross margins than revenues generated by our professional +services. +Agriculture +and Weather Analytics revenues in Fiscal 2020 included no product revenue and approximately $6.7 million of service revenues, largely consisting of subscription +revenues, reflecting an increase in total revenues of approximately $0.9 million or 15.5%, compared to Fiscal 2019. The increase was primarily due to increases in both ClearPath Weather and +ClearAg solutions under newly signed contracts during Fiscal 2020. +Gross Profit. The following tables present details of our gross profit for Fiscal 2020 compared to Fiscal 2019: +Year Ended March 31, +2020 +2019 +$ Increase +% Change +(In thousands, except percentages) +Product gross profit +$ +24,741 +$ +19,793 +$ +4,948 +25.0 +% +Service gross profit +23,020 +18,813 +4,207 +22.4 +% +Total gross profit +$ +47,761 +$ +38,606 +$ +9,155 +23.7 +% +Product gross margin as a % of product revenues +45.0 +% +41.0 +% +Service gross margin as a % of service revenues +38.9 +% +37.0 +% +Total gross margin as a % of total revenues +41.9 +% +38.9 +% +34 +Table of Contents +Our +product gross margin as a percentage of product revenues for Fiscal 2020 increased approximately 400 basis points compared to Fiscal 2019 primarily due to an increase in our Roadway +Sensors core +video detection products, which typically yields higher gross margins than our Roadway Sensors OEM sales and our Transportation Systems third-party product sales for installation under certain +construction-type contracts that we classify as product revenues. +Our +service gross margin as a percentage of service revenues for Fiscal 2020 increased 190 basis points compared to Fiscal 2019 primarily due to the completion of previously awarded +contracts, the timing of certain extension contracts, the contract mix and a decrease in the amount of related sub-consulting content of such contracts. Sub-consulting content generally results in +lower gross margins than our direct labor content. +Our +total gross margin as a percentage of total revenues for Fiscal 2020 increased 300 basis points compared to Fiscal 2019 primarily as a result of the revenue mix within our Roadway +Sensors and Transportation Systems segments. During Fiscal 2020, there was an increase in the percentage of revenue from our Roadway Sensors core video detection products as well as a decrease in the +percentage of revenue from our Transportation Systems sales of third-party products purchased for installation under certain construction-type contracts, both of which drove an increase in gross +margin. +Roadway +Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix between core products and third party OEM products, +competitive pricing requirements, product warranty costs and provisions for our excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining +activities, which we record as cost of goods sold. +We +recognize a portion of our Transportation Systems revenues and related gross profit over time using the costs incurred input method, where revenue is recognized based on the Company's +efforts or inputs toward satisfying a performance obligation, and the underlying mix of contract activity affects the related gross profit recognized in any given period. For the Transportation +Systems segment, we expect to experience gross profit variability in future periods due to our contract mix and the amount of related sub-consulting content of such contracts, as well as factors such +as our ability to efficiently utilize our internal workforce, which could cause fluctuations in our margins from period to period. +Selling, General and Administrative Expense +Selling, general and administration expense for Fiscal 2020 increased approximately 15.3% to $44.4 million, compared to +$38.5 million in Fiscal 2019. The increase was primarily due to expenses related to the acquisition of AGI, retention costs for certain Agriculture and Weather Analytics employees, and +executive severance costs. In connection with the AGI acquisition completed in July 2019, we added more than 40 employees, which has increased our selling, general and administrative expense in Fiscal +2020. +Research and Development Expense +Research and development expense for Fiscal 2020 increased approximately 10.3% to $8.6 million, compared to $7.8 million in Fiscal +2019. The overall increase was primarily due to continued investment in research and development activities largely focused on improving our existing software related product offerings. +During +Fiscal 2020, we invested in the development of further enhancements and functionality of the ClearAg and ClearPath Weather solutions in the Agriculture and Weather Analytics +segment and our Vantage products family in our Roadway Sensors segment. In our Transportation Systems segment, we invested in, and successfully released Iteris ClearGuide, our state-of-the-art +mobility intelligence platform, designed to help transportation agencies achieve safer, more efficient mobility for their +35 +Table of Contents +networks. +Going forward, we plan to continue to invest in Iteris ClearGuide and our Vantage products family. +In +both the current and prior year periods certain development costs were capitalized into intangible assets in the consolidated balance sheets; however, certain costs did not meet the +criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our solutions. This continued investment may result in +increases in research and development costs, as well as additional capitalized software in future periods. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2020 and 2019, we believe the carrying value of our goodwill was not impaired, as the +estimated fair values of our reporting units exceeded their carrying values at the end of Fiscal 2020 and 2019. If our actual financial results, or the +plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the +future. +Amortization of Intangible Assets +Amortization expense for intangible assets subject to amortization was approximately $1.5 million and $1.1 million for Fiscal 2020 +and Fiscal 2019, respectively. Approximately $736,000 and $850,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $757,000 and $275,000 was recorded to +amortization expense for Fiscal 2020 and Fiscal 2019, respectively, in the consolidated statements of operations. The increase in amortization was primarily due to amortization expenses related to +intangible assets acquired as part of the AGI acquisition. +Interest Income, Net +Net interest income was approximately $229,000 and $129,000 in Fiscal 2020 and Fiscal 2019, respectively. The increase in net interest income in +the current year was primarily due to interest earned on investments purchased and held during the current Fiscal year. +Income Taxes +The following table presents our (benefit) provision for income taxes for Fiscal 2020 and Fiscal 2019: +Year Ended +March 31, +2020 +2019 +(In thousands, +except percentages) +Provision (benefit) for income taxes +$ +160 +$ +36 +Effective tax rate +(3.1 +)% +(0.5 +)% +For +Fiscal 2020 and 2019, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it +appropriate to maintain valuation allowances of $14.2 million and $12.3 million against our deferred tax assets at March 31, +36 +Table of Contents +2020 +and 2019, respectively. We will continue to reassess the appropriateness of maintaining a valuation allowance. +As +we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective +tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to +the extent that we believe these assets will more likely than not be realized. +At +March 31, 2020, we had $10.7 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes. We had $7.3 million of +federal net operating loss carryforwards that begin to expire in 2038. We also had $8.7 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact +cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using +statutory tax rates. +On +March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the Pandemic. The CARES Act contains numerous income tax +provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. The CARES Act allows +net operating losses incurred in 2018, +2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The income tax provisions of the CARES Act had an immaterial impact +on our current taxes, deferred taxes, and uncertain tax positions of the Company. +Liquidity and Capital Resources +For a comparison of the 2019 to 2018 fiscal years, see Part II, Item 7. Management's Discussion and +Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2019." +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We expect to +continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least the next twelve months. However, we +may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to the public or to selected +investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may experience significant +dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure additional funding on a timely basis, +on terms acceptable to us, or at all. +At +March 31, 2020, we had $32.5 million in working capital, which included $14.4 million in cash and cash equivalents and $11.6 million in short-term +investments. This compares to working capital of $13.5 million at March 31, 2019, which included $7.1 million in cash and cash equivalents and $1.9 million in short-term +investments. +37 +Table of Contents +The +following table summarizes our cash flows for Fiscal 2020 and Fiscal 2019: +Year Ended +March 31, +2020 +2019 +(In thousands) +Net cash provided by (used in): +Operating activities +$ +(3,827 +) +$ +(5,828 +) +Investing activities +$ +(16,243 +) +$ +2,345 +Financing activities +$ +27,362 +$ +402 +Operating Activities. Cash used in our operations during Fiscal 2020 was primarily the result of our net loss of approximately +$5.6 million, +adjusted by approximately $6.9 million in non-cash items for noncash lease expense, deferred income taxes, depreciation, stock-based compensation, and amortization, offset by a decrease of +approximately $5.2 million from changes in working capital. +Cash +used in our operations during Fiscal 2019 was primarily the result of our net loss of approximately $7.8 million, adjusted by approximately $4.1 million in non-cash +items for deferred income taxes, depreciation, stock-based compensation, and amortization. The net loss was offset in part by approximately $2.1 million of working capital used in our +operations in Fiscal 2019. +Investing Activities. Net cash used in our investing activities during Fiscal 2020 was primarily the result of purchases of +approximately +$33.8 million of short-term investments and approximately $468,000 of property and equipment, as well as approximately $5.6 million in net cash paid for the AGI acquisition and +approximately $633,000 of capitalized software development, primarily in the Roadway Sensors and Transportation Systems business segments related to VantageLive! and Iteris ClearGuide, respectively. +These investments were partially offset by approximately $24.2 million in proceeds from the sale and maturity of short-term investments. +Net +cash provided by our investing activities during Fiscal 2019 was primarily the result of approximately $7.5 million in proceeds from the maturity of short-term investments and +approximately $107,000 in proceeds from the last earn-out payment related to the sale of the assets of the Vehicle Sensors segment in 2011. These amounts were partially offset by purchases of +approximately $4.1 million of short-term investments and approximately $486,000 of property and equipment as well as approximately $660,000 of capitalized software development primarily in the +Roadway Sensors business segment related to VantageLive! developments. +Financing Activities. Net cash provided by financing activities during Fiscal 2020 was the result of approximately +$26.8 million of proceeds +from the issuance of common stock in connection with the public offering, net of costs, of 6,182,797 shares of the Company's common stock on June 13, 2019. In addition, there was $370,000 of +cash proceeds from the purchase of ESPP shares and approximately $256,000 of cash proceeds from the exercises of stock options. +Net +cash provided by financing activities during Fiscal 2019 was primarily the result of approximately $365,000 of cash proceeds received from the purchases of Employee Stock Purchase +Plan ("ESPP") shares, and approximately $85,000 of cash proceeds from the exercise of stock options during Fiscal 2019. +Off-Balance Sheet Arrangements +We do not have any other material off-balance sheet arrangements at March 31, 2020. +38 +Table of Contents +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such sales in +our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally +impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal quarter due to +the increased number of holidays, causing a reduction in available billable hours. In addition, we have experienced seasonality related to certain ClearPath Weather services which adversely impacts +such sales in our first and second fiscal quarters, mainly because these services are generally not required during Spring and Summer when weather conditions are comparatively milder. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information +required by this Item. +39 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Consolidated Financial Statement +Report of Independent Registered Public Accounting Firm +41 +Consolidated Balance Sheets as of March 31, 2020 and 2019 +42 +Consolidated Statements of Operations for the fiscal years ended March 31, 2020, 2019 and 2018 +43 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 2020, 2019 and 2018 +44 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 2020, 2019 and 2018 +45 +Notes to Consolidated Financial Statements +46 +40 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the stockholders and the Board of Directors of Iteris, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2020 +and 2019, the related consolidated statements of operations, stockholders' equity, and cash flows, for each of the three years in the period ended March 31, 2020, and the related notes +(collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of +March 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2020, in conformity with accounting principles +generally accepted in the United States of America. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting +as of March 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of +Sponsoring Organizations of the Treadway Commission and our report dated June 9, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting. +Adoption of New Accounting Standard +As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases as of and +for the year ended March 31, 2020 due to the adoption of Accounting Standards Update 2016-02, Leases . +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's +financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal +securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We +conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the +financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial +statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in +the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the +financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ +Deloitte & Touche LLP +Costa +Mesa, CA +June 9, 2020 +We +have served as the Company's auditor since 2016. +41 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2020 +2019 +Assets +Current assets: +Cash and cash equivalents +$ +14,217 +$ +7,071 +Restricted cash +146 +— +Short-term investments +11,556 +1,935 +Trade accounts receivable, net of allowance for doubtful accounts of $802 and $539 at March 31, 2020 and 2019, respectively +17,569 +16,929 +Unbilled accounts receivable +10,352 +6,487 +Inventories +3,040 +2,916 +Prepaid expenses and other current assets +2,149 +1,367 +Total current assets +59,029 +36,705 +Property and equipment, net +1,942 +1,965 +Right-of-use assets +13,044 +— +Intangible assets, net +6,137 +3,286 +Goodwill +20,590 +15,150 +Other assets +1,215 +849 +Total assets +$ +101,957 +$ +57,955 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable +$ +8,355 +$ +9,441 +Accrued payroll and related expenses +8,441 +6,536 +Accrued liabilities +3,756 +2,370 +Deferred revenue +5,963 +4,883 +Total current liabilities +26,515 +23,230 +Deferred rent +— +455 +Lease liabilities +11,995 +— +Deferred income taxes +190 +65 +Unrecognized tax benefits +130 +150 +Total liabilities +38,830 +23,900 +Commitments and contingencies (Note 6) +Stockholders' equity: +Preferred stock, $1.00 par value: +Authorized shares—2,000 Issued and outstanding shares—none +— +— +Common stock, $0.10 par value: +Authorized shares—70,000 at March 31, 2020 and March 31, 2019 Issued and outstanding shares—40,713 at March 31, 2020 and 33,377 +at March 31, 2019 +4,071 +3,338 +Additional paid-in capital +176,209 +142,260 +Accumulated deficit +(117,153 +) +(111,543 +) +Total stockholders' equity +63,127 +34,055 +Total liabilities and stockholders' equity +$ +101,957 +$ +57,955 +See accompanying notes. +42 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2020 +2019 +2018 +Product revenues +$ +55,007 +$ +48,227 +$ +46,464 +Service revenues +59,110 +50,896 +57,265 +Total revenues +114,117 +99,123 +103,729 +Cost of product revenues +30,266 +28,434 +26,633 +Cost of service revenues +36,090 +32,083 +37,265 +Cost of revenues +66,356 +60,517 +63,898 +Gross profit +47,761 +38,606 +39,831 +Operating expenses: +Selling, general and administrative +44,383 +38,471 +37,400 +Research and development +8,597 +7,819 +7,945 +Amortization of intangible assets +757 +275 +88 +Total operating expenses +53,737 +46,565 +45,433 +Operating loss +(5,976 +) +(7,959 +) +(5,602 +) +Non-operating income (expense): +Other income (expense), net +297 +50 +(16 +) +Interest income, net +229 +129 +32 +Loss from continuing operations before income taxes +(5,450 +) +(7,780 +) +(5,586 +) +(Provision) benefit for income taxes +(160 +) +(36 +) +1,818 +Loss from continuing operations +(5,610 +) +(7,816 +) +(3,768 +) +Gain on sale of discontinued operation, net of tax +— +— +242 +Net loss +$ +(5,610 +) +$ +(7,816 +) +$ +(3,526 +) +Loss per share from continuing operations—basic and diluted +$ +(0.14 +) +$ +(0.23 +) +$ +(0.12 +) +Gain per share from sale of discontinued operation—basic and diluted +$ +— +$ +— +$ +0.01 +Net loss per share—basic and diluted +$ +(0.14 +) +$ +(0.23 +) +$ +(0.11 +) +Shares used in basic per share calculations +39,012 +33,266 +32,776 +Shares used in diluted per share calculations +39,012 +33,266 +32,776 +See accompanying notes. +43 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock +Additional +Paid-In +Capital +Accumulated +Deficit +Total +Stockholders' +Equity +Shares +Amount +Balance at March 31, 2017 +32,488 +$ +3,249 +$ +136,968 +$ +(99,993 +) +$ +40,224 +Stock option exercises +591 +59 +1,131 +— +1,190 +Stock-based compensation +— +— +1,781 +— +1,781 +Issuance of shares pursuant +— +to vesting of restricted stock units, +— +net of payroll withholding taxes +107 +10 +(158 +) +— +(148 +) +Net loss +(3,526 +) +(3,526 +) +Balance at March 31, 2018 +33,186 +$ +3,318 +$ +139,722 +$ +(103,519 +) +$ +39,521 +Adoption of ASU 2014-09 (see Note 1) +(208 +) +(208 +) +Stock option exercises +43 +4 +81 +— +85 +Issuance of shares pursuant +to Employee Stock Purchase Plan +92 +10 +355 +— +365 +Stock-based compensation +— +— +2,156 +— +2,156 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +56 +6 +(54 +) +— +(48 +) +Net loss +(7,816 +) +(7,816 +) +Balance at March 31, 2019 +33,377 +$ +3,338 +$ +142,260 +$ +(111,543 +) +$ +34,055 +Issuance of common stock in connection with public offerring, net of costs +6,183 +618 +26,133 +— +26,751 +Stock option exercises +120 +12 +244 +— +256 +Issuance of shares pursuant to Employee Stock Purchase Plan +91 +9 +361 +— +370 +Stock-based compensation +— +— +2,785 +— +2,785 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes +73 +7 +(22 +) +— +(15 +) +Issuance of common stock in connection with acquisition +869 +87 +4,448 +— +4,535 +Net loss +(5,610 +) +(5,610 +) +Balance at March 31, 2020 +40,713 +$ +4,071 +$ +176,209 +$ +(117,153 +) +$ +63,127 +See accompanying notes. +44 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Iteris, Inc. +Year Ended March 31, +2020 +2019 +2018 +Cash flows from operating activities +Net loss +$ +(5,610 +) +$ +(7,816 +) +$ +(3,526 +) +Adjustments to reconcile net loss to net cash used in operating activities: +Right-of-use asset non-cash expense +1,772 +— +— +Deferred income taxes +105 +(18 +) +(660 +) +Depreciation of property and equipment +848 +854 +819 +Stock-based compensation +2,785 +2,156 +1,781 +Amortization of intangible assets +1,492 +1,125 +726 +Gain on sale of discontinued operation, net of tax +— +— +(242 +) +Loss on disposal of equipment +— +— +16 +Other +(60 +) +— +— +Changes in operating assets and liabilities, net of effects of discontinued operation and acquisition: +Trade accounts receivable +265 +(4,063 +) +1,433 +Unbilled accounts receivable and deferred revenue +(2,438 +) +457 +(166 +) +Inventories +(124 +) +5 +(671 +) +Prepaid expenses and other assets +(987 +) +902 +(693 +) +Trade accounts payable and accrued expenses +(534 +) +570 +915 +Operating lease liabilities +(1,341 +) +— +— +Net cash used in operating activities +(3,827 +) +(5,828 +) +(268 +) +Cash flows from investing activities +Purchases of property and equipment +(468 +) +(486 +) +(1,079 +) +Purchase of short term investments +(33,786 +) +(4,079 +) +(5,319 +) +Maturities of investments +24,225 +7,463 +— +Capitalized software development costs +(633 +) +(660 +) +(2,936 +) +Cash paid in business acquisition, net of cash acquired +(5,581 +) +— +— +Net proceeds from sale of business segment +— +107 +511 +Net cash (used in) provided by investing activities +(16,243 +) +2,345 +(8,823 +) +Cash flows from financing activities +Proceeds from stock option exercises +256 +85 +1,190 +Proceeds from ESPP purchases +370 +365 +— +Tax withholding payments for net share settlements of restricted stock units +(15 +) +(48 +) +(148 +) +Proceeds from issuance of common stock, net of costs +26,751 +— +— +Net cash provided by financing activities +27,362 +402 +1,042 +Increase (decrease) in cash, cash equivalents and restricted cash +7,292 +(3,081 +) +(8,049 +) +Cash, cash equivalents and restricted cash at beginning of period +7,071 +10,152 +18,201 +Cash, cash equivalents and restricted cash at end of period +$ +14,363 +$ +7,071 +$ +10,152 +Supplemental cash flow information: +Cash paid during the year for: +Income taxes +$ +63 +$ +4 +$ +130 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units +$ +7 +$ +6 +$ +10 +Issuance of common stock in connection with acquisition +$ +4,535 +$ +— +$ +— +Lease liabilities arising from obtaining right-of-use assets +$ +581 +$ +— +$ +— +Capitalized software development costs included in accounts payable and accrued expenses +$ +— +$ +— +$ +102 +Landlord contribution for tenant improvements +$ +— +$ +— +$ +145 +See accompanying notes. +45 +Table of Contents +Notes to Consolidated Financial Statements +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), +in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions . Municipalities, government agencies, and other transportation +infrastructure providers use our solutions to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, we offer a comprehensive range of ITS technology solutions to our customers throughout +the U.S. and internationally through a combination intellectual property, products, and SaaS offerings. +Prior +to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling +techniques to offer smart content and analytical solutions that provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food +companies, and agricultural equipment manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on the roads we travel. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market and always exploring strategic alternatives intended to optimize the value of all of our businesses. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Recent Developments +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net +proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately +$6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm +headquartered in Tampa, Florida (see Note 11 for further details on the acquisition of AGI), and plans to use the balance of the net proceeds for general corporate purposes and possibly for +other future acquisitions. +Coronavirus +In March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of a novel strain of +coronavirus, COVID-19 ("the Pandemic"). The Pandemic is having an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, such as travel +restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our +vendors, our employees and customers and customer sentiment in general. Continued impacts of the Pandemic have materially adversely impacted global economic +46 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +conditions, +and could impact our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results and volatility of our stock +price will depend largely on future developments, including the duration of the spread of the outbreak, the impact on capital and financial markets and the related impact on the financial +circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of this report. +Sale of Segment +On May 5, 2020, pursuant to an Asset Purchase Agreement (the "Purchase Agreement") entered in on May 2, 2020, the Company sold the +assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather product lines, to DTN, LLC ("DTN"), an operating company of TBG AG, a Swiss-based holding +company. As of March 31, 2020, the Company determined that Agriculture and Weather Analytics did not meet the held for sale classification criteria under Accounting Standard Codification Topic +360 ("ASC 360"), and as such, Agriculture and Weather Analytics assets and liabilities as of March 31, 2020, and the results of operations for all periods presented are not classified as held +for sale and are included in continuing operations in the consolidated financial statements. See Note 14 for further details on the sale of the Agriculture and Weather Analytics segment. +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and all its subsidiaries and have been prepared in accordance +with generally accepted accounting principles in the United States of America ("GAAP"). All intercompany accounts and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions +that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses +during the reporting period. Actual results could differ from those estimates. Significant estimates made in the preparation of the consolidated financial statements include the collectability of +accounts receivable and related allowance for doubtful accounts, projections of taxable income used to assess realizability of deferred tax assets, warranty reserves, costs to complete long-term +contracts, indirect cost rates used in cost plus contracts, the valuation of purchased intangible assets and goodwill, the valuation of equity instruments, estimates of future cash flows used to +assess the recoverability of long-lived assets and the impairment of goodwill, and fair value of our stock option awards used to calculate the stock-based compensation. +Revenue Recognition +Revenues are recognized when control of the promised goods or services are transferred to our customers, in a gross amount that reflects the +consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +Product +revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase +orders are +47 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +short-term +in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best +represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service +revenues, primarily derived from the Transportation Systems and Agriculture and Weather Analytics segments, are primarily from long-term engineering and consulting service +contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using +the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as +the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") +contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the +Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon +inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to +consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service +revenues also consist of revenues derived from maintenance and support, as well as the use of the Company's service platforms and APIs on a subscription basis. We generate this +revenue from fees +for maintenance and support, monthly active user fees, software-as-a-service ("SaaS") fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single +performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company +applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the +transfer of services as the customer obtains equal benefit from the service throughout the service period. +The +Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the +products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer which combines the software functionality, maintenance +and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each constituting a separate performance obligation. +We +generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We +include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the +variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our +anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +48 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The +Company's typical performance obligations include the following: +Performance Obligation +When Performance +Obligation is Typically +Satisfied +When Payment is +Typically Due +How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product +Upon shipment (point in time) +Within 30 days of delivery +Observable transactions +Engineering services where the deliverable is considered a product +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services +As work is performed (over time) +Within 30 days of services being invoiced +Estimated using a cost-plus margin approach +SaaS +Over the course of the SaaS service once the system is available for use (over time) +At the beginning of the contract period +Estimated using a cost-plus margin approach +Disaggregation of Revenue +The +Company disaggregates revenue from contracts with customers into reportable segments and the nature of the products and services. See Note 12 for our revenue +by reportable segment. +Trade Accounts Receivable and Contract Balances +We +classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is +unconditional (i.e. only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in our consolidated balance sheet at their net +estimated realizable value. +The +Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is increased by the +Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are +deducted from the allowance. +49 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +A +contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable on the +accompanying balance sheet. For example, we would record a contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified +milestones. +Our +contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in +advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The +Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of +other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be +recovered. As of March 31, 2020 and 2019, there was approximately $1,236,000 and $172,000, respectively, of contract fulfillment costs which are +presented in the accompanying consolidated balance sheets as prepaid and other current assets. These costs primarily relate to the satisfaction of performance obligations related to the set up of SaaS +platforms. These costs are amortized on a straight-line basis over the estimated useful life of the SaaS platform. +Transaction Price Allocated to the Remaining Performance Obligations +As +of March 31, 2020 and 2019, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial primarily as a result of +termination provisions within our contracts which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF +qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the +contract and reassess the estimate each reporting period. +The +Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected +duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The +Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC +340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have +recognized is one year or less. +The +Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping +and handling costs are included as cost of revenues in the period during which the products ship. +50 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The +Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing +transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net +basis (excluded from revenues) in the Company's consolidated statements of operations. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of refund liabilities related to billings and consideration +received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade +accounts receivable. +Cash +and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of +insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal +credit risk. +Our +accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, South America and Asia. We generally do not require +collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's +expectations. +We +currently have, and historically have had, a diverse customer base. For the fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than +10% of our total revenues. For the fiscal years ended March 31, 2019 ("Fiscal 2019") and March 31, 2018 ("Fiscal 2018"), one individual customer represented approximately 24% and 22%, +respectively, of our total revenues. As of March 31, 2020 and 2019, no individual customer represented greater than 10% of our total accounts receivable. +Fair Values of Financial Instruments +The fair value of cash equivalents, receivables, accounts payable and accrued expenses approximate carrying value because of the short period of +time to maturity. Our investments are measured at fair value on a recurring basis. +The +framework for measuring fair value and related disclosure requirements about fair value measurements are provided in ASC 820, Fair Value +Measurements ("ASC 820"). This pronouncement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most +advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy proscribed by ASC 820 contains three levels as +follows: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +51 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +Cash, Cash Equivalents and Restricted Cash +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +Restricted +cash as of March 31, 2020 consisted of $146,000 related to cash restricted for shares purchased under the Employee Stock Purchase Plan ("ESPP") (see Note 9 for +further details on the ESPP). +Cash, +cash equivalents and restricted cash presented in the accompanying statements of cash flows consist of the following (in thousands): +Year Ended March 31, +2020 +2019 +Cash and cash equivalents +$ +14,217 +$ +7,071 +Restricted cash +146 +— +$ +14,363 +$ +7,071 +Investments +The Company's investments are classified as either held-to-maturity, available-for-sale or trading, in accordance with ASC 320. Held-to-maturity +securities are those securities that the Company has the positive intent and ability to hold until maturity. Trading securities are those securities that the Company intends to sell in the near term. +All other securities not included in the held-to-maturity or trading category are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost which approximates fair +market value. Trading securities are carried at fair value with unrealized gains and losses charged to earnings. Available-for-sale securities are carried at fair value with unrealized gains and +losses recorded within accumulated other comprehensive loss as a separate component of stockholders' equity. ASC 820 defines fair value as the price that would be received to sell an asset or paid to +transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of +observable inputs, where available (see Note 4). As of March 31, 2020, all of our investments are available-for-sale. +Under +ASC 320-10-35, a security is considered to be other-than-temporarily impaired if the present value of cash flows expected to be collected are less than the security's amortized +cost basis (the difference being defined as the "Credit Loss") or if the fair value of the security is less than the security's amortized cost basis and the investor intends, or will be required, to +sell the security before +52 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +recovery +of the security's amortized cost basis. If an other-than-temporary impairment exists, the charge to earnings is limited to the amount of Credit Loss if the investor does not intend to sell +the security, and will not be required to sell the security, before recovery of the security's amortized cost basis. Any remaining difference between fair value and amortized cost is recognized in +other comprehensive loss, net of applicable taxes. The Company evaluates whether the decline in fair value of its investments is other-than-temporary at each quarter-end. This evaluation consists of a +review by management, and includes market pricing information and maturity dates for the securities held, market and economic trends in the industry and information on the issuer's financial condition +and, if applicable, information on the guarantors' financial condition. Factors considered in determining whether a loss is temporary include the length of time and extent to which the investment's +fair value has been less than its cost basis, the financial condition and near-term prospects of the issuer and guarantors, including any specific events which may influence the operations of the +issuer and the Company's intent and ability to retain the investment for a reasonable period of time sufficient to allow for any anticipated recovery of fair value. +Allowance for Doubtful Accounts +The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our +customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will +record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. We also maintain an allowance based on our +historical collections experience. When we determine that collection is not likely, we write off accounts receivable against the allowance for doubtful accounts. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or net realizable value. Cost is +determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life ranging from three +to eight years. Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Intangible Assets +Intangible assets with determinable economic lives are carried at cost, less accumulated amortization. Amortization is computed over the +estimated useful life of each asset on a straight-line basis. The Company determines the useful lives of identifiable intangible assets after +considering the specific facts and circumstances related to each intangible asset. Factors the Company considers when determining useful lives include the contractual term of any agreement related to +the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset and other +economic factors, including competition and specific market conditions. +53 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Goodwill and Long-Lived Assets +The Company has the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of a +reporting unit is less than its carrying value. However, the Company may elect to bypass the qualitative assessment and proceed directly to the quantitative impairment tests. The first step of the +impairment test involves comparing the fair value of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, the Company would perform the second +step of the goodwill impairment test to determine the amount of the impairment loss. We perform an annual qualitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, +to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce +the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then +goodwill is not considered to be impaired and no further testing is required, if otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying +amount of a reporting unit exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. +We monitor the indicators for goodwill impairment testing between annual tests. As of March 31, 2020 and 2019, we determined that no adjustments to the carrying value of goodwill were required. +We +test long-lived assets and purchased intangible assets (other than goodwill) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an +asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an +impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets +and purchased intangible assets. As of March 31, 2020 and 2019, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary +differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation +allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. +As such, we determined it was appropriate to record a full valuation allowance against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +Income +tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are +recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are +derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +54 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of +our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options and restricted stock units. The +fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. While utilizing this model meets established requirements, the +estimated fair values generated by it may not be indicative of the actual fair values of our common stock option awards as it does not consider certain factors important to those awards to employees, +such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common +stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned +stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Right-of-Use Assets and Lease Liabilities +We determine if an arrangement contains a lease at inception and determine the classification of the lease, as either operating or finance, at +commencement. +Right-of-use +assets and lease liabilities are recorded based on the present value of future lease payments which factors in certain qualifying initial direct costs incurred as well as +any lease incentives received. If an implicit rate is not readily determinable, we utilize inputs from third-party lenders to determine the appropriate discount rate. Lease expense for operating lease +payments are recognized on a straight-line basis over the lease term. Finance leases incur interest expense using the effective interest method in addition to amortization of the leased asset on +straight-line basis, both over the applicable lease term. Lease terms may factor in options to extend or terminate the lease. +We +adhere to the short-term lease recognition exemption for all classes of assets (i.e. facilities and equipment). As a result, leases with an initial term of twelve months or +less are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. In addition, for certain equipment leases, we account for lease and non-lease components, +such as services, as a single lease component as permitted. +55 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to +various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We +accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The +accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. We do not provide any service-type warranties. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to +one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and +maintenance costs are charged to expense as incurred. +Comprehensive Loss +The difference between net loss and comprehensive loss was de minimis for the Fiscal 2020, Fiscal 2019, and Fiscal 2018. +Recent Accounting Pronouncements +In February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). ASU No. 2016-02 establishes a right-of-use model that +requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either "finance" or +"operating," with classification affecting the pattern of expense +recognition in the income statement. This update was effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. As a result of the adoption of +ASU 2016-02, on April 1, 2019, the Company recognized (a) an operating lease liability of $14.2 million, which represents the present value of our remaining lease payments and +(b) a related right-of-use asset of $13.4 million. In addition, the Company derecognized approximately $827,000 of deferred rent liability. The adoption of ASU 2016-02 did not have a +material impact on the Company's statement of operations, cash flows, or stockholders' equity. Due to the adoption of the standard using the modified retrospective cumulative-effect adjustment method, +there are no changes to our previously reported results prior to April 1, 2019. See Note 7, Right-of-Use Assets and Lease Liabilities, for additional details. +In +August 2018, the FASB issued Accounting Standards Update ("ASU") No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure +Requirement for Fair Value Measurements ("ASU 2018-13"), which modifies the disclosure requirements on fair value measurements. This update is effective for fiscal years, and interim periods within +those years, beginning after December 15, 2019, and early adoption is permitted. We have completed our preliminary assessment and do not anticipate this pronouncement will have a significant +impact on our consolidated financial statements upon adoption. +In +August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal Use Software (subtopic 350-40): Customer's Accounting for +Implementation Costs Incurred in a Cloud +56 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Computing +Arrangement That Is a Service Contract ("ASU 2018-15"), which clarifies the accounting for implementation costs in cloud computing arrangements. This update is effective for fiscal years, +and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. We have completed our preliminary assessment and do not anticipate this pronouncement +will have a significant impact on our consolidated financial statements upon adoption. +In +June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This update requires that +certain financial assets be measured at amortized cost net of an allowance for estimated credit losses such that the net receivable represents the present value of expected cash collection. In +addition, this standard update requires that certain financial assets be measured at amortized cost reflecting an allowance for estimated credit losses expected to occur over the life of the assets. +The estimate of credit losses must be based on all relevant information including historical information, current conditions and reasonable and supportable forecasts that affect the collectability of +the amounts. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective +Dates, which defers the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting +companies that are not smaller reporting companies. As a smaller reporting company, ASU 2016-13 will now be effective for our fiscal year 2024 beginning April 1, 2023; however, early adoption +is permitted. We are currently evaluating the timing and impact of adopting ASU 2016-13 on our consolidated financial statements. +In +July 2019, the FASB issued ASU 2019-07, "Codification Updates to SEC Sections". This update simplifies the guidance in various sections that was duplicative, redundant or outdated. +The Company adopted this update effective July 2019. It did not have a material impact on our consolidated financial statements upon adoption. +In +December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. The ASU removes certain exceptions to the general +principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This ASU is effective for fiscal years beginning after December 15, 2020, +including interim periods within that fiscal year, with early adoption permitted. The Company is currently evaluating the impact of this ASU, however we do not anticipate this pronouncement will have +a significant impact on our consolidated financial statements upon adoption. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2020 +2019 +(In thousands) +Materials and supplies +$ +1,380 +$ +1,517 +Work in process +162 +356 +Finished goods +1,498 +1,043 +$ +3,040 +$ +2,916 +57 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +2. Supplementary Financial Information (Continued) +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2020 +2019 +(In thousands) +Equipment +$ +7,134 +$ +6,444 +Leasehold improvements +3,009 +2,939 +Accumulated depreciation +(8,201 +) +(7,418 +) +$ +1,942 +$ +1,965 +Depreciation +expense was approximately $848,000, $854,000 and $819,000 in Fiscal 2020, Fiscal 2019 and Fiscal 2018, respectively. Approximately $291,000, $286,000 and $288,000 of the +depreciation expense was recorded to cost of revenues, and approximately $557,000, $568,000 and $531,000 was recorded to operating expenses in Fiscal 2020, Fiscal 2019 and Fiscal 2018, respectively, +in the consolidated statements of operations. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, 2020 +March 31, 2019 +Gross +Carrying +Amount +Accumulated +Amortization +Net +Book +Value +Gross +Carrying +Amount +Accumulated +Amortization +Net +Book +Value +(In thousands) +Technology +$ +1,856 +$ +(1,856 +) +$ +— +$ +1,856 +$ +(1,856 +) +$ +— +Customer contracts / relationships +4,250 +(1,188 +) +3,062 +750 +(750 +) +— +Trade names and non-compete agreements +1,320 +(1,163 +) +157 +1,110 +(1,110 +) +— +Capitalized software development costs +6,400 +(3,482 +) +2,918 +5,768 +(2,482 +) +3,286 +Total +$ +13,826 +$ +(7,689 +) +$ +6,137 +$ +9,484 +$ +(6,198 +) +$ +3,286 +Amortization +expense for intangible assets subject to amortization was approximately $1.5 million, $1.1 million and $726,000 for Fiscal 2020, Fiscal 2019 and Fiscal 2018, +respectively. Approximately $736,000, $850,000 and $638,000 of the intangible asset amortization was recorded to cost of revenues, and approximately $757,000, $275,000 and $88,000 was recorded to +amortization expense for Fiscal 2020, Fiscal 2019 and Fiscal 2018, respectively, in the consolidated statements of operations. The weighted average remaining useful lives of the intangible assets as +of March 31, 2020 is 5.3 years. +We +do not have any intangible assets with indefinite useful lives. Our net customer contracts/relationships have a useful life of 6 years beginning Fiscal 2020. Our net tradenames +and non-compete agreements have a useful life of 3 years beginning Fiscal 2020. Our net capitalized software development costs of approximately $2.9 million and $3.3 million +primarily consisted of our Oracle Enterprise Resource Planning ("ERP") system design and implementation of approximately +58 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +2. Supplementary Financial Information (Continued) +$1.9 million +and $2.2 million as of March 31, 2020 and 2019, respectively, which has a useful life of 10 years beginning Fiscal 2019. +As +of March 31, 2020, the future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2021 +$ +1,419 +2022 +1,234 +2023 +1,010 +2024 +879 +2025 +849 +Thereafter +746 +$ +6,137 +Goodwill +The following table presents the carrying value of our goodwill by reportable segments for Fiscal 2018, Fiscal 2019 and Fiscal 2020: +Roadway +Sensors +Transportation +Systems +Ag & Weather +Analytics +Total +(In thousands) +Balance—March 31, 2018 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +Balance—March 31, 2019 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +6,936 +$ +— +$ +15,150 +Balance—March 31, 2020 +Goodwill +$ +8,214 +$ +14,906 +$ +2,168 +$ +25,288 +Acquired goodwill (see Note 11) +— +5,440 +— +5,440 +Accumulated impairment losses +— +(7,970 +) +(2,168 +) +(10,138 +) +$ +8,214 +$ +12,376 +$ +— +$ +20,590 +59 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +2. Supplementary Financial Information (Continued) +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Balance at beginning of fiscal year +$ +463 +$ +403 +$ +278 +Additions charged to cost of sales +649 +647 +623 +Warranty claims +(696 +) +(587 +) +(498 +) +Balance at end of fiscal year +$ +416 +$ +463 +$ +403 +Earnings Per Share +The following table sets forth the computation of basic and diluted loss from continuing operations per share: +Year Ended March 31, +2020 +2019 +2018 +(In thousands, except per +share amounts) +Numerator: +Loss from continuing operations +$ +(5,610 +) +$ +(7,816 +) +$ +(3,768 +) +Gain on sale of discontinued operation, net of tax +— +— +242 +Net loss +$ +(5,610 +) +$ +(7,816 +) +$ +(3,526 +) +Denominator: +Weighted average common shares used in basic and diluted computation +39,012 +33,266 +32,776 +Loss from continuing operations per share: +Basic +$ +(0.14 +) +$ +(0.23 +) +$ +(0.12 +) +Diluted +$ +(0.14 +) +$ +(0.23 +) +$ +(0.12 +) +The +following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted loss per share from continuing operations as +their effect would have been anti-dilutive: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Stock options +6,190 +5,056 +3,917 +Restricted stock units +110 +12 +228 +60 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +3. Sale of Vehicle Sensors +On July 29, 2011, we completed the sale (the "Asset Sale") of substantially all of our assets used in connection with our prior Vehicle Sensors segment to Bendix Commercial +Vehicle Systems LLC ("Bendix"), a member of Knorr Bremse Group. In connection with the Asset Sale, we are entitled to additional consideration in the form of the following performance and +royalty related earn-outs: Bendix was obligated to pay us an amount in cash equal to 85% of revenue associated with royalties received under our license and distribution agreements with Audiovox +Electronics Corporation and Valeo +Schalter and Sensoren GmbH through December 31, 2017, subject to certain reductions and limitations set forth in the asset purchase agreement. From the date of the Asset Sale, through +March 31, 2019, we received approximately $2.7 million in connection with royalty-related earn-outs provisions for a total of $18 million in cash received from the Asset Sale. +In +accordance with applicable accounting guidance, we determined that the Vehicle Sensors segment, which constituted one of our operating segments, qualified as a discontinued operation. +For the fiscal years ended March 31, 2020, March 31, 2019, and 2018, we recorded a gain on sale of discontinued operation of approximately $0, $0 and $242,000, respectively, net of tax, +related to the earn-out provisions of the asset purchase agreement. +4. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset +or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair +value. These tiers include: +Level 1—Quoted +prices in active markets for identical assets or liabilities. +Level 2—Observable +inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities +in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs +that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or +liability. +We +did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2020 or 2019. Our +non-financial assets, such as goodwill, intangible assets, property and equipment, and acquired assets and liabilities assumed are measured at fair value on a non-recurring basis, generally when there +is a transaction involving those assets such as a purchase transaction, a business combination or an adjustment for impairment. In Fiscal 2020, Fiscal 2019 and Fiscal 2018, Level 3 inputs were +used to evaluate the fair value of our goodwill in our two reporting units that had goodwill balances. No other non-financial assets were measured at fair value during the fiscal years ended +March 31, 2020, March 31, 2019 and March 31, 2018. +61 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +4. Fair Value Measurements (Continued) +The +following tables present the Company's financial assets that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +As of March 31, 2020 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair Value +(In thousands) +Level 1: +Money market funds +$ +10,576 +$ +(1 +) +$ +— +$ +10,575 +Subtotal +10,576 +(1 +) +— +10,575 +Level 2: +Commercial paper +1,495 +(1 +) +— +1,494 +Corporate notes and bonds +6,044 +(22 +) +— +6,022 +US Treasuries +3,013 +— +20 +3,033 +US Government agencies +1,007 +— +— +1,007 +Subtotal +11,559 +(23 +) +20 +11,556 +Total +$ +22,135 +$ +(24 +) +$ +20 +$ +22,131 +As of March 31, 2019 +Amortized +Cost +Gross +Unrealized +Loss +Gross +Unrealized +Gain +Estimated +Fair Value +(In thousands) +Level 1: +Money market funds +$ +3,338 +$ +— +$ +— +$ +3,338 +Subtotal +3,338 +— +— +3,338 +Level 2: +Commercial paper +— +— +— +Corporate notes and bonds +1,434 +(1 +) +— +1,433 +US Treasuries +502 +— +— +502 +Subtotal +1,936 +(1 +) +— +1,935 +Total +$ +5,274 +$ +(1 +) +$ +— +$ +5,273 +Unrealized +losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than +not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, +2020. +62 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +5. Income Taxes +The components of current and deferred federal and state income tax (benefits) provision are as follows: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Loss from continuing operations before income taxes +$ +(5,450 +) +$ +(7,780 +) +$ +(5,586 +) +Current income tax provision: +Federal +— +— +3 +State +34 +36 +45 +Total current tax provision +34 +36 +48 +Deferred income tax benefit: +Federal +105 +— +(1,849 +) +State +21 +— +(17 +) +Total deferred benefit provision +126 +— +(1,866 +) +Provision (benefit) for income taxes on continued operations +160 +36 +(1,818 +) +Loss from continuing operations, net of taxes +$ +(5,610 +) +$ +(7,816 +) +$ +(3,768 +) +The +reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Benefit for income taxes at statutory rates +$ +(1,095 +) +$ +(1,634 +) +$ +(1,720 +) +Change in federal tax rate +— +— +4,134 +State income taxes net of federal benefit +(198 +) +(620 +) +(255 +) +Tax credits +(658 +) +(343 +) +(567 +) +Compensation charges +151 +199 +(324 +) +Change in valuation allowance +1,913 +2,385 +(3,153 +) +Other +47 +49 +67 +Provision (benefit) for income taxes +$ +160 +$ +36 +$ +(1,818 +) +63 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +5. Income Taxes (Continued) +The +components of deferred tax assets and liabilities are as follows: +March 31, +2020 +2019 +(In thousands) +Deferred tax assets: +Net operating losses +$ +4,284 +$ +5,335 +Capitalized R&D +3,520 +2,347 +Credit carry forwards +3,510 +2,806 +Deferred compensation and payroll +2,304 +1,655 +Bad debt allowance and other reserves +656 +618 +Deferred rent +— +202 +Operating leases +219 +— +Property and equipment +60 +139 +Other, net +556 +309 +Total deferred tax assets +15,109 +13,411 +Valuation allowance +(14,163 +) +(12,250 +) +Total deferred tax assets, net of valuation allowance +946 +1,161 +Deferred tax liabilities: +Acquired intangibles +(596 +) +(759 +) +Goodwill +(540 +) +(467 +) +Total deferred tax liabilities +(1,136 +) +(1,226 +) +Net deferred tax liabilities +$ +(190 +) +$ +(65 +) +At +March 31, 2020, we had $551,000 in federal alternative minimum tax credit carryforwards, which were classified as a current income tax receivable included in the prepaid +expenses and other current assets in the accompanying consolidated balance sheet. We also had $2.5 million in federal research credits that begin to expire in 2031 and $1.3 million in +state tax credits that begin to expire in 2023. We +had $10.7 million of federal net operating loss carryforwards at March 31, 2020 that do not expire as a result of recent tax law changes. We had $7.3 million of federal net +operating loss carryforwards at March 31, 2020 that begin to expire in 2038. We also had $8.7 million of state net operating loss carryforwards at March 31, 2020 that begin to +expire in 2036. +In +assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, +projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it +appropriate to maintain valuation allowances of $14.2 million and $12.3 million against our deferred tax assets at March 31, 2020 and 2019, respectively. We will continuously +reassess the appropriateness of maintaining a valuation allowance. +On +March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the Pandemic. The CARES Act contains numerous income tax +provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. The CARES Act allows +net operating losses incurred +64 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +5. Income Taxes (Continued) +in +2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The income tax provisions of the CARES Act had an +immaterial impact on our current taxes, deferred taxes, and uncertain tax positions of the Company. +Unrecognized Tax Benefits +As of March 31, 2020 and 2019, our gross unrecognized tax benefits were approximately $952,000 and $687,000, respectively, of which +approximately $861,000, and $580,000, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are approximately +$840,000 and $609,000, respectively. +A +reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Gross unrecognized tax benefits at beginning of year +$ +687 +$ +586 +$ +426 +Increases for tax positions taken in prior years +101 +2 +62 +Decreases for tax positions taken in prior years +— +— +— +Increases for tax positions taken in the current year +180 +116 +122 +Lapse in statute of limitations +(16 +) +(17 +) +(24 +) +Gross unrecognized tax benefits at March 31 +$ +952 +$ +687 +$ +586 +We +do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We +are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2017 or later, and state and local income tax examination for fiscal tax years ended March 31, 2016 or +later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax +authorities. +6. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural +industries, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company +cannot accurately predict the outcome of any such litigation, the Company is not a party to any legal proceeding, the outcome of which, in management's opinion, individually or in the aggregate, would +have a material effect on the Company's consolidated results of operations, financial position or cash flows. +Related Party Transaction +We previously subleased office space to Maxxess Systems, Inc. ("Maxxess"), one of our former subsidiaries that we sold in September 2003. +The sublease terminated in September 2007, at which time +65 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +6. Commitments and Contingencies (Continued) +Maxxess +owed us an aggregate of $274,000. Maxxess executed a promissory note for such amount, which was subsequently amended and restated on July 23, 2013, August 11, 2016 and on +August 11, 2018. The amended and restated note bears interest at a rate of 6% per annum, compounded annually, with accrued interest payable annually on the first business day of each calendar +year. When authorized by the Company, Maxxess may pay down the balance of this note by providing consulting services to Iteris. We had previously fully reserved for amounts owed to us by Maxxess. +During Fiscal 2020, the full amount due was paid to the Company, and a gain of approximately $146,000 was recognized in other income on the accompanying consolidated statements of operations. As of +March 31, 2020, no amounts are outstanding and payable to Iteris. Maxxess is currently owned by an investor group that includes, among others, two former Iteris directors, who have not been +directors of Iteris since September 2013 and March 2020. These former directors currently own less than 2% of Maxxess' capital stock. +7. Right-of-Use Assets and Lease Liabilities +We have various operating leases for our offices, office equipment and vehicles in the United States. These leases expire at various times through 2029. Certain lease agreements contain +renewal options from 1 to 5 years, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. +Through +March 31, 2019, we recognized rent expense related to operating leases on a straight-line basis over the lease term and, accordingly, recorded the difference between rent +payments and rent expense as a deferred rent liability. Effective April 1, 2019, we adopted ASU 2016-02, Leases, or ASC 842. +The +table below presents lease-related assets and liabilities recorded on the consolidated balance sheet as follows: +Classification +March 31, 2020 +(In thousands) +Assets +Operating lease right-of-use-assets +Right-of-use assets +$ +13,044 +Liabilities +Operating lease liabilities (short-term) +Accrued liabilities +$ +1,935 +Operating lease liabilities (long-term) +Lease liabilities +11,995 +Total lease liabilities +$ +13,930 +Lease Costs +For Fiscal 2020, Fiscal 2019 and Fiscal 2018, lease costs totaled approximately $2.6 million, $1.9 million and +$1.8 million, respectively. The Company currently has no variable lease costs. +66 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +7. Right-of-Use Assets and Lease Liabilities (Continued) +Supplemental Information +The table below presents supplemental information related to operating leases during the fiscal year ended March 31, 2020 (in thousands, +except weighted average information): +Cash paid for amounts included in the measurement of operating lease liabilities +$ +2,608 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ +581 +Weighted average remaining lease term +7.0 +Weighted average discount rate +5.0 +% +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the operating lease +liabilities recorded on the consolidated balance sheet as of March 31, 2020: +Fiscal Year Ending March 31, +(In thousands) +2021 +$ +2,577 +2022 +2,457 +2023 +2,326 +2024 +2,248 +2025 +2,062 +Thereafter +4,852 +Total lease payments +16,522 +Less imputed interest +(2,592 +) +Present value of future lease payments +13,930 +Less current obligations under leases +(1,935 +) +Long-term lease obligations +$ +11,995 +Disclosure Related to Periods Prior to Adoption of New Lease Standard +Minimum lease payments under operating leases with non-cancelable terms in excess of one year as of March 31, 2019, were as follows: +Fiscal Year Ending March 31, +(In thousands) +2020 +$ +2,408 +2021 +2,150 +2022 +1,981 +2023 +548 +2024 +177 +Thereafter +— +Total minimum lease payments +$ +7,264 +67 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +8. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to +issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or +restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2020 and 2019, there were no outstanding shares of +preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In +August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate +of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior +Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between +Iteris and Computershare Trust Company, N.A. ("Computershare"), as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of +Designations, which created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior +participating preferred stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. Effective on September 28, 2018, an +amendment was entered into by and between Iteris and Computershare to accelerate the expiration of the Rights from August 20, 2019 to September 28, 2019, wherein all of the Rights +distributed to the holders of the Company's common stock pursuant to the Rights Agreement expired. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2020: +Number of Shares +(In thousands) +Stock options outstanding +5,934 +Restricted stock units outstanding +404 +Authorized for future issuance under stock incentive plans +1,691 +8,029 +9. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares +of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date +of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common +stock. New shares are issued to satisfy stock option +68 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +9. Employee Benefit Plans (Continued) +exercises +and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance +under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized and +reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of +common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the 2007 Plan to +increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December 2016, our stockholders approved +the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs, cash incentive awards and other stock-based awards +to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options expire no more than ten +years after the date of grant and generally vest at the rate of 25% on each of the first four anniversaries of the grant date. Stock appreciation rights, restricted stock, RSUs and other stock-based +awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. +We +currently maintain two stock incentive plans, the 2007 Omnibus Incentive Plan and the 2016 Omnibus Incentive Plan (the "2016 Plan"). Of these plans, we may only grant future awards +from the 2016 Plan. The 2016 Plan allows for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), cash incentive awards and other stock-based +awards. At March 31, 2020, there were approximately 1.7 million shares of common stock available for grant or issuance under the 2016 Plan. Total stock options vested and expected to +vest were approximately 5.9 million as of March 31, 2020. +Stock Options +A summary of activity in the Plans with respect to our stock options for Fiscal 2020 is as follows: +Options +Weighted +Average +Exercise +Price Per +Share +Weighted +Average +Remaining +Contractual +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +Options outstanding at March 31, 2019 +5,035 +$ +3.70 +7.6 +$ +4,430 +Granted +1,206 +5.06 +Exercised +(119 +) +2.13 +Forfeited +(188 +) +4.94 +Expired +— +— +Options outstanding at March 31, 2020 +5,934 +$ +3.99 +7.2 +$ +2,095 +69 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +9. Employee Benefit Plans (Continued) +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under +the 2007 Plan vest at the rate of 25% on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs +granted under the 2016 Plan vest at varying terms between one and four anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. +The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A +summary of activity with respect to our RSUs for Fiscal 2020 is as follows: +# of Shares +Weighted +Average +Price Per +Share +Weighted +Average +Remaining +Life +Aggregate +Intrinsic +Value +(In thousands) +(Years) +(In thousands) +RSUs outstanding at March 31, 2019 +112 +$ +4.62 +1.1 +$ +19 +Granted +374 +5.12 +Vested +(78 +) +4.17 +Forfeited +(4 +) +5.52 +RSUs outstanding at March 31, 2020 +404 +$ +5.16 +2.0 +$ +1,295 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of +operations: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Cost of revenues +$ +175 +$ +146 +$ +71 +Selling, general and administrative expense +2,364 +1,804 +1,558 +Research and development expense +246 +206 +152 +Total stock-based compensation +$ +2,785 +$ +2,156 +$ +1,781 +At +March 31, 2020, there was approximately $5.5 million and $1.5 million of unrecognized compensation expense related to unvested stock options and RSUs, +respectively. This expense is currently expected to be recognized over a weighted average period of approximately 2.9 years for stock options and 2.0 years for RSUs. If there are any +modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based +compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +70 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +9. Employee Benefit Plans (Continued) +The +grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2020 +2019 +2018 +Expected life—years +6.8 +5.9 +6.5 +Risk-free interest rate +2.2 +% +2.7 +% +2.7 +% +Expected volatility of common stock +47 +% +43 +% +43 +% +Dividend yield +0 +% +0 +% +0 +% +Expected Life: The Company's expected life represents the weighted-average period that the Company's stock options are expected to be +outstanding. +The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral +patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of +grant for the +expected term of the option. +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the +expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A +summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2020 +2019 +2018 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted +$ +2.52 +$ +1.89 +$ +2.59 +Intrinsic value of options exercised +$ +378 +$ +114 +$ +2,469 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No +contributions were made during the fiscal years ended March 31, 2020, 2019 and 2018. +We +sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible employees voluntarily contribute to the plan, up to IRS maximums, through payroll +deductions. We match up to 50% of contributions, up to a stated limit, with all matching contributions being fully vested after three years of service. Our matching contributions under the 401(k) Plan +were approximately $1,317,000, $1,185,000 and $1,067,000 for the Fiscal 2020, Fiscal 2019 and Fiscal 2018, respectively. +71 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +9. Employee Benefit Plans (Continued) +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an ESPP which allows employees to withhold a percentage of their base compensation to +purchase the Company's common stock at 95% of the lower of the fair market at the beginning of the offering period and on the last trading day of the offering period. There are two offering periods +during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may contribute 1-15% of their eligible gross pay up to a $25,000 annual stock value +limit. During Fiscal 2020 and Fiscal 2019, 91,000 and 92,000 shares, respectively, were purchased. There were no share purchases in Fiscal 2018. The ESPP is considered a non-compensatory plan and +accordingly no compensation expense is recorded in connection with this benefit. +As +of March 31, 2020, approximately $146,000 of cash was restricted for the purchase of shares under the ESPP and is recorded as restricted cash in the accompanying consolidated +balance sheets. +10. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $3 million of our outstanding common stock from +time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $1.3 million. On August 9, 2012, our Board of +Directors cancelled the initial stock repurchase program and the approximate $1.7 million of remaining funds, and approved a new stock repurchase program pursuant to which we may acquire up to +$3 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open market and privately negotiated +transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be +repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a +$3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to time for an +unspecified length of time. +For +our fiscal years ended March 31, 2020, 2019, and 2018 we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2020, we +repurchased approximately 3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2020, all +repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2020, approximately $1.7 million remains +available for the repurchase of our common stock under our current program. +11. Acquisition +On July 2, 2019, the Company completed the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida, with offices +in Orlando (FL), Virginia Beach (VA) and Chadds Ford (PA). AGI assists municipalities in maximizing the effectiveness of their existing transportation networks through a collection of traffic +management services to cost effectively improve the performance of roadway systems and address increased traffic demands, traffic congestion and delay. With a foundation of arterial timing plan +development, AGI has expanded its +72 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +11. Acquisition (Continued) +services +into active arterial monitoring and management with multiple public sector clients. AGI is expected to expand the Company's geographic footprint for ITS services in Florida, as well as in the +Midwest and Mid-Atlantic region. AGI's typical contracts are for traffic operations professional engineering services focused on transportation systems management and operations. +Pursuant +to a Stock Purchase Agreement dated June 10, 2019 among the Company, AGI and the stockholders of AGI (the "Selling Shareholders"), the Company acquired all of the +outstanding capital stock of AGI from the Selling Shareholders for an aggregate purchase price of $10.8 million, after working capital adjustments, payable in cash and stock, of which 114,943 +shares are being held in escrow for 18 months to secure performance of indemnification and other post-closing obligations of the Selling Shareholders. +Since +the date of acquisition AGI operated as a wholly-owned subsidiary of the Company, as part of the Transportation Systems segment, and contributed approximately $6.4 million +of service revenue and approximately $1.7 million of net income. +The +acquisition of AGI has been accounted for as a business combination. We estimated the fair values of net assets acquired, and the excess of the consideration transferred over the +aggregate of such fair values was recorded as goodwill. +The +following tables summarize the purchase price allocation (in thousands) as of July 2, 2019: +Cash +$ +664 +Trade accounts receivable +905 +Unbilled accounts receivable +347 +Right-of-use assets +863 +Property and equipment +357 +Intangible assets +3,710 +Goodwill +5,440 +Other assets +161 +Total assets acquired +12,447 +Accounts payable +(378 +) +Accrued payroll and related expenses +(426 +) +Lease liabilities +(863 +) +Total liabilities assumed +(1,667 +) +Total purchase price +$ +10,780 +The +fair values of the remaining AGI assets and liabilities noted above approximate their carrying values at July 2, 2019. There was no difference between the fair value of trade +accounts receivables and the gross contractual value of those receivables. There are no contractual cash flows related to these receivables that are not expected to be collected. The Company believes +the goodwill related to the acquisition was a result of the ability of the Company to leverage its technology in the broader market, as well as offering cross-selling market exposure opportunities. +Goodwill from the acquisition of AGI is included within the Company's Transportation Systems reporting unit. The goodwill is fully deductible for tax purposes. The significant intangible assets +identified in the purchase price allocation include customer relationships and non-compete agreements, which are amortized over their respective useful +73 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +11. Acquisition (Continued) +lives +on a straight line basis which approximates the underlying cash flows. To value the customer relationships, the Company utilized the income approach, specifically a discounted cash-flow method +known as the excess earnings method. The Company utilized the with and without method to derive the fair value of the non-compete agreement. The fair value estimates are based on a complex series of +judgments about future events and uncertainties and rely heavily on estimates and assumptions. Varying discount rates were applied to the projected net cash flows and EBITDA as applicable to valuation +methodology. We believe the assumptions are representative of those a market participant would use in estimating fair value. +The +following table presents the fair values and useful lives of the identifiable intangible assets acquired: +Amount +Weighted Average +Useful Life +(in thousands) +(in years) +Customer relationships +$ +3,500 +6 +Non-compete agreement +210 +3 +Total intangible assets assumed +$ +3,710 +Acquisition-Related Costs +In connection with the acquisition, the Company agreed to grant $1.7 million in retention bonuses to the Selling Shareholders and other +employees payable in the form of restricted stock units at $5.22 per share, and $570,000 in retention bonuses payable in cash, each vesting and payable over three years following the closing, provided +such employees remain in our service on the first, second and third anniversary of the closing of the acquisition. For the fiscal year ended March 31, 2020, the Company recorded approximately +$1.0 million, as stock based compensation and salaries expense to selling, general and administrative expense in the consolidated statements of operations, related to these bonuses. +Additionally, approximately $689,000, in acquisition related professional fees was recorded to selling, general and administrative expense for the year ended March 31, 2020. +Pro Forma Financial Information (Unaudited) +The following pro forma information presents the consolidated results of operations of the Company and AGI for the fiscal years ended +March 31, 2020 and 2019, as if the acquisition of AGI had been completed on April 1, 2018. These pro forma consolidated financial results have been prepared for comparative purposes only +and include certain adjustments that reflect pro forma results of operations, such as increased amortization for the fair value of acquired intangible assets and increased salaries expense related to +the retention bonuses. The pro forma results do not reflect any operating efficiencies or potential cost savings that may result from the consolidation of the operations of the Company and AGI. +Accordingly, these pro forma results are presented for informational purposes only and are not necessarily indicative of the results of operations that actually would have +74 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +11. Acquisition (Continued) +been +achieved had the acquisition occurred as of April 1, 2018, nor are they intended to represent or be indicative of future results of operations: +Year Ended March 31, +2020 +2019 +Proforma revenue +$ +116,333 +$ +107,049 +Proforma net loss +(5,775 +) +(7,108 +) +Pro forma loss per common stock +Basic +(0.14 +) +(0.21 +) +Diluted +(0.14 +) +(0.21 +) +12. Business Segments, Significant Customer and Geographic Information +Business Segments +We have operated in three reportable segments: Roadway Sensors, Transportation Systems, and Agriculture and Weather Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadways Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, Vantage, +VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. In select +territories, our Roadway Sensors segment also sells OEM products for the traffic intersection markets, which include, among other things, traffic signal controllers and traffic signal equipment +cabinets. +The +Transportation Systems segment includes engineering and consulting services, managed services, performance measurement and traffic analytics solutions, as well as the development of +transportation management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, development and implementation of software and +hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in +the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of surface +transportation +infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to +reduce traffic congestion. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 (see Note 11 of Notes to Consolidated Financial Statements, +included in Part II, Item 8 of this report for further details on the acquisition of AGI). The Transportations Systems segment product line includes: Iteris Signal Performance Measures +("SPM"), Iteris ClearGuide, and iPeMS, our performance measurement and analytics solution, our advanced traveler information system solutions ClearPath 511 and Reverse 511, as well as our commercial +vehicle operations and vehicle safety compliance platforms known as ClearFleet, CVIEW-Plus, CheckPoint, UCRLink and inspect. +75 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +12. Business Segments, Significant Customer and Geographic Information (Continued) +The +Agriculture and Weather Analytics segment, which we sold in May 2020, consisted of ClearPath Weather, a road maintenance application, and ClearAg, a digital agriculture platform. +ClearPath Weather is a web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess historical weather conditions for both short-term and +long-range weather forecasts and customizable route/site weather and pavement forecasting, and providing winter road maintenance recommendations for state agencies, municipalities and commercial +companies that allow such users to create solutions to meet roadway maintenance decision needs. ClearAg combines weather and agronomic data with proprietary land-surface modeling and analytics to +solve complex agricultural problems and to increase the efficiency and sustainability of farmlands. ClearAg solutions are offered to companies in the agriculture industry, such as seed and crop +protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. ClearAg provides weather, environment, soil and plant growth modeling to deliver +environmental intelligence through ClearAg APIs and components, IMFocus APIs and ClearAg web applications. +On +May 5, 2020, pursuant to a Purchase Agreement the Company sold the assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather +product lines, to DTN, an operating company of TBG AG, a Swiss-based holding company. As a result of the sale, we no longer operate in the Agriculture and Weather Analytics segment. See Note 14 +for further details on the sale of the Agriculture and Weather Analytics segment. +The +accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1). Certain corporate general and +administrative expenses, including general overhead functions such as information systems, accounting, human resources, marketing, compliance costs and certain administrative expenses, as well as +interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or +provide services with different processes. All reported segment revenues are derived from external customers. Our Chief Executive Officer, who is our chief operating decision maker ("CODM"), reviews +financial information at the operating segment level. Our CODM does not review assets by segment in his resource allocation, and therefore, assets by segment are not disclosed below. +76 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +12. Business Segments, Significant Customer and Geographic Information (Continued) +Selected +financial information for our reportable segments for the fiscal years ended March 31, 2020, 2019 and 2018 is as follows: +Roadway +Sensors +Transportation +Systems +Agriculture +and Weather +Analytics +Total +(In thousands) +Year Ended March 31, 2020 +Product revenues +$ +49,082 +$ +5,925 +$ +— +$ +55,007 +Service revenues +288 +52,108 +6,714 +59,110 +Total revenues +49,370 +58,033 +6,714 +114,117 +Depreciation +200 +330 +77 +607 +Segment income (loss) +7,787 +10,556 +(3,852 +) +14,491 +Year Ended March 31, 2019 +Product revenues +43,253 +4,974 +— +48,227 +Service revenues +239 +44,841 +5,816 +50,896 +Total revenues +43,492 +49,815 +5,816 +99,123 +Depreciation +233 +195 +103 +531 +Segment income (loss) +7,011 +5,907 +(5,024 +) +7,894 +Year Ended March 31, 2018 +Product revenues +44,163 +2,301 +— +46,464 +Service revenues +194 +52,180 +4,891 +57,265 +Total revenues +44,357 +54,481 +4,891 +103,729 +Depreciation +221 +204 +109 +534 +Segment income (loss) +$ +8,825 +$ +8,639 +$ +(8,048 +) +$ +9,416 +The +following table reconciles total segment income to consolidated operating loss: +Year Ended March 31, +2020 +2019 +2018 +(In thousands) +Segment income: +Total income from reportable segments +$ +14,491 +$ +7,894 +$ +9,416 +Unallocated amounts: +Corporate expenses +(19,710 +) +(15,578 +) +(14,930 +) +Amortization of intangible assets +(757 +) +(275 +) +(88 +) +Operating loss +$ +(5,976 +) +$ +(7,959 +) +$ +(5,602 +) +$ +(5,976 +) +$ +(7,959 +) +$ +(5,602 +) +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance greater than 10% of our total trade accounts receivable balances as of +March 31, 2020 and March 31, 2019. One individual customer who is also a government agency had a receivable balance of 13% of our total trade accounts receivable balance as of +March 31, 2018. +77 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +12. Business Segments, Significant Customer and Geographic Information (Continued) +The +following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located +outside the U.S.: +Year Ended +March 31, +2020 +2019 +2018 +Canada +— +% +— +% +1 +% +Europe +— +1 +1 +— +% +1 +% +2 +% +Substantially +all of our long-lived assets are held in the U.S. +13. Quarterly Financial Data (Unaudited) +Quarter Ended: +Revenues +Gross +Profit +Net (Loss) +Income +Basic Net +Income (Loss) +per Share +Diluted Net +Income (Loss) +per Share +(In thousands, except per share amounts) +June 30, 2019 +$ +26,607 +$ +10,407 +$ +(1,572 +) +$ +(0.05 +) +$ +(0.05 +) +September 30, 2019 +27,882 +11,384 +(2,187 +) +(0.05 +) +(0.05 +) +December 31, 2019 +28,733 +11,938 +(2,068 +) +(0.05 +) +(0.05 +) +March 31, 2020 +30,895 +14,032 +217 +0.01 +0.01 +$ +114,117 +$ +47,761 +$ +(5,610 +) +$ +(0.14) +* +$ +(0.14) +* +June 30, 2018 +$ +25,475 +$ +10,192 +$ +(1,579 +) +$ +(0.05 +) +$ +(0.05 +) +September 30, 2018 +24,417 +9,661 +(1,341 +) +(0.04 +) +(0.04 +) +December 31, 2018 +23,140 +8,892 +(2,464 +) +(0.07 +) +(0.07 +) +March 31, 2019 +26,091 +9,861 +(2,432 +) +(0.07 +) +(0.07 +) +$ +99,123 +$ +38,606 +$ +(7,816 +) +$ +(0.23) +* +$ +(0.23) +* +* Annual +per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. +14. Subsequent Events +Sale of Segment +On May 2, 2020, Iteris, Inc. and its wholly-owned subsidiary, ClearAg, Inc. entered into an Asset Purchase Agreement (the +"Purchase Agreement") with DTN, LLC ("DTN"), an operating company of TBG AG, a Swiss-based holding company. Under the Purchase Agreement, the Company agreed to sell to DTN the assets of the +Company's Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather product lines (the "Business"). The transaction was completed by the parties and closed on +May 5, 2020. +Under +the Purchase Agreement, the parties agreed, upon the terms and subject to the conditions set forth in the Purchase Agreement, that DTN will purchase and assume from the Company +substantially all of the assets used in the conduct of the Business and certain specified liabilities of the +78 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +14. Subsequent Events (Continued) +Business +in exchange for a total purchase price of $12,000,000. Of that amount, $10,500,000 was paid at closing on May 5, 2020, and the balance of $1,500,000 will be paid at the 12- and +18-month anniversaries of the closing date, subject to satisfaction of the conditions set forth in the Purchase Agreement relating to the transition of certain customers to DTN and the collection of +certain receivables by DTN. The Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the Business at closing. +The +parties also entered into certain ancillary agreements at the closing of the transaction that will provide Iteris with ongoing access to weather and pavement data that it integrates +into its transportation software products, and a joint development agreement under which the parties agreed to pursue future joint opportunities in the global transportation market. +As +of March 31, 2020, the Company determined that Agriculture and Weather Analytics did not meet the held for sale classification criteria under ASC 360, and as such, Agriculture +and Weather Analytics assets and liabilities as of March 31, 2020, and the results of operations for all periods presented are not classified as held for sale and are included in continuing +operations in the consolidated financial statements. +79 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable +assurance level as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported within +the time periods specified in the SEC's rules and forms, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief +Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2020 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our President and Chief Executive Officer and Chief Financial Officer, +we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of +March 31, 2020. +80 +Table of Contents +The +Company acquired AGI on June 13, 2019. Management excluded AGI from its assessment of the effectiveness of the Company's internal control over financial reporting as of +March 31, 2020. AGI's total assets excluded from this assessment was approximately $2.8 million, representing 3% of the Company's consolidated total assets as of March 31, 2020, +and AGI's total revenue of approximately $6.4 million represented 6% of the Company's consolidated revenue for the year ended March 31, 2020. +The +effectiveness of our internal control over financial reporting as of March 31, 2020 has been audited by Deloitte & Touche LLP, an independent registered public +accounting firm, as stated in their report, which is included herein. +81 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, +2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of +the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2020, based on criteria +established in Internal Control—Integrated Framework (2013) issued by COSO. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the +year ended March 31, 2020, of the Company and our report dated June 9, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph +regarding the Company's adoption of Accounting Standards Update 2016-02, Leases , in the year ended March 31, 2020. +As +described in Management's Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting for Albeck +Gerken, Inc. ("AGI"), which was acquired on July 2, 2019, and whose financial statements constitute 3% of total assets, and 6% of revenues, of the consolidated financial statements of +the Company as of and for the year ended March 31, 2020. Accordingly, our audit did not include the internal control over financial reporting for AGI. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the +effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion +on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company +in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We +conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective +internal control over financial reporting was maintained in all material respects. Our audit included obtaining an +understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based +on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting +includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets +of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting +principles, and that receipts and expenditures of the company are being made only +82 +Table of Contents +in +accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or +disposition of the company's assets that could have a material effect on the financial statements. +Because +of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ +Deloitte & Touche LLP +Costa +Mesa, CA +June 9, 2020 +83 +Table of Contents +ITEM 9B. OTHER INFORMATION +None, except as reported in Part III, Item 11 +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K ("the +Form 10-K Amendment") or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2020 Annual Meeting of Stockholders (the "2020 +Proxy Statement") under the headings "Executive Compensation and Other Information—Executive Officers," "Election of Directors," "Corporate Governance," and "Delinquent +Section 16(a) Reports." +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2020 +Proxy Statement under the heading "Executive Compensation and Other Information" and "Election of Directors." +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2020 +Proxy Statement under the heading "Equity Compensation Plan Information" and "Stock Ownership of Certain Beneficial Owners and Management." +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2020 +Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2020 +Proxy Statement under the heading "Matters Related to Independent Registered Public Accounting Firm." +84 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents +filed as part of this report: +1. Financial Statements. +Our +consolidated financial statements are listed in the "Index to Consolidated Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All +financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our consolidated financial statements or +the notes thereto. +3. Exhibits. +The +following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit Number +Description +Reference +2.1 +† +Stock Purchase Agreement, dated June 10, 2019, by and among Iteris, Inc., Albeck Gerken, Inc. and its +shareholders. +Exhibit 2.1 to the registrant's Current Report on Form 8-K as filed with the SEC on June 14, 2019 +2.2 +† +Asset Purchase Agreement, dated May 2, 2020, by and among Iteris, Inc., ClearAg, Inc., and DTN, +LLC. +Exhibit 2.1 to the registrant's Current Report on Form 8-K as filed with the SEC on May 6, 2020 +3.1 +Restated Certificate of Incorporation of the registrant as filed with the Delaware Secretary of State on October 12, +2018 +Exhibit 3.1 to the registrant's Current Report on Form 8-K as filed with the SEC on October 15, 2018 +3.2 +Restated Bylaws of the registrant, as amended through August 6, 2018 +Exhibit 3.1 to the registrant's Quarterly Report on Form 10-Q as filed with the SEC on August 7, 2018 +4.1 +Description of Iteris, Inc. Securities Registered under Section 12 of the Exchange Act +Filed herewith +4.2 +Specimen of common stock certificate +Exhibit 4.1 to registrant's Registration Statement on Form 8-A as filed with the SEC on December 8, 2004 +10.1 +Form of Indemnification Agreement entered into by the registrant and certain of its officers and +directors +Exhibit 10.5 to the registrant's Annual Report on Form 10- K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +85 +Table of Contents +Exhibit Number +Description +Reference +10.2 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the +successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.3 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, +Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +10.4 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, +Inc. (as the successor to Realty Associate RREF II Freeway Acquisitions, LLC) and Iteris, Inc. +Exhibit 10.5 to registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.5 +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, +Inc. +Exhibit 10.6 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 filed with the SEC on June 6, 2019 +10.6 +* +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.7 +* +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.8 +* +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.9 +* +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.10 +* +Amended and Restated 2016 Omnibus Incentive Plan +Exhibit 99.1 to registrant's Registration Statement on Form S-8 (File No. 333-228210) as filed with the SEC on November 6, 2018. +10.11 +* +Form of Restricted Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 99.2 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.12 +* +Form of Form of Notice of Grant of Stock Option and form of Stock Option Agreement for use with 2016 Omnibus Incentive +Plan +Exhibit 99.3 to the registrant's Registration Statement on Form S-8 (File No.333-216407) as filed with the SEC on March 2, 2017 +10.13 +Amended and Restated Promissory Note, effective July 23, 2013, by and between Maxxess Systems, Inc. in favor +of Iteris, Inc. +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 as filed with the SEC on August 1, 2013 +86 +Table of Contents +Exhibit Number +Description +Reference +10.14 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, +Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014. +10.15 +* +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.16 +Employment Agreement, dated November 15, 2019, between Iteris, Inc. and Douglas Groves +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 4, 2019 +10.17 +* +Iteris, Inc. Amended and Restated Executive Severance Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.18 +* +Retention Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.21 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.19 +* +Incentive Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.22 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.20 +Form of Retention Bonus Agreement entered into between the Company and selling shareholders of Albeck Gerken, +Inc. +Exhibit 10.1 to registrant's Current Report on Form 8-K as filed with the SEC on July 9, 2019 +10.21 +Severance and Release Agreement, effective date December 12, 2019, between Iteris, Inc. and Andrew +Schmidt +Exhibit 10.1 to Amendment No. 1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 27, 2019 +23 +Consent of Independent Registered Public Accounting Firm, dated June 9, 2020 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS +XBRL Instance Document +Filed herewith +87 +Table of Contents +Exhibit Number +Description +Reference +101.SCH +XBRL Taxonomy Extension Schema Document +Filed herewith +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document +Filed herewith +101.LAB +XBRL Taxonomy Extension Label Linkbase Document +Filed herewith +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document +Filed herewith +101.DEF +XBRL Taxonomy Definition Presentation Linkbase Document +Filed herewith +† Pursuant +to Item 601(a)(5) of Regulation S-K, certain appendices to this agreement have been omitted. The Company agrees to furnish +supplementally to the Securities and Exchange Commission, upon its request, any or all of such omitted appendices. +* Indicates +a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +ITEM 16. FORM 10-K SUMMARY +None. +88 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to +be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 9, 2020 +ITERIS, INC. +(Registrant) +By +/s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Douglas Groves, and each of +them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and +all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said +attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all +intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause +to be done by virtue hereof. +Pursuant +to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities +and on the dates indicated: +Signature +Title +Date +/s/ JOE BERGERA +Joe Bergera +Director, President and Chief Executive Officer (principal executive officer) +June 9, 2020 +/s/ DOUGLAS GROVES +Douglas Groves +Chief Financial Officer (principal financial and accounting officer) +June 9, 2020 +/s/ THOMAS L. THOMAS +Thomas L. Thomas +Chairman of the Board +June 9, 2020 +/s/ LAURA L. SIEGAL +Laura L. Siegal +Director +June 9, 2020 +89 +Table of Contents +Signature +Title +Date +/s/ DENNIS W. ZANK +Dennis W. Zank +Director +June 9, 2020 +/s/ GERARD M. MOONEY +Gerard M. Mooney +Director +June 9, 2020 +/s/ SCOTT E. DEETER +Scott E. Deeter +Director +June 9, 2020 +90 \ No newline at end of file diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/filing_metadata.csv b/raw/filings/0000350868/2019/0001047469-20-003463/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..286fa7cbee8f26b7528188e332522f8dc43687b5 --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2020-06-09,2020-03-31,2020-06-09T20:21:25.000Z,0001047469-20-003463,a2241797z10-k.htm,10-K,10779665,1,0,https://www.sec.gov/Archives/edgar/data/350868/000104746920003463/a2241797z10-k.htm,https://www.sec.gov/Archives/edgar/data/350868/000104746920003463/,2019,2019,1 diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/item1.txt b/raw/filings/0000350868/2019/0001047469-20-003463/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a23dac445dfa0200a10a115b1eab0512bb9995d6 --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/item1.txt @@ -0,0 +1,278 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), +in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of essential applied informatics that enable smart transportation. Municipalities, government agencies and other +businesses use our solutions to make roads safer and travel more efficient. +As +a pioneer in intelligent transportation systems ("ITS") technology for more than two decades, our intellectual property, products and software-as-a-service ("SaaS") offerings offer a +comprehensive range of ITS solutions to our customers throughout the U.S. and internationally. +Prior +to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling +techniques to offer smart content and analytic solutions that provided analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food +companies, and agricultural equipment manufacturers and service providers. +We +believe our products, solutions and services improve and safely optimize mobility within our communities, while minimizing environmental impact on our roadways. +We +continue to make significant investments to leverage our existing technologies and further expand both our advanced detection sensors and performance analytics systems in the +transportation infrastructure market and we are always exploring strategic alternatives intended to optimize the value of all of our Company. +Iteris +was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California +92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by +reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, +together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically +filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net +proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately +$6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm +headquartered in Tampa, Florida (see Note 11, "Acquisition" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on +the acquisition of AGI), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +4 +Table of Contents +Coronavirus +In March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of a novel strain of +coronavirus, COVID-19 ("the Pandemic"). The Pandemic is having an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, such as travel +restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our +vendors, our employees and customers and customer sentiment in general. Continued impacts of the Pandemic have materially adversely impacted global economic conditions, and could impact our business, +results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results and volatility of our stock price will depend largely on future +developments, including the duration of the spread of the outbreak, the impact on capital and financial markets and the related impact on the +financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of this report. +Sale of Segment +On May 5, 2020, pursuant to an Asset Purchase Agreement (the "Purchase Agreement") entered in on May 2, 2020, the Company sold the +assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather product lines, to DTN, LLC ("DTN"), an operating company of TBG AG, a Swiss-based holding +company. See Note 14 "Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the sale of the +Agriculture and Weather Analytics segment. +Restructuring +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of +Iteris, Inc. approved a plan of restructuring that will involve a charge in the range of approximately $1.7 million to $1.9 million in the fiscal quarter ending June 30, +2020, of which approximately 60% relates to the sale of the Agriculture and Weather Analytics segment. The restructuring charge includes separation costs for certain employees who will not transition +to DTN and an additional 10 to 15 positions that are being eliminated to right-size the cost structure of the Company. The restructuring is expected to result in a cash expenditure of approximately +$1.7 million to $1.9 million. The annualized savings from the restructuring charges, excluding those related to the sale, are expected to be in the range of $1.2 million to +$1.3 million. The amounts stated above are preliminary and subject to change as the Company finalizes its assessment of the charges and savings associated with the above items. +Products and Services +Our reportable segments consist of: Roadway Sensors, Transportation Systems, and, prior to May 5, 2020, Agriculture and Weather +Analytics. +The +Roadway Sensors segment provides various advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection +applications. The Roadway Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, +bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. The Transportation Systems segment provides traffic engineering +and consulting services, as well as managed services, performance measurement, traffic analytics, traveler information and commercial vehicle operating software solutions. The Agriculture and Weather +Analytics segment includes ClearPath Weather, our road maintenance applications, and ClearAg, our digital agriculture platform. +5 +Table of Contents +See +Note 12 "Business Segments, Significant Customer and Geographic Information" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of +this report for further details on our reporting segments. See Note 14 "Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this +report for further details on the sale of the Agriculture and Weather Analytics segment. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next®, VantagePegasus, VantageRadius, Vantage +Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic +management systems. Vantage detection systems typically include up to four of our advanced cameras or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion +by visualizing and analyzing traffic patterns allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by +providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and +advanced zone detection, which enable advanced safety and adaptive control applications. Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, +high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and +understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles +with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from +bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and +illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians +within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that +require only a few detection points. +We +believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video detection technologies, instead of traditional +in-pavement loop technology, to manage traffic. +In +select territories, we also sell certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic +signal controllers and traffic signal equipment cabinets. +6 +Table of Contents +Transportation Systems +Our Transportation Systems segment includes engineering and consulting services, performance measurement and traffic analytics solutions, as +well as the development of transportation management and traveler information systems for the ITS industry. Our Transportation Systems services include planning, design, development and implementation +of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic +flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of +surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify +mitigation measures to reduce traffic congestion. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 (see Note 11 "Acquisition" of the Notes to +Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisition of AGI). +The +Transportations Systems segment also includes our performance measurement and traffic analytics solutions, Iteris Signal Performance Measures (SPM), Iteris ClearGuide, and +iPeMS—a state-of-the-art analytics software suite that provides prescriptive data insights for multiple applications, including to help determine current and future traffic patterns, +permitting the effective performance analysis and management of traffic infrastructure resources. Our analytics suite of products utilizes a wide range of data resources and analytical techniques to +determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources. This information can then be analyzed by traffic +professionals to measure how a transportation network is performing and to identify potential areas of improvement. These applications are also capable of providing users with predictive traffic +analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This +segment also includes our advanced traveler information system solutions and services, as well as our commercial vehicle operations and vehicle safety compliance platforms, known as +"ClearFleet", "CVIEW-Plus," "CheckPoint," "UCRLink" and "inspect." These software applications support state-based commercial vehicle operations by storing and distributing intrastate and interstate +commercial vehicle information for local, state and federal agencies' roadside and enforcement operations. +Our +Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding +mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We +believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, +our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the allocation of funds may prolong uncertainty regarding the allotment of +transportation funds in federal, state and local budgets. +Agriculture and Weather Analytics +The Agriculture and Weather Analytics segment, which we sold in May 2020, consisted of ClearPath Weather, a road maintenance application, and +ClearAg, a digital agriculture platform. +ClearPath +Weather is a web-based solution, which includes a suite of tools that apply data assimilation and modeling technologies to assess weather conditions for customizable route/site +weather and pavement forecasting, and render winter road maintenance recommendations for state agencies, municipalities and commercial companies to improve roadway maintenance decisions. +7 +Table of Contents +Beginning +in late 2013, we undertook the development of "ClearAg solutions" for the digital agricultural market. These new products utilize and expand the intellectual property, +technology base and product suites of our ClearPath Weather solutions. For ClearAg solutions, we developed additional +scientific and agronomic models and forecasts, expanded our computing infrastructure for additional big data acquisition and processing, and designed distributed delivery vehicles and products. +The +ClearAg solutions combine weather and agronomic data with proprietary land-surface modeling and analytics to solve complex agricultural problems and to increase the efficiency and +sustainability of farmlands. The ClearAg Platform delivers validation tools for ag inputs, irrigation, field readiness, and harvest solutions giving growers, researchers and other agribusinesses +access to a comprehensive database of historical, real-time and forecasted weather, soil and plant health information, as well as other information on crop growth. Companies use the ClearAg Platform +to simulate field conditions and determine how new products may perform on a crop given certain weather and soil conditions. Growers and agribusinesses leverage the ClearAg Platform to determine the +best times to plant, spray, fertilize, irrigate, and harvest crops. +ClearAg +solutions were offered on a subscription basis, with customers consuming ClearAg through visualization component application programming interfaces ("APIs"). These APIs +facilitate the integration of ClearAg's analytics and insights with the offerings of large enterprise customers in the agriculture market. +On +May 5, 2020, pursuant to a Purchase Agreement the Company sold the assets of its Agriculture and Weather Analytics segment, composed of its ClearAg and ClearPath Weather +product lines, to DTN, an operating company of TBG AG, a Swiss-based holding company. As a result of the sale, we no longer operate in the Agriculture and Weather Analytics segment. See Note 14 +"Subsequent Events" of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the sale of the Agriculture and Weather Analytics +segment. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct +channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel is comprised of a network +of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. In the fourth quarter of our fiscal +year ended March 31, 2018 ("Fiscal 2018"), we entered into a distribution agreement to expand our northern European sales coverage in the U.K. and Ireland. Our independent distributors are +trained in, and primarily responsible for, sales, installation, set-up and support of our products, maintain an inventory of demonstration traffic products from various manufacturers, and sell +directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of +various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We +periodically hold technical training classes for our distributors and end users, and maintain a full-time +staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to +accommodate the needs of the market and our customer base. +We +market and sell our Transportation Systems services and solutions and, prior to May 2020, our ClearPath Weather services, primarily to government agencies pursuant to negotiated +contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation +or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use +8 +Table of Contents +selected +members of our engineering, science and information technology teams on a regional basis to serve in sales and business development functions. Our Transportation Systems contracts generally +involve long lead times and require extensive specification development, evaluation and price negotiations. +ClearAg +solutions were marketed and sold on a subscription basis, under a SaaS license, to seed and crop protection companies, agriculture equipment manufacturers, irrigation solution +providers, allied providers and other agriculture service providers. +We +have historically had a diverse customer base. For the fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total +revenues. For the fiscal year ended March 31, 2019 ("Fiscal 2019) and Fiscal 2018, one individual customer represented greater than 10% of our total revenues. As of March 31, 2020 and +2019, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components +for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate +supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our +key suppliers include Veris +Manufacturing and MoboTrex, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our +subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control inventory levels. Typically, we do not manufacture any of the hardware used in the +transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all +requirements of the ISO 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service +revenue was not a material portion of our total revenues for Fiscal 2020, Fiscal 2019 and Fiscal 2018. We believe customer support is a key competitive factor for our Company. +Our +ClearAg solutions were primarily sold as annual subscription services with recurring monthly revenue. As an element of these services, we provided full-time support and customer +service for such ClearAg solutions. +Backlog +Our total backlog of unfulfilled firm orders was approximately $67.2 million at March 31, 2020, which included +$53.4 million related to Transportation Systems, $8.7 million related to Roadway Sensors, and $5.2 million related to Agriculture and Weather Analytics. Typically, we recognize +approximately more than 70% of our Transportation Systems backlog as of the end of a fiscal year in the subsequent fiscal year, and currently expect that trend to continue for the near future. +Substantially all of the backlog for Roadway Sensors at March 31, 2020 is expected to be recognized as revenue in the fiscal year ending March 31, 2021 ("Fiscal 2021") and only a small +portion of the backlog for Agriculture and Weather Analytics was realized prior to its sale in May 2020. At March 31, 2019, we had backlog of approximately $55.4 million, which included +$44.5 million related to Transportation Systems, $6.2 million related to Roadway Sensors and $4.7 million related to Agriculture and Weather +9 +Table of Contents +Analytics. +The increase in backlog in the current fiscal year was largely due to increased sales and marketing efforts in our Transportation Systems segment during the current fiscal year. +Backlog +is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred +revenue on our consolidated balance sheets. Backlog does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given +its relevance to total orders. +The +timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary +constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and +other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting +practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be +indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Grand +Forks, North Dakota and Oakland, California. Our research and development costs and expenses were approximately $8.6 million for Fiscal 2020, $7.8 million for Fiscal 2019, and +$7.9 million for Fiscal 2018. We expect to continue to pursue various product development programs and incur research and development expenditures, primarily in our Roadway Sensors and +Transportation Systems segments in future periods. +We +believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to +meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of our software offerings that +include Iteris SPM, iPeMS, Iteris ClearGuide, and Iteris ClearFleet, as well as our other commercial vehicle operations software products. In addition, we intend to continue to invest in further +enhancements and functionality in our Vantage products family. We believe that developing new and enhanced product +offerings across our segments and enhancing, refining and marketing our existing products are key components for strong organic growth and profitability. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross +margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +In +the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera detection systems and manufacturers and +distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive +loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity and VantagePegasus compete +against various competitors in the travel-time and data communications markets, respectively. +10 +Table of Contents +The markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety +standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, +regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and +our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary +hardware and software corporations. +The +markets in which our Agriculture and Weather Analytics segment operated vary from the commercial sector customers for ClearAg solutions to public sector customers for ClearPath +Weather solutions. Our competitors vary in number, scope and breadth of the products and services they offer. In the public sector, we competed with some of the same transportation engineering, +planning and design firms that also compete with our Transportation Systems segment. +In +general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and +prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and +marketing resources than we. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their +products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our +target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product +quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of +other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy +is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 21 issued U.S. patents, including: +(i) 14 relating to our Roadway Sensors technologies, four of which were issued in Fiscal 2020 and (ii) 7 relating to our Transportation Systems technologies. Prior to the sale of our +Agriculture and Weather Analytics segment in May 2020, we had a total of 36 issued U.S. patents relating to our Agriculture and Weather Analytics technologies. Prior to the sale of our Agriculture and +Weather Analytics in May 2020, we had a total of 14 pending patent applications in the U.S. and 8 total foreign patent applications. The expiration dates of our patents range from 2026 to 2038. We +intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In +addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information +through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks +other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other +proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +11 +Table of Contents +Litigation +may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of +infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed +from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, +the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, +could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2020, we employed 414 full-time employees and 26 part-time employees, for a total of 440 employees. As a result of the +sale of our Agriculture and Weather Analytics segment in May 2020 and related restructuring activities, we currently have approximately 348 full-time and 26 part-time employees. None of our employees +is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of +materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and +regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not +expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and +regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/item13.txt b/raw/filings/0000350868/2019/0001047469-20-003463/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..ccc848c701e9c072b9eb98b1edaed2d58427e0e5 --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2020 +Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." \ No newline at end of file diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/item9a.txt b/raw/filings/0000350868/2019/0001047469-20-003463/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..b57b68885d67ccd3f2de08c84fe103c3d8b0909d --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/item9a.txt @@ -0,0 +1,85 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Exchange +Act, as of the end of the period covered by this Annual Report on Form 10-K, management evaluated, with the participation of our President and Chief Executive Officer, and our Chief Financial +Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these +disclosure controls and procedures, the President and Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable +assurance level as of the date of such evaluation in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported within +the time periods specified in the SEC's rules and forms, and (2) accumulated and communicated to management, including the Company's President and Chief Executive Officer and the Chief +Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +(b) Changes in internal control. There was no significant change in our internal controls over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2020 that has materially affected, or is reasonably likely to +materially affect, our internal controls over financial reporting. +Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the +control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide +absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in +decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no +assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to +management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results +of operations. +Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in +Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our President and Chief Executive Officer and Chief Financial Officer, +we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal +Control—Integrated Framework (2013) , our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of +March 31, 2020. +80 +Table of Contents +The +Company acquired AGI on June 13, 2019. Management excluded AGI from its assessment of the effectiveness of the Company's internal control over financial reporting as of +March 31, 2020. AGI's total assets excluded from this assessment was approximately $2.8 million, representing 3% of the Company's consolidated total assets as of March 31, 2020, +and AGI's total revenue of approximately $6.4 million represented 6% of the Company's consolidated revenue for the year ended March 31, 2020. +The +effectiveness of our internal control over financial reporting as of March 31, 2020 has been audited by Deloitte & Touche LLP, an independent registered public +accounting firm, as stated in their report, which is included herein. +81 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, +2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of +the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2020, based on criteria +established in Internal Control—Integrated Framework (2013) issued by COSO. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the +year ended March 31, 2020, of the Company and our report dated June 9, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph +regarding the Company's adoption of Accounting Standards Update 2016-02, Leases , in the year ended March 31, 2020. +As +described in Management's Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting for Albeck +Gerken, Inc. ("AGI"), which was acquired on July 2, 2019, and whose financial statements constitute 3% of total assets, and 6% of revenues, of the consolidated financial statements of +the Company as of and for the year ended March 31, 2020. Accordingly, our audit did not include the internal control over financial reporting for AGI. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the +effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion +on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company +in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We +conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective +internal control over financial reporting was maintained in all material respects. Our audit included obtaining an +understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based +on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting +includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets +of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting +principles, and that receipts and expenditures of the company are being made only +82 +Table of Contents +in +accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or +disposition of the company's assets that could have a material effect on the financial statements. +Because +of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future +periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ +Deloitte & Touche LLP +Costa +Mesa, CA +June 9, 2020 +83 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/rp_note.txt b/raw/filings/0000350868/2019/0001047469-20-003463/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2019/0001047469-20-003463/rpt_disclosure.txt b/raw/filings/0000350868/2019/0001047469-20-003463/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..839bc1191a3765b332249d22a2e30c13022cbd5e --- /dev/null +++ b/raw/filings/0000350868/2019/0001047469-20-003463/rpt_disclosure.txt @@ -0,0 +1,3 @@ +Transactions with Related Persons +Since April 1, 2019, other than the agreements and transactions described in “Executive Compensation and Other Matters” above and the transactions described below, there has not been, nor is there any proposed transaction, where we (or any of our subsidiaries) were or will be a party in which the amount involved exceeded or will exceed the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two fiscal years and in which any director, director nominee, executive officer, holder of more than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest. +We previously had a promissory note, with an interest rate of 6%, owed to us by Maxxess Systems, Inc., which is currently owned by an investor group that includes two former Iteris directors. 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One) +ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31 , 2021 +OR +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-2588496 +(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) +1700 Carnegie Ave ., Santa Ana , +California +92705 +(Address of Principal Executive Offices) (Zip Code) +Registrant's Telephone Number, Including Area Code: ( 949 ) 270-9400 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which +registered +Common Stock, $0.10 par value ITI The Nasdaq Stock Market LLC +Securities registered pursuant to Section 12(g) of the Act. None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act"). Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.: +Large accelerated filer o Accelerated filer ý Non-accelerated filer o Smaller reporting company ý +Emerging growth company o +Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2020 was approximately $ 168,470,533 . For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of May 28, 2021, there were 41,847,838 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2021 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2021 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +22 +ITEM 2. +PROPERTIES +22 +ITEM 3. +LEGAL PROCEEDINGS +22 +ITEM 4. +MINE SAFETY DISCLOSURES +22 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +23 +ITEM 6. +SELECTED FINANCIAL DATA +23 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +23 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +33 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +34 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +73 +ITEM 9A. +CONTROLS AND PROCEDURES +73 +ITEM 9B. +OTHER INFORMATION +76 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +76 +ITEM 11. +EXECUTIVE COMPENSATION +76 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +76 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +76 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +76 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +77 +Unless otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiaries, including ClearAg, Inc., and Albeck Gerken, Inc. BlueARGUS™, BlueTOAD®, CheckPoint™, ClearGuide™, ClearFleet™, ClearMobility™, ClearRoute™, ClearPath 511®, CVIEW-Plus™, Edge®, EdgeConnect™, inspect™, iPeMS®, Iteris®, Iteris SPM®, Next®, P10™, P100™, P-Series™, PedTrax®, Reverse 511®, SmartCycle®, SmartCycle Bike Indicator®, SmartSpan®, Spectra™, SPM™ (logo), TrafficCarma™, UCRLink™, Vantage®, VantageLive!®, Vantage Next®, VantagePegasus®, VantageRadius®, Vantage Vector®, Velocity® and VersiCam™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words "expect(s)," "feel(s)," "believe(s)," "intend(s)," "plan(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, capital needs, backlog, manufacturing capabilities, the market acceptance of our products and services, impact of planned acquisitions and dispositions, the Company's strategy for growth, competition, the impact of the outbreak of a novel strain of coronavirus, COVID-19, the impact of any current or future litigation, the impact of recent accounting pronouncements, the applications for and acceptance of our products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in "Risk Factors" set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of smart mobility infrastructure management solutions. Our solutions enable public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, specialized consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +Prior to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and analytic solutions that provided analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further expand our advanced detection sensors, transportation performance analytics systems, and specialized consulting services and cloud-enabled managed services in the smart mobility infrastructure management market, and we are always exploring strategic alternatives intended to optimize the value of all of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than 12 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis with travel restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. While there has been no material impact to our business during the fiscal year ended March 31, 2021 (“Fiscal 2021”), we did experience some work delays due to the Pandemic. Should such conditions become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the spread of the outbreak, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, the Company has taken certain actions to preserve its liquidity, manage cash flow and strengthen its financial flexibility. Such actions include, but are not limited to, reducing discretionary spending, reducing capital expenditures, +4 +Table of Contents +implementing restructuring activities, and reducing payroll costs, including employee furloughs, pay freezes and pay cuts (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration (see Note 6, Income Taxes, to the Consolidated Financial Statements). +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world and its assessment of the impact of the Pandemic may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “ TrafficCast Business”). The transaction closed on December 7, 2020. +Under the Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million, with $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The parties also entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Sale of Agriculture and Weather Analytics Segment +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics segment to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to an Asset Purchase Agreement (the “Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million, subject to working capital adjustments. Upon closing on May 5, 2020, the Company received $10.5 million in cash and $1.5 million of deferred payment, of which $1.45 million has been paid by DTN at the 12-month anniversary of the closing date, and $0.05 million will be paid by DTN at the 18-month anniversary of the closing date, subject to satisfactions of the conditions set forth in the Purchase Agreement relating to the transition of certain customers to DTN and the collection of certain receivables by DTN (see Note 3, Discontinued Operations , to the Consolidated Financial Statements). +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Public Offering and Acquisition of Albeck Gerken, Inc. +5 +Table of Contents +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Products and Services +Our reportable segments consist of: Roadway Sensors and Transportation Systems. +The Roadway Sensors segment provides advanced detection sensors and systems for traffic management that collectively comprise our family of Vantage sensors and BlueTOAD line of products, as well as communication systems and roadway traffic data collection applications that complement our sensor products. The Vantage product line uses advanced image processing technology, radar technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and multiple data sets using various communication technologies. The Roadway Sensors segment also includes the public sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The Transportation Systems segment provides traffic engineering and specialized consulting services, cloud-enabled managed services, transportation performance measurement and traffic analytics solutions, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 as well as the commercial operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisitions of AGI and TrafficCast). +With the company’s adoption of the ClearMobility platform we have started aligning our portfolio of solutions under a common branding structure called ClearMobility. We believe this alignment to the ClearMobility Platform will drive internal synergies in our development and sales efforts, as well as increase our market recognition across our entire suite of solutions. As a result of this alignment, the Company’s chief operating decision maker (“CODM”) is evaluating our management and operating structure and as a result of this evaluation we anticipate that we will report as a single operating segment starting with our fiscal year 2022. +In the fourth quarter of the 2021 fiscal year, we launched the ClearMobility Cloud, our open-architecture cloud framework for smart mobility infrastructure management. The ClearMobility Cloud’s mobility data management engine, application programming interface ("API") framework and microservices ecosystem provide standardized data ingestion, cleansing and analytics, as well as authentication and security for each component of the ClearMobility Platform. The ClearMobility Cloud sets the foundation for horizontally scalable data processing, third-party extensibility, and secure, policy-based access to public transportation agencies and commercial entities throughout the United States and internationally. +See Note 13, Business Segments, Significant Customer and Geographic Information, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on our reporting segments. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, P-Series products, BlueTOAD Spectra, BlueTOAD Spectra RSU, and BlueARGUS. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic management systems. Vantage detection systems typically include up to four of our advanced cameras and/or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +6 +Table of Contents +Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueARGUS collects, analyzes and visualizes various information related to travel times, speeds, O-D, as well as connected vehicle information from the BlueTOAD Spectra RSU. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +We believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video and radar detection technologies, instead of traditional in-pavement loop technology, to manage traffic. +In select territories, the Roadway Sensors segment also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and specialized consulting services, transportation performance measurement and traffic analytics solutions, end-to-end solutions delivered as cloud-enabled managed services, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. Our Transportation Systems services include planning, design, development and implementation of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. The Transportation Systems segment also includes the commercial sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The Transportations Systems segment product line includes: the Iteris Signal Performance Measures ("Iteris SPM") and iPeMS traffic signal performance and traffic analytics software suites, the capabilities and customers of which have now respectively been incorporated into and migrated to ClearGuide, our state-of-the-art mobility intelligence and transportation performance measures solution; our advanced traveler information system ("ATIS") solution for public transportation agencies, ClearRoute; and our ATIS solution for the enterprise and commercial sector, TrafficCarma. Our analytics suite of products +7 +Table of Contents +utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources, whether at the intersection level, arterial and corridor level, or highway level. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This segment also includes our commercial vehicle operations and vehicle safety compliance platforms, known as "ClearFleet", "CVIEW-Plus", "CheckPoint", "UCRLink" and "Inspect". These software applications support state-based commercial vehicle operations by storing and distributing intrastate and interstate commercial vehicle information for local, state and federal agencies' roadside and enforcement operations. +Our Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, and sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We market and sell our Transportation Systems services and solutions primarily to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +With the acquisition of the TrafficCast Business on December 7, 2020, we expanded our customer segments to now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to both automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2021 and fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total revenues. For the fiscal year ended March 31, 2019 ("Fiscal 2019"), one individual customer represented greater than 10% of our total revenues. As of March 31, 2021 and 2020, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control +8 +Table of Contents +inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2021, Fiscal 2020 and Fiscal 2019. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $78.1 million at March 31, 2021, which included $66.5 million related to Transportation Systems and $11.6 million related to Roadway Sensors. We expect to recognize revenue of approximately 73% of our Transportation Systems and 27% of our Roadway Sensors backlog including TrafficCast's commercial business as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2020, we had backlog of approximately $62.1 million, which included $53.4 million related to Transportation Systems and $8.7 million related to Roadway Sensors. The increase in backlog in the current fiscal year was largely due to the additions of TrafficCast backlog of approximately $10.6 million and a slight increase in Transportation Systems backlog due to a few larger contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred revenue on our consolidated balance sheets. Backlog does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Madison, Wisconsin and Oakland, California. Our research and development costs and expenses were approximately $5.1 million for Fiscal 2021, $4.3 million for Fiscal 2020, and $3.8 million for Fiscal 2019. We expect to continue to pursue various product development programs and incur research and development expenditures in both our Roadway Sensors and Transportation Systems segments in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform, which includes among other things our software offering in our Transportation Systems segment, as well as our Vantage products family in our Roadway Sensors segment. +During Fiscal 2020, we successfully released ClearGuide, our state-of-the-art transportation performance measures solution, designed to help transportation agencies achieve safer, more efficient mobility for their networks. Certain development costs were capitalized into intangible assets in the consolidated balance sheets; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our solutions. This continued investment may result in increases in research and development costs, as well as additional capitalized software in future periods. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +9 +Table of Contents +In the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity, BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +The markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 25 issued U.S. patents, including: (i) 15 relating to our Roadway Sensors technologies, (ii) 7 relating to our Transportation Systems technologies and (iii) 3 related to our purchase of the TrafficCast Business. We had a total of 2 pending patent applications in the U.S. We currently have 3 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2039. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2021, we employed 415 full-time employees and 24 part-time employees, for a total of 439 employees. None of our employees is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +10 +Table of Contents +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. +Risk Related to Our Business +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues and fixed price contracts, that could adversely impact our future revenues and profitability. +A significant portion of our revenues is derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, delays in the expenditures from the federal highway bill and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the administration and repeal of government purchasing programs; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone requirements; +• performance bond requirements; +• adverse weather conditions or other natural or medical disasters or developments, such as, the novel coronavirus COVID-19, and evacuations and flooding due to hurricanes, can result in our inability to perform work in affected areas; and +• international relations and international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from transportation or other infrastructure projects. +11 +Table of Contents +Governmental budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and income to drop substantially or to fluctuate significantly between fiscal periods. +In addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our Transportation Systems workforce. +The cost of providing our Transportation Systems engineering and specialized consulting services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• the timing of new contract awards, the commencement of work under an awarded contract or the completion of large contracts; +• availability of funding or other budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An inability to properly and fully utilize our Transportation Systems workforce would reduce our profitability and could have an adverse effect on our results of operations. +Our management information systems and databases have been and could in the future be disrupted by data protection breaches, system security failures, cyber threats or by the failure of, or lack of access to, our internal operations, such as our enterprise resource planning ("ERP") system, or services provided to our customers. These disruptions could negatively impact our sales, increase our expenses, significantly harm our reputation and/or adversely affect our stock price. +Experienced users and computer programmers may be able to penetrate, or "hack", our network security and create system disruptions, cause shutdowns and compromise or misappropriate our confidential information or that of our employees and third parties. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our internal network, any of our systems, service offerings or otherwise exploit any security vulnerabilities of our network, systems or service offerings. In addition, sophisticated services, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of a system. We could incur expenses addressing problems created by cyber or other security problems, bugs, viruses, worms malicious software programs and security vulnerabilities, and our efforts to address these problems may not be successful. We must, and do, take precautions to secure customer information and prevent unauthorized access to our databases and systems containing confidential information. Any data security event, +12 +Table of Contents +such as a breach, data loss or information security lapses, whether resulting in the compromise of personal information or the improper use or disclosure of confidential, sensitive or classified information, could result in interruptions, cessation of service(s), claims, remediation costs, regulatory sanctions against us, loss of current and future contracts, adverse effects to results of operations and financial condition, serious harm to our reputation and/or adverse effects to our stock price. We operate our ERP system on a SaaS platform, and we use this system for reporting, planning, sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on this system, and the third-party provider of this service, for a number of aspects of our operations. If this service provider or this system fails, or if we are unable to continue to have access to this system on commercially reasonable terms, or at all, operations would be severely disrupted until an equivalent system could be identified, licensed or developed, and integrated into our operations. This disruption would have a material adverse effect on our business. We carry insurance, including cyber insurance, commensurate with its size and the nature of its operations, although there is no certainty that such insurance will in all cases be sufficient to fully reimburse us for all losses incurred in connection with the occurrence of any of these system security risks, data protection breaches, cyber-attacks or other events. +In April 2020, certain internal computer systems at our headquarters in Santa Ana were breached by an intruder, which prevented them temporarily from operating. We immediately took steps to isolate those systems and implemented measures to prevent additional systems from being affected, including taking systems offline as a precaution. The intrusion did not affect any customer-facing systems. Third party forensic experts were engaged to assist our information technology team to restore those affected internal systems to operation. We completed our investigation on June 3, 2020 and we have not experienced, nor do we believe there has been, any material impact to our operating activities nor our controls over financial reporting. To date, we have found no evidence of data exfiltration or misappropriation. +If unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our web-based and mobile application solutions and services, we may suffer various negative impacts, including a loss of customer and market confidence, loss of customer loyalty, and significant liability to our customers and to individuals or businesses whose information was being stored. +Protecting data of our customers is critical to our business, and if there is unauthorized access we may incur significant costs or liabilities. In addition, we are required to comply with government contracting requirements and make investments in our systems to protect that data. If we are unable to do so, our customers may lose confidence in us, which would harm our sales, and we may incur significant expenses or liabilities. +The recent coronavirus outbreak could have an adverse effect on our business. +In March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of the novel coronavirus COVID19 ("the Pandemic"). The Pandemic is having an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, with mitigation measures such as travel restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. The uncertainties caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our vendors, our employees and customers and customer sentiment in general, such as supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. . Continued impacts of the Pandemic have materially adversely impacted global economic conditions, and have impacted our business, results of operations and financial condition, such as expense reductions, in an effort to mitigate such impacts. The extent of the impact of the Pandemic on our business and financial results and volatility of our stock price will depend largely on future developments, including the duration of the spread of the outbreak, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the financial circumstances of our customers, all of which are highly uncertain and cannot be predicted. This situation is changing rapidly, and additional impacts may arise that we are not aware of currently. +Acquisitions of companies or technologies, including our acquisition of AGI and TrafficCast, may require us to undertake significant capital infusions and could result in disruptions of our business and diversion of resources and management attention. +We completed the acquisitions of AGI in July 2019 and TrafficCast in December 2020 and we plan to continue to explore acquiring additional complementary businesses, products, services, and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +13 +Table of Contents +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully integrate any acquisitions or realize the benefits and opportunities anticipated from any acquisition. +Acquisitions, investments and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. +Acquisitions, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and results of operations. We expect to continue to evaluate and enter into discussions regarding potential strategic transactions. Effecting these strategic transactions could create unforeseen operating difficulties and expenditures. We face risks that include, among other things: +• the strategic benefits and opportunities from any planned or completed acquisition or divestiture by the Company may not be realized or may take longer to realize than expected; +• strategic benefits and opportunities related to past and ongoing restructuring actions may not be realized or may take longer to realize than expected; +• our ability to realize the expected financial benefits of an acquisition, divestiture or other strategic transaction; +• cost reductions may not occur as expected; +• management time and focus may be diverted from operating our business to challenges related to acquisitions and other strategic transactions; +• cultural challenges may arise associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire; and +• we may fail to successfully further develop the acquired business or technology. +Our failure to address the risks and other issues in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits and opportunities, including unanticipated liabilities, increased costs, and harm our business generally. +We participate in the software development market, which may be subject to various technical and commercial challenges. +We have only been in the business of software development for a few years and have in the past and may in the future experience development and technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we cannot be certain that errors will not be found in our software after its release. Any faults or errors in our existing products or in any new products may cause delays in product introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. +14 +Table of Contents +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely decline. +Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• obsolescence of certain parts and components from time to time that may require re-engineering of certain portions of our product; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements in a cost-effective and timely manner, or are unable to achieve market acceptance of our new products, our operating results would be adversely affected. +We believe our revenue growth and future operating results will depend on our ability to complete development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production costs. During the past few fiscal years, we have introduced, and will continue to introduce this fiscal year, both new and enhanced products across all segments. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +We believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain competitive. We need to continue to prepare updates for existing products and develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and analysis in response to evolving customer requirements. In addition, we are beginning to migrate some of our products to a new platform. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. Should the credit markets further tighten or our business decline, we may need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +15 +Table of Contents +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards or commencement of work for a project; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms when needed, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The markets in which we operate are highly competitive with many companies more established than we are. +We compete with numerous other companies in our target markets including, but not limited to, large, multi-national corporations and many smaller regional engineering firms. +We compete with existing, well-established companies and technologies in our Roadway Sensors segment, both domestically and abroad. Only a portion of the traffic intersection market has adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +The Transportation Systems market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +In each of our operating segments, many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. We continually bid on new contracts and negotiate contract renewals on expiring contracts. Contract +16 +Table of Contents +proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. As a condition to contract award, customers require us to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. Government entities are also taking more time between contract award and approval to commence work under the contract, which delays our ability to recognize revenues under the contract. If negative market conditions materialize, or if we fail to secure adequate financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue, obtain or perform particular projects, which could reduce or eliminate our profitability. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. +Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may adversely affect our growth in the current fiscal year and in future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for highly skilled employees are on the rise. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled personnel, we may not be able to attract and retain such employees, which could impair our ability to perform our contractual obligations, meet our customers' needs, win new business, and adversely affect our future results. Likewise, the future success of our Transportation Systems segment will depend on our ability to hire additional qualified engineers, planners and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +Legal and Regulatory Risks +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. We have in the past, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have infringed upon or misappropriated another party's intellectual property. Our continued expansion into software development activities may subject us to increased possibility of litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and results of operations. +17 +Table of Contents +We may continue to be subject to traffic-related litigation. +The traffic industry in general is subject to frequent litigation claims due to the nature of personal injuries that can result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant expenses and result in a diversion of management's attention. +Financial and Market Risks +We may not be able to consistently achieve profitability on a quarterly or annual basis in the future. +We had net income of approximately $10.1 million in Fiscal 2021, which includes $9.6 million of net income from discontinued operations, and net losses of $5.6 million in Fiscal 2020 and $7.8 million in Fiscal 2019, and we cannot assure you that we will be profitable in the future. Our ability to operate at a profit in future periods could be impacted by governmental budgetary constraints, government and political agendas, economic instability and other items that are not in our control. Furthermore, we rely on operating profits from certain of our business segments to fund investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned investments. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +Our use of estimates in conjunction with the input method of measuring progress to completion of performance obligations for our Transportation Systems revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of Transportation Systems revenues are measured and recognized over time using the input method of measuring progress to completion. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenues and profits. +Declines in the value of securities held in our investment portfolio can affect us negatively. +As of March 31, 2021, the value of securities available for sale within our investment portfolio was $3.1 million, which is generally determined based upon market values available from third-party sources. The value of our investment portfolio has fluctuated as a result of market volatility and economic or financial market conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and liquidity. Further, to the extent that we experience unrealized losses in our portfolio of investment securities from declines in securities values that management determines to be other than temporary, the book value of those securities will be adjusted to their estimated recovery value and we will recognize a charge to earnings in the quarter during which we make that determination. Although we have policies and procedures in place to assess and mitigate potential impacts of market risks, those policies and procedures are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage these risks properly. +18 +Table of Contents +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that technology, decision-making and other processes can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. Factors that could affect our revenues and operating results include, among others, the following: +• the Pandemic, which may have a continuing impact on our future operating results; +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs, including costs associated with strategic alternatives; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +19 +Table of Contents +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• timing of backlog fulfillment; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• our ability to raise additional capital; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance. +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have in the past experienced, and may from time to time in the future continue to experience parts shortages or unforeseen quality control issues by our suppliers that may impact our ability to meet demand for our products. The Pandemic has increased the occurrence of such shortages. We have historically used and continue to use single suppliers for certain significant components in our products, and have had to reengineer products from time to time to address obsolete components, especially in our Roadway Sensors products. Our Roadway Sensors products are also included with other traffic intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should any such supply delay or disruption occur, or should a key supplier discontinue operations, our future sales and costs will likely be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a production gap should for any reason our contract manufacturers become unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. Further, foreign imports of components in our products subject the Company to risks of changes in, or the imposition of new, export/import requirements, tariffs, work stoppages, delays in shipment, product cost increases due to component shortages, public health issues that could lead to temporary closures of facilities or shipping ports, such as the Pandemic and other economic uncertainties, affecting trade between the U.S. and other countries where we source components for our Roadway Sensors products. Any such actions could increase the cost to us of such products and cause increases in the prices at which we sell such products, which could adversely affect the financial performance of our Roadway Sensors business. Similarly, these actions could result in cost increases or supply chain delays that impact third party products (e.g. steel poles) which could lead our customers to delay or cancel planned purchases of our products. +20 +Table of Contents +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution capabilities for our Roadway Sensors segment internationally, particularly in Europe and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to various inherent risks including, among others: +• the Pandemic and related government responses, including travel restrictions, quarantines and "stay-at-home" orders; +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S., as well as requirements and restrictions in the other countries in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has been subject to wide fluctuations in the past. From March 31, 2017 through March 31, 2021, our common stock has traded at prices as low as $2.08 per share and as high as $8.17 per share. The market price of our common stock could continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• statements made by third parties or speculation regarding our strategic alternatives; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +21 +Table of Contents +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other strategic transactions or dispositions; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The stock market is currently experiencing and has from time to time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common stock. +Provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For example, under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make nominations for directors. We may also adopt provisions and agreements from time to time that could make it harder for a potential acquirer. +ITEM 1B.UNRESOLVED STAFF COMMENTS +None. +ITEM 2. PROPERTIES +Our headquarters and principal operations are housed in approximately 47,000 square feet of leased office, manufacturing and warehouse space located in Santa Ana, California, pursuant to a lease which terminates in March 2027. For additional information regarding our lease obligations, see Note 8, Right-of-Use Assets and Lease Liabilities, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 7 to the Consolidated Financial Statements, included in Part II, Item 8 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +22 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock is traded on the Nasdaq Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock traded on the NYSE MKT under the same symbol. +As of May 28, 2021, we had 310 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business conditions, and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +On August 9, 2012, our Board of Directors approved a new stock repurchase program pursuant to which we may acquire up to $3.0 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan is in place. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +In Fiscal 2021, Fiscal 2020, and Fiscal 2019, we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2021, we repurchased approximately 3,422,000 shares of our common stock for an aggregate price of approximately $5.6 million, at an average price per share of $1.63. As of March 31, 2021, all repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2021, approximately $1.7 million remains available for the repurchase of our common stock under our current program. +ITEM 6. SELECTED FINANCIAL DATA +The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information required under this Item. +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Part I, Item 1A, as well as the other cautionary statements and risks described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General +23 +Table of Contents +We are a provider of smart mobility infrastructure management solutions. Our solutions enable public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +Recent Developments +Impact of COVID-19 on Our Business +The COVID-19 pandemic (the “Pandemic”) continues to have an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis with travel restrictions, quarantines and "stay-at-home" orders. The Pandemic has materially adversely impacted global economic conditions and the uncertainties caused by these events and actions include, but are not limited to, the adverse effect of the Pandemic on the economy, our vendors, our employees and customers and customer sentiment in general. While there has been no material impact, nor any facility closures during Fiscal 2021, we did experience some work delays due to the Pandemic. Should such delays become protracted or worsen the impacts of the Pandemic could impact our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the spread of the outbreak, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, the Company has taken certain actions to preserve its liquidity, manage cash flow and strengthen its financial flexibility. Such actions include, but are not limited to, reducing our discretionary spending, reducing capital expenditures, implementing restructuring activities that will lead to approximately $1.2 million to $1.3 million in annualized savings, and reducing payroll costs, including employee furloughs, pay freezes and pay cuts. +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. For more information, refer to Note 6, Income Taxes , to the Consolidated Financial Statements, including in Part II, Item 8 of this report. +The Pandemic has had an impact on the Company’s human capital. While our main Santa Ana facility has remained open as our business is considered essential under the criteria specified by the State of California, “stay-at-home” orders and Pandemic restrictions imposed by local and state authorities have forced the majority of our employees to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. We believe that our system of internal control over financial reporting has not been fundamentally altered and that the effectiveness of the design and operation of internal controls remained materially consistent during the fiscal year ended March 31, 2021. Additionally, we have been able to timely file financial reports. We believe we have the right infrastructure to efficiently work remotely for the balance of the Pandemic. We do not expect to incur significant costs to safely reopen our facilities to all our employees. +Despite the Pandemic, we believe that the smart mobility infrastructure management industry in the U.S. should continue to provide new opportunities for the Company although, in the near term, the pace of new opportunities emerging may be restrained and the start dates of awarded projects may be delayed. We believe that our expectations are valid and that our plans for the future continue to be based on reasonable assumptions. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”). The transaction closed on December 7, 2020. +Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million, with $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, +24 +Table of Contents +and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The parties also entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Sale of Agriculture and Weather Analytics Segment +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics segment to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to the Purchase Agreement signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million in cash, subject to working capital adjustments. Upon closing on May 5, 2020, the Company received $10.5 million in cash and $1.5 million of deferred payment, of which $1.45 million has been paid by DTN at the 12-month anniversary of the closing date, and $0.05 million will be paid by DTN at the 18-month anniversary of the closing date, subject to satisfactions of the conditions set forth in the Purchase Agreement relating to the transition of certain customers to DTN and the collection of certain receivables by DTN. The AWA Purchase Agreement also provides for customary post-closing adjustments to the purchase price related to working capital at closing. The parties also entered into certain ancillary agreements at the closing of the transaction that will provide Iteris with ongoing access to weather and pavement data that it integrates into its transportation software products, and a joint development agreement under which the parties agreed to pursue future joint opportunities in the global transportation market. +The sale of the Agriculture and Weather Analytics segment was a result of the Company’s shift in strategy to focus on its mobility infrastructure management solutions and to capitalize on the potential for a future partnership upon the sale of this business component to DTN. We have determined that the Agriculture and Weather Analytics segment, which constituted one of our operating segments, qualifies as a discontinued operation in accordance with the criteria set forth in ASC 205-20, Presentation of Financial Statements – Discontinued Operations . +On May 5, 2020, the Company also entered into a transition services agreement (“TSA”) with DTN, pursuant to which the Company agreed to support the information technology function of the Agriculture and Weather Analytics segment for a period up to 12 months and DTN agreed to provide the contract administration/account management services for certain contracts of the Company and other transition services. Either party may make any reasonable request to extend the period of time the other party shall provide a transition service beyond the initial service period or access to additional services that are necessary for the transition of the business operations. The Company earned $0.2 million in income and incurred $0.1 million in costs associated with the TSA for the fiscal year ended March 31, 2021, which was included in loss from discontinued operations before gain on sale, net of tax on the consolidated statement of operations (see Note 3, Discontinued Operations , to the Consolidated Financial Statements). +Non-GAAP Financial Measures +Adjusted income (loss) from continuing operations before interest, taxes, depreciation, amortization, stock-based compensation expense, restructuring charges, acquisition costs, non-recurring executive severance and transition costs, and fair value adjustment related to TrafficCast's opening balance inventory (“Adjusted EBITDA”) was approximately $7.5 million, $4.2 million and $0.5 million for the fiscal years ended March 31, 2021, 2020 and 2019, respectively. +When viewed with our financial results prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and accompanying reconciliations, we believe Adjusted EBITDA provides additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define these measures, explain how they are calculated and provide reconciliations of these measures to the most comparable GAAP measure in the table below. Adjusted EBITDA and the related financial ratios, as presented in this Annual Report on Form 10-K (“Form 10-K”), are supplemental measures of our performance that are not required by or presented in accordance with GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items. +We use Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We present Adjusted EBITDA and the related financial ratios, as +25 +Table of Contents +applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our operating commitments. +Adjusted EBITDA and the related financial ratios have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include: +• They do not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments; +• They do not reflect changes in, or cash requirements for, our working capital needs; +• Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; +• They are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; +• They do not reflect the impact on earnings of charges resulting from matters unrelated to our ongoing operations; and +• Other companies in our industry may calculate Adjusted EBITDA differently than we do, whereby limiting its usefulness as comparative measures. +Because of these limitations, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only as supplemental information. See our audited consolidated financial statements contained in this Form 10-K. However, in spite of the above limitations, we believe that Adjusted EBITDA and the related financial ratios are useful to an investor in evaluating our results of operations because these measures: +• Are widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors; +• Help investors to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and +• Are used by our management team for various other purposes in presentations to our Board of Directors as a basis for strategic planning and forecasting. +The following financial items have been added back to or subtracted from our net income (loss) when calculating Adjusted EBITDA: +• Interest expense. Iteris excludes interest expense because it does not believe this item is reflective of ongoing business and operating results. This amount may be useful to investors for determining current cash flow; +• Income tax. This amount may be useful to investors because it represents the taxes which may be payable for the period and the change in deferred taxes during the period, and may reduce cash flow available for use in our business; +• Depreciation expense. Iteris excludes depreciation expense primarily because it is a non-cash expense. These amounts may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations; +• Amortization. Iteris incurs amortization of intangible assets in connection with acquisitions. Iteris also incurs amortization related to capitalized software development costs. Iteris excludes these items because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to investors because it represents the estimated attrition of our acquired customer base and the diminishing value of product rights; +• Stock-based compensation. These expenses consist primarily of expenses from employee and director equity based compensation plans Iteris excludes stock-based compensation primarily because they are non-cash expenses and Iteris believes that it is useful to investors to understand the impact of stock-based compensation to its results of operations and current cash flow; +• Restructuring charges. These expenses consist primarily of employee separation expenses, facility termination costs, and other expenses associated with Company restructuring activities. Iteris excludes these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance; +• Acquisition costs. In connection with its business combinations, Iteris incurs professional service fees, changes to the fair value of contingent consideration, and other direct expenses. Iteris excludes such items as they are related to acquisitions and have no direct correlation to the operation of Iteris’ business. These amounts may be useful to our investors in evaluating our core operating performance. +26 +Table of Contents +• Executive severance and transition costs. Iteris excludes executive severance and transition costs because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance; +• Fair value adjustment related to acquired opening balance inventories. Iteris excludes fair value adjustment related to the opening inventory balance acquired as part of its business combination because it does not believe that these costs are reflective of operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +Reconciliations of net income (loss) from continuing operations to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of total revenues were as follows: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Net income (loss) from continuing operations $ 491 $ (1,758) $ (2,793) +Income tax expense 115 160 36 +Depreciation expense 734 770 754 +Amortization expense 2,036 1,255 629 +Stock-based compensation 2,902 2,495 1,861 +Other adjustments: +Restructuring charges 619 — — +Acquisition costs 417 689 — +Executive severance and transition costs — 553 — +Fair value adjustment - opening balance inventories 136 — — +Total adjustments 6,959 5,922 3,280 +Adjusted EBITDA $ 7,450 $ 4,164 $ 487 +Percentage of total revenues 6.4 % 3.9 % 0.5 % +Business Segments +Our reportable segments consist of: Roadway Sensors and Transportation Systems. +The Roadway Sensors segment provides advanced detection sensors and systems for traffic intersection management that collectively comprise our family of Vantage sensors, as well as communication systems and roadway traffic data collection applications that complement our Vantage sensor products. The Vantage product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. The Roadway Sensors segment also includes the public sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The Transportation Systems segment provides engineering and specialized consulting services, cloud-enabled managed services, performance measurement and traffic analytics solutions, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 and the commercial operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions, to the Consolidated Financial Statements). +With the company’s adoption of the ClearMobility platform we have started aligning our portfolio of solutions under a common branding structure called ClearMobility. We believe this alignment to the ClearMobility Platform will drive internal synergies in our development and sales efforts, as well as increase our market recognition across our entire suite of solutions. As a result of this alignment, the Company’s chief operating decision maker (“CODM”) is evaluating our management and operating structure and as a result of this evaluation we anticipate that we will report as a single operating segment starting with our fiscal year 2022. +27 +Table of Contents +In the fourth quarter of the 2021 fiscal year, Iteris launched the ClearMobility Cloud, our open-architecture cloud framework for smart mobility infrastructure management. The ClearMobility Cloud’s mobility data management engine, application programming interface ("API") framework and microservices ecosystem provide standardized data ingestion, cleansing and analytics, as well as authentication and security for each component of the ClearMobility Platform. The ClearMobility Cloud sets the foundation for horizontally scalable data processing, third-party extensibility, and secure, policy-based access to public transportation agencies and commercial entities throughout the United States and internationally. +See Note 13, Business Segments, Significant Customer and Geographic Information , to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on our reporting segments. +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements. In preparing our consolidated financial statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and other factors that we believe are reasonable. We evaluate our estimates, assumptions and judgments on a regular basis and apply our accounting policies on a consistent basis. We believe that the estimates, assumptions and judgments involved in the accounting for revenue recognition, goodwill, and income taxes have the most potential impact on our consolidated financial statements. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. +The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Our revenue arrangements are complex in nature and require significant judgement in determining the performance obligation structure. Each contract is unique in nature and therefore is assessed individually for appropriate accounting treatment. When applicable, we estimate variable considerations at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +Goodwill. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment in accordance with the provisions of ASC 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. +The estimates of fair value of the reporting units are computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of the reporting units. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including future gross margin rates, expense rates, capital expenditures and other estimates), and a rate used to discount estimated future cash flow projections to their present value (or estimated fair value) based on estimated weighted average cost of capital (i.e., the selected discount rate). We select assumptions used in the financial forecasts by using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses (i.e. guideline companies). The selection of comparable businesses is based on the markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity of products and services. +28 +Table of Contents +Income Taxes . Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it appropriate to maintain valuation allowances of $12.3 million and $14.2 million against our deferred tax assets at March 31, 2021 and 2020, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve +Recent Accounting Pronouncements +Refer to Note 1, Description of Business and Summary of Significant Accounting Policies, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for a discussion of recent accounting pronouncements. +Analysis of Fiscal 2021 and Fiscal 2020 Results of Operations +For a comparison of the 2020 to 2019 fiscal years, see Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2020. Note that the filings of the 2020 and 2019 fiscal years do not reflect results of discontinued operation related activities, which are reflected in this report. +Total Revenues. Total revenues are comprised of sales from our Roadway Sensors and Transportation Systems segments. The following tables present details of total revenues for Fiscal 2021 as compared to Fiscal 2020: +Year Ended March 31, +2021 2020 $ Increase % Change +(In thousands, except percentage) +Product revenues $ 62,933 $ 55,007 $ 7,926 14.4 % +Service revenues 54,205 52,396 1,809 3.5 % +Total revenues $ 117,138 $ 107,403 $ 9,735 9.1 % +Product revenues primarily consist of Roadway Sensors product sales, but also include OEM products for the traffic signal markets, Transportation Systems third-party product sales for installation under certain construction-type contracts and sales from TrafficCast's public sector business. Product revenues for Fiscal 2021 increased approximately 14.4% to $62.9 million, compared to $55.0 million in Fiscal 2020, primarily due to an increase in sales of our core Roadway Sensors video detection products of approximately $6.8 million, an increase of approximately $1.3 million from Transportation Systems third-party product sales for installation under certain construction-type contracts and an addition of TrafficCast's public sector business of approximately $1.4 million, offset by a decrease of approximately $1.0 million from our distribution in Texas of certain OEM products for the traffic intersection market. +Service revenues primarily consist of Transportation Systems engineering services, but also includes service revenues generated by our Roadway Sensors segment and the TrafficCast's commercial business. Service revenues for Fiscal 2021 increased approximately 3.5% to $54.2 million, compared to $52.4 million in Fiscal 2020, primarily due to approximately $2.7 million of revenues from the operations of TrafficCast's commercial business, and offset by reduction in subcontractor revenue in our Transportation Systems segment. This reduction was primarily due to supply chain and logistic issues attributable to the Pandemic, experienced by a group of third-party subcontractors. +Roadway Sensors revenues in Fiscal 2021 included approximately $55.8 million in product revenues and approximately $0.8 million of service revenues, reflecting an increase in total revenues of approximately $7.2 million or 14.5%, compared to Fiscal 2020, primarily due to higher sales from our core video detection products of $6.6 million, an addition of approximately $1.4 million from TrafficCast public sector business, offset by a decrease of approximately $1.0 million from our distribution in Texas of certain OEM products for the traffic intersection market. While OEM products generally have lower gross margins than our core video detection products, we believe the offering of OEM products can benefit sales of our core products in Texas by providing a more comprehensive suite of traffic solutions for our customers. Roadway Sensors added approximately $57.4 million of new bookings, or potential revenue under binding agreements, during Fiscal 2021. Roadway Sensors backlog +29 +Table of Contents +increased to approximately $11.6 million as of March 31, 2021, compared to approximately $8.7 million as of March 31, 2020. Going forward, we plan to grow revenues by focusing on our core domestic traffic intersection market, and refine and deliver products that address the needs of this market, primarily our Vantage processors and camera systems and our Vantage Vector video/radar hybrid sensor, as well as our SmartCycle, Velocity, PedTrax and SmartSpan products. +Transportation Systems revenues in Fiscal 2021 included approximately $53.3 million of service revenues including approximately $2.7 million of revenues from the operations of TrafficCast's commercial business, and approximately $7.3 million of sales of third-party products purchased for installation under certain construction-type contracts, reflecting an increase in total revenues of approximately $2.6 million or 4.4%, compared to Fiscal 2020, primarily due to the addition of TrafficCast's commercial business. Transportation Systems added approximately $64.4 million of new backlog during Fiscal 2021. Transportation Systems backlog increased to approximately $66.5 million as of March 31, 2021, compared to approximately $53.4 million as of March 31, 2020. +We plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with key agencies related to projects in their final project phases. While we believe our ability to obtain additional large contracts will contribute to overall revenue growth, the mix of subcontractor revenue and third-party product sales will likely affect the related total gross profit from period to period, as total revenues derived from subcontractors and third-party product sales generally have lower gross margins than revenues generated by our professional services. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred revenue on our consolidated balance sheets. Backlog includes new bookings but does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders, but there can be no assurances we will recognize revenue from bookings or backlog timely or ever. +Gross Profit. The following tables present details of our gross profit for Fiscal 2021 compared to Fiscal 2020: +Year Ended March 31, +2021 2020 $ Increase % Change +(In thousands,except percentage) +Product gross profit $ 28,000 $ 24,741 $ 3,259 13.2 % +Service gross profit 18,856 18,872 (16) (0.1 %) +Total gross profit $ 46,856 $ 43,613 $ 3,243 7.4 % +Product gross margin as a % of product revenues 44.4 % 45.0 % +Service gross margin as a % of service revenues 34.9 % 36.0 % +Total gross margin as a % of total revenues 40.0 % 40.6 % +Our product gross margin as a percentage of product revenues for Fiscal 2021 decreased approximately 60 basis points compared to Fiscal 2020 primarily due to an increase in third-party product sales and additions of TrafficCast's public sector business, which typically yield lower gross margins. +Our service gross margin as a percentage of service revenues for Fiscal 2021 decreased 110 basis points compared to Fiscal 2020 primarily due to the completion of previously awarded contracts, the timing of certain extension contracts, the contract mix and an increase in the amount of subcontractors of such contracts. Subcontractors generally result in lower gross margins than our direct labor. +Our total gross margin as a percentage of total revenues for Fiscal 2021 decreased 60 basis points compared to Fiscal 2020 primarily as a result of the revenue mix within our Roadway Sensors and Transportation Systems segments. +Roadway Sensors gross profit can fluctuate in any specific quarter or year based on, among other factors, customer and product mix between core products and third party OEM products, competitive pricing requirements, product warranty costs and provisions for our excess and obsolete inventories, as well as shifts of engineering resources from development activities to sustaining activities, which we record as cost of goods sold. +We recognize a portion of our Transportation Systems revenues and related gross profit over time using the costs incurred input method, where revenue is recognized based on our efforts or inputs toward satisfying a performance obligation, and the underlying mix of contract activity affects the related gross profit recognized in any given period. For the Transportation Systems segment, we expect to experience gross profit variability in future periods due to our contract mix and the amount of +30 +Table of Contents +related sub-consulting content of such contracts, as well as factors such as our ability to efficiently utilize our internal workforce, which could cause fluctuations in our margins from period to period. +Selling, General and Administrative Expense +Selling, general and administration expense for Fiscal 2021 decreased approximately 4% to $39.2 million, compared to $40.7 million in Fiscal 2020. The decrease was primarily due to a decrease in bid and proposal activities in the Transportations Systems segment driven by the timing and size of certain opportunities in the current year compared with the prior year. +Research and Development Expense +Research and development expense for Fiscal 2021 increased approximately 19% to $5.1 million, compared to $4.3 million in Fiscal 2020. The overall increase was primarily due to continued investment in research and development activities largely focused on improving our existing software related product offerings. +We plan to continue to invest in the development of further enhancements and functionality of our Iteris ClearMobility Platform which includes among other things the software offerings in our Transportation Systems segment, as well as our Vantage products family in our Roadway Sensors segment. +Certain development costs were capitalized into intangible assets in the consolidated balance sheets in both the current and prior year periods; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our software solutions. This continued investment may result in increases in research and development costs, as well as additional capitalized software in future periods. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2021 and 2020, we believe the carrying value of our goodwill was not impaired, as the estimated fair values of our reporting units exceeded their carrying values at the end of Fiscal 2021 and 2020. If our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Amortization of Intangible Assets +Amortization expense for intangible assets subject to amortization was approximately $2.0 million and $1.3 million for Fiscal 2021 and Fiscal 2020, respectively. Approximately $0.5 million and $0.5 million of the intangible asset amortization was recorded to cost of revenues, and approximately $1.5 million and $0.8 million was recorded to amortization expense for Fiscal 2021 and Fiscal 2020, respectively, in the consolidated statements of operations. The increase in amortization was primarily due to amortization expenses related to intangible assets acquired as part of the TrafficCast acquisition. +Interest Income, Net +Net interest income was approximately $0.1 million and $0.2 million in Fiscal 2021 and Fiscal 2020, respectively. The decrease in net interest income in the current year was primarily due to the decrease in interest earned on investments purchased and held during the current fiscal year. +Income Taxes +The following table presents our (benefit) provision for income taxes for Fiscal 2021 and Fiscal 2020: +Year Ended +March 31, +2021 +2020 +(In thousands, +except percentage) +Provision (benefit) for income taxes $ 115 $ 160 +Effective tax rate 1.8 % (3.1) % +For Fiscal 2021 and 2020, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +31 +Table of Contents +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $12.3 million and $14.2 million against our deferred tax assets at March 31, 2021 and 2020, respectively. We will continue to reassess the appropriateness of maintaining a valuation allowance. +As we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. +At March 31, 2021, we had $7.7 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes. We also had $5.9 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using statutory tax rates. +Liquidity and Capital Resources +For a comparison of the 2020 to 2019 fiscal years, see Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2020. +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure additional funding on a timely basis, on terms acceptable to us, or at all. +At March 31, 2021, we had $36.7 million in working capital, which included $25.5 million in cash and cash equivalents and $3.1 million in short-term investments. This compares to working capital of $33.9 million at March 31, 2020, which included $14.4 million in cash and cash equivalents and $11.6 million in short-term investments. +The following table summarizes our cash flows from continuing operations for Fiscal 2021 and Fiscal 2020: +Year Ended +March 31, +2021 +2020 +(In thousands) +Net cash provided by (used in): +Operating activities 8,888 (462) +Investing activities (7,998) (16,184) +Financing activities 2,873 27,362 +Operating Activities. Net cash provided by operating activities of our continuing operations for Fiscal 2021 of $8.9 million was primarily the result of $7.8 million in non-cash items, primarily for noncash lease expense, depreciation expenses, stock-based compensation, and amortization coupled with our net income from continuing operations of approximately $0.5 million, as well as approximately $0.6 million from increase in working capital. Net cash used in operating activities from discontinued operations was $2.4 million. +Net cash used by operating activities of our continuing operations for Fiscal 2020 was primarily the result of our net loss of approximately $1.8 million, coupled with approximately $4.5 million from changes in working capital, offset by approximately $5.8 million in noncash items for noncash lease expense, depreciation, stock-based compensation, and amortization. Net cash used in operating activities from discontinued operations was $3.4 million. +Investing Activities. Net cash used in investing activities of our continuing operations during Fiscal 2021 was primarily the result of purchases of approximately $23.7 million of short-term investments, approximately $15.0 million in cash paid for +32 +Table of Contents +the TrafficCast acquisition, approximately $0.6 million of property and equipment purchases, and approximately $0.8 million of capitalized software development costs, primarily in the Roadway Sensors and Transportation Systems business segments related to VantageLive! and ClearGuide, respectively. These investments were partially offset by approximately $32.0 million in proceeds from the sale and maturity of short-term investments. Net cash provided by investing activities from discontinued operations was $9.7 million. +Net cash used in investing activities of our continuing operations during Fiscal 2020 was primarily the result of approximately $33.8 million purchases of short-term investments, approximately $0.4 million of property and equipment purchases and $5.6 million in net cash paid for the AGI acquisition, coupled with approximately $0.6 million of capitalized software development costs, primarily in the Roadway Sensors and Transportation Systems business segments related to VantageLive! and ClearGuide, respectively. These investments were partially offset by approximately $24.2 million in proceeds from the sale and maturity of short-term investments. +Financing Activities. Net cash provided by financing activities of our continuing operations during Fiscal 2021 was primarily the result of approximately $2.6 million and $0.4 million of cash proceeds from the exercise of stock options and purchases of Employee Stock Purchase Plan ("ESPP") shares,, respectively. +Net cash provided by financing activities of our continuing operations during Fiscal 2020 was primarily the result of approximately $26.8 million of net proceeds from issuance of common stock in connection with the public offering. In addition, there was $0.3 million and $0.4 million of cash proceeds received from the exercise of stock options and purchases of ESPP shares. +Off-Balance Sheet Arrangements +We do not have any other material off-balance sheet arrangements at March 31, 2021. +Seasonality +We have historically experienced seasonality, particularly with respect to our Roadway Sensors segment, which adversely affects such sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally impacted the most by inclement weather. We have also experienced seasonality, particularly with respect to our Transportation Systems segment, which adversely impacts our third fiscal quarter due to the increased number of holidays, causing a reduction in available billable hours. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item. +33 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Consolidated Financial Statement +Report of Independent Registered Public Accounting Firm +35 +Consolidated Balance Sheets as of March 31, 20 21 and 20 20 +37 +Consolidated Statements of Operations for the fiscal years ended March 31, 202 1 , 20 20 and 201 9 +38 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 202 1 , 20 20 and 201 9 +39 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 202 1 , 20 2 0 and 201 9 +40 +Notes to Consolidated Financial Statements +41 +34 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2021 and 2020, the related consolidated statements of operations, stockholders' equity, and cash flows, for each of the three years in the period ended March 31, 2021, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2021, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of March 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 1, 2021, expressed an unqualified opinion on the Company's internal control over financial reporting. +Adoption of New Accounting Standard +As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for leases as of and for the year ended March 31, 2020 due to the adoption of Accounting Standards Update 2016-02, Leases . +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue from Contracts with Customers – Determination of Distinct Performance Obligations Relating to Service Revenues – Refer to Note 1 of the financial statements +Critical Audit Matter Description +The Company's service revenues within the Transportation Systems (“SYS”) operating segment, primarily derives revenue from long-term engineering & consulting services and software as a service ("SaaS"). The Company accounts for individual services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the services, the solution provided and the structure of the sales contract. During the year ended March 31, 2021, the Company recognized service revenues from contracts with customers of $53.3 million. +We identified the determination of distinct performance obligations in contracts with customers relating to service revenues as a critical audit matter. Significant judgment is required to determine whether the performance obligations in these sales contracts +35 +Table of Contents +are distinct; that is, if a service is separately identifiable from other items in the sales contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer . Auditing these aspects include especially challenging auditor judgment due to the nature and extent of audit effort required to address this matter. +How the Critical Audit Matter was Addressed in the Audit +Our audit procedures related to the Company’s determination of distinct performance obligations relating to service revenues for these contracts included the following, among others: +• We tested the effectiveness of controls related to management’s identification and assessment of distinct performance obligations in contracts with customers. +• We selected a sample of customer contracts to evaluate the appropriateness of management’s determination of distinct performance obligations. +• We selected a sample of invoices from the accounts receivable detail and determined whether amounts invoiced were in accordance with the related contract terms. Further, we inspected line items on the invoice to verify that all line items were included in management's evaluation of performance obligations. +• We selected a sample of customer contracts and investigated all changes in current forecasted cost to original forecasted cost to evaluate if changes in estimate are indicative of existing services known by operations personnel, but not previously considered as distinct performance obligations by management. +• We investigated offsets to revenue to determine that they represent a valid purpose and a service was not previously identified. +• We selected a sample of expenditures and determined whether the good/service represented by the selected transaction was properly identified and evaluated by management as a distinct performance obligation. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2021 +We have served as the Company's auditor since 2016. +36 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2021 2020 +Assets +Current assets: +Cash and cash equivalents $ 25,205 $ 14,217 +Restricted cash 263 146 +Short-term investments 3,100 11,556 +Trade accounts receivable, net of allowance for doubtful accounts of $ 1,019 and $ 802 at March 31, 2021 and 2020 respectively +19,020 16,706 +Unbilled accounts receivable 11,541 9,848 +Inventories 5,066 3,040 +Prepaid expenses and other current assets 5,445 2,040 +Current assets of discontinued operations — 1,476 +Total current assets 69,640 59,029 +Property and equipment, net 1,923 1,835 +Right-of-use assets 11,353 12,598 +Intangible assets, net 14,297 6,066 +Goodwill 28,340 20,590 +Other assets 1,238 1,213 +Noncurrent assets of discontinued operations 78 626 +Total assets $ 126,869 $ 101,957 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable $ 8,935 $ 8,101 +Accrued payroll and related expenses 11,734 7,508 +Accrued liabilities 4,921 3,665 +Deferred revenue 7,349 4,413 +Current liabilities of discontinued operations 94 2,828 +Total current liabilities 33,033 26,515 +Lease liabilities 10,146 11,638 +Deferred income taxes 808 190 +Unrecognized tax benefits 119 130 +Other long-term liabilities 3,523 — +Noncurrent liabilities of discontinued operations 261 357 +Total liabilities 47,890 38,830 +Commitments and contingencies (Note 7) +Stockholders' equity: +Preferred stock, $ 1.00 par value: +Authorized shares— 2,000 Issued and outstanding shares— 0 +— — +Common stock, $ 0.10 par value: +Authorized shares— 70,000 at March 31, 2021 and March 31, 2020 Issued and outstanding shares— 41,687 at March 31, 2021 and 40,713 at March 31, 2020 +4,170 4,071 +Additional paid-in capital +181,828 176,209 +Accumulated deficit ( 107,019 ) ( 117,153 ) +Total stockholders' equity 78,979 63,127 +Total liabilities and stockholders' equity $ 126,869 $ 101,957 +See accompanying Notes to the Consolidated Financial Statements. +37 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2021 2020 2019 +Product revenues $ 62,933 $ 55,007 $ 48,227 +Service revenues 54,205 52,396 45,080 +Total revenues 117,138 107,403 93,307 +Cost of product revenues 34,933 30,266 28,434 +Cost of service revenues 35,349 33,524 29,611 +Cost of revenues 70,282 63,790 58,045 +Gross profit 46,856 43,613 35,262 +Operating expenses: +Selling, general and administrative 39,164 40,665 34,166 +Research and development 5,130 4,315 3,755 +Amortization of intangible assets 1,504 757 275 +Restructuring charges 619 — — +Total operating expenses 46,417 45,737 38,196 +Operating income (loss) 439 ( 2,124 ) ( 2,934 ) +Non-operating income: +Other income, net 54 297 49 +Interest income, net 113 229 128 +Income (loss) from continuing operations before income taxes 606 ( 1,598 ) ( 2,757 ) +Provision for income taxes ( 115 ) ( 160 ) ( 36 ) +Net income (loss) from continuing operations 491 ( 1,758 ) ( 2,793 ) +Loss from discontinued operations before gain on sale, net of tax ( 1,654 ) ( 3,852 ) ( 5,023 ) +Gain on sale of discontinued operations, net of tax 11,297 — — +Net income (loss) from discontinued operations, net of tax 9,643 ( 3,852 ) ( 5,023 ) +Net income (loss) $ 10,134 $ ( 5,610 ) $ ( 7,816 ) +Income (loss) per share - basic: +Income (loss) per share from continuing operations $ 0.01 $ ( 0.04 ) $ ( 0.08 ) +Income (loss) per share from discontinued operations $ 0.23 $ ( 0.10 ) $ ( 0.15 ) +Net income (loss) per share $ 0.24 $ ( 0.14 ) $ ( 0.23 ) +Income (loss) per share - diluted: +Income (loss) per share from continuing operations $ 0.01 $ ( 0.04 ) $ ( 0.08 ) +Income (loss) per share from discontinued operations $ 0.23 $ ( 0.10 ) $ ( 0.15 ) +Net income (loss) per share $ 0.24 $ ( 0.14 ) $ ( 0.23 ) +Shares used in basic per share calculations 41,176 39,012 33,266 +Shares used in diluted per share calculations 41,599 39,012 33,266 +See accompanying Notes to the Consolidated Financial Statements. +38 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock Additional +Paid-In +Capital Accumulated +Deficit Total +Stockholders' +Equity +Shares Amount +Balance at March 31, 2018 33,186 $ 3,318 $ 139,722 $ ( 103,519 ) $ 39,521 +Adoption of ASU 2014-09 — — — ( 208 ) ( 208 ) +Stock option exercises 43 4 81 — 85 +Issuance of shares pursuant to Employee Stock Purchase Plan 92 10 355 — 365 +Stock-based compensation — — 2,156 — 2,156 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 56 6 ( 54 ) — ( 48 ) +Net loss — — — ( 7,816 ) ( 7,816 ) +Balance at March 31, 2019 33,377 3,338 142,260 ( 111,543 ) 34,055 +Issuance of common stock in connection with public offering, net of costs 6,183 618 26,133 — 26,751 +Stock option exercises 120 12 244 — 256 +Issuance of shares pursuant to Employee Stock Purchase Plan 91 9 361 — 370 +Stock-based compensation — — 2,785 — 2,785 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 73 7 ( 22 ) — ( 15 ) +Issuance of common stock in connection with acquisition 869 87 4,448 — 4,535 +Net loss — — — ( 5,610 ) ( 5,610 ) +Balance at March 31, 2020 40,713 4,071 176,209 ( 117,153 ) 63,127 +Stock option exercises 731 74 2,559 — 2,633 +Issuance of shares pursuant to Employee Stock Purchase Plan 97 10 438 — 448 +Stock-based compensation — — 2,845 — 2,845 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 146 15 ( 223 ) — ( 208 ) +Net income — — — 10,134 10,134 +Balance at March 31, 2021 41,687 $ 4,170 $ 181,828 $ ( 107,019 ) $ 78,979 +See accompanying Notes to the Consolidated Financial Statements. +39 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +Iteris, Inc. +Year Ended March 31, +2021 2020 2019 +Cash flows from operating activities +Net income (loss) $ 10,134 $ ( 5,610 ) $ ( 7,816 ) +Less: Net income (loss) from discontinued operations 9,643 ( 3,852 ) ( 5,023 ) +Net income (loss) from continuing operations 491 ( 1,758 ) ( 2,793 ) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Right-of-use asset non-cash expense 1,438 1,199 — +Deferred income taxes 607 105 ( 18 ) +Depreciation of property and equipment 734 770 754 +Stock-based compensation 2,902 2,495 1,861 +Amortization of intangible assets 2,036 1,255 629 +Other 86 ( 60 ) — +Changes in operating assets and liabilities, net of effects of discontinued operations and acquisitions: +Trade accounts receivable ( 227 ) 235 ( 3,773 ) +Unbilled accounts receivable and deferred revenue 903 ( 2,353 ) 601 +Inventories ( 1,085 ) ( 124 ) 5 +Prepaid expenses and other assets ( 1,738 ) ( 951 ) 671 +Trade accounts payable and accrued expenses 4,168 ( 409 ) 1,868 +Operating lease liabilities ( 1,427 ) ( 866 ) — +Net cash provided by (used in) operating activities - continuing operations 8,888 ( 462 ) ( 195 ) +Net cash used in operating activities - discontinued operations ( 2,398 ) ( 3,365 ) ( 5,633 ) +Net cash provided by (used in) in operating activities 6,490 ( 3,827 ) ( 5,828 ) +Cash flows from investing activities +Purchases of property and equipment ( 601 ) ( 409 ) ( 486 ) +Purchase of short-term investments ( 23,655 ) ( 33,786 ) ( 4,079 ) +Maturities of investments 32,025 24,225 7,463 +Capitalized software development costs ( 767 ) ( 633 ) ( 660 ) +Cash paid in business acquisition, net of cash acquired ( 15,000 ) ( 5,581 ) — +Net proceeds from sale of Vehicle Sensors — — 107 +Net cash provided by (used in) investing activities - continuing operations ( 7,998 ) ( 16,184 ) 2,345 +Net cash provided by (used in) investing activities - discontinued operations 9,740 ( 59 ) — +Net cash provided by (used in) investing activities 1,742 ( 16,243 ) 2,345 +Cash flows from financing activities +Proceeds from stock option exercises 2,633 256 85 +Proceeds from ESPP purchases 448 370 365 +Tax withholding payments for net share settlements of restricted stock units ( 208 ) ( 15 ) ( 48 ) +Proceeds from issuance of common stock, net of costs — 26,751 — +Net cash provided by financing activities - continuing operations 2,873 27,362 402 +Net cash provided by financing activities - discontinued operations — — — +Net cash provided by financing activities 2,873 27,362 402 +Increase (decrease) in cash, cash equivalents and restricted cash 11,105 7,292 ( 3,081 ) +Cash, cash equivalents and restricted cash at beginning of period 14,363 7,071 10,152 +Cash, cash equivalents and restricted cash at end of period $ 25,468 $ 14,363 $ 7,071 +Supplemental cash flow information: +Cash paid during the year for: +Income taxes $ 183 $ 63 $ 4 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units $ 15 $ 7 $ 6 +Lease liabilities arising from obtaining right-of-use assets $ 689 $ 581 $ — +Deferred purchase price receivable $ 1,500 $ — $ — +Issuance of common stock in connection with acquisition $ — $ 4,535 $ — +Deferred consideration related to TrafficCast acquisition $ 2,050 $ — $ — +Working capital adjustment related to TrafficCast acquisition $ 681 $ — $ — +See accompanying Notes to the Consolidated Financial Statements. +40 +Table of Contents +Notes to Consolidated Financial Statements +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions. Our solutions enable public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, specialized consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +Prior to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and analytical solutions that provide analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further expand our advanced detection sensors, transportation performance analytics systems, and specialized consulting services and cloud-enabled managed services in the smart mobility infrastructure management market, and we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than twelve months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis with travel restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. While there has been no material impact to our business during the fiscal year ended March 31, 2021, we did experience some work delays due to the Pandemic. Should such conditions become protracted or worsen or should longer term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the spread of the outbreak, the distribution, rate of adoption and efficacy of vaccines, the impact on capital and financial markets and the related impact on the budgets and financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, the Company has taken certain actions to preserve its liquidity, manage cash flow and strengthen its financial flexibility. Such actions include, but are not limited to, reducing discretionary spending, reducing capital expenditures, implementing restructuring activities, and reducing payroll costs, including employee furloughs, pay freezes and pay cuts. Refer to Note 4, Restructuring Activities, to the Consolidated Financial Statements. +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to +41 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. Refer to Note 6, Income Taxes, to the Consolidated Financial Statements. +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world and its assessment of the impact of the Pandemic may change . +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”). The transaction closed on December 7, 2020. +Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $ 17.7 million, with $ 15.0 million paid in cash on the closing date, $ 1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $ 1.1 million acquisition-related liability, and a $ 1.0 million earn out, fair valued at $ 0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The parties also entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $ 26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $ 6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Sale of Agriculture and Weather Analytics Segment +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics ("AWA") segment to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to an Asset Purchase Agreement (the “AWA Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $ 12.0 million in cash, subject to working capital adjustments. Upon closing on May 5, 2020, the Company received $ 10.5 million in cash and $ 1.5 million of deferred payment, of which $ 1.45 million has been paid by DTN at the 12-month anniversary of the closing date, and $ 0.05 million will be paid by DTN at the 18-month anniversary of the closing date, subject to satisfactions of the conditions set forth in the AWA Purchase Agreement relating to the transition of certain customers to DTN and the collection of certain receivables by DTN. See Note 3, Discontinued Operations , to the Consolidated Financial Statements, for further details on the sale of the Agriculture and Weather Analytics segment. +42 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of the Company approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $ 1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and all its wholly-owned subsidiaries and have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP"). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Significant estimates made in the preparation of the consolidated financial statements include, but not limited to, recoverability of long-lived and intangible assets; fair value of acquired intangible assets and goodwill; collectability of accounts receivable and related allowance for doubtful accounts; projections of taxable income used to assess realizability of deferred tax assets; warranty reserves; costs to complete long-term contracts; indirect cost rates used in cost plus contracts; fair value of stock option awards and equity instruments; estimates of future cash flows used to assess the recoverability of the impairment of goodwill; fair value of contingent consideration and capitalization and estimated useful life of the Company's internal-use software development costs. Estimates are based on historical experience and on various assumptions that the Company believes are reasonable under current circumstances. However, future events are subject to change and best estimates and judgments may require further adjustments, therefore, actual results could differ materially from those estimates. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. +Revenue Recognition +Revenues are recognized when control of the promised goods or services are transferred to our customers, in a gross amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +Product revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term and these purchase orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues, primarily derived from our Transportation Systems segment, are primarily from long-term engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service revenues also consist of revenues derived from maintenance and support, extended warranty, and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from fees for maintenance and +43 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +support, extended warranty, monthly active user fees, software-as-a-service ("SaaS") fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services as the customer obtains equal benefit from the service throughout the service period. +The Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer which combines the software functionality, maintenance and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each constituting a separate performance obligation. +We generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +The Company's typical performance obligations include the following: +Performance Obligation When Performance +Obligation is Typically +Satisfied When Payment is +Typically Due How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product Upon shipment (point in time) Within 30 days of delivery Observable transactions +Engineering services where the deliverable is considered a product As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +SaaS Over the course of the SaaS service once the system is available for use (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Extended warranty service Over the course of the extended warranty period (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Disaggregation of Revenue +The Company disaggregates revenue from contracts with customers into reportable segments and the nature of the products and services. See Note 13, Business Segments, Significant Customer and Geographic Information for further details. +Trade Accounts Receivable and Contract Balances +We classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e. only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in the accompanying consolidated balance sheet at their net estimated realizable value. +The Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is increased by the Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are deducted from the allowance. +A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable in the accompanying consolidated balance sheet. For example, we would record a +44 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified milestones. +Our contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be recovered. As of March 31, 2021 and 2020, there was approximately $ 3.2 million and $ 1.2 million, respectively, of contract fulfillment costs which are presented in the accompanying consolidated balance sheets as prepaid and other current assets. These costs primarily relate to the satisfaction of performance obligations related to the set up of SaaS platforms. These costs are amortized on a straight-line basis over the estimated useful life of the SaaS platform. +Transaction Price Allocated to the Remaining Performance Obligations +As of March 31, 2021 and 2020, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial primarily as a result of termination provisions within our contracts which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the estimate each reporting period. +The Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have recognized is one year or less. +The Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping and handling costs are included as cost of revenues in the period during which the products ship. +The Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net basis (excluded from revenues) in the accompanying consolidated statements of operations. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of refund liabilities related to billings and consideration received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade accounts receivable. +45 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Cash and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal credit risk. +Our accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, South America and Asia. We generally do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's expectations. +We currently have, and historically have had, a diverse customer base. For the fiscal years ended March 31, 2021 ("Fiscal 2021") and, March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10 % of our total revenues. For the fiscal year ended March 31, 2019 ("Fiscal 2019"), one individual customer represented approximately 24 % of our total revenues. As of March 31, 2021 and 2020, no individual customer represented greater than 10 % of our total accounts receivable. +Fair Values of Financial Instruments +The accounting guidance provided in ASC 820, Fair Value Measurements ("ASC 820") for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows: +Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date. +Level 2—Observable inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the assets or liabilities. +A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. +The Company applies fair value accounting for all financial instruments on a recurring basis. The Company's financial instruments, which include cash, cash equivalents, accounts receivable and accounts payable are recorded at their carrying amounts, which approximate their fair values due to their short-term nature. All marketable securities are considered to be available-for-sale and recorded at their estimated fair values. In valuing these items, the Company uses inputs and assumptions that market participants would use to determine their fair value, utilizing valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. +Cash, Cash Equivalents and Restricted Cash +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +As of March 31, 2021 and 2020 restricted cash was 0.3 million and 0.1 million, respectively, related to cash restricted for shares purchased under the Employee Stock Purchase Plan ("ESPP") (see Note 10 for further details on the ESPP). +Cash, cash equivalents and restricted cash presented in the accompanying statements of cash flows consist of the following (in thousands): +46 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Year Ended March 31, +2021 2020 +Cash and cash equivalents $ 25,205 $ 14,217 +Restricted cash 263 146 +$ 25,468 $ 14,363 +Investments +The Company's investments are classified as either held-to-maturity, available-for-sale or trading, in accordance with ASC 320. Held-to-maturity securities are those securities that the Company has the positive intent and ability to hold until maturity. Trading securities are those securities that the Company intends to sell in the near term. All other securities not included in the held-to-maturity or trading category are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost which approximates fair market value. Trading securities are carried at fair value with unrealized gains and losses charged to earnings. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded within accumulated other comprehensive loss as a separate component of stockholders' equity. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available (see Note 5). As of March 31, 2021, all of our investments are available-for-sale. +Under ASC 320-10-35, a security is considered to be other-than-temporarily impaired if the present value of cash flows expected to be collected are less than the security's amortized cost basis (the difference being defined as the "Credit Loss") or if the fair value of the security is less than the security's amortized cost basis and the investor intends, or will be required, to sell the security before recovery of the security's amortized cost basis. If an other-than-temporary impairment exists, the charge to earnings is limited to the amount of Credit Loss if the investor does not intend to sell the security, and will not be required to sell the security, before recovery of the security's amortized cost basis. Any remaining difference between fair value and amortized cost is recognized in other comprehensive loss, net of applicable taxes. The Company evaluates whether the decline in fair value of its investments is other-than-temporary at each quarter-end. This evaluation consists of a review by management, and includes market pricing information and maturity dates for the securities held, market and economic trends in the industry and information on the issuer's financial condition and, if applicable, information on the guarantors' financial condition. Factors considered in determining whether a loss is temporary include the length of time and extent to which the investment's fair value has been less than its cost basis, the financial condition and near-term prospects of the issuer and guarantors, including any specific events which may influence the operations of the issuer and the Company's intent and ability to retain the investment for a reasonable period of time sufficient to allow for any anticipated recovery of fair value. +Accounts Receivable and Allowance for Doubtful Accounts +Accounts receivable are recorded net of the allowance for doubtful accounts. The allowance for doubtful accounts is estimated based on the Company's assessment of its ability to collect on customer accounts receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. The Company writes-off accounts receivable against the allowance when a determination is made that the balance is uncollectible and collection of the receivable is no longer being actively pursued. The allowance for doubtful accounts was $ 1.0 million and $ 0.8 million as of March 31, 2021 and 2020, respectively. +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. +Property and Equipment +47 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life of the related assets ranging from three to eight years . Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Intangible Assets +Intangible assets with determinable economic lives are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful life of each asset on a straight-line basis. The Company determines the useful lives of identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors the Company considers when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset and other economic factors, including competition and specific market conditions. Intangible assets without determinable economic lives are carried at cost, not amortized and reviewed for impairment at least annually. +Goodwill +Goodwill represents the excess of the aggregate purchase price over the fair value of net identifiable assets acquired in a business combination. Goodwill is not amortized and is tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In the valuation of goodwill, management must make assumptions regarding estimated future cash flows to be derived from the Company's business. If these estimates or their related assumptions change in the future, the Company may be required to record impairment for these assets. +The Company has the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value. However, the Company may elect to bypass the qualitative assessment and proceed directly to the quantitative impairment tests. The first step of the impairment test involves comparing the fair value of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, the Company would perform the second step of the goodwill impairment test to determine the amount of the impairment loss. We perform an annual quantitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further testing is required, if otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. As of March 31, 2021 and 2020, we determined that no adjustments to the carrying value of goodwill were required. +Impairment of Long-Lived Assets +The Company evaluates its long-lived assets, including property, equipment and intangible assets (other than goodwill) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We determine whether the carrying value of an asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived and intangible assets. During the three months ended June 30, 2020, we recorded $ 0.3 million in impairment charges related to right-of-use assets and leasehold improvements directly resulting from the restructuring activities. During the fiscal years ended March 31, 2021 and 2020, there was no additional impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such +48 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +determination is made. As such, we determined it was appropriate to record a full valuation allowance against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options, restricted stock units and performance stock units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. The fair value of our performance stock unit awards is estimated on the grant date using a Monte Carlo simulation model. While the use of these models meets established requirements, the estimated fair values generated by the models may not be indicative of the actual fair values of our awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Right-of-Use Assets and Lease Liabilities +We determine if an arrangement contains a lease at inception and determine the classification of the lease, as either operating or finance, at commencement. +Right-of-use assets and lease liabilities are recorded based on the present value of future lease payments which factors in certain qualifying initial direct costs incurred as well as any lease incentives received. If an implicit rate is not readily determinable, we utilize inputs from third-party lenders to determine the appropriate discount rate. Lease expense for operating lease payments are recognized on a straight-line basis over the lease term. Finance leases incur interest expense using the effective interest method in addition to amortization of the leased asset on straight-line basis, both over the applicable lease term. Lease terms may factor in options to extend or terminate the lease. +We adhere to the short-term lease recognition exemption for all classes of assets (i.e. facilities and equipment). As a result, leases with an initial term of twelve months or less are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. In addition, for certain equipment leases, we account for lease and non-lease components, such as services, as a single lease component as permitted. +Warranty +We generally provide a one to three years warranty from the original invoice date on all products, materials and workmanship. Products sold to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of +49 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +sales at the time revenue for that product is recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. We do not provide any service-type warranties. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and maintenance costs are charged to expense as incurred. +Comprehensive Loss +The difference between net income (loss) and comprehensive income (loss) was de minimis for Fiscal 2021, Fiscal 2020 and Fiscal 2019. +Recent Accounting Pronouncements +In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This update requires that certain financial assets be measured at amortized cost net of an allowance for estimated credit losses such that the net receivable represents the present value of expected cash collection. In addition, this standard update requires that certain financial assets be measured at amortized cost reflecting an allowance for estimated credit losses expected to occur over the life of the assets. The estimate of credit losses must be based on all relevant information including historical information, current conditions and reasonable and supportable forecasts that affect the collectability of the amounts. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which defers the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting companies that are not smaller reporting companies. As a smaller reporting company, ASU 2016-13 will now be effective for our fiscal year 2024 beginning April 1, 2023; however, early adoption is permitted. We are currently evaluating the timing and impact of adopting ASU 2016-13 on our consolidated financial statements. +In August 2018, the FASB issued Accounting Standards Update ("ASU") No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirement for Fair Value Measurements ("ASU 2018-13"), which modifies the disclosure requirements on fair value measurements. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. The Company adopted this update effective April 2020. The adoption of this ASU did not have a material impact on the Company’s financial statements. +In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal Use Software (subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"), which clarifies the accounting for implementation costs in cloud computing arrangements. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, and early adoption is permitted. The Company adopted this update effective April 2020. The adoption of this ASU did not have a material impact on the Company’s financial statements. +In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. The ASU removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within that fiscal year, with early adoption permitted. The Company early adopted this update effective July 2020. The adoption of this ASU did not have a material impact on the Company’s financial statements. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +50 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +2. Supplementary Financial Information (Continued) +March 31, +2021 2020 +(In thousands) +Materials and supplies $ 2,714 $ 1,380 +Work in process 435 162 +Finished goods 1,917 1,498 +$ 5,066 $ 3,040 +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2021 2020 +(In thousands) +Equipment $ 6,806 $ 6,222 +Leasehold improvements 3,046 2,911 +Accumulated depreciation ( 7,929 ) ( 7,298 ) +$ 1,923 $ 1,835 +Depreciation expense was approximately $ 0.7 million, $ 0.8 million and $ 0.8 million in Fiscal 2021, Fiscal 2020 and Fiscal 2019, respectively. Approximately $ 0.2 million, $ 0.3 million, and $ 0.3 million of the depreciation expense was recorded to cost of revenues, and approximately $ 0.5 million, $ 0.5 million, and $ 0.5 million was recorded to operating expenses in Fiscal 2021, Fiscal 2020 and Fiscal 2019, respectively, in the accompanying consolidated statements of operations. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, 2021 March 31, 2020 +Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value +(In thousands) +Technology $ 4,986 $ ( 1,594 ) $ 3,392 $ 1,286 $ ( 1,286 ) $ — +Customer contracts / relationships 9,550 ( 1,547 ) 8,003 3,750 ( 688 ) 3,062 +Trade names and non-compete agreements +782 ( 683 ) 99 770 ( 613 ) 157 +Capitalized software development costs +5,177 ( 2,374 ) 2,803 4,423 ( 1,576 ) 2,847 +Total $ 20,495 $ ( 6,198 ) $ 14,297 $ 10,229 $ ( 4,163 ) $ 6,066 +Amortization expense for intangible assets subject to amortization was approximately $ 2.0 million, $ 1.3 million and $ 0.6 million for Fiscal 2021, Fiscal 2020 and Fiscal 2019, respectively. Approximately $ 0.5 million, $ 0.5 million and $ 0.4 million of the intangible asset amortization was recorded to cost of revenues, and approximately $ 1.5 million, $ 0.8 million and $ 0.3 million was recorded to amortization expense for Fiscal 2021, Fiscal 2020 and Fiscal 2019, respectively, in the consolidated statements of operations. The weighted average remaining useful lives of the intangible assets as of March 31, 2021 is 5.1 years. +We have one indefinite useful life intangible asset, with de minimis carrying value, which was included in trade names and non-complete agreements. Our net customer contracts/relationships have a useful life of 6 years. Our net trade names and non-compete agreements have a useful life of 3 years. Our net capitalized software development costs of approximately $ 2.8 million and $ 2.9 million primarily consisted of our Oracle Enterprise Resource Planning ("ERP") system design and implementation of approximately $ 1.7 million and $ 1.9 million as of March 31, 2021 and 2020, respectively, which has a useful life of 10 years. +51 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +2. Supplementary Financial Information (Continued) +As of March 31, 2021, the future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2022 3,216 +2023 2,999 +2024 2,779 +2025 2,318 +2026 1,257 +Thereafter 1,716 +$ 14,285 +The future estimated amortization expense does not include the indefinite useful life intangible asset described above. +Goodwill +The following table presents the carrying value of our goodwill by reportable segments for Fiscal 2021, Fiscal 2020 and Fiscal 2019: +Roadway +Sensors Transportation +Systems Total +(In thousands) +Balance—March 31, 2021 +Goodwill $ 8,214 $ 20,346 $ 28,560 +Acquired goodwill (see Note 12) 4,044 3,706 7,750 +Accumulated impairment losses — ( 7,970 ) ( 7,970 ) +$ 12,258 $ 16,082 $ 28,340 +Balance—March 31, 2020 +Goodwill $ 8,214 $ 14,906 $ 23,120 +Acquired goodwill (Note 12) — 5,440 5,440 +Accumulated impairment losses — ( 7,970 ) ( 7,970 ) +$ 8,214 $ 12,376 $ 20,590 +Balance—March 31, 2019 +Goodwill $ 8,214 $ 14,906 $ 23,120 +Accumulated impairment losses — ( 7,970 ) ( 7,970 ) +$ 8,214 $ 6,936 $ 15,150 +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Balance at beginning of fiscal year $ 416 $ 463 $ 403 +Additions charged to cost of sales 508 649 647 +Warranty claims ( 355 ) ( 696 ) ( 587 ) +Balance at end of fiscal year $ 569 $ 416 $ 463 +52 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +2. Supplementary Financial Information (Continued) +Earnings Per Share +The following table sets forth the computation of basic and diluted loss from continuing operations per share: +Year Ended March 31, +2021 2020 2019 +(In thousands, except per +share amounts) +Numerator: +Net income (loss) from continuing operations $ 491 $ ( 1,758 ) $ ( 2,793 ) +Net income (loss) from discontinued operations, net of tax 9,643 ( 3,852 ) ( 5,023 ) +Net income (loss) $ 10,134 $ ( 5,610 ) $ ( 7,816 ) +Denominator: +Weighted average common shares used in basic computation 41,176 39,012 33,266 +Dilutive stock options 423 — — +Weighted average common shares used in diluted computation 41,599 39,012 33,266 +Basic: +Net income (loss) per share from continuing operations: $ 0.01 $ ( 0.04 ) $ ( 0.08 ) +Net income (loss) per share from discontinued operations: $ 0.23 $ ( 0.10 ) $ ( 0.15 ) +Net income (loss) per basic share $ 0.24 $ ( 0.14 ) $ ( 0.23 ) +Diluted: +Net income (loss) per share from continuing operations: $ 0.01 $ ( 0.04 ) $ ( 0.08 ) +Net income (loss) per share from discontinued operations: $ 0.23 $ ( 0.10 ) $ ( 0.15 ) +Net income (loss) per diluted share $ 0.24 $ ( 0.14 ) $ ( 0.23 ) +The following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted loss per share from continuing operations as their effect would have been anti-dilutive for the years ended March 31, 2020 and 2019: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Stock options 3,935 6,190 5,056 +Restricted stock units 126 110 12 +3. Discontinued Operations +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics segment to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to the AWA Purchase Agreement signed on May 2, 2020, in exchange for a total purchase consideration of $ 12.0 million in cash, subject to working capital adjustments. Upon closing on May 5, 2020, the Company received $ 10.5 million in cash, $ 1.45 million has been paid by DTN at the 12-month anniversary of the closing date, and $ 0.05 million will be paid by DTN at the 18-month anniversary of the closing date, subject to satisfactions of the conditions set forth in the Purchase Agreement relating to the transition of certain customers to DTN and the collection of certain receivables by DTN. The AWA Purchase Agreement also provides for customary post-closing adjustments to the purchase price related to working capital at closing. The parties also entered into certain ancillary agreements at the closing of the transaction that will provide Iteris with ongoing access to weather and pavement data that it integrates into its transportation software products, and a joint development agreement under which the parties agreed to pursue future joint opportunities in the global transportation market. +The sale of the Agriculture and Weather Analytics segment was a result of the Company’s shift in strategy to focus on its smart mobility infrastructure management solutions and to capitalize on the potential for a future partnership upon the sale of this business component to DTN. We have determined that the Agriculture and Weather Analytics segment, which constituted +53 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +3. Discontinued Operations (Continued) +one of our operating segments, qualifies as a discontinued operation in accordance with the criteria set forth in ASC 205-20, Presentation of Financial Statements – Discontinued Operations. +On May 5, 2020, the Company also entered into a transition services agreement (“TSA”) with DTN, pursuant to which the Company agreed to support the information technology and accounting functions of the Agriculture and Weather Analytics segment for a period up to 12 months and DTN agreed to provide the contract administration/account management services for certain contracts of the Company and other transition services. Either party may make any reasonable request to extend the period of time the other party shall provide a transition service beyond the initial service period or access to additional services that are necessary for the transition of the operations and business. The Company earned approximately $ 0.2 million in income and incurred approximately $ 0.1 million in costs associated with the TSA for the year ended March 31, 2021, which were included in income (loss) from discontinued operations on the accompanying consolidated statement of operations. +The related assets and liabilities of the Agriculture and Weather Analytics segment were reclassified to assets and liabilities of discontinued operations as of March 31, 2021 and March 31, 2020 on the accompanying consolidated balance sheets. The following table is a summary of major classes of assets and liabilities of discontinued operations: +March 31, 2021 +March 31, 2020 +(In thousands) +Assets +Trade accounts receivable, net of allowance for doubtful accounts $ — $ 863 +Unbilled accounts receivable — 504 +Prepaid expenses and other current assets — 109 +Total current assets of discontinued operations — 1,476 +Property and equipment, net — 107 +Right-of-use assets 78 446 +Other classes of assets that are not major — 73 +Total noncurrent assets of discontinued operations 78 626 +Total assets of discontinued operations $ 78 $ 2,102 +Liabilities +Trade accounts payable $ — $ 254 +Accrued liabilities — 91 +Accrued payroll and related expenses — 933 +Deferred revenue — 1,550 +Current Lease Liabilities +94 — +Total current liabilities of discontinued operations 94 2,828 +Noncurrent Lease liabilities 261 357 +Total liabilities of discontinued operations $ 355 $ 3,185 +The results of operations for the Agriculture and Weather Analytics segment were included in net income (loss) from discontinued operations on the accompanying consolidated statements of operations. The following table provides information regarding the results of discontinued operations: +54 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +3. Discontinued Operations (Continued) +Year Ended March 31, +2021 2020 2019 +Service revenue $ 695 $ 6,714 $ 5,816 +Cost of service revenues 350 2,566 2,472 +Gross profit 345 4,148 3,344 +Operating expenses: +Selling, general and administration 780 3,718 4,304 +Research and development 407 4,282 4,063 +Restructuring charges 837 — — +Total operating expenses 2,024 8,000 8,367 +Operating loss from discontinued operations ( 1,679 ) ( 3,852 ) ( 5,023 ) +Other income, net 72 — — +Loss from discontinued operation before income tax ( 1,607 ) ( 3,852 ) ( 5,023 ) +Income tax expense ( 47 ) — — +Net loss from discontinued operations ( 1,654 ) ( 3,852 ) ( 5,023 ) +Gain on disposal of discontinued operations before income tax 11,315 — — +Income tax expense on gain on disposal ( 18 ) — — +Gain on disposal of discontinued operations after income tax 11,297 — — +Net income (loss) from discontinued operations $ 9,643 $ ( 3,852 ) $ ( 5,023 ) +The following table provides information on the gain recorded on the sale of the Agriculture and Weather Analytics segment for the year ended March 31, 2021. These amounts reflect the closing balance sheet of the Agriculture and Weather Analytics segment upon the closing of the sale on May 5, 2020 (in thousands). +Initial proceeds from sale, net of transaction costs $ 9,440 +Closing working capital adjustment 250 +Deferred payments of purchase price 1,500 +Total purchase considerations 11,190 +Trade accounts receivable, net of allowance for doubtful accounts 1,060 +Unbilled accounts receivable 488 +Other classes of assets that are not major 194 +Total Agriculture and Weather Analytics segment assets 1,742 +Trade accounts payable 349 +Deferred revenue 1,518 +Total Agriculture and Weather Analytics segment liabilities 1,867 +Gain on sale of Agriculture and Weather Analytics segment $ 11,315 +The initial proceeds were net of transaction costs of approximately $ 1.1 million. +4. Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth, and the Company incurred total restructuring charges of approximately $ 1.5 million, primarily resulting from a separation for certain +55 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +4. Restructuring Activities (Continued) +employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company and lease impairment related to our Grand Forks, North Dakota facility. +The following table presents the restructuring and severance costs for our reportable segments, as well as corporate expenses, for the fiscal year ended March 31, 2021 (in thousands): +Roadway +Sensors Transportation +Systems Agriculture and +Weather +Analytics Corporate Total +Severance and benefits $ 110 $ 43 $ 524 $ 428 $ 1,105 +Lease impairment and other costs — — 313 38 351 +Total restructuring and severance costs $ 110 $ 43 $ 837 $ 466 $ 1,456 +During the year ended March 31, 2021, approximately $ 0.6 million of the restructuring costs were recorded to restructuring charges in the accompanying consolidated statements of operations, and approximately $ 0.8 million of the restructuring costs were recorded to loss from discontinued operations in the accompanying consolidated statements of operations. +As of March 31, 2021, we have accrued approximately $ 0.1 million for severance and benefits related to the restructuring activities in accrued payroll and related expenses in the accompanying consolidated balance sheet. Our restructuring activities during the fiscal years ended March 31, 2021 were as follows (in thousands): +Balance at March 31, 2020 $ — +Charged to expenses 1,105 +Cash payments ( 1,005 ) +Balance at March 31, 2021 $ 100 +5 . Fair Value Measurements +We did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2021 or 2020, except for the contingent consideration of $ 0.6 million (with $ 0.2 million due in the next 12 months) related to the earn-out as part of the TrafficCast acquisition. Our non-financial assets, such as goodwill, intangible assets, property and equipment, and acquired assets and liabilities assumed are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets such as a purchase transaction, a business combination or an adjustment for impairment. Our non-financial assets, such as goodwill, intangible assets, property and equipment, securities held in the deferred compensation plan and the liabilities associated with the deferred compensation plan, and acquired assets and liabilities assumed are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets. In Fiscal 2021, Fiscal 2020 and Fiscal 2019, Level 3 inputs were used to evaluate the fair value of the contingent consideration and goodwill in our two reporting units that had goodwill balances. No other non-financial assets were measured at fair value as of March 31, 2021 and March 31, 2020. +The following tables present the Company's financial assets and liabilities that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +56 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +5. Fair Value Measurements (Continued) +As of March 31, 2021 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +Assets: (In thousands) +Level 1: +Money market funds $ 4,676 $ — $ — $ 4,676 +Securities held in deferred compensation plan (1) +89 — 11 100 +Subtotal 4,765 — 11 4,776 +Level 2: +Commercial paper 4,999 — — 4,999 +Corporate notes and bonds 1,085 — — 1,085 +US treasuries 4,600 — — 4,600 +Subtotal 10,684 — — 10,684 +Total $ 15,449 $ — $ 11 $ 15,460 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) +$ 100 $ — $ 11 $ 111 +Level 3: +Contingent consideration (3) +600 — — — 600 +Total $ 700 $ — $ 11 $ 711 +As of March 31, 2020 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +(In thousands) +Level 1: +Money market funds $ 10,576 $ ( 1 ) $ — $ 10,575 +Subtotal 10,576 ( 1 ) — 10,575 +Level 2: +Commercial paper 1,495 ( 1 ) — 1,494 +Corporate notes and bonds 6,044 ( 22 ) — 6,022 +US treasuries 3,013 — 20 3,033 +US government agencies 1,007 — — 1,007 +Subtotal 11,559 ( 23 ) 20 11,556 +Total $ 22,135 $ ( 24 ) $ 20 $ 22,131 +(1) Included in prepaid expenses and other current assets on the Company’s consolidated balance sheet. +(2) Included in accrued payroll and related expenses on the Company’s consolidated balance sheet. +(3) Included in other long-term liabilities on the Company’s consolidated balance sheet. +Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2021. +57 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +6. Income Taxes +The components of current and deferred federal and state income tax (benefit) provision are as follows: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Income (loss) from continuing operations before income taxes $ 606 $ ( 1,598 ) $ ( 2,757 ) +Current income tax provision: +Federal — — — +State 67 34 36 +Total current tax provision 67 34 36 +Deferred income tax benefit: +Federal 21 105 — +State 27 21 — +Total deferred benefit provision 48 126 — +Provision for income taxes on continued operations 115 160 36 +Income (loss) from continuing operations, net of taxes $ 491 $ ( 1,758 ) $ ( 2,793 ) +The reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Provision (benefit) for income taxes at statutory rates $ 90 $ ( 1,095 ) $ ( 1,634 ) +State income taxes net of federal benefit ( 177 ) ( 198 ) ( 620 ) +Tax credits ( 663 ) ( 658 ) ( 343 ) +Compensation charges 313 151 199 +Change in valuation allowance 523 1,913 2,385 +Other 29 47 49 +Provision for income taxes $ 115 $ 160 $ 36 +58 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +6. Income Taxes (Continued) +The components of deferred tax assets and liabilities are as follows: +Year Ended March 31, +2021 2020 +(In thousands) +Deferred tax assets: +Net operating losses $ 2,186 $ 4,284 +Capitalized R&D 2,282 3,520 +Credit carry forwards 4,088 3,510 +Deferred compensation and payroll 2,475 2,304 +Bad debt allowance and other reserves 930 656 +Operating leases — 219 +Property and equipment 354 60 +Other, net 765 556 +Total deferred tax assets 13,080 15,109 +Valuation allowance ( 12,349 ) ( 14,163 ) +Total deferred tax assets, net of valuation allowance 731 946 +Deferred tax liabilities: +Acquired intangibles ( 297 ) ( 596 ) +Goodwill ( 672 ) ( 540 ) +Total deferred tax liabilities ( 969 ) ( 1,136 ) +Net deferred tax liabilities $ ( 238 ) $ ( 190 ) +At March 31, 2021, we had $ 3.2 million in federal research credits that begin to expire in 2031 and $ 1.2 million in state tax credits that begin to expire in 2023. We had $ 7.7 million of federal net operating loss carryforwards at March 31, 2021 that do not expire as a result of recent tax law changes. We also had $ 5.9 million of state net operating loss carryforwards at March 31, 2021 that begin to expire in 2031. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it appropriate to maintain valuation allowances of $ 12.3 million and $ 14.2 million against our deferred tax assets at March 31, 2021 and 2020, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve. +On March 27, 2020, the CARES Act was enacted in response to the Pandemic. The CARES Act contains numerous income tax provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. The income tax provisions of the CARES Act had an immaterial impact on our current taxes, deferred taxes, and uncertain tax positions of the Company in the year ended March 31, 2020. The CARES Act also allows for the deferral of payroll taxes, as well as the immediate refund of federal Alternative Minimum Tax credits, which had previously been made refundable over a period of four years by the Tax Cuts and Jobs Act of 2017. +The Company is currently evaluating the impact of final IRS regulations under Internal Revenue Code section 263A relating to inventory capitalization for tax purposes. The Company does not expect there to be a material impact to the financial statements. +Unrecognized Tax Benefits +59 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +6. Income Taxes (Continued) +As of March 31, 2021 and 2020, our gross unrecognized tax benefits were approximately $ 1.1 million and $ 1.0 million, respectively, of which approximately $ 1.0 million and $ 0.9 million, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are approximately $ 1.0 million and $ 0.8 million, respectively. +A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Gross unrecognized tax benefits at beginning of year $ 952 $ 687 $ 586 +Increases for tax positions taken in prior years 35 101 2 +Decreases for tax positions taken in prior years 0 — — +Increases for tax positions taken in the current year 104 180 116 +Lapse in statute of limitations ( 12 ) ( 16 ) ( 17 ) +Gross unrecognized tax benefits at March 31 $ 1,079 $ 952 $ 687 +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2018 or later, and state and local income tax examination for fiscal tax years ended March 31, 2017 or later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +7. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural industries, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any legal proceeding, the outcome of which, in management's opinion, individually or in the aggregate, would have a material effect on the Company's consolidated results of operations, financial position or cash flows. +8. Right-of-Use Assets and Lease Liabilities +On April 1, 2019, the Company adopted ASU 2016-02, Leases and recognized (a) an operating lease liability of $ 14.2 million, which represents the present value of our remaining lease payments and (b) a related right-of-use asset of $ 13.4 million. In addition, the Company derecognized approximately $ 0.8 million of deferred rent liability. The adoption of ASU 2016-02 did not have a material impact on the Company's statement of operations, cash flows, or stockholders' equity. Due to the adoption of the standard using the modified retrospective cumulative-effect adjustment method, there were no changes to our previously reported results prior to April 1, 2019. +We have various operating leases for our offices, office equipment and vehicles in the United States. These leases expire at various times through 2029. Certain lease agreements contain renewal options from 1 to 5 years, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. +60 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +8. Right-of-Use Assets and Lease Liabilities(Continued) +The table below presents lease-related assets and liabilities recorded on the consolidated balance sheet as follows: +Classification March 31, 2021 +(In thousands) +Assets +Operating lease right-of-use-assets - continuing operations Right-of-use assets $ 11,353 +Operating lease right-of-use-assets - discontinued operations Noncurrent assets of discontinued operations 78 +Total operating lease right-of-use-assets $ 11,431 +Liabilities +Operating lease liabilities (short-term) - continuing operations Accrued liabilities $ 2,089 +Operating lease liabilities (short-term) - discontinued operations Current liabilities of discontinued operations 94 +Total operating lease liabilities (short-term) 2,183 +Operating lease liabilities (long-term) - continuing operations Lease liabilities 10,146 +Operating lease liabilities (long-term) - discontinued operations Noncurrent liabilities of discontinued operations 261 +Total operating lease liabilities (long-term) 10,407 +Total operating lease liabilities $ 12,590 +Lease Costs +For Fiscal 2021, Fiscal 2020 and Fiscal 2019, lease costs totaled approximately $ 2.7 million, $ 2.6 million and $ 1.9 million, respectively. The Company currently has no variable lease costs. +Supplemental Information +The table below presents supplemental information related to operating leases during the fiscal year ended March 31, 2021 (in thousands, except weighted average information): +Cash paid for amounts included in the measurement of operating lease liabilities $ 2,847 +Right-of-use assets obtained in exchange for new operating lease liabilities $ 689 +Weighted average remaining lease term 6 +Weighted average discount rate 5.0 % +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the operating lease liabilities recorded on the consolidated balance sheet as of March 31, 2021: +61 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +8. Right-of-Use Assets and Lease Liabilities(Continued) +Fiscal Year Ending March 31, Operating Leases Sublease Income Net Operating Leases +(In thousands) +2022 $ 2,750 $ 9 $ 2,741 +2023 2,513 — 2,513 +2024 2,348 — 2,348 +2025 2,076 — 2,076 +2026 1,865 — 1,865 +Thereafter 3,031 — 3,031 +Total lease payments 14,583 $ 9 $ 14,574 +Less imputed interest ( 1,993 ) +Present value of future lease payments 12,590 +Less current obligations under leases ( 2,183 ) +Long-term lease obligations $ 10,407 +9. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2021 and 2020, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between Iteris and Computershare Trust Company, N.A. ("Computershare"), as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of Designations, which created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. Effective on September 28, 2018, an amendment was entered into by and between Iteris and Computershare to accelerate the expiration of the Rights from August 20, 2019 to September 28, 2018, wherein all of the Rights distributed to the holders of the Company's common stock pursuant to the Rights Agreement expired. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2021: +Number of Shares +(In thousands) +Stock options outstanding 5,623 +Restricted stock units outstanding 448 +Performance stock units outstanding 61 +Authorized for future issuance under stock incentive plans 595 +6,727 +10. Employee Benefit Plans +Stock Incentive Plans +62 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +10. Employee Benefit Plans (Continued) +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December 2016, our stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs, cash incentive awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25 % on each of the first four anniversaries of the grant date. Stock appreciation rights, restricted stock, RSUs and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. +We currently maintain two stock incentive plans, the 2007 Omnibus Incentive Plan (the "2007 Plan") and the 2016 Omnibus Incentive Plan (the "2016 Plan"). Of these plans, we may only grant future awards from the 2016 Plan. The 2016 Plan allows for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), cash incentive awards and other stock-based awards. At March 31, 2021, there were approximately 0.6 million shares of common stock available for grant or issuance under the 2016 Plan. Total stock options vested and expected to vest were approximately 5.6 million as of March 31, 2021. +Stock Options +A summary of activity in the Omnibus Incentive Plans with respect to our stock options for Fiscal 2021 is as follows: +Options Weighted +Average +Exercise +Price Per +Share Weighted +Average +Remaining +Contractual +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +Options outstanding at March 31, 2020 5,934 $ 3.99 7.2 2,095 +Granted 831 4.90 +Exercised ( 743 ) 1.69 +Forfeited ( 378 ) 4.84 +Expired ( 21 ) 2.32 +Options outstanding at March 31, 2021 5,623 1.99 6.8 11,659 +As of March 31, 2021, 3,444 stock options were exercisable. +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under the 2007 Plan vest at the rate of 25 % on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs granted under the 2016 Plan vest at varying terms between one and four anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +63 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +10. Employee Benefit Plans (Continued) +A summary of activity with respect to our RSUs for Fiscal 2021 is as follows: +# of Shares Weighted +Average +Price Per +Share Weighted +Average +Remaining +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +RSUs outstanding at March 31, 2020 404 $ 5.16 2.0 1,295 +Granted 239 3.13 +Vested ( 189 ) 5.13 +Forfeited ( 6 ) 5.52 +RSUs outstanding at March 31, 2021 448 4.08 7.8 2,764 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of operations: +Year Ended March 31, +2021 2020 2019 +(In thousands) +Cost of revenues $ 209 $ 143 $ 122 +Selling, general and administrative expense 2,517 2,271 1,680 +Research and development expense 134 81 59 +Restructuring activities 42 — — +Loss from discontinued operations ( 57 ) 290 295 +Total stock-based compensation $ 2,845 $ 2,785 $ 2,156 +At March 31, 2021, there was approximately $ 4.7 million, $ 1.6 million and $ 0 of unrecognized compensation expense related to unvested stock options, RSUs, and PSUs respectively. This expense is currently expected to be recognized over a weighted average period of approximately 2.8 years for stock options, 1.6 years for RSUs. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +The grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2021 2020 2019 +Expected life—years 6.7 6.8 5.9 +Risk-free interest rate 1.0 % 2.2 % 2.7 % +Expected volatility of common stock 47 % 47 % 43 % +Dividend yield 0 % 0 % 0 % +Expected Life: The Company's expected life represents the weighted-average period that the Company's stock options are expected to be outstanding. The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of grant for the expected term of the option. +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +64 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +10. Employee Benefit Plans (Continued) +A summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2021 2020 2019 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted $ 2.38 $ 2.52 $ 1.89 +Intrinsic value of options exercised $ 1,494 $ 378 $ 114 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No contributions were made during the fiscal years ended March 31, 2021, 2020 and 2019. +We sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible employees voluntarily contribute to the plan, up to IRS maximums, through payroll deductions. We match up to 50 % of contributions, up to a stated limit, with all matching contributions being fully vested after one month of service. Our matching contributions under the 401(k) Plan were approximately $ 1.4 million, $ 1.3 million and $ 1.2 million for Fiscal 2021, Fiscal 2020 and Fiscal 2019, respectively. +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an ESPP which allows employees to withhold a percentage of their base compensation to purchase the Company's common stock at 95 % of the lower of the fair market at the beginning of the offering period and on the last trading day of the offering period. There are two offering periods during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may contribute 1 - 15 % of their eligible gross pay up to a $ 0.03 million annual stock value limit. During Fiscal 2021, Fiscal 2020, and Fiscal 2019, 97,000 , 91,000 and 92,000 shares, respectively, were purchased. The ESPP is considered a non-compensatory plan and accordingly no compensation expense is recorded in connection with this benefit. +As of March 31, 2021, approximately $ 0.3 million of cash was restricted for the purchase of shares under the ESPP and is recorded as restricted cash in the accompanying consolidated balance sheets. +Deferred Compensation Plan +Effective October 1, 2020, the Company adopted the Iteris, Inc. Non Qualified Deferred Compensation Plan (the "DC Plan"). The DC Plan consists of two plans, one that is intended to be an unfunded arrangement for eligible key employees who are part of a select group of management or highly compensated employees of the Company within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, and one for the benefit of non-employee members of our Board of Directors. Key employees, including our executive officers, and our non-employee directors who are notified regarding their eligibility to participate and delivered the DC Plan enrollment materials are eligible to participate in the DC Plan. Under the DC Plan, we will provide participants with the opportunity to make annual elections to defer a percentage of their eligible cash compensation and equity awards. A participant is always 100% vested in his or her own elective cash deferrals and any earnings thereon. Elective deferrals of equity awards are credited to a bookkeeping account established in the name of the participant with respect to an equivalent number of shares of our common stock, and such credited shares are subject to the same vesting conditions as are applicable to the equity award subject to the election. The Company established a rabbi trust to finance our obligations under the DC Plan with corporate-owned life insurance policies on participants, and the assets held within this trust are subject to the claims of the Company's creditors. +As of March 31, 2021, the amount invested under the DC Plan totaled $ 0.09 million and are classified as trading securities, which are recorded at fair market value with changes recorded as adjustments to other income. This amount is included in prepaid expenses and other current assets on the consolidated balance sheets. +As of March 31, 2021, the vested amounts under the DC Plan totaled $ 0.1 million and are included in accrued payroll and related expenses on the consolidated balance sheets. Changes in the deferred compensation plan liabilities are recorded as an adjustment to compensation expense. +65 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +10. Employee Benefit Plans (Continued) +As of March 31, 2021, no equity awards were deferred and held in the rabbi trust. The shares deferred and held in the rabbi trust will be classified as treasury stock, and the liability to participating employees will be classified as deferred compensation obligations in the stockholders' equity section of the consolidated balance sheets. The number of shares needed to settle the liability for deferred compensation obligations will be included in the denominator in both the basic and diluted earnings per share calculations. +The cash surrender value of the corporate-owned insurance policies totaled $ 0.07 million and is included in prepaid expenses and other current assets on the consolidated balance sheets. +Employment Inducement Incentive Plan +On December 4, 2020, the Board of Directors approved the Iteris, Inc. 2020 Employment Inducement Incentive Award Plan (the “Inducement Plan”) in conjunction with the TrafficCast acquisition. The terms of the Inducement Plan are substantially similar to the terms of the Company’s 2016 Omnibus Incentive Plan with the exception that incentive stock options may not be granted under the Inducement Plan. The Inducement Plan was adopted by the Board of Directors without stockholder approval pursuant to Rule 5635(c)(4) of the Nasdaq Listing Rules. +The Board of Directors has initially reserved 300,000 shares of the Company’s common stock for issuance pursuant to awards granted under the Inducement Plan. In accordance with Rule 5635(c)(4) of the Nasdaq Listing Rules, awards under the Inducement Plan may only be made to an employee who has not previously been an employee or member of the Board of Directors of the Company or any parent or subsidiary, or following a bona fide period of non-employment by the Company or a parent or subsidiary, and only if he or she is granted such award in connection with his or her commencement of employment with the Company or a subsidiary and such grant is an inducement material to his or her entering into employment with the Company or such subsidiary. +During the fiscal year ended March 31, 2021, the Company granted 95,000 stock options and 84,914 restricted stock units to TCI employees under the Inducement Plan. +11. Stock Repurchase Program +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $ 3.0 million of our outstanding common stock from time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $ 1.3 million. On August 9, 2012, our Board of Directors cancelled the initial stock repurchase program and the approximate $ 1.7 million of remaining funds, and approved a new stock repurchase program pursuant to which we may acquire up to $ 3.0 million of our outstanding common stock for an unspecified length of time. Under the new program, we may repurchase shares from time to time in open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $ 3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company may continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For our fiscal years ended March 31, 2021, 2020, and 2019 we did no t repurchase any shares. From inception of the program in August 2011 through March 31, 2021, we repurchased approximately 3,422,000 shares of our common stock for an aggregate price of approximately $ 5.6 million, at an average price per share of $ 1.63 . As of March 31, 2021, all repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2021, approximately 1.7 million remains available for the repurchase of our common stock under our current program. +12. Acquisitions +TrafficCast Acquisition +On December 7, 2020, the Company completed the acquisition of the assets of TrafficCast, a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to media, mobile technology, automotive and public sector customers throughout North America. Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business. +66 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +12. Acquisition (Continued) +The aggregate acquisition-date fair value of the consideration transferred totaled approximately $ 17.7 million, which consisted of the following: +Fair Value +(in thousands) +Cash $ 15,000 +Security hold back 1,000 +Acquisition-related liabilities 1,131 +Contingent consideration 600 +Total $ 17,731 +The security hold back relates to amounts held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, and is included in other long-term liabilities on the consolidated balance sheets. Acquisition-related liabilities include customary post-closing adjustments, as well as short term liabilities related to certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services. These items are included in accrued liabilities on the consolidated balance sheets. Contingent consideration relates to a $ 1.0 million earn out, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. This item is included in other long-term liabilities on the consolidated balance sheets. +TrafficCast operates two lines of business – commercial and public sector – each of which contributes about 50% of total revenue. Its commercial line of business develops software that collects, filters, and models real-time traveler information and traffic incident data for global media companies and other commercial customers. Its public sector line of business provides sensors and related software that help state and local agencies measure, visualize, and manage traffic flow. The management team has deep experience in traffic management systems, traffic flow theory and probe data technologies, as well as mobile services, digital content and media marketing. The commercial line of business is presented in the results of the Transportation Systems segment, while the public sector line of business is presented in the results of the Roadway Sensors segment. Since the date of acquisition, TrafficCast contributed approximately $ 2.7 million of service revenue and approximately $ 1.4 million of product revenue, as well as approximately $ 1.0 million of net loss. +The acquisition of TrafficCast has been accounted for as a business combination. We estimated the fair values of net assets acquired, and the excess of the consideration transferred over the aggregate of such fair values was recorded as goodwill. +The following tables summarize the preliminary purchase price allocation (in thousands) as of December 7, 2020: +Trade accounts receivable $ 2,087 +Unbilled accounts receivable 596 +Inventories 941 +Right-of-use assets 193 +Property and equipment 233 +Intangible assets 9,500 +Goodwill 7,750 +Other assets 242 +Total assets acquired 21,542 +Accounts payable 1,026 +Deferred revenue 2,460 +Lease liabilities 193 +Other liabilities 132 +Total liabilities assumed 3,811 +Total purchase price $ 17,731 +67 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +12. Acquisition (Continued) +The fair values of the TrafficCast Business and liabilities, other than goodwill and intangible assets, noted above approximate their carrying values at December 7, 2020. There was no difference between the fair value of trade accounts receivables and the gross contractual value of those receivables. There are no contractual cash flows related to these receivables that are not expected to be collected. The Company believes the goodwill related to the acquisition was a result of the ability of the Company to leverage its technology in the broader market, as well as offering cross-selling market exposure opportunities. Goodwill from the acquisition of TrafficCast is included within the Company’s Roadway Sensors and Transportation Systems reporting units and was included in the annual review for impairment. The goodwill is fully deductible for tax purposes. The significant intangible assets identified in the purchase price allocation include customer relationship and developed technology, which are amortized over their respective useful lives on a straight line basis which approximates the underlying cash flows. To value the customer relationships, the Company utilized the income approach, specifically a discounted cash-flow method known as the excess earnings method. The Company used the replacement cost method with consideration of opportunity costs to estimate the fair value of the technology. The fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. We believe the assumptions are representative of those a market participant would use in estimating fair value. +The following table presents the fair values and useful lives of the identifiable intangible assets acquired: +Amount Weighted Average +Useful Life +(in thousands) (in years) +Customer relationships $ 5,800 7 +Technology 3,700 4 +Total intangible assets assumed $ 9,500 +AGI Acquisition +On July 2, 2019, the Company completed the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida, with offices in Orlando (FL), Virginia Beach (VA) and Chadds Ford (PA). AGI assists municipalities in maximizing the effectiveness of their existing transportation networks through a collection of traffic management services to cost effectively improve the performance of roadway systems and address increased traffic demands, traffic congestion and delay. With a foundation of arterial timing plan development, AGI has expanded its services into active arterial monitoring and management with multiple public sector clients. AGI is expected to expand the Company's geographic footprint for ITS services in Florida, as well as in the Midwest and Mid-Atlantic region. AGI's typical contracts are for traffic operations professional engineering services focused on transportation systems management and operations. +Pursuant to a Stock Purchase Agreement dated June 10, 2019 among the Company, AGI and the stockholders of AGI (the "Selling Shareholders"), the Company acquired all of the outstanding capital stock of AGI from the Selling Shareholders for an aggregate purchase price of $ 10.8 million, after working capital adjustments, payable in cash and stock, of which 114,943 shares were held in escrow for 18 months to secure performance of indemnification and other post-closing obligations of the Selling Shareholders. +The acquisition of AGI has been accounted for as a business combination. We estimated the fair values of net assets acquired, and the excess of the consideration transferred over the aggregate of such fair values was recorded as goodwill. +68 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +12. Acquisition (Continued) +The following tables summarize the purchase price allocation (in thousands) as of July 2, 2019: +Cash $ 664 +Trade accounts receivable 905 +Unbilled accounts receivable 347 +Right-of-use assets 863 +Property and equipment 357 +Intangible assets 3,710 +Goodwill 5,440 +Other assets 161 +Total assets acquired 12,447 +Accounts payable ( 378 ) +Accrued payroll and related expenses ( 426 ) +Lease liabilities ( 863 ) +Total liabilities assumed ( 1,667 ) +Total purchase price $ 10,780 +The fair values of the remaining AGI assets and liabilities noted above approximate their carrying values at July 2, 2019. There was no difference between the fair value of trade accounts receivables and the gross contractual value of those receivables. There are no contractual cash flows related to these receivables that are not expected to be collected. The Company believes the goodwill related to the acquisition was a result of the ability of the Company to leverage its technology in the broader market, as well as offering cross-selling market exposure opportunities. Goodwill from the acquisition of AGI is included within the Company's Transportation Systems reporting unit. The goodwill is fully deductible for tax purposes. The significant intangible assets identified in the purchase price allocation include customer relationships and non-compete agreements, which are amortized over their respective useful lives on a straight line basis which approximates the underlying cash flows. To value the customer relationships, the Company utilized the income approach, specifically a discounted cash-flow method known as the excess earnings method. The Company utilized the with and without method to derive the fair value of the non-compete agreement. The fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. Varying discount rates were applied to the projected net cash flows and EBITDA as applicable to valuation methodology. We believe the assumptions are representative of those a market participant would use in estimating fair value. +The following table presents the fair values and useful lives of the identifiable intangible assets acquired: +Amount Weighted Average +Useful Life +(in thousands) (in years) +Customer relationships 3,500 6 +Non-compete agreement 210 3 +Total intangible assets assumed 3,710 +Acquisition-Related Costs +In connection with the acquisition of AGI, the Company agreed to grant $ 1.7 million in retention bonuses to the Selling Shareholders and other employees payable in the form of restricted stock units at $ 5.22 per share, and $ 0.6 million in retention bonuses payable in cash, each vesting and payable over three years following the closing, provided such employees remain in our service on the first, second and third anniversary of the closing of the acquisition. For the fiscal years ended March 31, 2021 and 2020, the Company recorded approximately $ 0.7 million and $ 1.0 million, respectively, as stock based compensation and salaries expense to selling, general and administrative expense in the consolidated statements of operations, related to these bonuses. +69 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +12. Acquisition (Continued) +In connection with the acquisition of AGI, the Company recorded approximately $ 0.7 million, in acquisition related professional fees, which was included in selling, general and administrative expense, in the consolidated statements of operations for the year ended March 31, 2020. +In connection with the acquisition of TrafficCast, the Company recorded approximately $ 0.4 million, in acquisition related professional fees, which was included in selling, general and administrative expense, in the consolidated statements of operations for the year ended March 31, 2021. +Pro Forma Financial Information (Unaudited) +The following pro forma information presents the consolidated results of operations of the Company, AGI and TrafficCast for the fiscal years ended March 31, 2021, 2020 and 2019, as if the acquisition of AGI had been completed on April 1, 2018 and the acquisition of TrafficCast had been completed on April 1, 2019. These pro forma unaudited consolidated financial results have been prepared for comparative purposes only and include certain adjustments that reflect pro forma results of operations, such as increased amortization for the fair value of acquired intangible assets and increased salaries expense related to the retention bonuses. The pro forma results do not reflect any operating efficiencies or potential cost savings that may result from the consolidation of the operations of the Company, AGI and TrafficCast. Accordingly, these pro forma results are presented for informational purposes only and are not necessarily indicative of the results of operations that actually would have been achieved had the acquisition of AGI occurred as of April 1, 2018 and the acquisition of TrafficCast occurred as of April 1, 2019, nor are they intended to represent or be indicative of future results of operations: +Year Ended March 31, +2021 2020 2019 +Proforma revenue $ 117,138 $ 124,156 $ 101,233 +Proforma net income (loss) from continuing operations $ 491 $ ( 5,262 ) $ ( 2,084 ) +Pro forma income (loss) per common stock +Basic $ 0.02 $ ( 0.13 ) $ ( 0.06 ) +Diluted $ 0.02 $ ( 0.13 ) $ ( 0.06 ) +13. Business Segments, Significant Customer and Geographic Information +Business Segments +We operate in two reportable segments: Roadway Sensors and Transportation Systems. +The Roadway Sensors segment provides advanced detection sensors and systems for traffic intersection management, communication systems and roadway traffic data collection applications. The Roadway Sensors product line uses advanced image processing technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and data using various communication technologies. Our Roadway Sensors products include, among others, the Vantage, VantageLive!, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax and P-Series products. Our Roadway Sensors segment also includes the sale of original equipment manufacturer (“OEM”) products for the traffic intersection markets, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. The Roadway Sensors segment also includes the public sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions, to the consolidated financial statements for further details). +The Transportation Systems segment provides engineering and specialized consulting services, cloud-enabled managed services, transportation performance measurement and traffic analytics solutions, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. Our Transportation Systems services include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement and commercial vehicle operations, as well as provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. Our Transportation Systems product line includes:the Iteris Signal Performance Measures ("Iteris SPM") and iPeMS traffic signal performance and traffic analytics software suites, the capabilities and customers of which have now respectively been incorporated into and migrated to ClearGuide, our comprehensive mobility intelligence and transportation performance measures solution; our advanced traveler +70 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +13. Business Segments, Significant Customer and Geographic Information (Continued) +information system ("ATIS") solution for public transportation agencies, ClearRoute; our ATIS solution for the enterprise and commercial sector, TrafficCarma; and our commercial vehicle operations and vehicle safety compliance platforms known as ClearFleet, CVIEW-Plus, CheckPoint, UCRLink and inspect. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 as well as the commercial operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions, to the consolidated financial statements for further details).. +The accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies (Note 1, Description of Business and Summary of Significant Accounting Policies , to the consolidated financial statements). Certain corporate general and administrative expenses, including general overhead functions such as information systems, accounting, human resources, marketing, compliance costs and certain administrative expenses, as well as interest and amortization of intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or provide services with different processes. All reported segment revenues are derived from external customers. Our Chief Executive Officer, who is our chief operating decision maker ("CODM"), reviews financial information at the operating segment level. Our CODM does not review assets by segments in his resource allocation, and therefore, assets by segments are not disclosed below. +The following table sets forth selected consolidated financial information for our reportable segments for the fiscal years ended March 31, 2021, March 31, 2020 and March 31, 2019 is as follows: +Roadway +Sensors Transportation +Systems Total +(In thousands) +Year Ended March 31, 2021 +Product revenues $ 55,665 $ 7,268 $ 62,933 +Service revenues 884 53,321 54,205 +Total revenues $ 56,549 $ 60,589 $ 117,138 +Segment income $ 11,554 $ 8,689 $ 20,243 +Year Ended March 31, 2020 +Product revenues $ 49,082 $ 5,925 $ 55,007 +Service revenues 288 52,108 52,396 +Total revenues $ 49,370 $ 58,033 $ 107,403 +Segment income $ 7,787 $ 10,556 $ 18,343 +Year Ended March 31, 2019 +Product revenues $ 43,253 $ 4,974 $ 48,227 +Service revenues 239 44,841 45,080 +Total revenues $ 43,492 $ 49,815 $ 93,307 +Segment income $ 7,011 $ 5,907 $ 12,918 +The following table reconciles total segment income to consolidated operating income (loss) from continuing operations: +71 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2021 +13. Business Segments, Significant Customer and Geographic Information (Continued) +Year Ended March 31, +2021 2020 2019 +(In thousands) +Segment income: +Total income from reportable segments $ 20,243 $ 18,343 $ 12,918 +Unallocated amounts: +Corporate expenses $ ( 17,264 ) $ ( 19,021 ) $ ( 15,577 ) +Amortization of intangible assets ( 1,504 ) ( 757 ) ( 275 ) +Restructuring activities ( 619 ) — — +Acquisition costs ( 417 ) ( 689 ) — +Operating income (loss) $ 439 $ ( 2,124 ) $ ( 2,934 ) +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance greater than 10 % of our total trade accounts receivable balances as of March 31, 2021 and 2020. +The following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located outside the U.S.: +Year Ended March 31, +2021 2020 2019 +Canada 1 % — % 1 % +Europe — 1 1 +1 % 1 % 2 % +Substantially all of our long-lived assets are held in the U.S. +14. Quarterly Financial Data (Unaudited) +Quarter Ended: Revenues Gross +Profit Net (Loss) +Income from continuing operations Basic Net +Income (Loss) +per Share from continuing operations Diluted Net +Income (Loss) +per Share from continuing operations +(In thousands, except per share amounts) +June 30, 2020 $ 28,000 $ 10,868 $ 418 $ 0.01 $ 0.01 +September 30, 2020 29,256 11,358 719 0.02 0.02 +December 31, 2020 28,170 11,650 ( 261 ) ( 0.01 ) ( 0.01 ) +March 31, 2021 31,712 12,980 ( 385 ) ( 0.01 ) ( 0.01 ) +$ 117,138 $ 46,856 $ 491 $ 0.01 * $ 0.01 +June 30, 2019 $ 25,167 $ 9,584 $ ( 537 ) $ ( 0.02 ) $ ( 0.02 ) +September 30, 2019 26,586 10,678 ( 1,051 ) ( 0.03 ) ( 0.03 ) +December 31, 2019 26,737 10,633 ( 1,252 ) ( 0.03 ) ( 0.03 ) +March 31, 2020 28,913 12,718 1,082 0.03 0.03 +$ 107,403 $ 43,613 $ ( 1,758 ) $ ( 0.05 ) * $ ( 0.05 ) +___________________________________________ +* Annual per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods +72 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2021, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2021 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2021. +The Company acquired substantially all the assets of TrafficCast International, Inc. on December 7, 2020. Management excluded TrafficCast from its evaluation as of the end of the period covered by this Annual Report. TrafficCast's total assets excluded from this evaluation was approximatel y $3.2 million, representing 3% o f the Company's consolidated total assets as of +73 +Table of Contents +March 31, 2021, and TrafficCast's total revenue of approxi mately $4.0 million represented 3% of the Company's consolidated revenue for the fiscal year ended March 31, 2021. +The effectiveness of our internal control over financial reporting as of March 31, 2021 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +74 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended March 31, 2021, of the Company and our report dated June 1, 2021, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company's adoption of Accounting Standards Update 2016-02, Leases , in the year ended March 31, 2020. +As described in Management's Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting for TrafficCast International, Inc. ("TrafficCast"), which was acquired on December 7, 2020, and whose financial statements constitute 3% of total assets, and 3% of revenues, of the consolidated financial statements of the Company as of and for the year ended March 31, 2021. Accordingly, our audit did not include the internal control over financial reporting for TrafficCast. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2021 +75 +Table of Contents +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K ("the Form 10-K Amendment") or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2021 Annual Meeting of Stockholders (the "2021 Proxy Statement") under the headings "Executive Compensation and Other Information—Executive Officers," "Election of Directors," "Corporate Governance," and "Delinquent Section 16(a) Reports." +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2021 Proxy Statement under the heading "Executive Compensation and Other Information" and "Election of Directors." +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2021 Proxy Statement under the heading "Equity Compensation Plan Information" and "Stock Ownership of Certain Beneficial Owners and Management." +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2021 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2021 Proxy Statement under the heading "Matters Related to Independent Registered Public Accounting Firm." +76 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents filed as part of this report: +1. Financial Statements. +Our consolidated financial statements are listed in the "Index to Consolidated Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our consolidated financial statements or the notes thereto. +3. Exhibits. +The following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit Number Description Reference +2.1 † +Asset Purchase Agreement, dated May 2, 2020, by and among Iteris, Inc., ClearAg, Inc., and DTN, LLC* +Exhibit 2.1 to the registrant's Current Report on Form 8-K as filed with the SEC on May 6, 2020 +4.1 +Restated Certificate of Incorporation of the registrant as filed with the Delaware Secretary of State on October 12, 2018 +Exhibit 3.1 to the Registrant’s Current Report on Form 8-K as filed with the Commission on October 15, 2018 +4.2 +Restated Bylaws of the Registrant, as amended through August 6, 2018 +Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 as filed with the Commission on August 7, 2018 +4.3 +Specimen common stock certificate +Exhibit 4.1 to the Registrant’s Registration Statement on Form 8-A (File No. 001-08762), as filed with the Commission on December 8, 2004 +4.4 † +Description of Iteris, Inc. Securities Registered under Section 12 of the Exchange Act +Exhibit 4.2 to the Registrant’s Annual Report on Form 10-K for the year ended for the year ended March 31, 2020 as filed with the SEC on June 9, 2020 +10.1 † +Asset Purchase Agreement dated December 6, 2020, by and between Iteris, Inc. and TrafficCast International, Inc. +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.2 * +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014 +77 +Table of Contents +Exhibit Number Description Reference +10.5 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway Acquisitions, LLC) and Iteris, Inc. +Exhibit 10.5 to registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.6 * +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.6 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 filed with the SEC on June 6, 2019 +10.7 +Fourth Amendment to Lease, dated May 17, 2021, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Filed herewith +10.8 * +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.9 * +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.10 * +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.11 * +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.12 * +Amended and Restated 2016 Omnibus Incentive Plan +Exhibit 99.1 to registrant's Registration Statement on Form S-8 (File No. 333-228210) as filed with the SEC on November 6, 2018 +10.13 * +Form of Performance Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan** +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.14 * +Revised Form of Restricted Stock Unit Issuance for use with 2016 Omnibus Incentive Plan** +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.15 * +Revised Form of Form of Notice of Grant of Stock Option and Form of Stock Option Agreement for use with 2016 Omnibus Incentive Plan** +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.16 * +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.17 * +Employment Agreement, dated November 15, 2019, between Iteris, Inc. and Douglas Groves +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 4, 2019 +10.18 * +Iteris, Inc. Amended and Restated Executive Severance Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.19 * +Retention Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.21 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.20 * +Incentive Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.22 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +78 +Table of Contents +Exhibit Number Description Reference +10.21 * +Form of Retention Bonus Agreement entered into between the Company and selling shareholders of Albeck Gerken, Inc. +Exhibit 10.1 to registrant's Current Report on Form 8-K as filed with the SEC on July 9, 2019 +10.22 * +2020 Employment Inducement Incentive Award Plan +Exhibit 10.2 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.23 * +Form of Notice Grant of Stock Option and Form of Stock Option Agreement for use with 2020 Employment Inducement Incentive Plan +Exhibit 10.3 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.24 * +Form of Restricted Stock Unit Issuance Agreement for use with 2020 Employment Inducement Incentive Award Plan +Exhibit 10.4 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.25 * +Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.5 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.26 * +Form of Restricted Stock Unit Issuance Agreement for use with the Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020. +Exhibit 10.6 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +23 +Consent of Independent Registered Public Accounting Firm, dated June 1, 2021 +Filed herewith +24 Power of Attorney Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS XBRL Instance Document Filed herewith +101.SCH XBRL Taxonomy Extension Schema Document Filed herewith +101.CAL XBRL Taxonomy Extension Calculation Linkbase Document Filed herewith +101.LAB XBRL Taxonomy Extension Label Linkbase Document Filed herewith +101.PRE XBRL Taxonomy Extension Presentation Linkbase Document Filed herewith +101.DEF XBRL Taxonomy Definition Presentation Linkbase Document Filed herewith +______________________________________ +79 +Table of Contents +† Pursuant to Item 601(a)(5) of Regulation S-K, certain appendices to this agreement have been omitted. The Company agrees to furnish supplementally to the Securities and Exchange Commission, upon its request, any or all of such omitted appendices. +* Indicates a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +ITEM 16. FORM 10-K SUMMARY +None. +80 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 1, 2021 ITERIS, INC. +(Registrant) +By /s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Douglas Groves, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated: +Signature Title Date +/s/ JOE BERGERA Director, President and Chief Executive Officer (principal executive officer) June 1, 2021 +Joe Bergera +/s/ DOUGLAS GROVES Chief Financial Officer (principal financial and accounting officer) June 1, 2021 +Douglas Groves +/s/ THOMAS L. THOMAS Chairman of the Board June 1, 2021 +Thomas L. Thomas +/s/ ANJALI JOSHI Director June 1, 2021 +Anjali Joshi +/s/ GERARD M. MOONEY Director June 1, 2021 +Gerard M. Mooney +/s/ LAURA L. SIEGAL Director June 1, 2021 +Laura L. Siegal +/s/ LUKE SCHNEIDER Director June 1, 2021 +Luke Schneider +/s/ DENNIS W. ZANK Director June 1, 2021 +Dennis W. Zank +81 \ No newline at end of file diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/filing_metadata.csv b/raw/filings/0000350868/2020/0000350868-21-000015/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a0d9d24c647c5a81b306aaaf312aff378228b18d --- /dev/null +++ b/raw/filings/0000350868/2020/0000350868-21-000015/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2021-06-01,2021-03-31,2021-06-01T20:32:15.000Z,0000350868-21-000015,iti-20210331.htm,10-K,17575749,1,1,https://www.sec.gov/Archives/edgar/data/350868/000035086821000015/iti-20210331.htm,https://www.sec.gov/Archives/edgar/data/350868/000035086821000015/,2020,2020,1 diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/item1.txt b/raw/filings/0000350868/2020/0000350868-21-000015/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..920d1bd95573365a4a286a23dc51eae937c28a27 --- /dev/null +++ b/raw/filings/0000350868/2020/0000350868-21-000015/item1.txt @@ -0,0 +1,98 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of smart mobility infrastructure management solutions. Our solutions enable public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers to monitor, visualize, and optimize mobility infrastructure to help ensure roads are safe, travel is efficient, and communities thrive. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, specialized consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +Prior to the sale of our Agriculture and Weather Analytics segment in May 2020, we combined our intellectual property with enhanced atmospheric, land surface and agronomic modeling techniques to offer smart content and analytic solutions that provided analytical support to large enterprises in the agriculture industry, such as seed and crop protection companies, integrated food companies, and agricultural equipment manufacturers and service providers. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further expand our advanced detection sensors, transportation performance analytics systems, and specialized consulting services and cloud-enabled managed services in the smart mobility infrastructure management market, and we are always exploring strategic alternatives intended to optimize the value of all of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana, California 92705, and our telephone number at that location is (949) 270-9400. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than 12 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis with travel restrictions, quarantines and "stay-at-home" orders. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. While there has been no material impact to our business during the fiscal year ended March 31, 2021 (“Fiscal 2021”), we did experience some work delays due to the Pandemic. Should such conditions become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the spread of the outbreak, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, the Company has taken certain actions to preserve its liquidity, manage cash flow and strengthen its financial flexibility. Such actions include, but are not limited to, reducing discretionary spending, reducing capital expenditures, +4 +Table of Contents +implementing restructuring activities, and reducing payroll costs, including employee furloughs, pay freezes and pay cuts (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration (see Note 6, Income Taxes, to the Consolidated Financial Statements). +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world and its assessment of the impact of the Pandemic may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “ TrafficCast Business”). The transaction closed on December 7, 2020. +Under the Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million, with $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The parties also entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Sale of Agriculture and Weather Analytics Segment +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics segment to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to an Asset Purchase Agreement (the “Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million, subject to working capital adjustments. Upon closing on May 5, 2020, the Company received $10.5 million in cash and $1.5 million of deferred payment, of which $1.45 million has been paid by DTN at the 12-month anniversary of the closing date, and $0.05 million will be paid by DTN at the 18-month anniversary of the closing date, subject to satisfactions of the conditions set forth in the Purchase Agreement relating to the transition of certain customers to DTN and the collection of certain receivables by DTN (see Note 3, Discontinued Operations , to the Consolidated Financial Statements). +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics segment, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Public Offering and Acquisition of Albeck Gerken, Inc. +5 +Table of Contents +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Products and Services +Our reportable segments consist of: Roadway Sensors and Transportation Systems. +The Roadway Sensors segment provides advanced detection sensors and systems for traffic management that collectively comprise our family of Vantage sensors and BlueTOAD line of products, as well as communication systems and roadway traffic data collection applications that complement our sensor products. The Vantage product line uses advanced image processing technology, radar technology and other techniques to capture and analyze sensor data through sophisticated algorithms, enabling vehicle, bicycle and pedestrian detection, as well as the transmission of both video images and multiple data sets using various communication technologies. The Roadway Sensors segment also includes the public sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The Transportation Systems segment provides traffic engineering and specialized consulting services, cloud-enabled managed services, transportation performance measurement and traffic analytics solutions, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. The Transportation Systems segment also includes the operations of AGI beginning July 2, 2019 as well as the commercial operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisitions of AGI and TrafficCast). +With the company’s adoption of the ClearMobility platform we have started aligning our portfolio of solutions under a common branding structure called ClearMobility. We believe this alignment to the ClearMobility Platform will drive internal synergies in our development and sales efforts, as well as increase our market recognition across our entire suite of solutions. As a result of this alignment, the Company’s chief operating decision maker (“CODM”) is evaluating our management and operating structure and as a result of this evaluation we anticipate that we will report as a single operating segment starting with our fiscal year 2022. +In the fourth quarter of the 2021 fiscal year, we launched the ClearMobility Cloud, our open-architecture cloud framework for smart mobility infrastructure management. The ClearMobility Cloud’s mobility data management engine, application programming interface ("API") framework and microservices ecosystem provide standardized data ingestion, cleansing and analytics, as well as authentication and security for each component of the ClearMobility Platform. The ClearMobility Cloud sets the foundation for horizontally scalable data processing, third-party extensibility, and secure, policy-based access to public transportation agencies and commercial entities throughout the United States and internationally. +See Note 13, Business Segments, Significant Customer and Geographic Information, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on our reporting segments. +Roadway Sensors +Our Roadway Sensors products include, among others, Vantage, VantageLive!, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, P-Series products, BlueTOAD Spectra, BlueTOAD Spectra RSU, and BlueARGUS. +• Our Vantage detection systems detect vehicle presence at intersections, as well as vehicle count, speed and other traffic data used in traffic management systems. Vantage detection systems typically include up to four of our advanced cameras and/or radar devices. Our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. +• Our Vantage Vector video/radar hybrid product is an all-in-one detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +6 +Table of Contents +Vantage Vector includes all of the benefits of Iteris video detection, including high accuracy, high-availability remote viewing of video images, bicycle and pedestrian detection capability, and dilemma-zone detection. +• VantageLive! is a cloud-based platform that allows users to collect, process and analyze advanced intersection data, as well as to view and understand intersection activity. +• All of our Vantage systems are available with SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, enabling more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing can now benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• The SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• Our Vantage systems are also available with the PedTrax capability, which provides bi-directional counting and speed tracking of pedestrians within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, our integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueARGUS collects, analyzes and visualizes various information related to travel times, speeds, O-D, as well as connected vehicle information from the BlueTOAD Spectra RSU. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +We believe that future growth domestically and internationally, will be dependent in part on the continued adoption of above-ground video and radar detection technologies, instead of traditional in-pavement loop technology, to manage traffic. +In select territories, the Roadway Sensors segment also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +Transportation Systems +Our Transportation Systems segment includes engineering and specialized consulting services, transportation performance measurement and traffic analytics solutions, end-to-end solutions delivered as cloud-enabled managed services, as well as the development of transportation management and traveler information systems for the smart mobility infrastructure management industry. Our Transportation Systems services include planning, design, development and implementation of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. The Transportation Systems segment also includes the commercial sector operations of TrafficCast beginning December 7, 2020 (see Note 12, Acquisitions , to the Consolidated Financial Statements). +The Transportations Systems segment product line includes: the Iteris Signal Performance Measures ("Iteris SPM") and iPeMS traffic signal performance and traffic analytics software suites, the capabilities and customers of which have now respectively been incorporated into and migrated to ClearGuide, our state-of-the-art mobility intelligence and transportation performance measures solution; our advanced traveler information system ("ATIS") solution for public transportation agencies, ClearRoute; and our ATIS solution for the enterprise and commercial sector, TrafficCarma. Our analytics suite of products +7 +Table of Contents +utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns, permitting the effective performance analysis and management of traffic infrastructure resources, whether at the intersection level, arterial and corridor level, or highway level. This information can then be analyzed by traffic professionals to measure how a transportation network is performing and to identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +This segment also includes our commercial vehicle operations and vehicle safety compliance platforms, known as "ClearFleet", "CVIEW-Plus", "CheckPoint", "UCRLink" and "Inspect". These software applications support state-based commercial vehicle operations by storing and distributing intrastate and interstate commercial vehicle information for local, state and federal agencies' roadside and enforcement operations. +Our Transportation Systems segment is largely dependent upon state and local governmental funding, and to a lesser extent federal governmental funding. In addition, various other funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to, bonds, dedicated sales and gas tax measures, and other alternative funding sources. We believe the overall expansion of our Transportation Systems segment in the future will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our Transportation Systems business has been, at times, adversely affected by governmental budgetary issues. Delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Sales and Marketing +We currently sell our Roadway Sensors products through both direct and indirect sales channels. In the territories we sell through direct channels, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, and sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, and are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end users, and maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we have the ability to modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We market and sell our Transportation Systems services and solutions primarily to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our engineering, science and information technology teams on a regional basis to serve in sales and business development functions. Our Transportation Systems contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +With the acquisition of the TrafficCast Business on December 7, 2020, we expanded our customer segments to now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to both automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2021 and fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total revenues. For the fiscal year ended March 31, 2019 ("Fiscal 2019"), one individual customer represented greater than 10% of our total revenues. As of March 31, 2021 and 2020, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our Roadway Sensors products. Additionally, we procure certain components for our Roadway Sensors products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon quarterly forecasts that we generally adjust on a monthly basis to control +8 +Table of Contents +inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2021, Fiscal 2020 and Fiscal 2019. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $78.1 million at March 31, 2021, which included $66.5 million related to Transportation Systems and $11.6 million related to Roadway Sensors. We expect to recognize revenue of approximately 73% of our Transportation Systems and 27% of our Roadway Sensors backlog including TrafficCast's commercial business as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2020, we had backlog of approximately $62.1 million, which included $53.4 million related to Transportation Systems and $8.7 million related to Roadway Sensors. The increase in backlog in the current fiscal year was largely due to the additions of TrafficCast backlog of approximately $10.6 million and a slight increase in Transportation Systems backlog due to a few larger contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred revenue on our consolidated balance sheets. Backlog does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues, in particular for our Roadway Sensors segment. +Product Development +Our product development activities are mostly conducted at our principal facility in Santa Ana, California, as well as our facilities in Madison, Wisconsin and Oakland, California. Our research and development costs and expenses were approximately $5.1 million for Fiscal 2021, $4.3 million for Fiscal 2020, and $3.8 million for Fiscal 2019. We expect to continue to pursue various product development programs and incur research and development expenditures in both our Roadway Sensors and Transportation Systems segments in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform, which includes among other things our software offering in our Transportation Systems segment, as well as our Vantage products family in our Roadway Sensors segment. +During Fiscal 2020, we successfully released ClearGuide, our state-of-the-art transportation performance measures solution, designed to help transportation agencies achieve safer, more efficient mobility for their networks. Certain development costs were capitalized into intangible assets in the consolidated balance sheets; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our solutions. This continued investment may result in increases in research and development costs, as well as additional capitalized software in future periods. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +9 +Table of Contents +In the market for our Roadway Sensors detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as Velocity, BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +The markets in which our Transportation Systems segment operates is highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 25 issued U.S. patents, including: (i) 15 relating to our Roadway Sensors technologies, (ii) 7 relating to our Transportation Systems technologies and (iii) 3 related to our purchase of the TrafficCast Business. We had a total of 2 pending patent applications in the U.S. We currently have 3 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2039. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2021, we employed 415 full-time employees and 24 part-time employees, for a total of 439 employees. None of our employees is represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +10 +Table of Contents +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/item13.txt b/raw/filings/0000350868/2020/0000350868-21-000015/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..179770b1f83bd2482dbd3260c28aa7de8e110282 --- /dev/null +++ b/raw/filings/0000350868/2020/0000350868-21-000015/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2021 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." \ No newline at end of file diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/item9a.txt b/raw/filings/0000350868/2020/0000350868-21-000015/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..af93beae53ea5308f49408ff6ec511c37a5b8c64 --- /dev/null +++ b/raw/filings/0000350868/2020/0000350868-21-000015/item9a.txt @@ -0,0 +1,35 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2021, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2021 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2021. +The Company acquired substantially all the assets of TrafficCast International, Inc. on December 7, 2020. Management excluded TrafficCast from its evaluation as of the end of the period covered by this Annual Report. TrafficCast's total assets excluded from this evaluation was approximatel y $3.2 million, representing 3% o f the Company's consolidated total assets as of +73 +Table of Contents +March 31, 2021, and TrafficCast's total revenue of approxi mately $4.0 million represented 3% of the Company's consolidated revenue for the fiscal year ended March 31, 2021. +The effectiveness of our internal control over financial reporting as of March 31, 2021 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +74 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended March 31, 2021, of the Company and our report dated June 1, 2021, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company's adoption of Accounting Standards Update 2016-02, Leases , in the year ended March 31, 2020. +As described in Management's Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting for TrafficCast International, Inc. ("TrafficCast"), which was acquired on December 7, 2020, and whose financial statements constitute 3% of total assets, and 3% of revenues, of the consolidated financial statements of the Company as of and for the year ended March 31, 2021. Accordingly, our audit did not include the internal control over financial reporting for TrafficCast. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2021 +75 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/rp_note.txt b/raw/filings/0000350868/2020/0000350868-21-000015/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2020/0000350868-21-000015/rpt_disclosure.txt b/raw/filings/0000350868/2020/0000350868-21-000015/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d59bd0d8f56cb663f2effd8c0d17e19086806c8 --- /dev/null +++ b/raw/filings/0000350868/2020/0000350868-21-000015/rpt_disclosure.txt @@ -0,0 +1,2 @@ +Certain Transactions with 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+(Mark One) +ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31 , 2022 +OR +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-2588496 +(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) +1250 S. Capital of Texas Hwy., Building 1, Suite 330 ., Austin , +Texas +78746 +(Address of Principal Executive Offices) (Zip Code) +Registrant's Telephone Number, Including Area Code: ( 512 ) 716-0808 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which +registered +Common Stock, $0.10 par value ITI The Nasdaq Stock Market LLC +Securities registered pursuant to Section 12(g) of the Act. None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act"). Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.: +Large accelerated filer o Accelerated filer ý Non-accelerated filer o Smaller reporting company ý +Emerging growth company o +Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ý +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2021 was approximately $ 223,257,646 . For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of May 31, 2022, there were 42,429,597 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2022 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2022 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +12 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +23 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +24 +ITEM 4. +MINE SAFETY DISCLOSURES +24 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +25 +ITEM 6. +RESERVED +25 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +25 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +35 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +36 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +75 +ITEM 9A. +CONTROLS AND PROCEDURES +75 +ITEM 9B. +OTHER INFORMATION +77 +ITEM 9C . +DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +78 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +78 +ITEM 11. +EXECUTIVE COMPENSATION +78 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +78 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +78 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +78 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +79 +Unless otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. and its wholly-owned subsidiaries, including ClearAg, Inc., and Albeck Gerken, Inc. BlueARGUS™, BlueTOAD®, CheckPoint™, ClearGuide®, ClearFleet®, ClearMobility™, ClearRoute™, CVIEW-Plus™, Inspect™, iPeMS®, Iteris®, Iteris SPM®, Next®, P10™, P100™, P-Series™, PedTrax®, Reverse 511®, SmartCycle®, SmartCycle Bike Indicator®, SmartSpan®, Spectra™, SPM® (logo), TrafficCarma®, UCRLink™, Vantage®, Vantage Apex™, VantageFusion™, VantageLive!®, Vantage Next®, VantagePegasus®, VantageRadius®, Vantage Vector®, Velocity® and VersiCam™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management's beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words "expect(s)," "feel(s)," "believe(s)," "intend(s)," "plan(s)," "should," "will," "may," "anticipate(s)," "estimate(s)," "could," "should," and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, capital needs, backlog, manufacturing capabilities, the market acceptance of our products and services, competition, statements concerning any potential future impact of the coronavirus disease COVID-19 pandemic on our business, the impact of any current or future litigation, the impact of recent accounting pronouncements, the impact of current supply chain constraints, the applications for and acceptance of our products and services, the status of our facilities and product development, the impact of the sale of our Agriculture and Weather Analytics Business, and the impact of the acquisition of substantially all of the assets of TrafficCast International, Inc. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in "Risk Factors" set forth in Part I, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of smart mobility infrastructure management solutions. Our cloud-enabled end-to-end solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, mobility intelligence software, mobility data sets, mobility consulting services, and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than 24 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the global economy. Though there has been a trend in increasing availability of COVID-19 vaccines, as well as an easing of restrictions on social, business, travel and government activities and functions, infection rates continue to fluctuate and federal, state and local government regulations continue to rapidly change. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. We have not had any facility closures due to the Pandemic, but we have experienced supply chain and work delays on certain projects. Should such delays become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the Pandemic, new and potentially more contagious variants, such as the Delta and Omicron variants, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers and suppliers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, we have taken certain actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. Refer to Note 4, Restructuring Activities, for more information. +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate for component shortages, we have begun to increase inventory levels and may continue to do so for an extended period. In the event demand doesn’t materialize, we may need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, to meet customer demand, resulting in high levels of unshippable backlog. We have placed non- +4 +Table of Contents +cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. Still, we may remain supply-constrained beyond the fiscal year ended March 31, 2022 ("Fiscal 2022"). +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration (see Note 6, Income Taxes, to the Consolidated Financial Statements, including in Part II, Item 8 of this report). +The Pandemic has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility has remained open, easing of Pandemic restrictions imposed by local and state authorities have allowed a portion of our workforce to return to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. Additionally, we have been able to timely file financial reports. We believe we have the right infrastructure to efficiently work remotely for the balance of the Pandemic. We do not expect to incur significant costs to safely reopen our facilities to all our employees. +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of the Pandemic may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million. +The $17.7 million in total consideration was comprised of $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provided for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). The transaction closed on December 7, 2020. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Sale of Agriculture and Weather Analytics Business +5 +Table of Contents +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our former Agriculture and Weather Analytics business to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to an Asset Purchase Agreement (the “AWA Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million, subject to working capital adjustments. Upon closing, the Company received $10.5 million in cash and $1.5 million of payment was deferred. DTN paid the Company $1.45 million at the 12-month anniversary of the closing date, and $0.05 million at the 18-month anniversary of the closing date. (See Note 3, Discontinued Operations , to the Consolidated Financial Statements.) +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics business, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Products and Services +Iteris provides comprehensive smart mobility infrastructure solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. Beginning December 7, 2020, Iteris includes the public-sector and private-sector operations of TrafficCast (see Note 12, Acquisitions , to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisition of TrafficCast). +Software Solutions +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, Commercial Vehicle Operations, BlueArgus, TrafficCarma and others as described below. +• ClearGuide, which is provided on a software-as-a-service basis, is a state-of-the-art mobility intelligence and transportation performance measures solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement ("SPM"). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response ("IVR"). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial vehicle operations and vehicle safety compliance applications, which are provided on a software-as-a-service basis include various applications branded as ClearFleet, CVIEW-Plus, CheckPoint, UCRLink, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for peoples’ daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +6 +Table of Contents +• VantageLive! is a software-a-as-service solution that allows users to collect, process and analyze advanced intersection data for our Vantage sensors, as well as to view and understand intersection activity +• BlueARGUS is a software-as-a-service solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Cloud, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public- and private-sector customers via subscription-based direct data feeds or application programming interfaces (APIs), or through ClearGuide, our mobility intelligence and transportation performance measures software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary algorithms and selective quality control from experienced traffic analysts. +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and BlueARGUS) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Fusion, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, and P-Series products. +• Vantage Fusion is a connected-vehicle (CV) focused detection product that tracks and reports vehicles and pedestrians in and around intersections. This product helps the industry bridge the currently fledgling CV market to an eventually CV-dominant world by providing non-CV vehicle locations (and details) to the CV network. This product is developed in partnership with Continental AG, a global automotive parts manufacturer and leading CV equipment provider. +• Vantage Apex is the industry’s first full 1080p high-definition (HD) video and 4D/HD radar hybrid sensor with integrated artificial intelligence (AI) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +7 +Table of Contents +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +The BlueTOAD product family combines unique MAC Address capture with the latest Connected Vehicle technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra RSU, both of which we bundle with a Cloud-based software application branded as BlueARGUS. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +In select territories, the Company also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products, will be dependent in part on the continued replacement of adoption of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services offer traffic management centers ("TMC") design, staffing, and operations services to public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ cloud-enabled managed services combine software-as-a-service, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterials and highways along with their related in-field technology. These services include congestion and asset management areas of focus, combining innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators can save time and money while better keeping road users safe and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, we launched the ClearMobility Cloud that enables seamless interoperation among our solutions via a common mobility data management engine, application +8 +Table of Contents +programming interface ("API") framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. ClearMobility Cloud is both horizontally scalable and third-party extensible. +Because we are now aligning, harmonizing, and optimizing our portfolio of individual solutions to a common platform, the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, in fiscal 2022 we began reporting as a single operating segment. +Market Conditions +Currently, over 90% of our revenue is attributable to public-sector customers. Therefore, most of our revenue is dependent upon state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +We believe that overall demand for our solutions will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. Therefore, we were pleased that the Infrastructure Investment and Jobs Act ("IIJA") became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. With that funding pool, areas of direct relevant to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +With the acquisition of the TrafficCast Business on December 7, 2020, we now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2022, fiscal year ended March 31, 2021 ("Fiscal 2021"), and fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total revenues. As of March 31, 2022 and 2021, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing +9 +Table of Contents +strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our assembly and test activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2022, Fiscal 2021 and Fiscal 2020. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $99.9 million at March 31, 2022. We expect to recognize revenue of approximately 75% of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2021, we had backlog of approximately $78.1 million. The increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm and earned under existing agreements. Backlog is not included in deferred revenue on our consolidated balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues. +Product Development +Our product development activities are mostly conducted at our facility in Santa Ana, California, as well as our facilities in Madison, Wisconsin and Oakland, California. Our research and development costs and expenses were approximately $7.4 million for Fiscal 2022, $5.1 million for Fiscal 2021, and $4.3 million for Fiscal 2020. We expect to continue to pursue various product development programs and incur research and development expenditures for the Company in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations and, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +10 +Table of Contents +In the market for our products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 30 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 7 relating to our engineering and consulting services technologies and (iii) 6 related to our purchase of the TrafficCast Business. We had a total of 2 pending patent applications in the U.S. We currently have 5 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2040. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2022, we employed 428 full-time employees and 16 part-time employees, for a total of 444 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the near future. Currently, +11 +Table of Contents +compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. +Risk Related to Our Business +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues and fixed price contracts, that could adversely impact our future revenues and profitability. +A significant portion of our revenues is derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, cut-backs, delays or reallocation of government funding, including without limitation, changes in the administration and repeal of government purchasing programs; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone requirements; +• performance bond requirements; +• adverse weather conditions or other natural or medical disasters or developments, such as, the novel coronavirus COVID-19, and evacuations and flooding due to hurricanes, can result in our inability to perform work in affected areas; and +• international relations and international conflicts or other military operations that could cause the temporary or permanent diversion of government funding from transportation or other infrastructure projects. +Governmental budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, and the current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and income to drop substantially or to fluctuate significantly between fiscal periods. +12 +Table of Contents +In addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our engineering and consulting workforce. +The cost of providing our engineering and mobility consulting services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions; +• the timing of new contract awards, the commencement of work under an awarded contract or the completion of large contracts; +• the availability of project funding or other project budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An inability to properly and fully utilize our engineering and consulting workforce would reduce our profitability and could have an adverse effect on our results of operations. +Our management information systems and databases have been and could in the future be disrupted by data protection breaches, system security failures, cyber threats or by the failure of, or lack of access to, our internal operations, such as our enterprise resource planning ("ERP") system, or services provided to our customers. These disruptions could negatively impact our sales, increase our expenses, significantly harm our reputation and/or adversely affect our stock price. +Experienced users and computer programmers may be able to penetrate, or "hack", our network security and create system disruptions, cause shutdowns and compromise or misappropriate our confidential information or that of our employees and third parties. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our internal network, any of our systems, service offerings or otherwise exploit any security vulnerabilities of our network, systems or service offerings. In addition, sophisticated services, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of a system. We could incur expenses addressing problems created by cyber or other security problems, bugs, viruses, worms malicious software programs and security vulnerabilities, and our efforts to address these problems may not be successful. We must, and do, take precautions to secure customer information and prevent unauthorized access to our databases and systems containing confidential information. Any data security event, such as a breach, data loss or information security lapses, whether resulting in the compromise of personal information or the improper use or disclosure of confidential, sensitive or classified information, could result in interruptions, cessation of service(s), claims, remediation costs, regulatory sanctions against us, loss of current and future contracts, adverse effects to results of operations and financial condition, serious harm to our reputation and/or adverse effects to our stock price. We operate our ERP system on a SaaS platform, and we use this system for reporting, planning, sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on this system, and the third-party provider of this service, for a number of aspects of our operations. If this service provider or this system fails, or if we are unable to continue to have access to this system on commercially reasonable terms, or at all, operations would be severely disrupted until an equivalent system could be identified, licensed or developed, and integrated into our operations. This disruption would have a material adverse effect on our business. We carry insurance, including cyber insurance, commensurate +13 +Table of Contents +with our size and the nature of our operations, although there is no certainty that such insurance will in all cases be sufficient to fully reimburse us for all losses incurred in connection with the occurrence of any of these system security risks, data protection breaches, cyber-attacks or other events. +If unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our web-based and mobile application solutions and services, we may suffer various negative impacts, including a loss of customer and market confidence, loss of customer loyalty, and significant liability to our customers and to individuals or businesses whose information was being stored. +Protecting data of our customers is critical to our business, and if there is unauthorized access, we may incur significant costs or liabilities. In addition, we are required to comply with government contracting requirements and make investments in our systems to protect that data. If we are unable to do so, our customers may lose confidence in us, which would harm our sales, and we may incur significant expenses or liabilities. +The coronavirus pandemic could have an adverse effect on our business. +The COVID-19 Pandemic has materially adversely impacted global economic conditions. More than 24 months into the Pandemic, COVID-19 continues to have an unprecedented impact on the global. Though there has been a trend in increasing availability of COVID-19 vaccines, as well as an easing of restrictions on social, business, travel and government activities and functions, infection rates continue to fluctuate and federal, state and local government regulations continue to rapidly change. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. We have not had any facility closures due to the Pandemic, but we have experienced supply chain and work delays on certain projects. Should such delays become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and volatility of our stock price will depend largely on future developments, including the duration of the Pandemic, new and potential more contagious variants, such as the Delta and Omicron variants, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the financial circumstances of our customers and suppliers, all of which are highly uncertain and cannot be predicted. This situation is changing continuously and can be rapid, and additional impacts may arise that we are not aware of currently. +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate for component shortages, we have begun to increase inventory levels and may continue to do so for an extended period. In the event demand doesn’t materialize, we may need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, to meet customer demand, resulting in high levels of unshippable backlog. We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. Still, we may remain supply-constrained beyond the fiscal year ended March 31, 2022 ("Fiscal 2022"). +The Company cannot predict the duration or direction of current trends or their sustained impact. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world and its assessment of the impact of the Pandemic may change. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. +Acquisitions of companies or technologies, including our acquisition of TrafficCast, may require us to undertake significant capital infusions and could result in disruptions of our business and diversion of resources and management attention. +We completed the acquisition of TrafficCast in December 2020 and we plan to continue to explore acquiring additional complementary businesses, products, services, and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information system of the acquired companies; +14 +Table of Contents +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; and +• increased interest expense and amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully integrate any acquisitions or realize the benefits and opportunities anticipated from any acquisition. +Acquisitions, investments and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. +Acquisitions, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and results of operations. We expect to continue to evaluate and enter into discussions regarding potential strategic transactions. These strategic transactions could create unforeseen operating difficulties and expenditures. We face risks that include, among other things: +• the strategic benefits and opportunities from any planned or completed acquisition or divestiture by the Company may not be realized or may take longer to realize than expected; +• strategic benefits and opportunities related to past and ongoing restructuring actions may not be realized or may take longer to realize than expected; +• our ability to realize the expected financial benefits of an acquisition, divestiture or other strategic transaction; +• cost reductions may not occur as expected; +• management time and focus may be diverted from operating our business to challenges related to acquisitions and other strategic transactions; +• cultural challenges may arise associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire; and +• we may fail to successfully further develop the acquired business or technology. +Our failure to address the risks and other issues in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits and opportunities, including unanticipated liabilities, increased costs, and harm our business generally. +We participate in the software development market, which may be subject to various technical and commercial challenges. +We have only been in the business of software development for a few years and have in the past and may in the future experience development and technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we cannot be certain that errors will not be found in our software after its release. Any faults or errors in our existing products or in any new products may cause delays in product introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. Due to delays in the completion of a software development contract with a customer, the Company recorded an estimated loss on the contract during the year ended March 31, 2022. The estimates and assumptions used in these assessments were based upon management's judgment and may be subject to change as new events occur and additional information is obtained. In particular, there remains uncertainty with regards to the additional costs required to fulfill the Company's obligations with regards to the +15 +Table of Contents +contract. If the future estimated costs to fulfill this contract exceed current estimates, the Company's financial condition, cash flows, and results of operations may be materially impacted. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely decline. +Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• obsolescence of certain parts and components from time to time that may require re-engineering of certain portions of our product; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements in a cost-effective and timely manner, or are unable to achieve market acceptance of our new products, our operating results would be adversely affected. +We believe our revenue growth and future operating results will depend on our ability to complete development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our production costs. During the past few fiscal years, we have introduced, and will continue to introduce this fiscal year, both new and enhanced products. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +We believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain competitive. We need to continue to prepare updates for existing products and develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and analysis in response to evolving customer requirements. In addition, we are beginning to migrate some of our products to a new platform. We cannot assure you that we will be able to adequately manage product transition issues. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. Should the credit markets further tighten or our business decline, we may need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +16 +Table of Contents +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards or commencement of work for a project; +• our ability to successfully negotiate credit arrangements with our bank and the state of the financial markets in general; and +• general economic conditions, including the effects of the economic slowdowns and international conflicts. +If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms when needed, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The markets in which we operate are highly competitive with many companies more established than we are. +Our competitors tend to vary across the various product categories in which we participate. +The engineering and consulting market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +Our sensors line of business competes with existing, well-established companies and technologies, both domestically and abroad. Only a portion of the traffic intersection market has adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +Many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. We continually bid on new contracts and negotiate contract renewals on expiring contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. As a condition to contract award, customers require us to provide a surety bond or letter of credit to protect the client should we fail to perform +17 +Table of Contents +under the terms of the contract. Government entities are also taking more time between contract award and approval to commence work under the contract, which delays our ability to recognize revenues under the contract. If negative market conditions materialize, or if we fail to secure adequate financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue, obtain or perform particular projects, which could reduce or eliminate our profitability. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. +Due to the specialized nature of our business and the current tight labor market, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may adversely affect our growth in the current fiscal year and in future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for most employees are on the rise. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled personnel, we may not be able to attract and retain such employees, which could impair our ability to perform our contractual obligations, meet our customers' needs, win new business, and adversely affect our future results. Likewise, the future success of our consulting services will depend on our ability to hire additional qualified engineers, planners and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense and has become more so in recent months. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +The ongoing military action between Russia and Ukraine could adversely affect our business, financial condition and results of operations. +On February 24, 2022, Russian military forces launched a military action in Ukraine and sustained conflict and disruption in the region is likely. Although the length, impact and outcome of the ongoing military action in Ukraine is highly unpredictable, this conflict could lead to significant market and other disruptions, including significant volatility in commodity prices and supply of energy resources, instability in financial markets, supply chain interruptions, political and social instability, changes in government agency budgets and funding preferences as well as increase in cyberattacks and cyber and corporate espionage. To date we have not experienced any material interruptions in our infrastructure, supplies, technology systems or networks needed to support our operations. We are actively monitoring the situation in Ukraine and assessing its impact on our business. The extent and duration of the military action and resulting market disruptions could be significant and could potentially have substantial impact on the global economy and our business for an unknown period of time. Any such disruptions may also magnify the impact of other risks described in this Annual Report on Form 10-K. +Legal and Regulatory Risks +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. We have in the past, currently, and may in the future, be subject to litigation regarding our intellectual property rights. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us +18 +Table of Contents +to license disputed rights from others or require us to cease marketing or using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have infringed upon or misappropriated another party's intellectual property. Our continued expansion into software development activities may subject us to increased possibility of litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and results of operations. +We may continue to be subject to traffic-related litigation. +The traffic industry in general is subject to frequent litigation claims due to the nature of personal injuries that can result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant expenses and result in a diversion of management's attention. +Financial and Market Risks +We may not be able to consistently achieve profitability on a quarterly or annual basis in the future. +We had a GAAP net loss of approximately $7.1 million in Fiscal 2022, which includes $0.2 million of net loss from discontinued operations, and net income of $10.1 million in Fiscal 2021 and net loss of $5.6 million in Fiscal 2020, and we cannot assure you that we will be profitable in the future. Our ability to operate at a profit in future periods could be impacted by governmental budgetary constraints, government and political agendas, economic instability, supply chain constraints and other items that are not in our control. Furthermore, we rely on operating profits to fund investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned investments. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could continue to be adversely affected. +Our use of estimates in conjunction with the input method of measuring progress to completion of performance obligations for our engineering and consulting services revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of our engineering and consulting services revenues are measured and recognized over time using the input method of measuring progress to completion. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenues and profits. +Declines in the value of securities held in our investment portfolio can affect us negatively. +19 +Table of Contents +As of March 31, 2022, we had no securities available for sale within our investment portfolio. The value of our investment portfolio has fluctuated as a result of market volatility and economic or financial market conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and liquidity. Further, to the extent that we experience unrealized losses in our portfolio of investment securities from declines in securities values that management determines to be other than temporary, the book value of those securities will be adjusted to their estimated recovery value and we will recognize a charge to earnings in the quarter during which we make that determination. Although we have policies and procedures in place to assess and mitigate potential impacts of market risks, those policies and procedures are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage these risks properly. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that technology, decision-making and other processes can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. Factors that could affect our revenues and operating results include, among others, the following: +• the Pandemic, which may have a continuing impact on our future operating results; +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our ability to access stimulus funding, funding from the federal highway bill or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant customer orders; +• our ability to control costs, including costs associated with strategic alternatives; +20 +Table of Contents +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• timing of backlog fulfillment; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• risks and uncertainties associated with our international business; +• market condition changes such as industry structure consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• our ability to raise additional capital; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance. +21 +Table of Contents +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have experienced, and may from time to time in the future continue to experience parts shortages, sharp increases in component costs and unforeseen quality control issues by our suppliers that may impact our ability to meet demand for our products. The Pandemic has increased the occurrence of such shortages. We have historically used and continue to use single suppliers for certain significant components in our products; however, in light of the current supply chain shortage we have begun to use other suppliers to meet our demand, and we have had to reengineer products from time to time to address obsolete or unavailable components. Our products are also included with other traffic intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should any such supply delay or disruption occur, or should a key supplier discontinue operations, our future sales and costs will likely be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a production gap should for any reason our contract manufacturers become unable to meet our production requirements and our cost of goods sold could increase, adversely affecting our margins. Further, foreign imports of components in our products subject the Company to risks of changes in, or the imposition of new, export/import requirements, tariffs, work stoppages, delays in shipment, product cost increases due to component shortages, public health issues that could lead to temporary closures of facilities or shipping ports, such as the Pandemic and other economic uncertainties, affecting trade between the U.S. and other countries where we source components for our products. Any such actions could increase the cost to us of such products and cause increases in the prices at which we sell such products, which could adversely affect the financial performance of our business. Similarly, these actions could result in cost increases or supply chain delays that impact third party products (e.g., steel poles) which could lead our customers to delay or cancel planned purchases of our products. +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution capabilities for our products internationally, particularly in Europe and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to various inherent risks including, among others: +• the Pandemic and related government responses, including travel restrictions, quarantines and "stay-at-home" orders; +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S., as well as requirements and restrictions in the other countries in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; and +• reduced protection for intellectual property rights in some countries. +Substantially all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, as we pursue the expansion of our international business, +22 +Table of Contents +certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has been subject to wide fluctuations in the past. From March 31, 2019 through March 31, 2022, our common stock has traded at prices as low as $2.08 per share and as high as $7.81 per share. The market price of our common stock could continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• statements made by third parties or speculation regarding our strategic alternatives; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other strategic transactions or dispositions; +• the impact of any litigation; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The stock market is currently experiencing and has from time-to-time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common stock. +Provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For example, under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make nominations for directors. We may also adopt provisions and agreements from time to time that could make it harder for a potential acquirer. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +23 +Table of Contents +ITEM 2. PROPERTIES +Our largest physical office is located in Santa Ana, CA where we lease approximately 47,000 square feet of leased office, manufacturing and warehouse space located in Santa Ana, California, pursuant to a lease which terminates in March 2027. For additional information regarding our lease obligations, see Note 8, Right-of-Use Assets and Lease Liabilities, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details. +ITEM 3. LEGAL PROCEEDINGS +The information set forth under the heading "Litigation and Other Contingencies" under Note 7 to the Consolidated Financial Statements, included in Part II, Item 8 of this report, is incorporated herein by reference. +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +24 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock is traded on the Nasdaq Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock traded on the NYSE MKT under the same symbol. +As of May 31, 2022, we had 286 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business conditions, and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +On August 9, 2012, our Board of Directors approved a stock repurchase program pursuant to which we could acquire up to $3.0 million of our outstanding common stock for an unspecified length of time. Under the program, we could repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and could also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan was in place. There was no guarantee as to the exact number of shares that would be repurchased. We could modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company could continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +In Fiscal 2022, Fiscal 2021, and Fiscal 2020, we did not repurchase any shares. From inception of the program in August 2011 through March 31, 2022, we repurchased approximately 2,458,000 shares of our common stock for an aggregate price of approximately $4.3 million, at an average price per share of $1.73. As of March 31, 2022, all repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2022, prior to the termination of the 2012 repurchase program, approximately $1.7 million remained available for the repurchase of our common stock. +On May 12, 2022 the Board of Directors retired the previously approved plan and approved a new plan for the company to acquire up to $10.0 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan is in place. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. +ITEM 6. RESERVED +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Part I, Item 1A, as well as the +25 +Table of Contents +other cautionary statements and risks described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General +We are a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient, and sustainable for everyone. +Recent Developments +Impact of COVID-19 on Our Business +The Pandemic has materially adversely impacted global economic conditions. More than 24 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the global economy. Though there has been a trend in increasing availability of COVID-19 vaccines, as well as an easing of restrictions on social, business, travel and government activities and functions, infection rates continue to fluctuate and federal, state and local government regulations continue to rapidly change. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. We have not had any facility closures due to the Pandemic, but we have experienced supply chain and work delays on certain projects. Should such delays become protracted or worsen or should longer term budgets or priorities of our clients be impacted, the Pandemic could impact our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the Pandemic, new and potentially more contagious variants, such as the Delta and Omicron variants, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers and suppliers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, we have taken certain actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but are not limited to, reducing our discretionary spending, reducing capital expenditures, implementing restructuring activities with the goal of reducing payroll costs, including employee furloughs, pay freezes and pay cuts. +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate for component shortages, we have begun to increase inventory levels and may continue to do so for an extended period. In the event demand doesn’t materialize, we may need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, to meet customer demand, resulting in high levels of unshippable backlog. We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. Still, we may remain supply-constrained beyond our Fiscal 2022. +On March 27, 2020, the CARES Act was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. For more information, refer to Note 6, Income Taxes , to the Consolidated Financial Statements, including in Part II, Item 8 of this report. +The Pandemic has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility has remained open throughout the Pandemic, the easing of Pandemic restrictions imposed by local and state authorities have allowed a portion of our workforce to return to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. We believe that our system of internal control over financial reporting has not been fundamentally altered and that the effectiveness of the design and operation of internal controls remained materially consistent during the fiscal year ended March 31, 2022. Additionally, we have been able to timely file financial reports. We believe we have the right infrastructure to efficiently work remotely for the balance of the Pandemic. We do not expect to incur significant costs to safely reopen our facilities to all our employees. +26 +Table of Contents +Despite the Pandemic, we believe that the ITS ("Intelligent Traffic Systems") industry in the U.S. should continue to provide new opportunities for the Company although, in the near term, the pace of new opportunities emerging may be restrained and the start dates of awarded projects may be delayed. We believe that our expectations are valid and that our plans for the future continue to be based on reasonable assumptions. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into the TrafficCast Purchase Agreement with TrafficCast, a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million. +The $17.7 million in total consideration was comprised of $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provides for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). The transaction closed on December 7, 2020. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +TrafficCast operates two lines of business – commercial and public sector – each of which contributes about 50% of total revenue. Its commercial line of business develops software that collects, filters, and models real-time traveler information and traffic incident data for global media companies and other commercial customers. Its public sector line of business provides sensors and related software that help state and local agencies measure, visualize, and manage traffic flow. Since its integration in early Fiscal 2022, TrafficCast’s market-leading software and internet of things, or IoT, devices, as well as its data ingestion, data science and analytics solutions, has enhanced Iteris’ suite of smart mobility infrastructure management solutions. +Sale of Agriculture and Weather Analytics Business +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our former Agriculture and Weather Analytics business to DTN, an operating company of TBG AG, a Swiss-based holding company, pursuant to the AWA Purchase Agreement signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million in cash, subject to working capital adjustments. Upon closing, the Company received $10.5 million in cash and $1.5 million of payment was deferred. DTN paid the Company $1.45 million at the 12-month anniversary of the closing date, and $0.05 million at the 18-month anniversary of the closing date. The AWA Purchase Agreement also provides for customary post-closing adjustments to the purchase price related to working capital at closing. The parties also entered into certain ancillary agreements at the closing of the transaction that will provide Iteris with ongoing access to weather and pavement data that it integrates into its transportation software products, and a joint development agreement under which the parties agreed to pursue future joint opportunities in the global transportation market. +The sale of the Agriculture and Weather Analytics business was a result of the Company’s shift in strategy to focus on its mobility infrastructure management solutions and to capitalize on the potential for a future partnership upon the sale of this business component to DTN. We have determined that the Agriculture and Weather Analytics business, qualifies as a discontinued operation in accordance with the criteria set forth in ASC 205-20, Presentation of Financial Statements – Discontinued Operations . +On May 5, 2020, the Company also entered into a transition services agreement (“TSA”) with DTN, pursuant to which the Company agreed to support the information technology function of the Agriculture and Weather Analytics business for a period up to 12 months and DTN agreed to provide the contract administration/account management services for certain contracts of the Company and other transition services. Either party may make any reasonable request to extend the period of time the other party shall provide a transition service beyond the initial service period or access to additional services that are necessary for the transition of the business operations. The Company earned less than $0.1 million in income and incurred less than $0.1 million in costs associated with the TSA for the fiscal year ended March 31, 2022, which was included in loss from discontinued +27 +Table of Contents +operations before gain on sale, net of tax on the consolidated statement of operations (see Note 3, Discontinued Operations , to the Consolidated Financial Statements). +Non-GAAP Financial Measures +Adjusted income (loss) from continuing operations before interest, taxes, depreciation, amortization, stock-based compensation expense, restructuring charges, project loss reserves, acquisition costs, executive severance and transition costs, and fair value adjustment related to TrafficCast's opening balance inventory (“Adjusted EBITDA”) was approximately $4.5 million, $7.5 million and $4.2 million for the fiscal years ended March 31, 2022, 2021 and 2020, respectively. +When viewed with our financial results prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and accompanying reconciliations, we believe Adjusted EBITDA provides additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define these measures, explain how they are calculated and provide reconciliations of these measures to the most comparable GAAP measure in the table below. Adjusted EBITDA and the related financial ratios, as presented in this Annual Report on Form 10-K (“Form 10-K”), are supplemental measures of our performance that are not required by or presented in accordance with GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items. +We use Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We present Adjusted EBITDA and the related financial ratios, as applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our operating commitments. +Adjusted EBITDA and the related financial ratios have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include: +• They do not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments; +• They do not reflect changes in, or cash requirements for, our working capital needs; +• Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; +• They are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; +• They do not reflect the impact on earnings of charges resulting from matters unrelated to our ongoing operations; and +• Other companies in our industry may calculate Adjusted EBITDA differently than we do, whereby limiting its usefulness as comparative measures. +Because of these limitations, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only as supplemental information. See our audited consolidated financial statements contained in this Form 10-K. However, in spite of the above limitations, we believe that Adjusted EBITDA and the related financial ratios are useful to an investor in evaluating our results of operations because these measures: +• Are widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors; +• Help investors to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and +• Are used by our management team for various other purposes in presentations to our Board of Directors as a basis for strategic planning and forecasting. +The following financial items have been added back to or subtracted from our net income (loss) when calculating Adjusted EBITDA: +• Interest expense. Iteris excludes interest expense because it does not believe this item is reflective of ongoing business and operating results. This amount may be useful to investors for determining current cash flow. +28 +Table of Contents +• Income tax. This amount may be useful to investors because it represents the taxes which may be payable for the period and the change in deferred taxes during the period, and may reduce cash flow available for use in our business; +• Depreciation expense. Iteris excludes depreciation expense primarily because it is a non-cash expense. These amounts may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations. +• Amortization. Iteris incurs amortization of intangible assets in connection with acquisitions. Iteris also incurs amortization related to capitalized software development costs. Iteris excludes these items because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to investors because it represents the estimated attrition of our acquired customer base and the diminishing value of product rights. +• Stock-based compensation. These expenses consist primarily of expenses from employee and director equity based compensation plans Iteris excludes stock-based compensation primarily because they are non-cash expenses and Iteris believes that it is useful to investors to understand the impact of stock-based compensation to its results of operations and current cash flow. +• Restructuring charges. These expenses consist primarily of employee separation expenses, facility termination costs, and other expenses associated with Company restructuring activities. Iteris excludes these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Project loss reserves. These expenses consist primarily of expenses incurred to complete a software development contract that will not be recoverable and are largely related to previously incurred and capitalized costs for non-recurring engineering activity. Iteris excludes these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Acquisition costs. In connection with its business combinations, Iteris incurs professional service fees, changes to the fair value of contingent consideration, and other direct expenses. Iteris excludes such items as they are related to acquisitions and have no direct correlation to the operation of Iteris’ business. These amounts may be useful to our investors in evaluating our core operating performance. +• Executive severance and transition costs. Iteris excludes executive severance and transition costs because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Fair value adjustment related to acquired opening balance inventories. Iteris excludes fair value adjustment related to the opening inventory balance acquired as part of its business combination because it does not believe that these costs are reflective of operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +Reconciliations of net income (loss) from continuing operations to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of total revenues were as follows: +29 +Table of Contents +Year Ended March 31, +2022 2021 2020 +(In thousands) +Net income (loss) from continuing operations $ (6,900) $ 491 $ (1,758) +Income tax expense 174 115 160 +Depreciation expense 820 734 770 +Amortization expense 3,240 2,036 1,255 +Stock-based compensation 3,401 2,902 2,495 +Other adjustments: +Restructuring charges — 619 — +Project loss reserve 3,394 — — +Acquisition costs — 417 689 +Executive severance and transition costs 340 — 553 +Fair value adjustment - opening balance inventories — 136 — +Total adjustments 11,369 6,959 5,922 +Adjusted EBITDA $ 4,469 $ 7,450 $ 4,164 +Percentage of total revenues 3.3 % 6.4 % 3.9 % +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our consolidated financial statements included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements. In preparing our consolidated financial statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and other factors that we believe are reasonable. We evaluate our estimates, assumptions and judgments on a regular basis and apply our accounting policies on a consistent basis. We believe that the estimates, assumptions and judgments involved in the accounting for revenue recognition, goodwill, and income taxes have the most potential impact on our consolidated financial statements. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. +The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. +Revenue Recognition. Our revenue arrangements are complex in nature and require significant judgement in determining the performance obligation structure. Each contract is unique in nature and therefore is assessed individually for appropriate accounting treatment. +Revenues are recognized when control of the promised goods or services are transferred to our customers, in a gross amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +Product revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term and these purchase orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues, primarily derived from long-term engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using the proportion of actual costs incurred to the total costs expected to complete +30 +Table of Contents +the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service revenues also consist of revenues derived from maintenance and support, extended warranty, and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from fees for maintenance and support, extended warranty, monthly active user fees, SaaS fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services as the customer obtains equal benefit from the service throughout the service period. +Goodwill. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment in accordance with the provisions of ASC 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. +The estimates of fair value of the reporting units are computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of the reporting units. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including future gross margin rates, expense rates, capital expenditures and other estimates), and a rate used to discount estimated future cash flow projections to their present value (or estimated fair value) based on estimated weighted average cost of capital (i.e., the selected discount rate). We select assumptions used in the financial forecasts by using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses (i.e. guideline companies). The selection of comparable businesses is based on the markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity of products and services. +Income Taxes . Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $14.6 million and $12.3 million against our deferred tax assets at March 31, 2022 and 2021, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve. +Recent Accounting Pronouncements +Refer to Note 1, Description of Business and Summary of Significant Accounting Policies, to the Consolidated Financial Statements, included in Part II, Item 8 of this report for a discussion of recent accounting pronouncements. +31 +Table of Contents +Analysis of Fiscal 2022 and Fiscal 2021 Results of Operations +For a comparison of the 2021 to 2020 fiscal years, see Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2021. Note that the filings of the 2020 and 2019 fiscal years do not reflect results of discontinued operation related activities, which are reflected in this report. +Total Revenues. The following table presents details of total revenues for Fiscal 2022 as compared to Fiscal 2021: +Year Ended March 31, +2022 2021 $ Increase % Change +(In thousands, except percentage) +Product revenues $ 68,729 $ 62,933 $ 5,796 9.2 % +Service revenues 64,843 54,205 10,638 19.6 % +Total revenues $ 133,572 $ 117,138 $ 16,434 14.0 % +Product revenues primarily consist of product sales, but also includes OEM products for the traffic signal markets, as well as third-party product sales for installation under certain construction-type contracts. Product revenues for Fiscal 2022 increased approximately 9.2% to $68.7 million, compared to $62.9 million in Fiscal 2021, primarily due to continued strong demand for our hardware solutions, further augmented by approximately $6.0 million of TrafficCast product sales in Fiscal 2022 as compared to approximately $1.4 million of TrafficCast product sales in Fiscal 2021, or a net increase of approximately $4.6 million. +Service revenues primarily consist of traffic study, design, engineering, and management services, but also includes service revenues generated from advanced sensor technologies product installation services and cloud-based application installation and support services. Service revenues for Fiscal 2022 increased approximately 19.6% to $64.8 million, compared to $54.2 million in Fiscal 2021. This increase was primarily due to continued adoption of Iteris' ClearMobility Platform and the addition of $7.9 million of TrafficCast SaaS revenue in Fiscal 2022 as compared to approximately $2.7 million of TrafficCast service sales in Fiscal 2021, or a net increase of approximately $5.2 million. Total annual recurring revenue, which we define as revenues from software and managed services contracts, was approximately 25% of total revenue for Fiscal 2022 and approximately 22% of total revenue for Fiscal 2021. +The Company added approximately $155.4 million of new bookings, or potential revenue under binding agreements, during Fiscal 2022. The Company's total backlog increased to approximately $99.9 million as of March 31, 2022, as compared to approximately $78.1 as of March 31, 2021. +We plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with both key public-sector and private-sector customers related to projects in their final project phases. While we believe our ability to obtain additional large contracts will contribute to overall revenue growth, the mix of subcontractor revenue and third-party product sales to our public-sector customers will likely affect the related total gross profit from period to period, as total revenues derived from subcontractors and third-party product sales generally have lower gross margins than revenues generated by our professional services. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements and are not included in deferred revenue on our consolidated balance sheets. Backlog includes new bookings but does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders, but there can be no assurances we will recognize revenue from bookings or backlog timely or ever. +Gross Profit. The following tables present details of our gross profit for Fiscal 2022 compared to Fiscal 2021: +32 +Table of Contents +Year Ended March 31, +2022 2021 $ Increase (decrease) % Change +(In thousands, except percentage) +Product gross profit $ 28,228 $ 28,000 $ 228 0.8 % +Service gross profit 19,165 18,856 309 1.6 % +Total gross profit $ 47,393 $ 46,856 $ 537 1.1 % +Product gross margin as a % of product revenues 41.1 % 44.4 % +Service gross margin as a % of service revenues 29.6 % 34.9 % +Total gross margin as a % of total revenues 35.5 % 40.0 % +Our product gross margin as a percentage of product revenues for Fiscal 2022 decreased approximately 330 basis points compared to Fiscal 2021 primarily due to an increase in raw material costs as a result of global supply chain constraints. +Our service gross margin as a percentage of service revenues for Fiscal 2022 decreased 530 basis points compared to Fiscal 2021 primarily due to the completion of previously awarded contracts, the timing of certain extension contracts, the contract mix, an increase in the number of subcontractors of such contracts, and recognition of an estimated contractual loss on a project with a customer, for which approximately $3.4 million was recorded in Fiscal 2022. Subcontractor revenue generally results in lower gross margins than our direct labor revenue. +Our total gross margin as a percentage of total revenues for Fiscal 2022 decreased 450 basis points compared to Fiscal 2021 primarily as a result of the aforementioned reasons. +General and Administrative Expense +General and administration expense for Fiscal 2022 increased approximately 4% to $25.1 million, compared to $24.2 million in Fiscal 2021 primarily due to the addition of TrafficCast, and additional professional services fees related to the Company's review of strategic alternatives. +Sales and Marketing Expense +Sales and marketing expense for Fiscal 2022 increased approximately 27% to $18.9 million, compared to $15.0 million in Fiscal 2021 primarily due to the addition of TrafficCast, and higher sales commissions based on higher sales for Fiscal 2022. +Research and Development Expense +Research and development expense for Fiscal 2022 increased approximately 43% to $7.4 million, compared to $5.1 million in Fiscal 2021. The overall increase was primarily due to continued investment in research and development activities largely focused on improving our existing software related product offerings. +We plan to continue to invest in the development of further enhancements and functionality of our Iteris ClearMobility Platform which includes among other things our software portfolio and our Vantage sensors. +Certain development costs were capitalized into intangible assets in the consolidated balance sheets in both the current and prior year periods; however, certain costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our software solutions. This continued investment may result in increases in research and development costs, as well as additional capitalized software in future periods. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2022, we believe the carrying value of our goodwill was not impaired, as the estimated fair values of our reporting units exceeded their carrying values at the end of Fiscal 2022. If our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our original estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Amortization of Intangible Assets +Amortization expense for intangible assets subject to amortization was approximately $3.2 million and $2.0 million for Fiscal 2022 and Fiscal 2021, respectively. Approximately $0.6 million and $0.5 million of the intangible asset amortization was +33 +Table of Contents +recorded to cost of revenues, and approximately $2.7 million and $1.5 million was recorded to amortization expense for Fiscal 2022 and Fiscal 2021, respectively, in the consolidated statements of operations. The increase in amortization was primarily due to amortization expenses related to intangible assets acquired as part of the TrafficCast acquisition. +Interest Income (Expense), Net +Net interest expense was approximately $0.0 million and net interest income was approximately $0.1 million in Fiscal 2022 and Fiscal 2021, respectively. The decrease in net interest income in the current year was primarily due to the decrease in interest earned on investments purchased and held during the current fiscal year. +Income Taxes +The following table presents our provision for income taxes for Fiscal 2022 and Fiscal 2021: +Year Ended +March 31, +2022 +2021 +(In thousands, +except percentage) +Provision for income taxes $ 174 $ 115 +Effective tax rate (2.5) % 1.8 % +For Fiscal 2022 and 2021, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $14.6 million and $12.3 million against our deferred tax assets at March 31, 2022 and 2021, respectively. We will continue to reassess the appropriateness of maintaining a valuation allowance. +As we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. +At March 31, 2022, we had $16.0 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes. We also had $9.9 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using statutory tax rates. +Liquidity and Capital Resources +For a comparison of the 2021 to 2020 fiscal years, see Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Form 10-K for the fiscal year ended March 31, 2021. +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure additional funding on a timely basis, on terms acceptable to us, or at all. +At March 31, 2022, we had $36.8 million in working capital, excluding current liabilities of discontinued operations, which included $23.8 million in cash and cash equivalents. This compares to working capital of $36.7 million at March 31, 2021, which included $25.5 million in cash and cash equivalents and $3.1 million in short-term investments. +34 +Table of Contents +The following table summarizes our cash flows from continuing operations for Fiscal 2022 and Fiscal 2021: +Year Ended +March 31, +2022 +2021 +(In thousands) +Net cash provided by (used in): +Operating activities $ (5,593) $ 8,888 +Investing activities 999 (7,998) +Financing activities 1,563 2,873 +Operating Activities. Net cash used by operating activities of our continuing operations for Fiscal 2022 of $5.6 million was primarily the result of noncash lease expense, depreciation expenses, stock-based compensation, and amortization coupled with our net loss from continuing operations of approximately $6.9 million, as well as approximately $11.8 million of outflows from changes in working capital offset by $13.1 million in non-cash items. Net cash used in operating activities due to discontinued operations was $0.1 million. +Net cash provided by operating activities of our continuing operations for Fiscal 2021 of $8.9 million was primarily the result of $7.8 million in non-cash items, primarily for noncash lease expense, depreciation expenses, stock-based compensation, and amortization coupled with our net income from continuing operations of approximately $0.5 million, as well as approximately $0.6 million of inflows due to changes in working capital. Net cash used in operating activities from discontinued operations was $2.4 million. +Investing Activities. Net cash provided by investing activities of our continuing operations during Fiscal 2022 was primarily the result of approximately $3.1 million in proceeds from the sale and maturity of short-term investments which were partially offset by approximately $0.5 million of property and equipment purchases, and approximately $1.6 million of capitalized software development costs, primarily in VantageLive! and ClearGuide, respectively. Net cash provided by investing activities from discontinued operations was $1.5 million. +Net cash used in investing activities of our continuing operations during Fiscal 2021 was primarily the result of purchases of approximately $23.7 million of short-term investments, approximately $15.0 million in cash paid for the TrafficCast acquisition, approximately $0.6 million of property and equipment purchases, and approximately $0.8 million of capitalized software development costs, related to VantageLive! and ClearGuide. These investments were partially offset by approximately $32.0 million in proceeds from the sale and maturity of short-term investments. +Financing Activities. Net cash provided by financing activities of our continuing operations during Fiscal 2022 was primarily the result of approximately $1.3 million and $0.4 million of cash proceeds from the exercise of stock options and purchases of Employee Stock Purchase Plan ("ESPP") shares, respectively. +Net cash provided by financing activities of our continuing operations during Fiscal 2021 was primarily the result of approximately $2.6 million and $0.4 million of cash proceeds from the exercise of stock options and purchases of ESPP shares, respectively. +Off-Balance Sheet Arrangements +We do not have any other material off-balance sheet arrangements at March 31, 2022. +Seasonality +We have historically experienced seasonality, particularly with respect to our products, which adversely affects such sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally impacted the most by inclement weather. We have also experienced seasonality, which adversely impacts our third fiscal quarter due to the increased number of holidays, causing a reduction in available billable hours. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item. +35 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Consolidated Financial Statement +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +37 +Consolidated Balance Sheets as of March 31, 202 2 and 20 2 1 +39 +Consolidated Statements of Operations for the fiscal years ended March 31, 202 2 , 202 1 and 20 2 0 +40 +Consolidated Statements of Stockholders' Equity for the fiscal years ended March 31, 202 2 , 202 1 and 20 2 0 +41 +Consolidated Statements of Cash Flows for the fiscal years ended March 31, 202 2 , 202 1 and 20 2 0 +42 +Notes to Consolidated Financial Statements +44 +36 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Iteris, Inc. and subsidiaries (the “Company”) as of March 31, 2022 and 2021, the related consolidated statements of operations, stockholders’ equity, and cash flows, for each of the three years in the period ended March 31, 2022, and the related notes (collectively, referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2022, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of March 31, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 1, 2022, expressed an unqualified opinion on the Company’s internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue from Contracts with Customers – Determination of Distinct Performance Obligations Relating to Service Revenues – Refer to Note 1 of the financial statements +Critical Audit Matter Description +The Company’s service revenues within the Consulting Solutions (“CS”) and Application and Cloud Solutions (“ACS”) revenue streams, primarily derive revenue from long-term engineering and consulting services and software as a service (“SaaS”). The Company accounts for individual services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the services, the solution provided, and the structure of the sales contract. During the year ended March 31, 2022, the Company recognized service revenues from contracts with customers of $64.8 million. +We identified the determination of distinct performance obligations in contracts with customers relating to service revenues as a critical audit matter. Significant judgment is required to determine whether the performance obligations in these sales contracts are distinct; that is, if a service is separately identifiable from other items in the sales contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer. Auditing these aspects include especially challenging auditor judgment due to the nature and extent of audit effort required to address this matter. +How the Critical Audit Matter was Addressed in the Audit +37 +Table of Contents +Our audit procedures related to the Company’s determination of distinct performance obligations relating to service revenues for these contracts included the following, among others: +• We tested the effectiveness of controls related to management’s identification and assessment of distinct performance obligations in contracts with customers. +• We selected a sample of customer contracts to evaluate the appropriateness of management’s determination of distinct performance obligations. +• We selected a sample of invoices from the accounts receivable detail and determined whether amounts invoiced were in accordance with the related contract terms. Further, we inspected line items on the invoice to verify that all line items were included in management's evaluation of performance obligations. +• We selected a sample of customer contracts and investigated all changes in current forecasted cost to original forecasted cost to evaluate if changes in estimate are indicative of existing services known by operations personnel, but not previously considered as distinct performance obligations by management. +• We investigated offsets to revenue to determine that they represent a valid purpose, and a service was not previously identified. +• We selected a sample of expenditures and determined whether the good/service represented by the selected transaction was properly identified and evaluated by management as a distinct performance obligation. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2022 +We have served as the Company's auditor since 2016. +38 +Table of Contents +Iteris, Inc. +Consolidated Balance Sheets +(In thousands, except par value) +March 31, +2022 2021 +Assets +Current assets: +Cash and cash equivalents $ 23,689 $ 25,205 +Restricted cash 120 263 +Short-term investments — 3,100 +Trade accounts receivable, net of allowance for doubtful accounts of $ 903 and $ 1,019 at March 31, 2022 and 2021, respectively +25,628 19,020 +Unbilled accounts receivable 10,870 11,541 +Inventories 7,980 5,066 +Prepaid expenses and other current assets 4,076 5,445 +Total current assets 72,363 69,640 +Property and equipment, net 1,392 1,923 +Right-of-use assets 11,382 11,353 +Intangible assets, net 11,780 14,297 +Goodwill 28,340 28,340 +Other assets 1,120 1,238 +Noncurrent assets of discontinued operations 6 78 +Total assets $ 126,383 $ 126,869 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable $ 11,926 $ 8,935 +Accrued payroll and related expenses 11,409 11,734 +Accrued liabilities 5,623 4,921 +Deferred revenue 6,566 7,349 +Current liabilities of discontinued operations 163 94 +Total current liabilities 35,687 33,033 +Lease liabilities 10,763 10,146 +Deferred income taxes 337 808 +Unrecognized tax benefits 105 119 +Other long-term liabilities 2,456 3,523 +Noncurrent liabilities of discontinued operations 172 261 +Total liabilities 49,520 47,890 +Commitments and contingencies (Note 7) +Stockholders' equity: +Preferred stock, $ 1.00 par value: +Authorized shares— 2,000 +— — +Issued and outstanding shares— none +— — +Common stock, $ 0.10 par value: +Authorized shares—Authorized shares— 70,000 at March 31, 2022 and March 31, 2021 +Issued and outstanding shares— 42,416 at March 31, 2022 and 41,687 at March 31, 2021 +4,242 4,170 +Additional paid-in capital +186,720 181,828 +Accumulated deficit ( 114,099 ) ( 107,019 ) +Total stockholders' equity 76,863 78,979 +Total liabilities and stockholders' equity $ 126,383 $ 126,869 +See accompanying Notes to the Consolidated Financial Statements. +39 +Table of Contents +Iteris, Inc. +Consolidated Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2022 2021 2020 +Product revenues $ 68,729 $ 62,933 $ 55,007 +Service revenues 64,843 54,205 52,396 +Total revenues 133,572 117,138 107,403 +Cost of product revenues 40,501 34,933 30,266 +Cost of service revenues 45,678 35,349 33,524 +Cost of revenues 86,179 70,282 63,790 +Gross profit 47,393 46,856 43,613 +Operating expenses: +General and administrative 25,131 24,207 24,047 +Sales and Marketing 18,929 14,957 16,618 +Research and development 7,354 5,130 4,315 +Amortization of intangible assets 2,673 1,504 757 +Restructuring charges — 619 — +Total operating expenses 54,087 46,417 45,737 +Operating income (loss) ( 6,694 ) 439 ( 2,124 ) +Non-operating income (expense): +Other income (expense) ( 18 ) 54 297 +Interest income (expense) ( 14 ) 113 229 +Income (loss) from continuing operations before income taxes ( 6,726 ) 606 ( 1,598 ) +Provision for income taxes ( 174 ) ( 115 ) ( 160 ) +Net income (loss) from continuing operations ( 6,900 ) 491 ( 1,758 ) +Loss from discontinued operations before gain on sale, net of tax ( 180 ) ( 1,654 ) ( 3,852 ) +Gain on sale of discontinued operations, net of tax — 11,297 — +Net income (loss) from discontinued operations, net of tax ( 180 ) 9,643 ( 3,852 ) +Net income (loss) $ ( 7,080 ) $ 10,134 $ ( 5,610 ) +Income (loss) per share - basic: +Income (loss) per share from continuing operations $ ( 0.16 ) $ 0.01 $ ( 0.04 ) +Income (loss) per share from discontinued operations $ 0.00 $ 0.23 $ ( 0.10 ) +Net income (loss) per share $ ( 0.16 ) $ 0.24 $ ( 0.14 ) +Income (loss) per share - diluted: +Income (loss) per share from continuing operations $ ( 0.16 ) $ 0.01 $ ( 0.04 ) +Income (loss) per share from discontinued operations $ 0.00 $ 0.23 $ ( 0.10 ) +Net income (loss) per share $ ( 0.16 ) $ 0.24 $ ( 0.14 ) +Shares used in basic per share calculations 42,222 41,176 39,012 +Shares used in diluted per share calculations 42,222 41,599 39,012 +See accompanying Notes to the Consolidated Financial Statements. +40 +Table of Contents +Iteris, Inc. +Consolidated Statements of Stockholders' Equity +(In thousands) +Common Stock Additional +Paid-In +Capital Accumulated +Deficit Total +Stockholders' +Equity +Shares Amount +Balance at March 31, 2019 33,377 $ 3,338 $ 142,260 $ ( 111,543 ) $ 34,055 +Issuance of common stock in connection with public offering, net of costs 6,183 618 26,133 — 26,751 +Stock option exercises 120 12 244 — 256 +Issuance of shares pursuant to Employee Stock Purchase Plan 91 9 361 — 370 +Stock-based compensation — — 2,785 — 2,785 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 73 7 ( 22 ) — ( 15 ) +Issuance of common stock in connection with acquisition 869 87 4,448 — 4,535 +Net loss — — — ( 5,610 ) ( 5,610 ) +Balance at March 31, 2020 40,713 4,071 176,209 ( 117,153 ) 63,127 +Stock option exercises 731 74 2,559 — 2,633 +Issuance of shares pursuant to Employee Stock Purchase Plan 97 10 438 — 448 +Stock-based compensation — — 2,845 — 2,845 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 146 15 ( 223 ) — ( 208 ) +Net income — — — 10,134 10,134 +Balance at March 31, 2021 41,687 4,170 181,828 ( 107,019 ) 78,979 +Stock option exercises 489 48 1,282 1,330 +Issuance of shares pursuant to Employee Stock Purchase Plan 95 9 427 436 +Stock-based compensation — — 3,401 3,401 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 145 15 ( 218 ) ( 203 ) +Net loss ( 7,080 ) ( 7,080 ) +Balance at March 31, 2022 42,416 $ 4,242 $ 186,720 $ ( 114,099 ) $ 76,863 +See accompanying Notes to the Consolidated Financial Statements. +41 +Table of Contents +Iteris, Inc. +Consolidated Statements of Cash Flows +(In thousands) +42 +Table of Contents +Year Ended March 31, +2022 2021 2020 +Cash flows from operating activities +Net income (loss) $ ( 7,080 ) $ 10,134 $ ( 5,610 ) +Less: Net income (loss) from discontinued operations ( 180 ) 9,643 ( 3,852 ) +Net income (loss) from continuing operations ( 6,900 ) 491 ( 1,758 ) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Project Loss 3,394 +Right-of-use asset non-cash expense 2,515 1,438 1,199 +Deferred income taxes ( 485 ) 607 105 +Depreciation of property and equipment 820 734 770 +Stock-based compensation 3,401 2,902 2,495 +Amortization of intangible assets 3,240 2,036 1,255 +Loss on disposal of equipment 177 — — +Other — 86 ( 60 ) +Changes in operating assets and liabilities, net of effects of discontinued operations and acquisitions: +Trade accounts receivable ( 6,608 ) ( 227 ) 235 +Unbilled accounts receivable and deferred revenue 148 903 ( 2,353 ) +Inventories ( 2,914 ) ( 1,085 ) ( 124 ) +Prepaid expenses and other assets ( 2,495 ) ( 1,738 ) ( 951 ) +Trade accounts payable and accrued expenses 2,683 4,168 ( 409 ) +Operating lease liabilities ( 2,569 ) ( 1,427 ) ( 866 ) +Net cash provided by (used in) operating activities - continuing operations ( 5,593 ) 8,888 ( 462 ) +Net cash used in operating activities - discontinued operations ( 128 ) ( 2,398 ) ( 3,365 ) +Net cash provided by (used in) in operating activities ( 5,721 ) 6,490 ( 3,827 ) +Cash flows from investing activities +Purchases of property and equipment ( 466 ) ( 601 ) ( 409 ) +Purchase of short-term investments — ( 23,655 ) ( 33,786 ) +Maturities of investments 3,100 32,025 24,225 +Capitalized software development costs ( 1,635 ) ( 767 ) ( 633 ) +Cash paid in business acquisition, net of cash acquired — ( 15,000 ) ( 5,581 ) +Net cash provided by (used in) investing activities - continuing operations 999 ( 7,998 ) ( 16,184 ) +Net cash provided by (used in) investing activities - discontinued operations 1,500 9,740 ( 59 ) +Net cash provided by (used in) investing activities 2,499 1,742 ( 16,243 ) +Cash flows from financing activities +Proceeds from stock option exercises 1,330 2,633 256 +Proceeds from ESPP purchases 436 448 370 +Tax withholding payments for net share settlements of restricted stock units ( 203 ) ( 208 ) ( 15 ) +Proceeds from issuance of common stock, net of costs — — 26,751 +Net cash provided by financing activities - continuing operations 1,563 2,873 27,362 +Net cash provided by financing activities - discontinued operations — — — +Net cash provided by financing activities 1,563 2,873 27,362 +Increase (decrease) in cash, cash equivalents and restricted cash ( 1,659 ) 11,105 7,292 +Cash, cash equivalents and restricted cash at beginning of period 25,468 14,363 7,071 +Cash, cash equivalents and restricted cash at end of period $ 23,809 $ 25,468 $ 14,363 +Supplemental cash flow information: +Cash paid during the year for: +Income taxes $ 223 $ 183 $ 63 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units $ 15 $ 15 $ 7 +Lease liabilities arising from obtaining right-of-use assets $ 2,544 $ 689 $ 581 +Deferred purchase price receivable $ — $ 1,500 $ — +Issuance of common stock in connection with acquisition $ — $ — $ 4,535 +Deferred consideration related to TrafficCast acquisition $ — $ 2,050 $ — +Working capital adjustment related to TrafficCast acquisition $ — $ 681 $ — +See accompanying Notes to the Consolidated Financial Statements. +43 +Table of Contents +Iteris, Inc. +Notes to Consolidated Financial Statements +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced sensors, mobility intelligence software, mobility data sets, mobility consulting services and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than 24 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the global economy. Though there has been a trend in increasing availability of COVID-19 vaccines, as well as an easing of restrictions on social, business, travel and government activities and functions, infection rates continue to fluctuate and federal, state and local government regulations continue to rapidly change. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. Due to the Pandemic, we have experienced supply chain and work delays on certain projects. Should such conditions become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the Pandemic, new and potentially more contagious variants, such as the Delta and Omicron variants, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers and suppliers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, the Company has taken certain actions to preserve its liquidity, manage cash flow and strengthen its financial flexibility. Such actions include, but are not limited to, reducing discretionary spending, reducing capital expenditures, and implementing restructuring activities. Refer to Note 4, Restructuring Activities, for more information. +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate for component shortages, we have begun to increase inventory levels and may continue to do so for an extended period. In the event demand doesn’t materialize, we may need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, to meet customer demand, resulting in high levels of unshippable backlog. We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. Still, we may remain supply-constrained beyond the fiscal year ended March 31, 2022 ("Fiscal 2022"). +44 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. Refer to Note 6, Income Taxes, for more information. +The Pandemic has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility has remained open, easing of Pandemic restrictions imposed by local and state authorities have allowed a portion of our workforce to return to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. Additionally, we have been able to timely file financial reports. We believe we have the right infrastructure to efficiently work remotely for the balance of the Pandemic. We do not expect to incur significant costs to safely reopen our facilities to all our employees. +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of the Pandemic may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $ 17.7 million. +The $ 17.7 million in total consideration was comprised of $ 15.0 million paid in cash on the closing date, $ 1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $ 1.1 million acquisition-related liability, and a $ 1.0 million earn out, fair valued at $ 0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provided for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). The transaction closed on December 7, 2020. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $ 26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $ 6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Sale of Agriculture and Weather Analytics Business +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics ("AWA") business to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding +45 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +company, pursuant to an Asset Purchase Agreement (the “AWA Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $ 12.0 million in cash, subject to working capital adjustments. Upon closing, the Company received $ 10.5 million in cash and $ 1.5 million of payment was deferred. DTN paid the Company $ 1.45 million at the 12-month anniversary of the closing date, and $ 0.05 million at the 18-month anniversary of the closing date. See Note 3, Discontinued Operations , to the Consolidated Financial Statements, for further details on the sale of the Agriculture and Weather Analytics business. +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics business, the Board of Directors of the Company approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $ 1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Basis of Presentation +Our consolidated financial statements include the accounts of Iteris, Inc. and all its wholly-owned subsidiaries and have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP"). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of consolidated financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Significant estimates made in the preparation of the consolidated financial statements include, but are not limited to, recoverability of long-lived and intangible assets; fair value of acquired intangible assets and goodwill; collectability of accounts receivable and related allowance for doubtful accounts; projections of taxable income used to assess realizability of deferred tax assets; warranty reserves; costs to complete long-term contracts; indirect cost rates used in cost plus contracts; fair value of stock option awards and equity instruments; estimates of future cash flows used to assess the recoverability of the impairment of goodwill; fair value of contingent consideration and capitalization and estimated useful life of the Company's internal-use software development costs. Estimates are based on historical experience and on various assumptions that the Company believes are reasonable under current circumstances. However, future events are subject to change and best estimates and judgments may require further adjustments, therefore, actual results could differ materially from those estimates. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. +Revenue Recognition +Revenues are recognized when control of the promised goods or services are transferred to our customers, in a gross amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers. +Product revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term and these purchase orders are short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues, primarily derived from long-term engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. We recognize revenue on fixed fee contracts, over time, using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportion closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Time & Materials ("T&M") and Cost Plus Fixed Fee ("CPFF") contracts are considered variable consideration. However, performance obligations with these fee types qualify for the "Right to Invoice" Practical Expedient. Under this practical expedient, the Company is allowed to recognize revenue, over time, in the amount to which the Company has a right +46 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company's performance completed to date. +Service revenues also consist of revenues derived from maintenance and support, extended warranty, and the use of the Company's service platforms and APIs on a subscription basis. We generate this revenue from fees for maintenance and support, extended warranty, monthly active user fees, SaaS fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services as the customer obtains equal benefit from the service throughout the service period. +The Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer which combines the software functionality, maintenance and hosting into a single performance obligation. In product related contracts, a purchase order may contain different products, each constituting a separate performance obligation. +We generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +The Company's typical performance obligations include the following: +Performance Obligation When Performance +Obligation is Typically +Satisfied When Payment is +Typically Due How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product Upon shipment (point in time) Within 30 days of delivery Observable transactions +Engineering services where the deliverable is considered a product As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +Service Revenues +Engineering and consulting services As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +SaaS Over the course of the SaaS service once the system is available for use (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Extended warranty service Over the course of the extended warranty period (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Disaggregation of Revenue +The Company disaggregates revenue from contracts with customers into product revenues and services revenues. +Trade Accounts Receivable and Contract Balances +We classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e., only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in the accompanying consolidated balance sheet at their net estimated realizable value. +47 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is increased by the Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are deducted from the allowance. +A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable in the accompanying consolidated balance sheet. For example, we would record a contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified milestones. +Our contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be recovered. As of March 31, 2022 and 2021, there was approximately $ 0.6 million and $ 3.2 million, respectively, of contract fulfillment costs which are presented in the accompanying consolidated balance sheets as prepaid and other current assets. These costs primarily relate to the satisfaction of performance obligations related to the set up of SaaS platforms. These costs are amortized on a straight-line basis over the estimated useful life of the SaaS platform. +Due to delays in the completion of a software development contract with a customer, the Company recorded an estimated loss on the contract. During the twelve months ended March 31, 2022, the Company has recorded approximately $ 3.4 million, charged to cost of sales, of which approximately $ 0.9 million related to previously capitalized software development costs and the remainder reduced the balance of the related contract fulfillment costs. The estimates and assumptions used in these assessments were based upon management's judgment and may be subject to change as new events occur and additional information is obtained. In particular, there remains uncertainty with regards to the additional costs required to fulfill the Company's obligations with regards to the contract. If the future estimated costs to fulfill this contract exceed current estimates, the Company's financial condition, cash flows, and results of operations may be materially impacted. +Transaction Price Allocated to the Remaining Performance Obligations +As of March 31, 2022 and 2021, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial, primarily as a result of termination provisions within our contracts, which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the contract and reassess the estimate each reporting period. +The Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have recognized is one year or less. +The Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping and handling costs are included as cost of revenues in the period during which the products ship. +48 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +The Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net basis (excluded from revenues) in the accompanying consolidated statements of operations. +Deferred Revenue +Deferred revenue in the accompanying consolidated balance sheets is comprised of billings and consideration received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade accounts receivable. +Cash and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal credit risk. +Our accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, South America and Asia. We generally do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's expectations. +We currently have, and historically have had, a diverse customer base. For the fiscal years ended March 31, 2022 ("Fiscal 2022"), March 31, 2021 ("Fiscal 2021"), and March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10 % of our total revenues. As of March 31, 2022 and 2021, no individual customer represented greater than 10 % of our total accounts receivable. +Fair Values of Financial Instruments +The accounting guidance provided in ASC 820, Fair Value Measurements ("ASC 820") for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows: +Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date. +Level 2—Observable inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the assets or liabilities. +A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. +The Company applies fair value accounting for all financial instruments on a recurring basis. The Company's financial instruments, which include cash, cash equivalents, accounts receivable and accounts payable are recorded at their carrying amounts, which approximate their fair values due to their short-term nature. All marketable securities are considered to be available-for-sale and recorded at their estimated fair values. In valuing these items, the Company uses inputs and assumptions that market participants would use to determine their fair value, utilizing valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. +49 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Cash, Cash Equivalents and Restricted Cash +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +As of March 31, 2022 and 2021 restricted cash was $ 0.1 million and $ 0.3 million, respectively, related to cash restricted for shares purchased under the Employee Stock Purchase Plan ("ESPP") (see Note 10 for further details on the ESPP). +Cash, cash equivalents and restricted cash presented in the accompanying statements of cash flows consist of the following (in thousands): +March 31, +2022 2021 +Cash and cash equivalents $ 23,689 $ 25,205 +Restricted cash 120 263 +$ 23,809 $ 25,468 +Investments +The Company's investments are classified as either held-to-maturity, available-for-sale or trading, in accordance with ASC 320. Held-to-maturity securities are those securities that the Company has the positive intent and ability to hold until maturity. Trading securities are those securities that the Company intends to sell in the near term. All other securities not included in the held-to-maturity or trading category are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost which approximates fair market value. Trading securities are carried at fair value with unrealized gains and losses charged to earnings. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded within accumulated other comprehensive loss as a separate component of stockholders' equity. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available (see Note 5). The Company had no investments as of March 31, 2022. As of March 31, 2021, all of our investments were available-for-sale. +Under ASC 320-10-35, a security is considered to be other-than-temporarily impaired if the present value of cash flows expected to be collected are less than the security's amortized cost basis (the difference being defined as the "Credit Loss") or if the fair value of the security is less than the security's amortized cost basis and the investor intends, or will be required, to sell the security before recovery of the security's amortized cost basis. If an other-than-temporary impairment exists, the charge to earnings is limited to the amount of Credit Loss if the investor does not intend to sell the security, and will not be required to sell the security before recovery of the security's amortized cost basis. Any remaining difference between fair value and amortized cost is recognized in other comprehensive loss, net of applicable taxes. The Company evaluates whether the decline in fair value of its investments is other-than-temporary at each quarter-end. This evaluation consists of a review by management, and includes market pricing information and maturity dates for the securities held, market and economic trends in the industry and information on the issuer's financial condition and, if applicable, information on the guarantors' financial condition. Factors considered in determining whether a loss is temporary include the length of time and extent to which the investment's fair value has been less than its cost basis, the financial condition and near-term prospects of the issuer and guarantors, including any specific events which may influence the operations of the issuer and the Company's intent and ability to retain the investment for a reasonable period of time sufficient to allow for any anticipated recovery of fair value. +Accounts Receivable and Allowance for Doubtful Accounts +Accounts receivable are recorded net of the allowance for doubtful accounts. The allowance for doubtful accounts is estimated based on the Company's assessment of its ability to collect on customer accounts receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. The Company writes-off accounts receivable against the allowance when a determination is made that the balance is uncollectible and collection of the receivable is no longer being actively pursued. The allowance for doubtful accounts was approximately $ 0.9 million and $ 1.0 million as of March 31, 2022 and 2021, respectively. +50 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +Inventories +Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life of the related assets ranging from three to eight years . Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Intangible Assets +Intangible assets with determinable economic lives are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful life of each asset on a straight-line basis. The Company determines the useful lives of identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors the Company considers when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset and other economic factors, including competition and specific market conditions. Intangible assets without determinable economic lives are carried at cost, not amortized and reviewed for impairment at least annually. +Goodwill +Goodwill represents the excess of the aggregate purchase price over the fair value of net identifiable assets acquired in a business combination. Goodwill is not amortized and is tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In the valuation of goodwill, management must make assumptions regarding estimated future cash flows to be derived from the Company's business. If these estimates or their related assumptions change in the future, the Company may be required to record impairment for these assets. +The Company has the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value. However, the Company may elect to bypass the qualitative assessment and proceed directly to the quantitative impairment tests. The first step of the impairment test involves comparing the fair value of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, the Company would perform the second step of the goodwill impairment test to determine the amount of the impairment loss. We perform an annual quantitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further testing is required, if otherwise, we compare the fair value of our reporting unit to its carrying value, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. In prior years the Company had two operating and reportable segments, Roadway Sensors ("RWS") and Transportation Systems ("SYS"), which also represented the reporting units for purposes of goodwill impairment testing. In conjunction with the change in segments described in Note 13, Business Segments, the Company also reassessed the reporting unit conclusion and determined that there are now three reporting units and a single operating and reportable segment. As of March 31, 2022, there were no indicators of goodwill impairment. +Impairment of Long-Lived Assets +The Company evaluates its long-lived assets, including property, equipment and intangible assets (other than goodwill) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We determine whether the carrying value of an asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived and intangible assets . During the three months ended June 30, 2020, we recorded $ 0.3 million i n impairment charges related to right-of-use assets and leasehold improvements +51 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +directly resulting from the restructuring activities. During the twelve months ended March 31, 2022, approximately $ 0.9 million of previously capitalized software development costs was charged to cost of sales due to the expected modification of a contract with a customer. See discussion on contract fulfillment costs for further details. During the fiscal years ended March 31, 2022 and 2021, there was no additional impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. As such, we determined it was appropriate to record a full valuation allowance against our deferred tax assets. We will continuously reassess the appropriateness of maintaining a valuation allowance. +Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our consolidated statements of operations as an expense, based on the estimated grant date fair value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options, restricted stock units and performance stock units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. The fair value of our performance stock unit awards is estimated on the grant date using a Monte Carlo simulation model. While the use of these models meets established requirements, the estimated fair values generated by the models may not be indicative of the actual fair values of our awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the consolidated statements of operations. +Right-of-Use Assets and Lease Liabilities +We determine if an arrangement contains a lease at inception and determine the classification of the lease, as either operating or finance, at commencement. +Right-of-use assets and lease liabilities are recorded based on the present value of future lease payments which factors in certain qualifying initial direct costs incurred as well as any lease incentives received. If an implicit rate is not readily determinable, we utilize inputs from third-party lenders to determine the appropriate discount rate. Lease expense for operating lease payments are recognized on a straight-line basis over the lease term. Finance leases incur interest expense using the effective interest method in addition to amortization of the leased asset on straight-line basis, both over the applicable lease term. Lease terms may factor in options to extend or terminate the lease. +52 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +1. Description of Business and Summary of Significant Accounting Policies (Continued) +We adhere to the short-term lease recognition exemption for all classes of assets (i.e., facilities and equipment). As a result, leases with an initial term of twelve months or less are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. In addition, for certain equipment leases, we account for lease and non-lease components, such as services, as a single lease component as permitted. +Warranty +We generally provide a one to three years warranty from the original invoice date on all products, materials and workmanship. Products sold to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying consolidated balance sheets. We do not provide any service-type warranties. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and maintenance costs are charged to expense as incurred. +Comprehensive Loss +The difference between net income (loss) and comprehensive income (loss) was de minimis for Fiscal 2022, Fiscal 2021 and Fiscal 2020. +Recent Accounting Pronouncements +In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This update requires that certain financial assets be measured at amortized cost net of an allowance for estimated credit losses such that the net receivable represents the present value of expected cash collection. In addition, this standard update requires that certain financial assets be measured at amortized cost reflecting an allowance for estimated credit losses expected to occur over the life of the assets. The estimate of credit losses must be based on all relevant information including historical information, current conditions and reasonable and supportable forecasts that affect the collectability of the amounts. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which defers the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting companies that are not smaller reporting companies. As a smaller reporting company, ASU 2016-13 will now be effective for our fiscal year 2024 beginning April 1, 2023; however, early adoption is permitted. We are currently evaluating the timing and impact of adopting ASU 2016-13 on our consolidated financial statements. +2. Supplementary Financial Information +Inventories +The following table presents details regarding our inventories: +March 31, +2022 2021 +(In thousands) +Materials and supplies $ 5,680 $ 2,714 +Work in process 200 435 +Finished goods 2,100 1,917 +$ 7,980 $ 5,066 +53 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +2. Supplementary Financial Information (Continued) +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2022 2021 +(In thousands) +Equipment $ 6,825 $ 6,806 +Leasehold improvements 3,117 3,046 +Accumulated depreciation ( 8,550 ) ( 7,929 ) +$ 1,392 $ 1,923 +Depreciation expense was approximately $ 0.8 million, $ 0.7 million and $ 0.8 million in Fiscal 2022, Fiscal 2021 and Fiscal 2020, respectively. Approximately $ 0.2 million, $ 0.2 million, and $ 0.3 million of the depreciation expense was recorded to cost of revenues, and approximately $ 0.6 million, $ 0.5 million, and $ 0.5 million was recorded to operating expenses in Fiscal 2022, Fiscal 2021 and Fiscal 2020, respectively, in the accompanying consolidated statements of operations. +Intangible Assets +The following table presents details regarding our intangible assets: +March 31, 2022 March 31, 2021 +Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value +(In thousands) +Technology $ 4,986 $ ( 2,519 ) $ 2,467 $ 4,986 $ ( 1,594 ) $ 3,392 +Customer contracts / relationships 9,550 ( 2,959 ) 6,591 9,550 ( 1,547 ) 8,003 +Trade names and non-compete agreements +782 ( 753 ) 29 782 ( 683 ) 99 +Capitalized software development costs +5,900 ( 3,207 ) 2,693 5,177 ( 2,374 ) 2,803 +Total $ 21,218 $ ( 9,438 ) $ 11,780 $ 20,495 $ ( 6,198 ) $ 14,297 +Amortization expense for intangible assets subject to amortization was approximately $ 3.2 million, $ 2.0 million and $ 1.3 million for Fiscal 2022, Fiscal 2021 and Fiscal 2020, respectively. Approximately $ 0.6 million, $ 0.5 million and $ 0.5 million of the intangible asset amortization was recorded to cost of revenues, and approximately $ 2.7 million, $ 1.5 million and $ 0.8 million was recorded to amortization expense for Fiscal 2022, Fiscal 2021 and Fiscal 2020, respectively, in the consolidated statements of operations. The weighted average remaining useful lives of the intangible assets as of March 31, 2022 is 4.2 years. +We have one indefinite useful life intangible asset, with de minimis carrying value, which was included in trade names and non-complete agreements. Our net customer contracts/relationships have a useful life of 6 years. Our net trade names and non-compete agreements have a useful life of 3 years. Our net capitalized software development costs of approximately $ 2.7 million and $ 2.8 million primarily consisted of our Oracle Enterprise Resource Planning system design and implementation of approximately $ 1.4 million and $ 1.7 million as of March 31, 2022 and 2021, respectively, which has a useful life of 10 years. +54 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +2. Supplementary Financial Information (Continued) +As of March 31, 2022, the future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2023 3,198 +2024 3,021 +2025 2,538 +2026 1,298 +2027 1,095 +Thereafter 618 +$ 11,768 +The future estimated amortization expense does not include the indefinite useful life intangible asset described above. +Goodwill +The following table presents the carrying value of our goodwill for Fiscal 2022, Fiscal 2021 and Fiscal 2020: +Total +Balance—March 31, 2022 +Goodwill $ 36,310 +Acquired goodwill (see Note 12) — +Accumulated impairment losses ( 7,970 ) +$ 28,340 +Balance—March 31, 2021 +Goodwill $ 28,560 +Acquired goodwill (see Note 12) 7,750 +Accumulated impairment losses ( 7,970 ) +$ 28,340 +Balance—March 31, 2020 +Goodwill $ 23,120 +Acquired goodwill (Note 12) 5,440 +Accumulated impairment losses ( 7,970 ) +$ 20,590 +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Balance at beginning of fiscal year $ 569 $ 416 $ 463 +Additions charged to cost of sales 238 508 649 +Warranty claims ( 191 ) ( 355 ) ( 696 ) +Balance at end of fiscal year $ 616 $ 569 $ 416 +55 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +2. Supplementary Financial Information (Continued) +Earnings Per Share +The following table sets forth the computation of basic and diluted income (loss) from continuing operations per share: +Year Ended March 31, +2022 2021 2020 +(In thousands, except per +share amounts) +Numerator: +Net income (loss) from continuing operations $ ( 6,900 ) $ 491 $ ( 1,758 ) +Net income (loss) from discontinued operations, net of tax ( 180 ) 9,643 ( 3,852 ) +Net income (loss) $ ( 7,080 ) $ 10,134 $ ( 5,610 ) +Denominator: +Weighted average common shares used in basic computation 42,222 41,176 39,012 +Dilutive stock options — 423 — +Weighted average common shares used in diluted computation 42,222 41,599 39,012 +Basic: +Net income (loss) per share from continuing operations: $ ( 0.16 ) $ 0.01 $ ( 0.04 ) +Net income (loss) per share from discontinued operations: $ — $ 0.23 $ ( 0.10 ) +Net income (loss) per basic share $ ( 0.16 ) $ 0.24 $ ( 0.14 ) +Diluted: +Net income (loss) per share from continuing operations: $ ( 0.16 ) $ 0.01 $ ( 0.04 ) +Net income (loss) per share from discontinued operations: $ — $ 0.23 $ ( 0.10 ) +Net income (loss) per diluted share $ ( 0.16 ) $ 0.24 $ ( 0.14 ) +The following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted income (loss) per share from continuing operations as their effect would have been anti-dilutive for the years ended March 31, 2022, 2021, and 2020: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Stock options 3,857 3,935 6,190 +Restricted stock units 386 126 110 +3. Discontinued Operations +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our Agriculture and Weather Analytics business to DTN, an operating company of TBG AG, a Swiss-based holding company, pursuant to the AWA Purchase Agreement signed on May 2, 2020, in exchange for a total purchase consideration of $ 12.0 million in cash, subject to working capital adjustments. Upon closing, the Company received $ 10.5 million in cash and $ 1.5 million of payment was deferred. DTN paid the Company $ 1.45 million at the 12-month anniversary of the closing date, and $ 0.05 million at the 18-month anniversary of the closing date. The parties also entered into certain ancillary agreements at the closing of the transaction that will provide Iteris with ongoing access to weather and pavement data that it integrates into its transportation software products, and a joint development agreement under which the parties agreed to pursue future joint opportunities in the global transportation market. +The sale of the Agriculture and Weather Analytics business was a result of the Company’s shift in strategy to focus on its smart mobility infrastructure management solutions and to capitalize on the potential for a future partnership upon the sale of this business component to DTN. We have determined that the Agriculture and Weather Analytics business, which constituted one of our operating segments prior to first quarter of Fiscal 2021, qualifies as a discontinued operation in accordance with the criteria set forth in ASC 205-20, Presentation of Financial Statements – Discontinued Operations. +56 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +3. Discontinued Operations (Continued) +On May 5, 2020, the Company also entered into a transition services agreement (“TSA”) with DTN, pursuant to which the Company agreed to support the information technology and accounting functions of the Agriculture and Weather Analytics business for a period up to 12 months and DTN agreed to provide the contract administration/account management services for certain contracts of the Company and other transition services. Either party may make any reasonable request to extend the period of time the other party shall provide a transition service beyond the initial service period or access to additional services that are necessary for the transition of the operations and business. The income and costs associated with the TSA for the year ended March 31, 2022 were de minimis, as compared to approximately $ 0.2 million in income and approximately $ 0.1 million in costs for the year ended March 31, 2021, which were included in Other income (expense) on the accompanying consolidated statement of operations. +The related assets and liabilities of the Agriculture and Weather Analytics business were reclassified to assets and liabilities of discontinued operations as of March 31, 2022 and March 31, 2021 on the accompanying consolidated balance sheets. The following table is a summary of major classes of assets and liabilities of discontinued operations: +March 31, 2022 +March 31, 2021 +(In thousands) +Assets +Trade accounts receivable, net of allowance for doubtful accounts $ — $ — +Unbilled accounts receivable — — +Prepaid expenses and other current assets — — +Total current assets of discontinued operations — — +Property and equipment, net $ — — +Right-of-use assets 6 78 +Other classes of assets that are not major — — +Total noncurrent assets of discontinued operations 6 78 +Total assets of discontinued operations $ 6 $ 78 +Liabilities +Trade accounts payable $ — $ — +Accrued liabilities — — +Accrued payroll and related expenses 63 — +Deferred revenue — — +Current Lease Liabilities +100 94 +Total current liabilities of discontinued operations 163 94 +Noncurrent Lease liabilities 172 261 +Total liabilities of discontinued operations $ 335 $ 355 +The results of operations for the Agriculture and Weather Analytics business were included in net income (loss) from discontinued operations on the accompanying consolidated statements of operations. The following table provides information regarding the results of discontinued operations: +57 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +3. Discontinued Operations (Continued) +Year Ended March 31, +2022 2021 2020 +Service revenue $ — $ 695 $ 6,714 +Cost of service revenues — 350 2,566 +Gross profit — 345 4,148 +Operating expenses: +Selling, general and administration 180 780 3,718 +Research and development — 407 4,282 +Restructuring charges — 837 — +Total operating expenses 180 2,024 8,000 +Operating loss from discontinued operations ( 180 ) ( 1,679 ) ( 3,852 ) +Other income, net — 72 — +Loss from discontinued operation before income tax ( 180 ) ( 1,607 ) ( 3,852 ) +Income tax expense ( 47 ) — +Net loss from discontinued operations ( 180 ) ( 1,654 ) ( 3,852 ) +Gain on disposal of discontinued operations before income tax — 11,315 — +Income tax expense on gain on disposal — ( 18 ) — +Gain on disposal of discontinued operations after income tax — 11,297 — +Net income (loss) from discontinued operations $ ( 180 ) $ 9,643 $ ( 3,852 ) +The following table provides information on the gain recorded on the sale of the Agriculture and Weather Analytics business for the year ended March 31, 2021. These amounts reflect the closing balance sheet of the Agriculture and Weather Analytics business upon the closing of the sale on May 5, 2020 (in thousands). +Initial proceeds from sale, net of transaction costs $ 9,440 +Closing working capital adjustment 250 +Deferred payments of purchase price 1,500 +Total consideration, net of transaction costs 11,190 +Trade accounts receivable, net of allowance for doubtful accounts 1,060 +Unbilled accounts receivable 488 +Other classes of assets that are not major 194 +Total Agriculture and Weather Analytics business assets 1,742 +Trade accounts payable 349 +Deferred revenue 1,518 +Total Agriculture and Weather Analytics business liabilities 1,867 +Gain on sale of Agriculture and Weather Analytics business $ 11,315 +The initial proceeds were net of transaction costs of approximately $ 1.1 million. +4. Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics business, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth, and the Company incurred total restructuring charges of approximately $ 1.5 million, primarily resulting from a separation for certain +58 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +4. Restructuring Activities (Continued) +employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company and lease impairment related to our Grand Forks, North Dakota facility. +As of March 31, 2022, we did not accrue any amounts for severance and benefits related to the restructuring activities in accrued payroll and related expenses in the accompanying consolidated balance sheet. Our restructuring activities during the fiscal year ended March 31, 2022 were as follows (in thousands): +Balance at March 31, 2021 $ 100 +Cash payments ( 79 ) +Adjustment to estimated expenses ( 21 ) +Balance at March 31, 2022 $ — +5 . Fair Value Measurements +We did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2022 or 2021. Our non-financial assets, such as goodwill, intangible assets, property and equipment, securities held in the deferred compensation plan and the liabilities associated with the deferred compensation plan, and acquired assets and liabilities assumed are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets. In Fiscal 2022, Fiscal 2021 and Fiscal 2020, Level 3 inputs were used to evaluate the fair value of the contingent consideration and goodwill of the Company. No other non-financial assets were measured at fair value as of March 31, 2022 and March 31, 2021. +The following tables present the Company's financial assets and liabilities that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +As of March 31, 2022 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +Assets: (In thousands) +Level 1: +Money market funds $ 71 $ — $ — $ 71 +Securities held in deferred compensation plan (1) +998 ( 106 ) 73 965 +Subtotal 1,069 ( 106 ) 73 1,036 +Level 2: +Commercial paper 7,499 — — 7,499 +Corporate notes and bonds — — — — +US treasuries 7,798 — — 7,798 +Subtotal 15,297 — — 15,297 +Total $ 16,366 $ ( 106 ) $ 73 $ 16,333 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) $ 1,013 $ ( 106 ) $ 72 $ 979 +Level 3: +Contingent consideration (3) 600 — — — 600 +Total $ 1,613 $ ( 106 ) $ 72 $ 1,579 +59 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +5. Fair Value Measurements (Continued) +As of March 31, 2021 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +(In thousands) +Level 1: +Money market funds $ 4,676 $ — $ — $ 4,676 +Securities held in deferred compensation plan (1) 89 — 11 100 +Subtotal 4,765 — 11 4,776 +Level 2: +Commercial paper 4,999 — — 4,999 +Corporate notes and bonds 1,085 — — 1,085 +US treasuries 4,600 — — 4,600 +Subtotal 10,684 — — 10,684 +Total $ 15,449 $ — $ 11 $ 15,460 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) $ 100 $ — $ 11 $ 111 +Level 3: +Contingent consideration (3) $ 600 $ — $ — $ 600 +Total $ 700 $ — $ 11 $ 711 +(1) Included in prepaid expenses and other current assets on the Company’s consolidated balance sheet. +(2) Included in accrued payroll and related expenses on the Company’s consolidated balance sheet. +(3) Included in other long-term liabilities on the Company’s consolidated balance sheet. +Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2022. +60 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +6. Income Taxes +The components of current and deferred federal and state income tax (benefit) provision are as follows: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Income (loss) from continuing operations before income taxes $ ( 6,726 ) $ 606 $ ( 1,598 ) +Current income tax provision: +Federal — 0 — +State 75 67 34 +Total current tax provision 75 67 34 +Deferred income tax provision: +Federal 33 21 105 +State 66 27 21 +Total deferred tax provision 99 48 126 +Provision for income taxes on continuing operations 174 115 160 +Income (loss) from continuing operations, net of taxes $ ( 6,900 ) $ 491 $ ( 1,758 ) +The reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Provision (benefit) for income taxes at statutory rates $ ( 1,422 ) $ 90 $ ( 1,095 ) +State income taxes net of federal benefit ( 559 ) ( 177 ) ( 198 ) +Tax credits ( 141 ) ( 663 ) ( 658 ) +Compensation charges 34 313 151 +Change in valuation allowance 2,169 523 1,913 +Other 93 29 47 +Provision for income taxes $ 174 $ 115 $ 160 +61 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +6. Income Taxes (Continued) +The components of deferred tax assets and liabilities are as follows: +March 31, +2022 2021 +(In thousands) +Deferred tax assets: +Net operating losses $ 3,980 $ 2,186 +Capitalized R&D 1,808 2,282 +Credit carry forwards 4,530 4,088 +Deferred compensation and payroll 2,902 2,475 +Bad debt allowance and other reserves 1,299 930 +Property and equipment 297 354 +Acquired intangibles 129 — +Other, net 171 765 +Total deferred tax assets 15,116 13,080 +Valuation allowance ( 14,552 ) ( 12,349 ) +Total deferred tax assets, net of valuation allowance 564 731 +Deferred tax liabilities: +Acquired intangibles — ( 297 ) +Goodwill ( 901 ) ( 672 ) +Total deferred tax liabilities ( 901 ) ( 969 ) +Net deferred tax liabilities $ ( 337 ) $ ( 238 ) +At March 31, 2022, we had $ 3.3 million in federal research credits that begin to expire in 2031 and $ 1.5 million in state tax credits that begin to expire in 2023. We had $ 16.0 million of federal net operating loss carryforwards at March 31, 2022 that do not expire as a result of recent tax law changes. We also had $ 9.9 million of state net operating loss carryforwards at March 31, 2022 that begin to expire in 2031. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it appropriate to maintain valuation allowances of $ 14.6 million and $ 12.3 million against our deferred tax assets at March 31, 2022 and 2021, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve. +On March 27, 2020, the CARES Act was enacted in response to the Pandemic. The CARES Act contains numerous income tax provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. The income tax provisions of the CARES Act had an immaterial impact on our current taxes, deferred taxes, and uncertain tax positions of the Company in the year ended March 31, 2022. The CARES Act also allows for the deferral of payroll taxes, as well as the immediate refund of federal Alternative Minimum Tax credits, which had previously been made refundable over a period of four years by the Tax Cuts and Jobs Act of 2017. The Company is utilizing the provision of the CARES Act allowing for the deferral of payroll taxes as of March 31, 2022. +Unrecognized Tax Benefits +As of March 31, 2022 and 2021, our gross unrecognized tax benefits were approximately $ 1.2 million and $ 1.1 million, respectively, of which approximately $ 1.1 million and $ 1.0 million, respectively, are netted against certain noncurrent deferred +62 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +6. Income Taxes (Continued) +tax assets. The amounts that would affect our effective tax rate if recognized are approximately $ 1.1 million and $ 1.0 million, respectively. +A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Gross unrecognized tax benefits at beginning of year $ 1,079 $ 952 $ 687 +Increases for tax positions taken in prior years — 35 101 +Decreases for tax positions taken in prior years ( 29 ) — — +Increases for tax positions taken in the current year 159 104 180 +Lapse in statute of limitations ( 11 ) ( 12 ) ( 16 ) +Gross unrecognized tax benefits at March 31 $ 1,198 $ 1,079 $ 952 +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2019 or later, and state and local income tax examination for fiscal tax years ended March 31, 2018 or later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +7. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic and agricultural industries, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any legal proceeding, the outcome of which, in management's opinion, individually or in the aggregate, would have a material effect on the Company's consolidated results of operations, financial position or cash flows. +8. Right-of-Use Assets and Lease Liabilities +We have various operating leases for our offices, office equipment and vehicles in the United States. These leases expire at various times through 2029. Certain lease agreements contain renewal options from 1 year to 5 years, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. +63 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +8. Right-of-Use Assets and Lease Liabilities(Continued) +The table below presents lease-related assets and liabilities recorded on the consolidated balance sheet as follows: +Classification March 31, 2022 +(In thousands) +Assets +Operating lease right-of-use-assets - continuing operations Right-of-use assets $ 11,382 +Operating lease right-of-use-assets - discontinued operation Noncurrent assets of discontinued operations 6 +Total operating lease right-of-use-assets $ 11,388 +Liabilities +Operating lease liabilities (short-term) - continuing operations Accrued liabilities $ 1,447 +Operating lease liabilities (short-term) - discontinued operation Current liabilities of discontinued operations 100 +Total operating lease liabilities (short-term) 1,547 +Operating lease liabilities (long-term) - continuing operations Lease liabilities 10,763 +Operating lease liabilities (long-term) - discontinued operation Noncurrent liabilities of discontinued operations 172 +Total operating lease liabilities (long-term) 10,935 +Total operating lease liabilities $ 12,482 +Lease Costs +For Fiscal 2022, Fiscal 2021 and Fiscal 2020, lease costs totaled approximately $ 2.9 million, $ 2.7 million and $ 2.6 million, respectively. The Company currently has no variable lease costs. +Supplemental Information +The table below presents supplemental information related to operating leases during the fiscal year ended March 31, 2022 (in thousands, except weighted average information): +Cash paid for amounts included in the measurement of operating lease liabilities $ 2,795 +Right-of-use assets obtained in exchange for new operating lease liabilities $ 2,544 +Weighted average remaining lease term 5 +Weighted average discount rate 4.8 % +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the operating lease liabilities recorded on the consolidated balance sheet as of March 31, 2022: +64 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +8. Right-of-Use Assets and Lease Liabilities(Continued) +Fiscal Year Ending March 31, Operating Leases Sublease Income Net Operating Leases +(In thousands) +2023 $ 2,114 $ 9 $ 2,105 +2024 2,809 — 2,809 +2025 2,587 — 2,587 +2026 2,336 — 2,336 +2027 2,391 — 2,391 +Thereafter 2,097 — 2,097 +Total lease payments 14,334 $ 9 $ 14,325 +Less imputed interest ( 1,852 ) +Present value of future lease payments 12,482 +Less current obligations under leases ( 1,547 ) +Long-term lease obligations $ 10,935 +9. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2022 and 2021, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +In August 2009, our Board of Directors adopted a stockholder rights plan, which calls for preferred stock purchase rights (each, a "Right") to be distributed, as a dividend, at the rate of one Right for each share of common stock held as of September 3, 2009. Each Right will entitle holders of common stock to buy one one-thousandth of one share of Series A Junior Participating Preferred Stock of Iteris. A further description and terms of the Rights are set forth in the Rights Agreement dated August 20, 2009 (as amended in August 2012) by and between Iteris and Computershare Trust Company, N.A. ("Computershare"), as rights agent. In connection with the stockholder rights plan, our Board of Directors approved the adoption of a Certificate of Designations, which created the Series A Junior Participating Preferred Stock, and likewise authorized the filing of a Certification of Elimination to eliminate the two series of junior participating preferred stock, which were originally created in April 1998 in connection with our previous stockholder rights plan which expired in 2008. Effective on September 28, 2018, an amendment was entered into by and between Iteris and Computershare to accelerate the expiration of the Rights from August 20, 2019 to September 28, 2018, wherein all of the Rights distributed to the holders of the Company's common stock pursuant to the Rights Agreement expired. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2022: +Number of Shares +(In thousands) +Stock options outstanding 5,943 +Restricted stock units outstanding 451 +Performance stock units outstanding 115 +Authorized for future issuance under stock incentive plans 2,990 +Total common stock reserved for future issuance at March 31, 2022 +9,499 +10. Employee Benefit Plans +65 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +10. Employee Benefit Plans (Continued) +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares of our unissued common stock may be granted to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. In December 2016, our stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs, cash incentive awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25 % on each of the first 4 years anniversaries of the grant date. Stock appreciation rights, restricted stock, RSUs and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. In September 2021, our stockholders approved an amendment of the 2016 Plan to increase the number of shares of common stock authorized for issuance under the 2016 Plan by an additional 3,360,000 shares. +We currently maintain two stock incentive plans, the 2007 Omnibus Incentive Plan (the "2007 Plan") and the 2016 Omnibus Incentive Plan (the "2016 Plan"). Of these plans, we may only grant future awards from the 2016 Plan. The 2016 Plan allows for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), cash incentive awards and other stock-based awards. At March 31, 2022, there were approximately 3.0 million shares of common stock available for grant or issuance under the 2016 Plan. Total stock options vested and expected to vest were approximately 5.9 million as of March 31, 2022. +Stock Options +A summary of activity in the Omnibus Incentive Plans with respect to our stock options for Fiscal 2022 is as follows: +Options Weighted +Average +Exercise +Price Per +Share Weighted +Average +Remaining +Contractual +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +Options outstanding at March 31, 2021 5,623 $ 4.10 6.8 11,659 +Granted 932 4.95 +Exercised ( 489 ) 2.89 +Forfeited ( 123 ) 4.88 +Expired — — +Options outstanding at March 31, 2022 5,943 4.32 6.5 974 +As of March 31, 2022, approximately 3,769,000 stock options were exercisable. +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under the 2007 Plan vest at the rate of 25 % on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs granted under the 2016 Plan vest at varying terms between 1 year and 4 years anniversaries of the grant date provided that the holder remains in service +66 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +10. Employee Benefit Plans (Continued) +(as defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A summary of activity with respect to our RSUs for Fiscal 2022 is as follows: +# of Shares Weighted +Average +Price Per +Share Weighted +Average +Remaining +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +RSUs outstanding at March 31, 2021 448 $ 4.08 7.8 2,764 +Granted 191 5.00 +Vested ( 184 ) 4.92 +Forfeited ( 4 ) 4.80 +RSUs outstanding at March 31, 2022 451 4.12 7.5 1,271 +Performance Stock Units +The Company has granted a total "target" number of 132,403 PSUs to our executive officers. Between 0 % and 160 % of the PSUs will be eligible to vest based on average annual performance during the three-year performance period relative to the revenues per share and cash flow from operations objectives to be established by the Compensation Committee at the beginning of each year. In addition, the final PSU vesting based on the revenues per share and cash flow from operations performance will be subject to a modifier between .75x-1.25x based on the Company's total shareholder return relative to the Russell 2000 during the performance period, for a maximum achievement percentage of 200 % of the "target" number of PSUs. The PSUs are amortized over a derived service period of 3 years. The value and the derived service period of the PSUs were estimated using the Monte-Carlo simulation model. The following table summarizes the details of the performance stock units: +# of Shares Weighted Average Price Per Share +(In thousands) +PSUs outstanding at March 31, 2021 68 $ 5.47 +Granted 64 7.26 +Forfeited ( 17 ) 6.37 +PSUs outstanding at March 31, 2022 115 6.33 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our consolidated statements of operations: +Year Ended March 31, +2022 2021 2020 +(In thousands) +Cost of revenues $ 242 $ 209 $ 143 +General and Administrative 2,574 2,359 2,116 +Sales and marketing 340 158 156 +Research and development expense 245 134 81 +Restructuring activities — 42 — +Loss from discontinued operations — ( 57 ) 290 +Total stock-based compensation $ 3,401 $ 2,845 $ 2,785 +At March 31, 2022, there was approximately $ 4.6 million, $ 1.3 million and $ 0.4 million of unrecognized compensation expense related to unvested stock options, RSUs, and PSUs respectively. This expense is currently expected to be recognized +67 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +10. Employee Benefit Plans (Continued) +over a weighted average period of approximately 2.8 years for stock options, 2.6 years for RSUs and 1.7 years for PSUs. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +The grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2022 2021 2020 +Expected life—years 7.2 6.7 6.8 +Risk-free interest rate 1.5 % 1.0 % 2.2 % +Expected volatility of common stock 49 % 47 % 47 % +Dividend yield 0 % 0 % 0 % +Expected Life: The Company's expected life represents the weighted-average period that the Company's stock options are expected to be outstanding. The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of grant for the expected term of the option. +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2022 2021 2020 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted $ 2.58 $ 2.38 $ 2.52 +Intrinsic value of options exercised $ 1,966 $ 1,494 $ 378 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No contributions were made during the fiscal years ended March 31, 2022, 2021 and 2020. +We sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible employees voluntarily contribute to the plan, up to IRS maximums, through payroll deductions. We match up to 50 % of contributions, up to a stated limit, with all matching contributions being fully vested after one month of service. Our matching contributions under the 401(k) Plan were approximately $ 1.8 million, $ 1.4 million and $ 1.3 million for Fiscal 2022, Fiscal 2021 and Fiscal 2020, respectively. +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an ESPP which allows employees to withhold a percentage of their base compensation to purchase the Company's common stock at 95 % of the lower of the fair market at the beginning of the offering period and on the last trading day of the offering period. There are two offering periods during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may contribute 1 - 15 % of their eligible gross pay up to a $ 0.03 million annual stock value limit. During Fiscal 2022, Fiscal 2021, and Fiscal 2020, 95,000 , 97,000 and 91,000 shares, respectively, were purchased. The ESPP is considered a non-compensatory plan and accordingly no compensation expense is recorded in connection with this benefit. +68 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +10. Employee Benefit Plans (Continued) +As of March 31, 2022, approximately $ 0.1 million of cash was restricted for the purchase of shares under the ESPP and is recorded as restricted cash in the accompanying consolidated balance sheets. +Deferred Compensation Plan +Effective October 1, 2020, the Company adopted the Iteris, Inc. Non Qualified Deferred Compensation Plan (the "DC Plan"). The DC Plan consists of two plans, one that is intended to be an unfunded arrangement for eligible key employees who are part of a select group of management or highly compensated employees of the Company within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, and one for the benefit of non-employee members of our Board of Directors. Key employees, including our executive officers, and our non-employee directors who are notified regarding their eligibility to participate and delivered the DC Plan enrollment materials are eligible to participate in the DC Plan. Under the DC Plan, we will provide participants with the opportunity to make annual elections to defer a percentage of their eligible cash compensation and equity awards. A participant is always 100% vested in his or her own elective cash deferrals and any earnings thereon. Elective deferrals of equity awards are credited to a bookkeeping account established in the name of the participant with respect to an equivalent number of shares of our common stock, and such credited shares are subject to the same vesting conditions as are applicable to the equity award subject to the election. The Company established a rabbi trust to finance our obligations under the DC Plan with corporate-owned life insurance policies on participants, and the assets held within this trust are subject to the claims of the Company's creditors. +As of March 31, 2022, the amount invested under the DC Plan totaled approximately $ 1.0 million and are classified as trading securities, which are recorded at fair market value with changes recorded as adjustments to other income. This amount is included in prepaid expenses and other current assets on the consolidated balance sheets. +As of March 31, 2022, the vested amounts under the DC Plan totaled $ 1.0 million and are included in accrued payroll and related expenses on the consolidated balance sheets. Changes in the deferred compensation plan liabilities are recorded as an adjustment to compensation expense. +As of March 31, 2022, no equity awards were deferred and held in the rabbi trust. The shares deferred and held in the rabbi trust will be classified as treasury stock, and the liability to participating employees will be classified as deferred compensation obligations in the stockholders' equity section of the consolidated balance sheets. The number of shares needed to settle the liability for deferred compensation obligations will be included in the denominator in both the basic and diluted earnings per share calculations. +Employment Inducement Incentive Plan +On December 4, 2020, the Board of Directors approved the Iteris, Inc. 2020 Employment Inducement Incentive Award Plan (the “Inducement Plan”) in conjunction with the TrafficCast acquisition. The terms of the Inducement Plan are substantially similar to the terms of the Company’s 2016 Omnibus Incentive Plan with the exception that incentive stock options may not be granted under the Inducement Plan. The Inducement Plan was adopted by the Board of Directors without stockholder approval pursuant to Rule 5635(c)(4) of the Nasdaq Listing Rules. +The Board of Directors has initially reserved 300,000 shares of the Company’s common stock for issuance pursuant to awards granted under the Inducement Plan. In accordance with Rule 5635(c)(4) of the Nasdaq Listing Rules, awards under the Inducement Plan may only be made to an employee who has not previously been an employee or member of the Board of Directors of the Company or any parent or subsidiary, or following a bona fide period of non-employment by the Company or a parent or subsidiary, and only if he or she is granted such award in connection with his or her commencement of employment with the Company or a subsidiary and such grant is an inducement material to his or her entering into employment with the Company or such subsidiary. +During the fiscal year ended March 31, 2021, the Company granted 95,000 stock options and 84,914 restricted stock units to TCI employees under the Inducement Plan. There were no awards granted under the Inducement Plan during the year ended March 31, 2022. No further awards will be granted under the Inducement Plan, although the outstanding awards under the Inducement Plan remain outstanding in accordance with their terms. +11. Stock Repurchase Program +69 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2020 +11. Stock Repurchase Program (Continued) +In August 2011, our Board of Directors approved a stock repurchase program pursuant to which we were authorized to acquire up to $ 3.0 million of our outstanding common stock from time to time through August 2012. We repurchased approximately 964,000 shares under this original program for a total purchase price of $ 1.3 million. On August 9, 2012, our Board of Directors cancelled the initial stock repurchase program and the approximate $ 1.7 million of remaining funds, and approved a subsequent stock repurchase program pursuant to which we could acquire up to $ 3.0 million of our outstanding common stock for an unspecified length of time. Under the program, we could repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and could also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan was in place. There was no guarantee as to the exact number of shares that would be repurchased. We could modify or terminate the repurchase program at any time without prior notice. On November 6, 2014, our Board of Directors approved a $ 3.0 million increase to the Company's existing stock repurchase program, pursuant to which the Company could continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. +For our fiscal years ended March 31, 2022, 2021, and 2020 we did no t repurchase any shares. From inception of the 2012 stock repurchase program through March 31, 2022, we repurchased approximately 2,458,000 shares of our common stock for an aggregate price of approximately $ 4.3 million, at an average price per share of $ 1.73 . As of March 31, 2022, all repurchased shares have been retired and returned to their status as authorized and unissued shares of our common stock. As of March 31, 2022, prior to the termination of the 2012 repurchase program, approximately $ 1.7 million remained available for the repurchase of our common stock. +On May 12, 2022 the Board of Directors retired the previously approved plan and approved a new plan for the company to acquire up to $ 10.0 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows, to the extent such a 10b5-1 plan is in place. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. +12. Acquisitions +TrafficCast Acquisition +On December 7, 2020, the Company completed the acquisition of the assets of TrafficCast, a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to media, mobile technology, automotive and public sector customers throughout North America. Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business. +The aggregate acquisition-date fair value of the consideration transferred totaled approximately $ 17.7 million, which consisted of the following: +Fair Value +(in thousands) +Cash $ 15,000 +Security hold back 1,000 +Acquisition-related liabilities 1,131 +Contingent consideration 600 +Total $ 17,731 +The security hold back relates to amounts held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, and is included in other long-term liabilities on the consolidated balance sheets. Acquisition-related liabilities include customary post-closing adjustments, as well as short term liabilities related to certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services. These items are included in accrued liabilities on the consolidated balance sheets. Contingent consideration relates to a $ 1.0 million earn out, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. This item is included in other long-term liabilities on the consolidated balance sheets. +70 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +12. Acquisitions (Continued) +The acquisition of TrafficCast has been accounted for as a business combination. We estimated the fair values of net assets acquired, and the excess of the consideration transferred over the aggregate of such fair values was recorded as goodwill. +The following tables summarize the purchase price allocation (in thousands) as of December 7, 2020: +Trade accounts receivable $ 2,087 +Unbilled accounts receivable 596 +Inventories 941 +Right-of-use assets 193 +Property and equipment 233 +Intangible assets 9,500 +Goodwill 7,750 +Other assets 242 +Total assets acquired 21,542 +Accounts payable 1,026 +Deferred revenue 2,460 +Lease liabilities 193 +Other liabilities 132 +Total liabilities assumed 3,811 +Total purchase price $ 17,731 +The fair values of the TrafficCast assets and liabilities noted above approximate their carrying values at December 7, 2020. There was no difference between the fair value of trade accounts receivables and the gross contractual value of those receivables. There are no contractual cash flows related to these receivables that are not expected to be collected. The Company believes the goodwill related to the acquisition was a result of the ability of the Company to leverage its technology in the broader market, as well as offering cross-selling market exposure opportunities. Goodwill from the acquisition of TrafficCast was initially allocated to the Company's Roadway Sensors and Transportation Systems reporting segments and upon the reorganization described in Note 13, Business Segments, the goodwill has been reallocated to the Company's three new reporting units and will be included in the annual review for impairment. The goodwill is fully deductible for tax purposes. The significant intangible assets identified in the purchase price allocation include customer relationship and developed technology, which are amortized over their respective useful lives on a straight line basis which approximates the underlying cash flows. To value the customer relationships, the Company utilized the income approach, specifically a discounted cash-flow method known as the excess earnings method. The Company used the replacement cost method with consideration of opportunity costs to estimate the fair value of the technology. The fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. We believe the assumptions are representative of those a market participant would use in estimating fair value. +The following table presents the fair values and useful lives of the identifiable intangible assets acquired: +Amount Weighted Average +Useful Life +(in thousands) (in years) +Customer relationships $ 5,800 7 +Technology 3,700 4 +Total intangible assets assumed $ 9,500 +AGI Acquisition +On July 2, 2019, the Company completed the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida, with offices in Orlando, Florida, Virginia Beach, Virginia and Chadds Ford, Pennsylvania. AGI assists municipalities in maximizing the effectiveness of their existing transportation networks through a collection of traffic management services to cost effectively improve the performance of roadway systems and address +71 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +12. Acquisitions (Continued) +increased traffic demands, traffic congestion and delay. With a foundation of arterial timing plan development, AGI has expanded its services into active arterial monitoring and management with multiple public sector clients. AGI is expected to expand the Company's geographic footprint for ITS services in Florida, as well as in the Midwest and Mid-Atlantic region. AGI's typical contracts are for traffic operations professional engineering services focused on transportation systems management and operations. +Pursuant to a Stock Purchase Agreement dated June 10, 2019 among the Company, AGI and the stockholders of AGI (the "Selling Shareholders"), the Company acquired all of the outstanding capital stock of AGI from the Selling Shareholders for an aggregate purchase price of $ 10.8 million, after working capital adjustments, payable in cash and stock, of which 114,943 shares were held in escrow for 18 months to secure performance of indemnification and other post-closing obligations of the Selling Shareholders. +The acquisition of AGI has been accounted for as a business combination. We estimated the fair values of net assets acquired, and the excess of the consideration transferred over the aggregate of such fair values was recorded as goodwill. +The following tables summarize the purchase price allocation (in thousands) as of July 2, 2019: +Cash $ 664 +Trade accounts receivable 905 +Unbilled accounts receivable 347 +Right-of-use assets 863 +Property and equipment 357 +Intangible assets 3,710 +Goodwill 5,440 +Other assets 161 +Total assets acquired 12,447 +Accounts payable ( 378 ) +Accrued payroll and related expenses ( 426 ) +Lease liabilities ( 863 ) +Total liabilities assumed ( 1,667 ) +Total purchase price $ 10,780 +The fair values of the remaining AGI assets and liabilities noted above approximate their carrying values at July 2, 2019. There was no difference between the fair value of trade accounts receivables and the gross contractual value of those receivables. There are no contractual cash flows related to these receivables that are not expected to be collected. The Company believes the goodwill related to the acquisition was a result of the ability of the Company to leverage its technology in the broader market, as well as offering cross-selling market exposure opportunities. Goodwill from the acquisition of AGI was initially included within the Company's Transportation Systems reporting segment. The goodwill is fully deductible for tax purposes. The significant intangible assets identified in the purchase price allocation include customer relationships and non-compete agreements, which are amortized over their respective useful lives on a straight line basis which approximates the underlying cash flows. To value the customer relationships, the Company utilized the income approach, specifically a discounted cash-flow method known as the excess earnings method. The Company utilized the with and without method to derive the fair value of the non-compete agreement. The fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. Varying discount rates were applied to the projected net cash flows and EBITDA as applicable to valuation methodology. We believe the assumptions are representative of those a market participant would use in estimating fair value. +The following table presents the fair values and useful lives of the identifiable intangible assets acquired: +72 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +12. Acquisitions (Continued) +Amount Weighted Average +Useful Life +(in thousands) (in years) +Customer relationships 3,500 6 +Non-compete agreement 210 3 +Total intangible assets assumed 3,710 +Acquisition-Related Costs +In connection with the acquisition of AGI, the Company agreed to grant $ 1.7 million in retention bonuses to the Selling Shareholders and other employees payable in the form of restricted stock units at $ 5.22 per share, and $ 0.6 million in retention bonuses payable in cash, each vesting and payable over three years following the closing, provided such employees remain in our service on the first, second and third anniversary of the closing of the acquisition. For the fiscal years ended March 31, 2022, 2021, and 2020, the Company recorded approximately $ 0.7 million, $ 0.7 million, and $ 1.0 million respectively, as stock- based compensation and salaries expense to selling, general and administrative expense in the consolidated statements of operations, related to these bonuses. +In connection with the acquisition of AGI, the Company recorded approximately $ 0.7 million, in acquisition related professional fees, which was included in selling, general and administrative expense, in the consolidated statements of operations for the year ended March 31, 2020. +In connection with the acquisition of TrafficCast, the Company recorded approximately $ 0.4 million in acquisition related professional fees, which was included in selling, general and administrative expense, in the consolidated statements of operations for the year ended March 31, 2021. +13. Business Segments, Significant Customer and Geographic Information +Business Segments +In Fiscal 2021, the Company completed the sale of substantially all of the assets used in connection with the Agriculture and Weather Analytics segment to DTN in exchange for a total purchase consideration of $ 12.0 million. On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics business, the Board approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $ 1.5 million were incurred in Fiscal 2021 for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets. +On December 6, 2020, the Company entered into an Asset Purchase Agreement with TrafficCast, a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content. The transaction closed on December 7, 2020. +After these two significant transactions in Fiscal 2021, the Company underwent a re-organization that was completed in April 2021. The purpose of this was to align the Company’s organization structure with its singular goal of providing best in-class smart mobility infrastructure management solutions to the marketplace. As a result of the reorganization, the Company's Chief Operating Decision Maker ("CODM"), which is our Chief Executive Officer, reviews the Company's results on a consolidated basis and our financial results are presented on a consolidated basis under a single reporting segment in order to provide the most accurate representation of Company's performance. +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance greater than 10 % of our total trade accounts receivable balances as of March 31, 2022 and 2021. +73 +Table of Contents +Notes to Consolidated Financial Statements (Continued) +March 31, 2022 +13. Business Segments, Significant Customer and Geographic Information (Continued) +The following table sets forth the percentages of our revenues, by geographic region, derived from shipments to, or contract, service and other revenues from, external customers located outside the U.S.: +Year Ended March 31, +2022 2021 2020 +Canada — % 1 % — % +Europe — — 1 +— % 1 % 1 % +14. Long-Term Debt +On January 25, 2022, Iteris, Inc., entered into a Credit Agreement (the “Credit Agreement”) with Capital One, National Association, as agent. The Credit Agreement provides for a $ 20 million revolving credit facility with a maturity date of January 24, 2026. In addition, the Company has the ability from time to time to increase the revolving commitments up to an additional aggregate amount not to exceed $ 40 million, subject to receipt of lender commitments and certain conditions precedent. The Credit Agreement evidencing the facility contains customary representation, warranties, covenants, and event of default. The Credit Agreement is collateralized by substantially all of our property and assets, including intellectual property. The Credit Agreement also contains certain restrictions and covenants that require the Company to maintain, on an ongoing basis, (i) a leverage ratio of no greater than 3.00 to 1.00 and (ii) a fixed charge coverage ratio of not less than 1.25 to 1.00 . The leverage ratio also determines the applicable interest rate under the Credit Agreement. Borrowings under the revolving credit facility accrue interest at a rate equal to either SOFR or a specified base rate, at the Company’s option, plus an applicable margin. The applicable margins range from 2.00 % to 2.80 % per annum for SOFR loans and 1.00 % to 1.80 % per annum for base rate loans. The revolving credit facility is subject to a commitment fee payable on the unused revolving credit facility commitments ranging from 0.25 % to 0.35 %, depending on the Company’s leverage ratio. +As of March 31, 2022, there were no amounts borrowed under the revolving credit facility and the Company is in compliance with the covenants. During the fiscal year ended March 31, 2022, capitalized deferred financing costs of $ 0.3 million associated with the Credit Agreement are included in Other assets. Amortization of the deferred financing costs and commitment fees on the unused revolving credit facility commitments are included in Interest Income (Expense), net. +74 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2022, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2022 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2022. +The effectiveness of our internal control over financial reporting as of March 31, 2022 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +75 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended March 31, 2022, of the Company and our report dated June 1, 2022, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2022 +76 +Table of Contents +ITEM 9B. OTHER INFORMATION +None. +77 +Table of Contents +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K ("the Form 10-K Amendment") or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2022 Annual Meeting of Stockholders (the "2022 Proxy Statement") under the headings "Executive Compensation and Other Information—Executive Officers," "Election of Directors," "Corporate Governance," and "Delinquent Section 16(a) Reports." +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2022 Proxy Statement under the heading "Executive Compensation and Other Information" and "Election of Directors." +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2022 Proxy Statement under the heading "Equity Compensation Plan Information" and "Stock Ownership of Certain Beneficial Owners and Management." +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2022 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2022 Proxy Statement under the heading "Matters Related to Independent Registered Public Accounting Firm." +78 +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents filed as part of this report: +1. Financial Statements. +Our consolidated financial statements are listed in the "Index to Consolidated Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our consolidated financial statements or the notes thereto. +3. Exhibits. +The following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit Number Description Reference +2.1 † +Asset Purchase Agreement, dated May 2, 2020, by and among Iteris, Inc., ClearAg, Inc., and DTN, LLC* +Exhibit 2.1 to the registrant's Current Report on Form 8-K as filed with the SEC on May 6, 2020 +4.1 +Restated Certificate of Incorporation of the registrant as filed with the Delaware Secretary of State on October 12, 2018 +Exhibit 3.1 to the Registrant’s Current Report on Form 8-K as filed with the Commission on October 15, 2018 +4.2 +Restated Bylaws of the Registrant, as amended through August 6, 2018 +Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 as filed with the Commission on August 7, 2018 +4.3 +Specimen common stock certificate +Exhibit 4.1 to the Registrant’s Registration Statement on Form 8-A (File No. 001-08762), as filed with the Commission on December 8, 2004 +4.4 +Description of Iteris, Inc. Securities Registered under Section 12 of the Exchange Act +Exhibit 4.2 to the Registrant’s Annual Report on Form 10-K for the year ended for the year ended March 31, 2020 as filed with the SEC on June 9, 2020 +10.1 † +Asset Purchase Agreement dated December 6, 2020, by and between Iteris, Inc. and TrafficCast International, Inc. +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.2 * +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014 +79 +Table of Contents +Exhibit Number Description Reference +10.5 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway Acquisitions, LLC) and Iteris, Inc. +Exhibit 10.5 to registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.6 † +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.6 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 filed with the SEC on June 6, 2019 +10.7 +Fourth Amendment to Lease, dated May 17, 2021, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.7 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2021 filed with the SEC on June 1, 2021 +10.8 * +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.9 * +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.10 * +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.11 * +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.12 * +Amended and Restated 2016 Omnibus Incentive Plan +Exhibit 10.1 to registrant's Current Report on Form 8-K as filed with the SEC on September 16, 2021 +10.13 * +Form of Performance Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan** +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.14 * +Revised Form of Restricted Stock Unit Issuance for use with 2016 Omnibus Incentive Plan** +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.15 * +Revised Form of Form of Notice of Grant of Stock Option and Form of Stock Option Agreement for use with 2016 Omnibus Incentive Plan** +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.16 * +Employment Agreement dated September 8, 2015 between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.17 * +Employment Agreement, dated November 15, 2019, between Iteris, Inc. and Douglas Groves +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 4, 2019 +10.18 * +Iteris, Inc. Amended and Restated Executive Severance Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.19 * +Retention Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.21 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.20 * +Incentive Bonus Agreement dated June 4, 2019 between Iteris, Inc. and James Chambers +Exhibit 10.22 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +80 +Table of Contents +Exhibit Number Description Reference +10.21 * +Form of Retention Bonus Agreement entered into between the Company and selling shareholders of Albeck Gerken, Inc. +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on July 9, 2019 +10.22 * +2020 Employment Inducement Incentive Award Plan +Exhibit 10.2 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.23 * +Form of Notice Grant of Stock Option and Form of Stock Option Agreement for use with 2020 Employment Inducement Incentive Plan +Exhibit 10.3 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.24 * +Form of Restricted Stock Unit Issuance Agreement for use with 2020 Employment Inducement Incentive Award Plan +Exhibit 10.4 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.25 * +Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.5 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.26 * +Form of Restricted Stock Unit Issuance Agreement for use with the Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020. +Exhibit 10.6 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.27 * +2016 Omnibus Incentive Plan (Amended and Restated effective September 9, 2021) +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on September 9, 2021 +10.28 +Credit Agreement, dated as of January 25, 2022, by and between Iteris, Inc. and Capital One, National Association +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on January 28, 2022 +10.29 * +Severance Agreement, dated December 30, 2021 between Iteris, Inc. and Ramin Massoumi +Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2021 as filed with the SEC on February 3, 2022 +23 +Consent of Independent Registered Public Accounting Firm, dated June 1, 2022 +Filed herewith +24 Power of Attorney Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS XBRL Instance Document Filed herewith +101.SCH XBRL Taxonomy Extension Schema Document Filed herewith +101.CAL XBRL Taxonomy Extension Calculation Linkbase Document Filed herewith +81 +Table of Contents +Exhibit Number Description Reference +101.LAB XBRL Taxonomy Extension Label Linkbase Document Filed herewith +101.PRE XBRL Taxonomy Extension Presentation Linkbase Document Filed herewith +101.DEF XBRL Taxonomy Definition Presentation Linkbase Document Filed herewith +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) +Filed herewith +______________________________________ +† Pursuant to Item 601(a)(5) of Regulation S-K, certain appendices to this agreement have been omitted. The Company agrees to furnish supplementally to the Securities and Exchange Commission, upon its request, any or all of such omitted appendices. +* Indicates a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +ITEM 16. FORM 10-K SUMMARY +None. +82 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 1, 2022 ITERIS, INC. +(Registrant) +By /s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Douglas Groves, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated: +Signature Title Date +/s/ JOE BERGERA Director, President and Chief Executive Officer (principal executive officer) June 1, 2022 +Joe Bergera +/s/ DOUGLAS GROVES Chief Financial Officer (principal financial and accounting officer) June 1, 2022 +Douglas Groves +/s/ THOMAS L. THOMAS Chairman of the Board June 1, 2022 +Thomas L. Thomas +/s/ GERARD M. MOONEY Director June 1, 2022 +Gerard M. Mooney +/s/ LAURA L. SIEGAL Director June 1, 2022 +Laura L. Siegal +/s/ DENNIS W. ZANK Director June 1, 2022 +Dennis W. Zank +83 \ No newline at end of file diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/filing_metadata.csv b/raw/filings/0000350868/2021/0001628280-22-015920/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..03949bdc9f6b9c6d2b820643dcaf6abc16cb5f12 --- /dev/null +++ b/raw/filings/0000350868/2021/0001628280-22-015920/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2022-06-01,2022-03-31,2022-06-01T20:27:02.000Z,0001628280-22-015920,iti-20220331.htm,10-K,11886773,1,1,https://www.sec.gov/Archives/edgar/data/350868/000162828022015920/iti-20220331.htm,https://www.sec.gov/Archives/edgar/data/350868/000162828022015920/,2021,2021,1 diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/item1.txt b/raw/filings/0000350868/2021/0001628280-22-015920/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..3f54e203e9b735e0851f2136f2176e692e993102 --- /dev/null +++ b/raw/filings/0000350868/2021/0001628280-22-015920/item1.txt @@ -0,0 +1,113 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively with its wholly-owned subsidiaries, ClearAg, Inc. and Albeck Gerken, Inc. ("AGI"), in this report as "Iteris," the "Company," "we," "our," and "us") is a provider of smart mobility infrastructure management solutions. Our cloud-enabled end-to-end solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services and end-to-end solutions delivered as cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase safety and decrease congestion within our communities, while also minimizing environmental impact. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, mobility intelligence software, mobility data sets, mobility consulting services, and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) has materially adversely impacted global economic conditions. More than 24 months into the Pandemic, COVID-19 continues to have an unpredictable and unprecedented impact on the global economy. Though there has been a trend in increasing availability of COVID-19 vaccines, as well as an easing of restrictions on social, business, travel and government activities and functions, infection rates continue to fluctuate and federal, state and local government regulations continue to rapidly change. The uncertainties caused by the Pandemic include, but are not limited to, supply chain disruptions, workplace dislocations, economic contraction, and downward pressure on some customer budgets and customer sentiment in general. We have not had any facility closures due to the Pandemic, but we have experienced supply chain and work delays on certain projects. Should such delays become protracted or worsen or should longer-term budgets or priorities of our clients be impacted, the Pandemic could negatively affect our business, results of operations and financial condition. The extent of the impact of the Pandemic on our business and financial results, and the volatility of our stock price will depend largely on future developments, including the duration of the Pandemic, new and potentially more contagious variants, such as the Delta and Omicron variants, the impact on capital and financial markets, the distribution, rate of adoption and efficacy of vaccines, and the related impact on the budgets and financial circumstances of our customers and suppliers, all of which are highly uncertain and cannot be reasonably estimated as of the date of this report. +Given the uncertainties surrounding the impacts of the Pandemic on the Company's future financial condition and results of operations, we have taken certain actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. Refer to Note 4, Restructuring Activities, for more information. +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate for component shortages, we have begun to increase inventory levels and may continue to do so for an extended period. In the event demand doesn’t materialize, we may need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, to meet customer demand, resulting in high levels of unshippable backlog. We have placed non- +4 +Table of Contents +cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. Still, we may remain supply-constrained beyond the fiscal year ended March 31, 2022 ("Fiscal 2022"). +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company is applying certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration (see Note 6, Income Taxes, to the Consolidated Financial Statements, including in Part II, Item 8 of this report). +The Pandemic has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility has remained open, easing of Pandemic restrictions imposed by local and state authorities have allowed a portion of our workforce to return to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. Additionally, we have been able to timely file financial reports. We believe we have the right infrastructure to efficiently work remotely for the balance of the Pandemic. We do not expect to incur significant costs to safely reopen our facilities to all our employees. +The Company assessed the impacts of the Pandemic on the estimates and assumptions used in preparing these audited consolidated financial statements. The estimates and assumptions used in these assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of the Pandemic and its resulting impact on global economic conditions. If economic conditions caused by the Pandemic do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. See below for areas that required more judgments and estimates as a result of the Pandemic. The Company will continue to assess the effect on its operations by monitoring the spread of the Pandemic and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of the Pandemic may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business in exchange for a total purchase price of up to $17.7 million. +The $17.7 million in total consideration was comprised of $15.0 million paid in cash on the closing date, $1.0 million held back as security for certain post-closing adjustments and post-closing indemnity obligations of TrafficCast, $1.1 million acquisition-related liability, and a $1.0 million earn out, fair valued at $0.6 million as of March 31, 2021, that if earned, will be paid over two years based on the TrafficCast Business’ achievement of certain revenue targets. The TrafficCast Purchase Agreement also provided for customary post-closing adjustments to the purchase price tied to working capital balances of the TrafficCast Business at closing (see Note 12, Acquisitions , to the Consolidated Financial Statements). The transaction closed on December 7, 2020. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that will provide Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business uses to support its real-time and predictive travel data and associated content. +Public Offering and Acquisition of Albeck Gerken, Inc. +On June 13, 2019, the Company completed an underwritten public offering of 6,182,797 shares of the Company's common stock for net proceeds to the Company of approximately $26.8 million, after deducting underwriting discounts and estimated offering expenses payable by the Company. The Company used approximately $6.2 million of the net proceeds of this offering to pay the cash portion of the purchase price in the acquisition of AGI, a privately-held professional transportation engineering services firm headquartered in Tampa, Florida (see Note 12, Acquisitions , to the Consolidated Financial Statements), and plans to use the balance of the net proceeds for general corporate purposes and possibly for other future acquisitions. +Sale of Agriculture and Weather Analytics Business +5 +Table of Contents +On May 5, 2020, the Company completed the sale of substantially all of our assets used in connection with our former Agriculture and Weather Analytics business to DTN, LLC (“DTN”), an operating company of TBG AG, a Swiss-based holding company, pursuant to an Asset Purchase Agreement (the “AWA Purchase Agreement”) signed on May 2, 2020, in exchange for a total purchase consideration of $12.0 million, subject to working capital adjustments. Upon closing, the Company received $10.5 million in cash and $1.5 million of payment was deferred. DTN paid the Company $1.45 million at the 12-month anniversary of the closing date, and $0.05 million at the 18-month anniversary of the closing date. (See Note 3, Discontinued Operations , to the Consolidated Financial Statements.) +Restructuring Activities +On April 30, 2020, in connection with the sale of the Agriculture and Weather Analytics business, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. Restructuring charges of approximately $1.5 million were incurred for separation costs for certain employees who did not transition to DTN, additional positions that were eliminated to right-size the cost structure of the Company, and the impairment of certain lease-related assets (see Note 4, Restructuring Activities , to the Consolidated Financial Statements). +Products and Services +Iteris provides comprehensive smart mobility infrastructure solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. Beginning December 7, 2020, Iteris includes the public-sector and private-sector operations of TrafficCast (see Note 12, Acquisitions , to the Consolidated Financial Statements, included in Part II, Item 8 of this report for further details on the acquisition of TrafficCast). +Software Solutions +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, Commercial Vehicle Operations, BlueArgus, TrafficCarma and others as described below. +• ClearGuide, which is provided on a software-as-a-service basis, is a state-of-the-art mobility intelligence and transportation performance measures solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement ("SPM"). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response ("IVR"). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial vehicle operations and vehicle safety compliance applications, which are provided on a software-as-a-service basis include various applications branded as ClearFleet, CVIEW-Plus, CheckPoint, UCRLink, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for peoples’ daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +6 +Table of Contents +• VantageLive! is a software-a-as-service solution that allows users to collect, process and analyze advanced intersection data for our Vantage sensors, as well as to view and understand intersection activity +• BlueARGUS is a software-as-a-service solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Cloud, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public- and private-sector customers via subscription-based direct data feeds or application programming interfaces (APIs), or through ClearGuide, our mobility intelligence and transportation performance measures software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary algorithms and selective quality control from experienced traffic analysts. +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and BlueARGUS) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Fusion, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, and P-Series products. +• Vantage Fusion is a connected-vehicle (CV) focused detection product that tracks and reports vehicles and pedestrians in and around intersections. This product helps the industry bridge the currently fledgling CV market to an eventually CV-dominant world by providing non-CV vehicle locations (and details) to the CV network. This product is developed in partnership with Continental AG, a global automotive parts manufacturer and leading CV equipment provider. +• Vantage Apex is the industry’s first full 1080p high-definition (HD) video and 4D/HD radar hybrid sensor with integrated artificial intelligence (AI) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +7 +Table of Contents +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +The BlueTOAD product family combines unique MAC Address capture with the latest Connected Vehicle technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra RSU, both of which we bundle with a Cloud-based software application branded as BlueARGUS. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +In select territories, the Company also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products, will be dependent in part on the continued replacement of adoption of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services offer traffic management centers ("TMC") design, staffing, and operations services to public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ cloud-enabled managed services combine software-as-a-service, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterials and highways along with their related in-field technology. These services include congestion and asset management areas of focus, combining innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators can save time and money while better keeping road users safe and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, we launched the ClearMobility Cloud that enables seamless interoperation among our solutions via a common mobility data management engine, application +8 +Table of Contents +programming interface ("API") framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. ClearMobility Cloud is both horizontally scalable and third-party extensible. +Because we are now aligning, harmonizing, and optimizing our portfolio of individual solutions to a common platform, the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, in fiscal 2022 we began reporting as a single operating segment. +Market Conditions +Currently, over 90% of our revenue is attributable to public-sector customers. Therefore, most of our revenue is dependent upon state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +We believe that overall demand for our solutions will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. Therefore, we were pleased that the Infrastructure Investment and Jobs Act ("IIJA") became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. With that funding pool, areas of direct relevant to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the allocation of funds may prolong uncertainty regarding the allotment of transportation funds in federal, state and local budgets. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +With the acquisition of the TrafficCast Business on December 7, 2020, we now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2022, fiscal year ended March 31, 2021 ("Fiscal 2021"), and fiscal year ended March 31, 2020 ("Fiscal 2020"), no individual customer represented greater than 10% of our total revenues. As of March 31, 2022 and 2021, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing +9 +Table of Contents +strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our assembly and test activities are conducted in approximately 9,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Typically, we do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2022, Fiscal 2021 and Fiscal 2020. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $99.9 million at March 31, 2022. We expect to recognize revenue of approximately 75% of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2021, we had backlog of approximately $78.1 million. The increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm and earned under existing agreements. Backlog is not included in deferred revenue on our consolidated balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues. +Product Development +Our product development activities are mostly conducted at our facility in Santa Ana, California, as well as our facilities in Madison, Wisconsin and Oakland, California. Our research and development costs and expenses were approximately $7.4 million for Fiscal 2022, $5.1 million for Fiscal 2021, and $4.3 million for Fiscal 2020. We expect to continue to pursue various product development programs and incur research and development expenditures for the Company in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in the managed services and consulting business lines include a mix of local, regional and international engineering services firms. Our competitors in the software business line (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations and, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +10 +Table of Contents +In the market for our products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently have a total of 30 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 7 relating to our engineering and consulting services technologies and (iii) 6 related to our purchase of the TrafficCast Business. We had a total of 2 pending patent applications in the U.S. We currently have 5 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2040. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +Litigation may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2022, we employed 428 full-time employees and 16 part-time employees, for a total of 444 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the near future. Currently, +11 +Table of Contents +compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/item13.txt b/raw/filings/0000350868/2021/0001628280-22-015920/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..f4ba5ddd2505a10593e63544815fcf8a621435d4 --- /dev/null +++ b/raw/filings/0000350868/2021/0001628280-22-015920/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2022 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." \ No newline at end of file diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/item9a.txt b/raw/filings/0000350868/2021/0001628280-22-015920/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..053c2c6ef088396210dc03f1e41d86475f92622d --- /dev/null +++ b/raw/filings/0000350868/2021/0001628280-22-015920/item9a.txt @@ -0,0 +1,30 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2022, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2022 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2022. +The effectiveness of our internal control over financial reporting as of March 31, 2022 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +75 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. and subsidiaries (the "Company") as of March 31, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended March 31, 2022, of the Company and our report dated June 1, 2022, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 1, 2022 +76 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/rp_note.txt b/raw/filings/0000350868/2021/0001628280-22-015920/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2021/0001628280-22-015920/rpt_disclosure.txt b/raw/filings/0000350868/2021/0001628280-22-015920/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..60bce770b7b608c21daa2be5eb5f816b3d29f691 --- /dev/null +++ b/raw/filings/0000350868/2021/0001628280-22-015920/rpt_disclosure.txt @@ -0,0 +1,2 @@ +Certain Transactions with 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us-gaap:LineOfCreditMember 2022-01-25 2022-01-25 0000350868 us-gaap:RevolvingCreditFacilityMember us-gaap:LineOfCreditMember 2023-03-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +___________________________________________ +(Mark One) +ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31 , 2023 +OR +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-2588496 +(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) +1250 S. Capital of Texas Hwy., Building 1, Suite 330 , Austin , +Texas +78746 +(Address of Principal Executive Offices) (Zip Code) +Registrant's Telephone Number, Including Area Code: ( 512 ) 716-0808 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which +registered +Common Stock, $0.10 par value ITI The Nasdaq Stock Market LLC +Securities registered pursuant to Section 12(g) of the Act. None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act"). Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.: +Large accelerated filer o Accelerated filer ý Non-accelerated filer o Smaller reporting company ý +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ý +If securities are registered pursuant to Section 12(b) of the Exchange Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. o +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No ý +The aggregate market value of the registrant's common stock held by nonaffiliates of the registrant as of September 30, 2022 was approximately $ 123,850,913 . For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of June 26, 2023, there were 42,569,363 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant's definitive proxy statement for the 2023 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2023 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +23 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +24 +ITEM 4. +MINE SAFETY DISCLOSURES +24 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +25 +ITEM 6. +RESERVED +25 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +25 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +35 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +36 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +66 +ITEM 9A. +CONTROLS AND PROCEDURES +66 +ITEM 9B. +OTHER INFORMATION +68 +ITEM 9C . +DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +69 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +69 +ITEM 11. +EXECUTIVE COMPENSATION +69 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +69 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +69 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +69 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +70 +Unless otherwise indicated in this report, the "Company," "we," "us" and "our" refer to Iteris, Inc. BlueARGUS™, CheckPoint™, ClearData™, ClearFleet®, ClearGuide®, ClearMobility®, ClearRoute®, CVIEWplus™, Inspect™, Iteris®, PedTrax®, SmartCycle®, SmartCycle Bike Indicator®, SmartSpan®, Spectra™, TrafficCarma®, TrafficCast®, UCRLink™, Vantage®, Vantage Apex®, Vantage Fusion™, Vantage Next®, VantagePegasus®, VantageRadius®, VantageLive!®, Vantage Vector®, Velocity®, and VersiCam™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement +This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management’s beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words “expect,” “believe,” “intend,” “plan,” “should,” “will,” “may,” "might," “anticipate,” “estimate,” “could,” “should,” and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenue, expenses, profitability, capital needs, backlog, manufacturing capabilities, and the market acceptance of our products and services, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, the impacts of ongoing and new supply chain constraints, the status of our facilities and product development, reliance on key personnel, general economic conditions, including rising interest rates and federal government deadlock over the debt ceiling, future responses to and effects of COVID-19, and other characterizations of future events or circumstances are forward-looking statements. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause our actual results to differ materially and adversely from those projected. We encourage you to carefully read this report on Form 10-K in its entirety, including the various disclosures made by us which describe certain factors which could affect our business, such as those set forth in the “Risk Factors” of Part 1A of this report, before deciding to invest in our Company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services, and cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, mobility intelligence software, mobility data sets, mobility consulting services, and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the "Pandemic") materially adversely impacted global economic conditions. As COVID-19 has entered an endemic stage, COVID-19 may continue to have an unpredictable and unprecedented impact on the global economy, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. +Given the uncertainties surrounding the impacts of COVID-19 on the Company's future financial condition and results of operations, we have and may continue to identify and execute various actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions include, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate the impact of component shortages, we have increased inventory levels for parts in short supply. In the event demand does not materialize, we would need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components at any price, even from third-party brokers, to meet customer demand, resulting in high levels of backlog that we are unable to ship. The Company's tactics to mitigate the current global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and by accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 ("Fiscal 2023"). We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. +Due to the supply chain environment, the Company increased inventory by approximately $2.9 million as part of the Company's supply chain strategy for Fiscal 2023. The cash flow used in operating activities of our continuing operations was approximately $4.5 million during the twelve months ended March 31, 2023. Cash used during Fiscal 2023 was primarily due to two factors. First, the planned increase in inventory during the first half of Fiscal 2023 and the continued re-design of certain +4 +Table of Contents +circuit boards as part of the Company’s supply chain strategy to help assure the Company has enough product to satisfy customer demand. Second, the net operating loss as a result of higher inventory component costs related to the global supply chain constraints. The increase in inventory purchases and in particular components purchased in the secondary markets was curtailed in the second half of Fiscal 2023, and the Company currently does not expect to continue to accumulate inventory, in the same magnitude, in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to have sufficient liquidity. +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company applied certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. As of March 31, 2023, the Company had repaid all amounts deferred under the CARES Act (see Note 5, Income Taxes , to the Financial Statements for more information). +COVID-19 has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility remained open throughout the Pandemic, many of our employees worked remotely during the past three years. With the recent easing of COVID-19 related restrictions imposed by local and state authorities, a larger portion of our workforce has returned to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. We believe we have the infrastructure to efficiently work remotely during COVID-19's current endemic stage and well into the future. +The Company assessed the impacts of COVID-19 on the estimates and assumptions used in preparing our financial statements. The estimates and assumptions used in our assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of COVID-19, which has entered an endemic stage, and its resulting impact on global economic conditions. If economic conditions caused by COVID-19 do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. The Company will continue to assess the effect of COVID-19 on its operations and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of COVID-19 may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business. +On May 6, 2022, approximately $0.9 million was paid to settle the balance of a security hold back agreed to as part of the acquisition, net of approximately $0.1 million of post-closing adjustments. As of March 31, 2023, the achievement levels of the revenue targets with respect to the earnout were resolved and the balance remaining of approximately $0.6 million was accrued in accordance with the terms of the agreement. This item is included in accrued liabilities on the balance sheets. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that provided Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business used to support its real-time and predictive travel data and associated content until termination of these agreements on December 6, 2022. +Restructuring Activities +To help offset recent increases in supply chain costs, on May 12, 2022, the Board of Directors of Iteris, Inc. approved additional restructuring activities to better position the Company for increased profitability and growth. The Company incurred $0.7 million of employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Products and Services +Iteris provides comprehensive smart mobility infrastructure solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. +Software Solutions +5 +Table of Contents +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, commercial vehicle operations, TrafficCarma, VantageLive! and BlueARGUS as described below. +• ClearGuide, which is provided on a software-as-a-service basis ("SaaS"), is a state-of-the-art mobility intelligence and transportation performance measures solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement ("SPM"). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response ("IVR"). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial vehicle operations and vehicle safety compliance applications, which are provided on a SaaS basis include various applications branded as ClearFleet, CVIEWplus, CheckPoint, UCRLink, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for peoples’ daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +• VantageLive! is a SaaS solution that allows users to collect, process and analyze advanced intersection data from our Vantage sensors, as well as to view and understand intersection activity. +• BlueARGUS is a SaaS solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Cloud, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public-sector and private-sector customers via subscription-based direct data feeds or application programming interfaces ("APIs"), or through ClearGuide, our mobility intelligence and transportation performance measures software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary computerized algorithms and selective quality control from experienced traffic analysts. +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and BlueARGUS) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply +6 +Table of Contents +sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Fusion, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, and P-Series products. +• Vantage Fusion is a connected-vehicle ("CV") focused detection product that tracks and reports vehicles and pedestrians in and around intersections. This product helps the industry bridge the currently fledgling CV market to an eventually CV-dominant world by providing non-CV vehicle locations (and details) to the CV network. This product is developed in partnership with Continental AG, a global automotive parts manufacturer and leading CV equipment provider. +• Vantage Apex is the industry’s first full 1080p high-definition ("HD") video and 4D/HD radar hybrid sensor with integrated artificial intelligence (AI) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Next uses a powerful processor that enables future functional growth while maintaining proven Iteris video detection performance and reliability. The architecture supports expanding ITS applications and easily integrates with existing technologies and is anticipated to integrate with future technologies. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +The BlueTOAD product family combines unique MAC Address capture with the latest CV technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra RSU, both of which we bundle with a Cloud-based software application branded as BlueARGUS. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +7 +Table of Contents +In select territories, the Company also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products will be dependent, in part, on the continued replacement of adoption of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services include traffic management centers ("TMC") design, staffing, and operations services to public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ cloud-enabled managed services combine SaaS, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterial roads and highways along with their related in-field technology. These services include congestion and asset management areas of focus, combining innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators are provided the opportunity to save time and money while better keeping road users safe and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, we launched the ClearMobility Cloud that enables seamless interoperation among our solutions via a common mobility data management engine, API framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. ClearMobility Cloud is both horizontally scalable and third-party extensible. +Because we are now aligning, harmonizing, and optimizing our portfolio of individual solutions to a common platform, the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, beginning in the fiscal year ended March 31, 2022 ("Fiscal 2022") and throughout Fiscal 2023, we reported as a single operating segment. +Market Conditions +Currently, over 90% of our revenue is attributable to public-sector customers. Therefore, most of our revenue is dependent upon state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +8 +Table of Contents +We believe that overall demand for our solutions will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. The Infrastructure Investment and Jobs Act ("IIJA") became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. With that funding pool, areas of direct relevance to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the appropriation of annual funding and current debates related to the federal debt ceiling may cause some uncertainty regarding the availability of transportation funds in federal, state and local budgets. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +With the acquisition of the TrafficCast Business on December 7, 2020, we now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2023 and Fiscal 2022, no individual customer represented greater than 10% of our total revenues. As of March 31, 2023 and 2022, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our assembly and test activities are conducted in approximately 12,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors typically is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2023 and Fiscal 2022. We believe customer support is a key competitive factor for our Company. +Backlog +9 +Table of Contents +Our total backlog of unfulfilled firm orders was approximately $114.2 million at March 31, 2023. We typically expect to recognize revenue in the range of approximately two-thirds to three-quarters of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2022, we had backlog of approximately $99.9 million. The 14% increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm and earned under existing agreements, but it does not represent the total contract award if a firm purchase order or task order has not yet been issued under the contract. Backlog is not included in deferred revenue on our balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often can be affected by a variety of factors including the scheduling and forecasting practices of our individual customers, as well as availability of installation labor and ancillary parts related to installation which we do not manufacture or supply. These factors can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of the timing of our future revenues. +Product Development +Our product development activities are mostly conducted at our facilities in Santa Ana, California, and Madison, Wisconsin as well as using additional employee and partner resources across North America. Our research and development costs and expenses were approximately $8.3 million for Fiscal 2023 and $7.4 million for Fiscal 2022. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors providing managed services and consulting include a mix of local, regional and international engineering services firms. Our competitors in software products (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +In the market for our detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our +10 +Table of Contents +new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets could have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights of protection for any potentially significant new technology acquired or developed by us. We currently have a total of 31 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 8 relating to our engineering and consulting services technologies and (iii) 6 related to our purchase of the TrafficCast Business. We have a total of 2 pending patent applications in the U.S. We currently have 5 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2040. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in litigation in the normal course of business related to our intellectual property rights and the intellectual property rights of others. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any litigation or other legal proceedings related to its intellectual property or the intellectual property of others, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on the Company’s results of operations, financial position or cash flows. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2023, we employed 450 full-time employees and 17 part-time employees, for a total of 467 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our other filings with the SEC, including our subsequent quarterly reports on Form 10-Q and current reports on Form 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not +11 +Table of Contents +presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. +Risk Related to Our Business +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues and fixed price contracts, that could adversely impact our future revenues and profitability. +A significant portion of our revenues is derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. We anticipate that revenue from government contracts will continue to remain a significant portion of our revenues. Government business is, in general, subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government budgetary constraints, including reaching the current federal debt ceiling; cut-backs, delays or reallocation of government funding, including without limitation, changes in the administration and repeal of government purchasing programs; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenue is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone requirements; +• performance bond requirements; +• adverse weather conditions or other natural or health disasters or developments, such as COVID-19, and evacuations and flooding due to hurricanes, can result in our inability to perform work in affected areas; and +• international relations and international conflicts such as the war in Ukraine, or other military operations that could cause the temporary or permanent diversion of government funding from transportation or other infrastructure projects. +Governmental budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities and rescheduling or cancellation in purchase decisions by governmental entities, and the current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and income to drop substantially or to fluctuate significantly between fiscal periods. +In addition, a number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project's requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to +12 +Table of Contents +address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our engineering and consulting workforce. +The cost of providing our engineering and mobility consulting services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions and related professional disciplines; +• the timing of new contract awards, the commencement of work under an awarded contract or the completion of large contracts; +• the availability of project funding or other project budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An inability to properly and fully utilize our engineering and consulting workforce would reduce our profitability and could have an adverse effect on our results of operations. +Our management information systems and databases have been and could in the future be disrupted by data protection breaches, system security failures, cyber threats or by the failure of, or lack of access to, our internal operations, such as our enterprise resource planning ("ERP") system, or services provided to our customers. These disruptions could negatively impact our sales, increase our expenses, significantly harm our reputation and/or adversely affect our stock price. +Experienced users and computer programmers may be able to penetrate, or "hack", our network security and create system disruptions, cause shutdowns and compromise or misappropriate our confidential information or that of our employees and third parties. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our internal network, any of our systems, service offerings or otherwise exploit any security vulnerabilities of our network, systems or service offerings. In addition, sophisticated services, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of a system. We could incur expenses addressing problems created by cyber or other security problems, bugs, viruses, worms malicious software programs and security vulnerabilities, and our efforts to address these problems may not be successful. We must, and do, take precautions to secure customer information and prevent unauthorized access to our databases and systems containing confidential information. Any data security event, such as a breach, data loss or information security lapses, whether resulting in the compromise of personal information or the improper use or disclosure of confidential, sensitive or classified information, could result in interruptions, cessation of service(s), claims, remediation costs, regulatory sanctions against us, loss of current and future contracts, adverse effects to results of operations and financial condition, serious harm to our reputation and/or adverse effects to our stock price. We operate our ERP system and other key business systems on SaaS platforms, and we use these systems for reporting, planning, sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on these systems, and the third-party providers of these services, for a number of aspects of our operations. If these service providers or these systems fail, or if we are unable to continue to have access to these systems on commercially reasonable terms, or at all, operations could be severely disrupted until an equivalent system(s) could be identified, licensed or developed, and integrated into our operations. This disruption could have a material adverse effect on our business. We carry insurance, including cyber insurance, commensurate with our size and the nature of our operations, although there is no certainty that such insurance will in all cases be sufficient to fully reimburse us for all losses incurred in connection with the occurrence of any of these system security risks, data protection breaches, cyber-attacks or other events. +If unauthorized access is obtained to our customer's personal and/or proprietary data in connection with our web-based and mobile application solutions and services, we may suffer various negative impacts, including a loss of customer and +13 +Table of Contents +market confidence, loss of customer loyalty, and significant liability to our customers and to individuals or businesses whose information was being stored. +Protecting data of our customers is critical to our business, and if there is unauthorized access, we may incur significant costs or liabilities. In addition, we are required to comply with government contracting requirements and make investments in our systems to protect that data. If we are unable to do so, our customers may lose confidence in us, which would harm our sales, and we may incur significant expenses or liabilities. +Acquisitions of companies or technologies may require us to undertake significant capital infusions and could result in disruptions of our business and diversion of resources and management attention. +We completed the acquisition of TrafficCast in December 2020 and we plan to continue to explore acquiring additional complementary businesses, products, services, and technologies. Acquisitions may require significant capital infusions which could be in the form of debt, equity, or both, and, in general, acquisitions also involve a number of special risks, including: +• potential disruption of our ongoing business and the diversion of our resources and management's attention; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; +• increased interest expense or increased share or equity dilution; and +• amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully integrate any acquisitions or realize the benefits and opportunities anticipated from any acquisition. +Acquisitions, investments and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. +Acquisitions, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and results of operations. We expect to continue to evaluate and enter into discussions regarding potential strategic transactions. These strategic transactions could create unforeseen operating difficulties and expenditures. We face risks that include, among other things: +• the strategic benefits and opportunities from any planned or completed acquisition or divestiture by the Company may not be realized or may take longer to realize than expected; +• strategic benefits and opportunities related to past and ongoing restructuring actions may not be realized or may take longer to realize than expected; +• our ability to realize the expected financial benefits of an acquisition, divestiture or other strategic transaction may not be realized or may take longer to realize than expected; +• cost reductions may not occur as expected; +• management time and focus may be diverted from operating our business to challenges related to acquisitions and other strategic transactions; +14 +Table of Contents +• cultural challenges may arise associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire; and +• we may fail to successfully further develop the acquired business or technology. +Our failure to address the risks and other issues in connection with our past or future acquisitions and other strategic transactions could cause us to not realize their anticipated benefits and opportunities, incur unanticipated liabilities, experience increased costs, and harm our business generally. +We participate in the software development market, which may be subject to various technical and commercial challenges. +We invest in software development and have in the past and may in the future experience development and technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we cannot be certain that errors will not be found in our software after its release. Any faults or errors in our existing products or in any new products may cause delays in product introduction and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. During the twelve months ended March 31, 2022, due to delays in the completion of a software development contract with a customer, the Company recorded an estimated loss on a contract of approximately $3.4 million. The terms of the contract have since been amended to a time and materials structure and no further additional contract losses are expected for this contract. No further subsequent loss on this contract was recorded through the year ended March 31, 2023 based on our assessment. The estimates and assumptions used in these assessments were based upon management's judgment and may be subject to change as new events occur and additional information is obtained. If the future estimated costs to fulfill a contract exceed the expected consideration from the customer, the Company's financial condition, cash flows, and results of operations may be adversely and materially impacted. +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely decline. +Our markets are in general characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• obsolescence of certain parts and components from time to time that may require re-engineering of certain portions of our product or products; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements in a cost-effective and timely manner, or are unable to achieve market acceptance of our new products, our operating results could be adversely affected. +We believe our revenue growth and future operating results will depend on our ability to complete development of new products and product enhancements, introduce these products and product enhancements in a timely, cost-effective manner, achieve broad market acceptance of these products and product enhancements, and reduce our production costs. During the past few fiscal years we have introduced, and we expect we will continue to introduce, both new and enhanced products. We cannot guarantee the success of these products, and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +15 +Table of Contents +We believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain competitive. We need to continue to prepare updates for existing products and develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and analysis in response to evolving customer requirements. In addition, we are continuing to migrate some of our products to a new platform. We cannot assure you that we will be able to adequately manage product transitions. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory requirements typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue. +We may need to raise additional capital in the future, which may not be available on terms acceptable to us, or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. Should the financial results of our business decline, we may need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +• the supply of key components for our products; +• our ability to increase revenue and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors' introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards or commencement of work for a project; +• our ability to successfully secure credit arrangements with banks or other lenders and/or negotiate equity arrangements subject to the state of the financial markets in general; and +• general economic conditions, including the effects of economic slowdowns and international conflicts. +If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional equity or debt financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms when needed, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The markets in which we operate are highly competitive with many companies more established than we are. +Our competitors tend to vary across the various product categories in which we participate. +The engineering and consulting market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +16 +Table of Contents +Our sensors line of business competes with existing, well-established companies and technologies, both domestically and abroad. Only a portion of the traffic intersection market has adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +Many of our competitors have greater name recognition and greater financial, technological, marketing and customer service resources than we do. This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. We continually bid on new contracts and negotiate contract renewals on expiring contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. As a condition to contract award, customers typically require us to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. Government entities are also taking more time between contract award and approval to commence work under the contract, which delays our ability to recognize revenues under the contract. If negative market conditions materialize, or if we fail to secure adequate financing arrangements or the required governmental approval or fail to meet other required conditions, we may not be able to pursue, obtain or perform particular projects, which could reduce or eliminate our profitability. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. +Due to the specialized nature of our business and the current tight labor market, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may adversely affect our growth in the current fiscal year and in future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for employees are on the rise. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled personnel, we may not be able to attract and retain such employees, which could impair our ability to perform our contractual obligations, meet our customers' needs, win new business, and adversely affect our future results. Likewise, the future success of our consulting services will depend on our ability to hire additional qualified engineers, planners and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense and has become more so over time. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +COVID-19 could continue to have an adverse effect on our business. +COVID-19 has affected and may continue to adversely impact our financial condition and results of operations. Although COVID-19 has entered an endemic stage, it may continue to have an unpredictable and unprecedented impact on the global economy including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on some customer budgets and customer sentiment. All of these factors have had or could result in future material negative impacts on our ability to ensure a consistent supply chain for manufacturing of our hardware products, and maintain the effectiveness and productivity of our operations. +Given the uncertainties surrounding the impacts of COVID-19 on the Company's future financial condition and results of operations, we have and may continue to identify and execute various actions to preserve our liquidity, manage cash flow and +17 +Table of Contents +strengthen our financial flexibility. Such actions include, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate the impact of component shortages, we increased inventory levels for parts in short supply. In the event demand does not materialize, we would need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components at any price, even from third-party brokers, to meet customer demand, resulting in high levels of backlog that we are unable to ship. The Company’s tactics to mitigate the current global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and by accumulating inventory in the first two quarters for the Fiscal 2023. We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. +The Company cannot predict the duration or direction of current trends or their sustained impact. As COVID-19 has entered an endemic stage, the Company will continue to assess the effects on its operations. While the spread of COVID-19 has slowed and certain challenges have been abated, uncertainty remains about the duration and extent of the impact of COVID-19 and its resulting impact on global economic conditions. If economic conditions caused by COVID-19 persists or do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. +Industry consolidation may lead to increased competition and may harm our operating results. +There is a continuing trend toward industry consolidation in our markets. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, some of our current and potential competitors for transportation infrastructure solutions have made acquisitions, or announced new strategic alliances, designed to position them with the ability to provide end-to-end technology solutions for the transportation industry. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for public transportation agencies, municipalities, and commercial entities. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results, and financial condition. +The ongoing war between Russia and Ukraine could adversely affect our business, financial condition and results of operations. +On February 24, 2022, Russian military forces launched a military attack on Ukraine and sustained conflict and disruption in the region is likely. Although the length, impact and outcome of the ongoing war in Ukraine is highly unpredictable, this conflict could lead to significant market and other disruptions, including significant volatility in commodity prices and supply of energy resources, instability in financial markets, supply chain interruptions, political and social instability, changes in government agency budgets and funding preferences as well as increase in cyberattacks and cyber and corporate espionage. To date we have not experienced any material interruptions in our infrastructure, supplies, technology systems or networks needed to support our operations. We are actively monitoring the situation in Ukraine and assessing its impact on our business. The extent and duration of the war and resulting market disruptions could be significant and could potentially have substantial impact on the global economy and our business for an unknown period of time. Any such disruptions may also magnify the impact of other risks described in this Annual Report on Form 10-K. +The availability of data we purchase and use in certain of our Mobility Data Sets may become more limited due to changes in strategy or financial health of data suppliers, and adversely affect performance of our products or the cost of data purchased. +A recent announcement of Wejo Group Limited to appoint an administrator due to insolvency, and the change in strategy of Otonomo Technologies Ltd. after being acquired, both reduced the number of suppliers selling data to us for use in some of our Mobility Data sets. Although similar data can be purchased from other sources, future changes in data sources or availability could adversely affect the quality of our Mobility Data Sets and/or the cost to purchase data. +Legal and Regulatory Risks +We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. +18 +Table of Contents +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations may be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or illegally use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we may not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. We have in the past, currently, and may in the future, be subject to litigation regarding our intellectual property rights and the intellectual property rights of others. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or using certain products, product features, or technologies. In addition, in the event of an adverse outcome in litigation or any similar proceedings we may find ourselves at a competitive disadvantage to others who need not incur the substantial expense, time, and effort required to market or use certain products, product features, or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have infringed upon or misappropriated another party's intellectual property. Our continued expansion into software development activities may subject us to increased possibility of litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and expenses, and the diversion of management's attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and results of operations. +We may continue to be subject to traffic-related litigation. +The traffic industry in general is subject to frequent litigation claims due to the nature of personal injuries that can result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims may not be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant expenses and result in a diversion of management's attention. +Financial and Market Risks +We may not be able to consistently achieve profitability on a quarterly or annual basis in the future. +We had a GAAP net loss of approximately $14.9 million in Fiscal 2023, net loss of $7.1 million in Fiscal 2022, and we cannot assure you that we will be profitable in the future. Our ability to operate at a profit in future periods could be impacted by governmental budgetary constraints, government and political agendas, economic instability, supply chain constraints and other items that are not in our control. Furthermore, we rely on operating profits to fund investments in sales and marketing and research and development initiatives. We cannot assure you that our financial performance will sustain a sufficient level to completely support those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned investments. +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to add additional qualified personnel, and invest in additional research and development and sales and marketing activities, which could lead to increases in our expenses and future declines in our operating results. In addition, our past expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these activities or any revenue declines successfully, our growth, our business, our financial condition and our results of operations could be adversely affected. +19 +Table of Contents +Our use of estimates in conjunction with the input method of measuring progress to completion of performance obligations for our engineering and consulting services revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of our engineering and consulting services revenues are measured and recognized over time using the input method of measuring progress to completion. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to estimated costs and resulting revenues recognized are recorded when the amounts are known or can be reasonably estimated based on updated information. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates which may result in reductions or reversals of previously recorded revenues and profits. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to obtain our auditors' attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we may not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that technology, decision-making and other processes can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls also can possibly be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. Factors that could affect our revenues and operating results include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our customers' or our ability to access stimulus funding, funding from the federal transportation bills or other government funding; +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as increased price competition in general; +• the long lead times associated with government contracts; +20 +Table of Contents +• the size, timing, rescheduling or cancellation of significant vendor and customer orders; +• our ability to control costs, including costs associated with strategic alternatives; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• timing of backlog fulfillment; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• interruptions or other significant disruption in our supply chain which may negatively impact our ability to ship products and/or the cost of our products; +• risks and uncertainties associated with our international business; +• market condition changes such as industry consolidations that could slow down our ability to procure new business; +• general economic and political conditions; +• our ability to raise additional capital; +• pandemic and epidemic events, such as COVID-19, which may have a continuing impact on our future operating results; +• international conflicts and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance. +21 +Table of Contents +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have experienced, and may from time to time in the future continue to experience parts shortages, end of life events, sharp increases in component costs and unforeseen quality control issues by our suppliers that may impact our ability to meet demand for our products. COVID-19 has increased the occurrence of such shortages and increased costs for materials. We have historically used and continue to use single suppliers for certain significant components in our products; however, in light of the current supply chain shortage we have begun to use other suppliers to meet our demand, and we have had to reengineer products from time to time to address discontinued, obsolete or unavailable components. Our products are also included with other traffic intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should any such supply delay or disruption occur, or should a key supplier discontinue operations, our future sales and costs may be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a production gap should for any reason our contract manufacturers become unable to meet our production requirements and the cost of our products could increase, adversely affecting our margins. Further, foreign imports of components in our products subject the Company to risks of changes in, or the imposition of new, export/import requirements, tariffs, work stoppages, delays in shipment, product cost increases due to component shortages, public health issues, such as COVID-19, that could lead to temporary closures of facilities or shipping ports, and other economic uncertainties affecting trade between the U.S. and other countries where we source components for our products. Any such actions could increase the cost to us of such products and cause increases in the prices at which we sell such products, which could adversely affect the financial performance of our business. Similarly, these actions could result in cost increases or supply chain delays that impact third party products (e.g., steel poles) which could lead our customers to delay or cancel planned purchases of our products. +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution capabilities for our products internationally, particularly in Europe and in South America. We plan to continue to expand our international efforts, but we cannot assure you that we will be successful in such efforts. International operations subject us to various inherent risks including, among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S., as well as requirements and restrictions in the other countries in which we operate; +• currency fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; +• reduced protection for intellectual property rights in some countries; and +• pandemic and epidemic events, such as COVID-19, and related government responses, including travel restrictions, quarantines and "stay-at-home" orders. +Substantially all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the U.S. dollar could make our products more expensive and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. +Any of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, as we pursue the expansion of our international business, +22 +Table of Contents +certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has been subject to wide fluctuations in the past. From March 31, 2020 through March 31, 2023, our common stock has traded at prices as low as $2.40 per share and as high as $7.81 per share. The market price of our common stock could continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• statements made by third parties or speculation regarding our strategic alternatives; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other strategic transactions or dispositions; +• the impact of any litigation or other legal proceedings; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The stock market is currently experiencing and has from time-to-time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology and smaller companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management's attention and resources from other matters. +Provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common stock. +Provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For example, under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make nominations for directors. We may also adopt provisions and agreements from time to time that could make it harder for a potential acquirer. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +23 +Table of Contents +ITEM 2. PROPERTIES +Our largest facility is located in Santa Ana, CA where we lease approximately 47,000 square feet of office, manufacturing and warehouse space pursuant to a lease which terminates in March 2027 (see Note 7, Right-of-Use Assets and Lease Liabilities, to the Financial Statements for more information). +ITEM 3. LEGAL PROCEEDINGS +The information is set forth under the heading "Litigation and Other Contingencies" (see Note 6, Commitments and Contingencies, to the Financial Statements for more information). +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +24 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock has traded on the Nasdaq Capital Market under the symbol "ITI" since February 8, 2016. Prior to that, our common stock traded on the New York Stock Exchange under the same symbol. +As of June 26, 2023, we had 276 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than this number of record holders, as the total number also includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters." +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We currently intend to retain any earnings for working capital, investment and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business conditions, and such other factors as the Board of Directors may deem relevant. +Issuer Purchases of Equity Securities +On August 9, 2012, the Board approved a stock repurchase program pursuant to which we could acquire up to $3.0 million of our outstanding common stock for an unspecified length of time. Under the program, we could repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and could also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There was no guarantee as to the exact number of shares that would be repurchased. We reserved the right to modify or terminate the repurchase program at any time without prior notice. +On November 6, 2014, the Board approved a $3.0 million increase to the Company’s 2012 stock repurchase program, pursuant to which the Company could continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. From the inception of the 2012 stock repurchase program through its termination on May 12, 2022, we repurchased approximately 2,458,000 shares of our common stock for an aggregate price of approximately $4.3 million, at an average price per share of $1.73. As of March 31, 2023, these repurchased shares had been retired and resumed their status as authorized and unissued shares of our common stock. +On May 12, 2022 the Board of Directors terminated the 2012 stock repurchase program and approved a new plan for the company to acquire up to $10.0 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market through privately negotiated transactions and through block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. During Fiscal 2023, we repurchased 0.3 million shares, for an aggregate price of approximately $0.9 million, at an average price of $2.90 per share. As of March 31, 2023 approximately $9.1 million remained available for the repurchase of our common stock under our current program. No shares were repurchased during the three months ended March 31, 2023. +ITEM 6. RESERVED +ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +25 +Table of Contents +You should read the following discussion and analysis in conjunction with our Financial Statements and related Notes thereto included in Part II, Item 8 of this report and the "Risk Factors" section in Part I, Item 1A, as well as the other cautionary statements and risks described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General +We are a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient, and sustainable for everyone. +Recent Developments +Impact of COVID-19 on Our Business +The Pandemic materially adversely impacted global economic conditions. As COVID-19 has entered an endemic stage, COVID-19 may continue to have an unpredictable and unprecedented impact, including possible additional supply chain disruption, workplace dislocation, economic contraction, and negative pressure on customer budgets and customer sentiment. +Given the uncertainties surrounding the impacts of COVID-19 on the Company's future financial condition and results of operations, we have and may continue to identify and execute various actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions include, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate the impact of component shortages, we increased inventory levels for parts in short supply. In the event demand does not materialize, we would need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components at any price, even from third-party brokers, to meet customer demand, resulting in high levels of backlog that we are unable to ship. The Company's tactics to mitigate the current global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and by accumulating inventory in the first two quarters of Fiscal 2023. We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. +Due to the supply chain environment, the Company increased inventory by approximately $2.9 million as part of the Company's supply chain strategy for Fiscal 2023. The cash flow used in operating activities of our continuing operations was approximately $4.5 million during the twelve months ended March 31, 2023. Cash used during Fiscal 2023 was primarily due to two factors. First, the planned increase in inventory during the first half of Fiscal 2023 and the continued re-design of certain circuit boards as part of the Company’s supply chain strategy to help assure the Company has enough product to satisfy customer demand. Second, the net operating loss as a result of higher inventory component costs related to the global supply chain constraints. The increase in inventory purchases and in particular components purchased in the secondary markets was curtailed in the second half of Fiscal 2023, and the Company currently does not expect to continue to accumulate inventory, in the same magnitude, in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to have sufficient liquidity. +The Company assessed the impacts of COVID-19 on the estimates and assumptions used in preparing our financial statements. The estimates and assumptions used in our assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of COVID-19, which has entered an endemic stage, and its resulting impact on global economic conditions. If economic conditions caused by COVID-19 do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. The Company will continue to assess the effect on its operations by monitoring the spread of COVID-19 and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of COVID-19 may change. +Despite the impact of COVID-19, we believe that the ITS ("Intelligent Traffic Systems") industry in the U.S. should continue to provide new opportunities for the Company although, in the near term, the pace of new opportunities emerging may be restrained and the start dates of awarded projects may be delayed. We believe that our expectations are valid and that our plans for the future continue to be based on reasonable assumptions. +Climate Change +26 +Table of Contents +We take climate change and the risks associated with climate change seriously. Increased frequency of severe and extreme weather events associated with climate change could adversely impact our facilities, interfere with intersection construction projects, and have a material impact on our financial condition, cash flows and results of operations. More extreme and volatile temperatures, increased storm intensity and flooding, and more volatile precipitation are among the weather events that are most likely to impact our business. We are unable to predict the timing or magnitude of these events. However, we perform ongoing assessments of physical risk, including physical climate risk, to our business and efforts to mitigate these physical risks continue to be implemented on an ongoing basis. +As a global leader in smart mobility infrastructure management, we are committed to a cleaner, healthier and more sustainable future. Our core business aims to reduce climate impact through our work with public and private-sector partners to improve the efficiency of mobility, which, among other things has the benefit of reducing vehicle carbon emissions. For example, by reducing vehicle delays and stops through traffic signal timing projects, improving the efficiency and fuel consumption of public transit via signal priority programs, reducing time spent roadside for heavy-emitting commercial freight vehicles during inspection, our industry-leading portfolio of smart mobility infrastructure management solutions is currently helping cities and states to reduce their carbon footprint. Additionally, we continue to enhance the design of our sensors to withstand increasingly extreme weather conditions. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into the TrafficCast Purchase Agreement with TrafficCast, a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, Iteris purchased from TrafficCast substantially all of the assets used in the conduct of the TrafficCast Business and assumed certain specified liabilities of the TrafficCast Business. +On May 6, 2022, approximately $0.9 million was paid to settle the balance of a security hold back agreed to as part of the acquisition, net of approximately $0.1 million of post-closing adjustments. As of March 31, 2023, the achievement levels of the revenue targets with respect to the earnout were resolved and the balance remaining of approximately $0.6 million was accrued in accordance with the terms of the agreement. This item is included in accrued liabilities on the balance sheets. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that provided Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business used to support its real-time and predictive travel data and associated content until termination of these agreements on December 6, 2022. +Non-GAAP Financial Measures +Adjusted income (loss) from continuing operations before taxes, depreciation, amortization, interest expense, stock-based compensation expense, restructuring charges, project loss reserves, acquisition earnout payments, and executive severance and transition costs (“Adjusted EBITDA”) was approximately $(6.6) million, and $4.5 million for the fiscal years ended March 31, 2023 and 2022, respectively. Components of Adjusted EBITDA may be adjusted from time to time to reflect specific events and circumstances as they occur. +When viewed with our financial results prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and accompanying reconciliations, we believe Adjusted EBITDA provides additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define these measures, explain how they are calculated and provide reconciliations of these measures to the most comparable GAAP measure in the table below. Adjusted EBITDA and the related financial ratios, as presented in this Annual Report on Form 10-K (“Form 10-K”), are supplemental measures of our performance that are not required by or presented in accordance with GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items. +We use Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We present Adjusted EBITDA and the related financial ratios, as applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our operating commitments. +27 +Table of Contents +Adjusted EBITDA and the related financial ratios have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include: +• They do not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments; +• They do not reflect changes in, or cash requirements for, our working capital needs; +• Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; +• They are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; +• They do not reflect the impact on earnings of charges resulting from matters unrelated to our ongoing operations; and +• Other companies in our industry may calculate Adjusted EBITDA differently than we do, whereby limiting its usefulness as comparative measures. +Because of these limitations, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only as supplemental information. See our audited financial statements contained in this Form 10-K. However, in spite of the above limitations, we believe that Adjusted EBITDA and the related financial ratios are useful to an investor in evaluating our results of operations because these measures: +• Are widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors; +• Help investors to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and +• Are used by our management team for various other purposes in presentations to our Board of Directors as a basis for strategic planning and forecasting. +The following financial items have been added back to or subtracted from our net income (loss) when calculating Adjusted EBITDA: +• Income tax expense. This amount may be useful to investors because it represents the taxes that might be payable for the period and the change in deferred taxes during the period, and therefore could reduce cash flow available for use in our business. +• Depreciation expense. Iteris excludes depreciation expense primarily because it is a non-cash expense. These amounts may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations. +• Amortization expense. Iteris incurs amortization of intangible assets in connection with acquisitions. Iteris also incurs amortization related to capitalized software development costs. Iteris excludes these items because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to investors because it represents the estimated attrition of our acquired customer base and the diminishing value of product rights. +• Interest expense. Iteris excludes interest expense because it does not believe this item is reflective of ongoing business and operating results. This amount may be useful to investors for determining current cash flow. For Fiscal 2023, interest expense includes amortization of the remaining capitalized deferred financing costs due to the termination of the Credit Agreement (see Note 12, Long-Term Debt, to the Financial Statements for more information). +• Stock-based compensation. These expenses consist primarily of expenses from employee and director equity based compensation plans. Iteris excludes stock-based compensation primarily because they are non-cash expenses and Iteris believes that it is useful to investors to understand the impact of stock-based compensation to its results of operations and current cash flow. +• Restructuring charges. These expenses consist primarily of employee separation expenses, facility termination costs, and other expenses associated with Company restructuring activities. Iteris excludes these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +28 +Table of Contents +• Project loss reserves. These expenses consist primarily of expenses incurred to complete a software development contract that will not be recoverable and largely related to previously incurred and capitalized costs for non-recurring engineering activity. Iteris excludes these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Acquisition earnout payments. These expenses are a result of the TrafficCast International, Inc. acquisition in December, 2020 and are the final earnout payments per the acquisition agreement. Iteris excluded these expenses as it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Executive severance and transition costs. Iteris excludes executive severance and transition costs because it does not believe that these expenses are reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +Reconciliations of net income (loss) from continuing operations to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of total revenues were as follows: +Year Ended March 31, +2023 2022 +(In thousands) +Net income (loss) from continuing operations $ (14,855) $ (6,900) +Income tax expense 135 174 +Depreciation expense 615 820 +Amortization expense 3,179 3,240 +Interest expense 329 — +Stock-based compensation 2,890 3,401 +Other adjustments: +Restructuring charges 707 — +Project loss reserves — 3,394 +Acquisition earnout payments 376 — +Executive severance and transition costs — 340 +Total adjustments 8,231 11,369 +Adjusted EBITDA $ (6,624) $ 4,469 +Percentage of total revenues (4.2) % 3.3 % +Critical Accounting Policies and Estimates +"Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on our financial statements included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period (see Note 1, Description of Business and Summary of Significant Accounting Policies, to the Financial Statements for more information). In preparing our financial statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and other factors that we believe are reasonable. We evaluate our estimates, assumptions and judgments on a regular basis and apply our accounting policies on a consistent basis. We believe that the estimates, assumptions and judgments involved in the accounting for revenue recognition, goodwill, and income taxes have the +29 +Table of Contents +most potential impact on our financial statements. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. +The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements. +Revenue Recognition. Our revenue arrangements are complex in nature and require significant judgement in determining the performance obligation structure. Each contract is unique in nature and therefore is assessed individually for appropriate accounting treatment. +Revenues are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers, ranging from multi-year agreements to purchase orders. +Product revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase orders are generally short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues sometimes consist of revenues derived from the use of the Company’s service platforms and APIs on a subscription basis as well as from maintenance and support. We generate this revenue from fees monthly active user fees, SaaS fees, hosting and storage fees, and maintenance and support fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services in these situations as the customer obtains equal benefit from the service throughout the service period. +Service revenues are also derived from engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. For fixed fee contracts, we recognize revenue over time using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportional cost incurred closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Other contracts can be based on a Time & Materials (“T&M”) and Cost Plus Fixed Fee (“CPFF”) structure, where such contracts are considered to involve variable consideration. However, contractual performance obligations with these fee types qualify for the “Right to Invoice” practical expedient. Under this practical expedient, the Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company’s performance completed to date. +Goodwill. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment in accordance with the provisions of ASC 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines that the fair value of a reporting unit is more likely than not, less than its carrying value, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. +The estimates of fair value of the reporting units are computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of the reporting units. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth +30 +Table of Contents +assumptions for future revenues (including future gross margin rates, expense rates, capital expenditures and other estimates), and a rate used to discount estimated future cash flow projections to their present value (or estimated fair value) based on estimated weighted average cost of capital (i.e., the selected discount rate). We select assumptions used in the financial forecasts by using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses (i.e., guideline companies). The selection of comparable businesses is based on the markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity of products and services. +Income Taxes . Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $18.7 million and $14.9 million against our deferred tax assets at March 31, 2023 and March 31, 2022, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Due to the magnitude of the impact of supply chain issues occurring during Fiscal 2023 and the addition to cumulative pre-tax loss, we currently cannot estimate when sufficient positive evidence may become available to allow us to reach a conclusion that any portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to the level of profitability that we are able to actually achieve. +Recent Accounting Pronouncements +Refer to Note 1, Description of Business and Summary of Significant Accounting Policies, to the Financial Statements, included in Part II, Item 8 of this report for a discussion of recent accounting pronouncements. +Analysis of Fiscal 2023 and Fiscal 2022 Results of Operations +Total Revenues. The following table presents details of total revenues for Fiscal 2023 as compared to Fiscal 2022: +Year Ended March 31, +2023 2022 $ Increase % Change +(In thousands, except percentage) +Product revenues $ 85,097 $ 68,729 $ 16,368 23.8 % +Service revenues 70,955 64,843 6,112 9.4 % +Total revenues $ 156,052 $ 133,572 $ 22,480 16.8 % +Product revenues primarily consist of product sales, but also includes OEM products for the traffic signal markets, as well as third-party product sales for installation under certain construction-type contracts. Product revenues for Fiscal 2023 increased approximately 23.8% to $85.1 million, compared to $68.7 million in Fiscal 2022, primarily due to continued strong demand for our sensors. Our circuit board redesign efforts allowed us to ship more sensor units compared to the prior year period, despite supply chain shortages and constraints, particularly in the second half of Fiscal 2023. +Service revenues consist of software, managed services, systems integration, and consulting services revenues. In certain instances, the lack of third-party product availability can impact the timing of systems integration projects and associated revenue recognition. Service revenues for Fiscal 2023 increased approximately 9.4% to $71.0 million, compared to $64.8 million in Fiscal 2022. This increase was primarily due to continued adoption of Iteris' ClearMobility Platform and increased software and managed services revenue. Total annual recurring revenue, which we define as revenues from software and managed services contracts, was approximately 25% of total revenue for Fiscal 2023 and approximately 25% of total revenue for Fiscal 2022. +The Company added approximately $170.3 million of new bookings, or potential revenue under binding agreements, during Fiscal 2023. The Company's total ending backlog increased approximately 14% to approximately $114.2 million as of March 31, 2023, as compared to approximately $99.9 million as of March 31, 2022. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm that are to be earned under our existing agreements, but it does not represent the total contract award if a firm purchase order or task order has not yet been issued under the contract, and are not included in deferred revenue on our balance sheets. Backlog includes new bookings but does not include announced orders for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders, but there can be no assurances we will recognize revenue from bookings or backlog timely or ever. +31 +Table of Contents +Gross Profit. The following tables present details of our gross profit for Fiscal 2023 compared to Fiscal 2022: +Year Ended March 31, +2023 2022 $ Increase (decrease) % Change +(In thousands, except percentage) +Product gross profit $ 22,084 $ 28,228 $ (6,144) (21.8 %) +Service gross profit 19,934 19,165 769 4.0 % +Total gross profit $ 42,018 $ 47,393 $ (5,375) (11.3 %) +Product gross margin as a % of product revenues 26.0 % 41.1 % +Service gross margin as a % of service revenues 28.1 % 29.6 % +Total gross margin as a % of total revenues 26.9 % 35.5 % +Our product gross margin as a percentage of product revenues for Fiscal 2023 decreased approximately 1,510 basis points compared to Fiscal 2022. The decline was primarily due to global supply chain constraints that prevented the Company from sourcing certain electronics components (most notably semiconductors) through traditional channels at normal prices and resulted in approximately $16.0 million higher cost for Fiscal 2023 than otherwise would have occurred. To maintain customer loyalty, increase market penetration, and build buffer stock to reduce future shipping disruptions, the Company sourced various components from electronics brokers (or aftermarket brokers) at significantly elevated prices. The Company saw supply chain improvement in the second half of Fiscal 2023, aided by the release of new circuit board designs containing components more readily available from traditional supplier channels at more reasonable prices. +Our service gross margin as a percentage of service revenues for Fiscal 2023 decreased 150 basis points compared to Fiscal 2022 primarily due to a higher proportion of cost of revenue related to subcontractors and higher costs for data we purchased in the current year. +Our total gross margin as a percentage of total revenues for Fiscal 2023 decreased 860 basis points compared to Fiscal 2022 primarily as a result of the aforementioned reasons. +We plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with both key public-sector and private-sector customers. While we believe our ability to obtain additional large contracts will contribute to overall revenue growth, the mix of subcontractor revenue and third-party product sales to our public-sector customers will likely affect the related total gross profit from period to period, as total revenues derived from subcontractors and third-party product sales generally have lower gross margins than revenues generated by our own products and professional services. +General and Administrative Expense +General and administrative expense for Fiscal 2023 decreased approximately 12% to $22.1 million, compared to $25.1 million in Fiscal 2022 due to restructuring activities and the Company's continued cost control measures. +Sales and Marketing Expense +Sales and marketing expense for Fiscal 2023 increased approximately 20% to $22.8 million, compared to $18.9 million in Fiscal 2022 primarily due to the planned addition of sales and sales support representatives to drive revenue growth, resulting in higher compensation and benefit costs. +Research and Development Expense +Research and development expense for Fiscal 2023 increased approximately 13% to $8.3 million, compared to $7.4 million in Fiscal 2022. The overall increase was primarily due to the continued investment in research and development activities largely focused on improving our existing software related offerings and the re-design of certain circuit boards as part of the Company's supply chain management program. +We plan to continue to invest in the development of further enhancements and new functionality of our Iteris ClearMobility Platform which includes among other things our software portfolio and our Vantage sensors. +Certain development costs were capitalized into intangible assets in the Company's balance sheets in both the current and prior year periods; however, certain development costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our software solutions. This continued +32 +Table of Contents +investment may result in increases in research and development costs, as well as additional capitalized software assets in future periods. +Impairment of Goodwill +Based on our goodwill impairment testing for Fiscal 2023, we believe the carrying value of our goodwill was not impaired, as the estimated fair values of our reporting units exceeded their carrying values. If factors such as our actual financial results, or the plans and estimates used in future goodwill impairment analyses, are lower than our current estimates used to assess impairment of our goodwill, we could incur goodwill impairment charges in the future. +Amortization of Intangible Assets +Amortization expense for intangible assets subject to amortization was approximately $3.2 million for both Fiscal 2023 and Fiscal 2022. Approximately $0.5 million and $0.6 million of the intangible asset amortization was recorded to cost of revenues, and approximately $2.6 million and $2.7 million was recorded to amortization expense for Fiscal 2023 and Fiscal 2022, respectively, in the statements of operations. +Interest Income (Expense), Net +Net interest expense was approximately $0.3 million and $0.0 million in Fiscal 2023 and Fiscal 2022, respectively. The increase in net interest expense in the current year was primarily due to amortization of capitalized deferred financing costs and commitment fees upon termination of our Credit Agreement with Capital One (see Note 12, Long-Term Debt, to the Financial Statements for more information). +Income Taxes +The following table presents our provision for income taxes for Fiscal 2023 and Fiscal 2022: +Year Ended +March 31, +2023 +2022 +(In thousands, +except percentage) +Provision for income taxes $ 135 $ 174 +Effective tax rate (0.9) % (2.5) % +For Fiscal 2023 and Fiscal 2022, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $18.7 million and $14.9 million against our deferred tax assets at March 31, 2023 and 2022, respectively. We will continue to reassess the appropriateness of maintaining a valuation allowance. +As we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. +At March 31, 2023, we had $23.5 million of federal net operating loss carryforwards that do not expire as a result of recent tax law changes. We also had $16.4 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using statutory tax rates. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we +33 +Table of Contents +believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure additional funding on a timely basis, on terms acceptable to us, or at all. +At March 31, 2023, we had $24.8 million in working capital, excluding current liabilities of discontinued operations, which included $16.7 million in cash and cash equivalents. This compares to working capital of $35.2 million at March 31, 2022, which included $23.8 million in cash and cash equivalents. +The following table summarizes our cash flows from continuing operations for Fiscal 2023 and Fiscal 2022: +Year Ended +March 31, +2023 +2022 +(In thousands) +Net cash provided by (used in): +Operating activities $ (4,507) $ (5,593) +Investing activities (1,874) 999 +Financing activities (372) 1,563 +Operating Activities. Net cash used by operating activities of our continuing operations for Fiscal 2023 was $4.5 million and primarily reflects our net loss from continuing operations of approximately $14.9 million, which included $8.9 million of non-cash items including lease expense, depreciation expenses, stock-based compensation, and amortization of intangible assets. Changes in the balances of operating assets and liabilities provided inflows of approximately $1.5 million in total, as the benefit of strong overall working capital management in relation to revenue growth was offset by higher cost of inventory due to supply chain disruption. Net cash used in operating activities due to discontinued operations was $0.3 million. +Net cash used by operating activities of our continuing operations for Fiscal 2022 of $5.6 million was primarily the result of our net loss from continuing operations of approximately $6.9 million, which included $13.1 million of non-cash items including lease expense, depreciation expenses, stock-based compensation, and amortization of intangible assets, coupled with approximately $11.8 million of outflows from changes in working capital. Net cash used in operating activities due to discontinued operations was $0.1 million. +Investing Activities. Net cash used by investing activities of our continuing operations during Fiscal 2023 was primarily the result of approximately $0.5 million of property and equipment purchases, and approximately $1.3 million of capitalized software development costs, primarily in VantageLive! and ClearGuide, respectively. Net cash provided by investing activities from discontinued operations was $0.0 million. +Net cash provided by investing activities of our continuing operations during Fiscal 2022 was primarily the result of approximately $3.1 million in proceeds from the sale and maturity of short-term investments which were partially offset by approximately $0.5 million of property and equipment purchases, and approximately $1.6 million of capitalized software development costs, primarily in VantageLive! and ClearGuide, respectively. Net cash provided by investing activities from discontinued operations was $1.5 million. +Financing Activities. Net cash used by financing activities of our continuing operations during Fiscal 2023 was primarily the result of approximately $0.1 million and $0.5 million of cash proceeds from the exercise of stock options and purchases of Employee Stock Purchase Plan ("ESPP") shares, respectively which were offset by repurchases of common stock of approximately $0.9 million. +Net cash provided by financing activities of our continuing operations during Fiscal 2022 was primarily the result of approximately $1.3 million and $0.4 million of cash proceeds from the exercise of stock options and purchases of ESPP shares, respectively. +Off-Balance Sheet Arrangements +We do not have any other material off-balance sheet arrangements at March 31, 2023. +Seasonality +34 +Table of Contents +We have historically experienced seasonality, particularly with respect to our products, which adversely affects such sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally impacted the most by inclement weather. We have also experienced seasonality, which adversely impacts our third fiscal quarter due to the increased number of holidays, causing a reduction in available billable hours. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item. +35 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Financial Statement +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +37 +Balance Sheets as of March 31, 2023 and 2022 +39 +Statements of Operations for the fiscal years ended March 31, 2023 and 2022 +40 +Statements of Stockholders' Equity for the fiscal years ended March 31, 2023 and 2022 +41 +Statements of Cash Flows for the fiscal years ended March 31, 2023 and 2022 +42 +Notes to Financial Statements +43 +36 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on the Financial Statements +We have audited the accompanying balance sheets of Iteris, Inc. (the "Company") as of March 31, 2023 and 2022, the related statements of operations, stockholder's equity, and cash flows, for each of the two years in the period ended March 31, 2023, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2023 and 2022, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 2023, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of March 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 29, 2023, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue from Contracts with Customers – Determination of Distinct Performance Obligations Relating to Service Revenues – Refer to Note 1 of the financial statements +Critical Audit Matter Description +The Company's service revenues within the Services and Software revenue streams, primarily derive revenue from long-term engineering & consulting services and software as a service ("SaaS"). The Company accounts for individual services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the services, the solution provided and the structure of the sales contract. During the year ended March 31, 2023, the Company recognized service revenues from contracts with customers of $71.0 million. +We identified the determination of distinct performance obligations in contracts with customers relating to service revenues as a critical audit matter. Significant judgment is required to determine whether the performance obligations in these sales contracts are distinct; that is, if a service is separately identifiable from other items in the sales contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer. Auditing these aspects include especially challenging auditor judgment due to the nature and extent of audit effort required to address this matter. +How the Critical Audit Matter was Addressed in the Audit +Our audit procedures related to the Company’s determination of distinct performance obligations relating to service revenues for these contracts included the following, among others: +37 +Table of Contents +· We tested the effectiveness of controls related to management’s identification and assessment of distinct performance obligations in contracts with customers. +· We selected a sample of customer contracts to evaluate the appropriateness of management’s determination of distinct performance obligations. +· We selected a sample of invoices and determined whether amounts invoiced were in accordance with the related contract terms. Further, we inspected line items on the invoice to verify that all line items were included in management's evaluation of performance obligations. +· We selected a sample of customer contracts and investigated changes in current forecasted cost to original forecasted cost to evaluate if changes in estimate are indicative of existing services known by operations personnel, but not previously considered as distinct performance obligations by management. +· We investigated offsets to revenue to determine that they represent a valid purpose and a service was not previously unidentified. +· We selected a sample of expenditures and determined whether the service represented by the selected transaction was properly identified and evaluated by management as a distinct performance obligation. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 29, 2023 +We have served as the Company's auditor since 2016. +38 +Table of Contents +Iteris, Inc. +Balance Sheets +(In thousands, except par value) +March 31, +2023 2022 +Assets +Current assets: +Cash and cash equivalents $ 16,587 $ 23,689 +Restricted cash 140 120 +Trade accounts receivable, net of allowance for doubtful accounts of $ 357 and $ 903 at March 31, 2023 and 2022, respectively +23,809 25,628 +Unbilled accounts receivable 8,349 8,470 +Inventories 10,841 7,980 +Prepaid expenses and other current assets 3,128 4,076 +Total current assets 62,854 69,963 +Property and equipment, net 1,297 1,392 +Right-of-use assets 8,345 11,382 +Intangible assets, net 10,190 11,780 +Goodwill 28,340 28,340 +Other assets 768 1,120 +Noncurrent assets of discontinued operations — 6 +Total assets $ 111,794 $ 123,983 +Liabilities and stockholders' equity +Current liabilities: +Trade accounts payable $ 12,943 $ 11,926 +Accrued payroll and related expenses 12,923 11,409 +Accrued liabilities 5,453 5,623 +Deferred revenue 6,720 5,779 +Current liabilities of discontinued operations — 163 +Total current liabilities 38,039 34,900 +Lease liabilities 7,641 10,763 +Deferred income taxes 422 337 +Unrecognized tax benefits 79 105 +Other long-term liabilities 2,707 2,456 +Noncurrent liabilities of discontinued operations — 172 +Total liabilities 48,888 48,733 +Commitments and contingencies (Note 6) +Stockholders' equity: +Preferred stock, $ 1.00 par value: +Authorized shares— 2,000 +— — +Issued and outstanding shares— none +— — +Common stock, $ 0.10 par value: +Authorized shares—Authorized shares— 70,000 at March 31, 2023 and March 31, 2022 +Issued and outstanding shares— 42,808 at March 31, 2023 and 42,416 at March 31, 2022 +4,282 4,242 +Treasury Stock ( 891 ) — +Additional paid-in capital +190,082 186,720 +Accumulated deficit ( 130,567 ) ( 115,712 ) +Total stockholders' equity 62,906 75,250 +Total liabilities and stockholders' equity $ 111,794 $ 123,983 +See accompanying Notes to the Financial Statements. +39 +Table of Contents +Iteris, Inc. +Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2023 2022 +Product revenues $ 85,097 $ 68,729 +Service revenues 70,955 64,843 +Total revenues 156,052 133,572 +Cost of product revenues 63,013 40,501 +Cost of service revenues 51,021 45,678 +Cost of revenues 114,034 86,179 +Gross profit 42,018 47,393 +Operating expenses: +General and administrative 22,083 25,131 +Sales and Marketing 22,802 18,929 +Research and development 8,321 7,354 +Amortization of intangible assets 2,620 2,673 +Restructuring charges 707 — +Total operating expenses 56,533 54,087 +Operating income (loss) ( 14,515 ) ( 6,694 ) +Non-operating income (expense): +Other income (expense) 124 ( 18 ) +Interest income (expense) ( 329 ) ( 14 ) +Income (loss) from continuing operations before income taxes ( 14,720 ) ( 6,726 ) +Provision for income taxes ( 135 ) ( 174 ) +Net income (loss) from continuing operations ( 14,855 ) ( 6,900 ) +Loss from discontinued operations before gain on sale, net of tax — ( 180 ) +Net income (loss) from discontinued operations, net of tax — ( 180 ) +Net income (loss) $ ( 14,855 ) $ ( 7,080 ) +Income (loss) per share - basic: +Income (loss) per share from continuing operations $ ( 0.35 ) $ ( 0.16 ) +Income per share from discontinued operations $ 0.00 $ 0.00 +Net income (loss) per share $ ( 0.35 ) $ ( 0.16 ) +Income (loss) per share - diluted: +Income (loss) per share from continuing operations $ ( 0.35 ) $ ( 0.16 ) +Income per share from discontinued operations $ 0.00 $ 0.00 +Net income (loss) per share $ ( 0.35 ) $ ( 0.16 ) +Shares used in basic per share calculations 42,374 42,222 +Shares used in diluted per share calculations 42,374 42,222 +See accompanying Notes to the Financial Statements. +40 +Table of Contents +Iteris, Inc. +Statements of Stockholders' Equity +(In thousands) +Common Stock Treasury Stock Additional +Paid-In +Capital Accumulated +Deficit Total +Stockholders' +Equity +Shares Amount Shares Amount +Balance at March 31, 2021 (as previously reported) 41,687 4,170 — — 181,828 ( 107,019 ) 78,979 +Correction (Note 1) — — — — — ( 1,613 ) ( 1,613 ) +Balance at March 31, 2021 (as corrected) 41,687 4,170 — — 181,828 ( 108,632 ) 77,366 +Stock option exercises 489 48 — — 1,282 — 1,330 +Issuance of shares pursuant to Employee Stock Purchase Plan 95 9 — — 427 — 436 +Stock-based compensation — — — — 3,401 — 3,401 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 145 15 — — ( 218 ) — ( 203 ) +Net loss — — — — — ( 7,080 ) ( 7,080 ) +Balance at March 31, 2022 42,416 4,242 — — 186,720 ( 115,712 ) 75,250 +Stock option exercises 60 7 — — 98 — 105 +Issuance of shares pursuant to Employee Stock Purchase Plan 180 19 — — 471 — 490 +Stock-based compensation — — — — 2,890 — 2,890 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 152 14 — — ( 97 ) — ( 83 ) +Treasury stock purchases — — 300 ( 884 ) — — ( 884 ) +Deferred shares held within rabbi trust — — 69 ( 7 ) — — ( 7 ) +Net loss — — — — — ( 14,855 ) ( 14,855 ) +Balance at March 31, 2023 42,808 $ 4,282 369 $ ( 891 ) $ 190,082 $ ( 130,567 ) $ 62,906 +See accompanying Notes to the Financial Statements. +41 +Table of Contents +Iteris, Inc. +Statements of Cash Flows +(In thousands) +Year Ended March 31, +2023 2022 +Cash flows from operating activities +Net income (loss) $ ( 14,855 ) $ ( 7,080 ) +Less: Net income (loss) from discontinued operations — ( 180 ) +Net income (loss) from continuing operations ( 14,855 ) ( 6,900 ) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Project Loss — 3,394 +Right-of-use asset non-cash expense 2,114 2,515 +Deferred income tax 59 ( 485 ) +Depreciation of property and equipment 615 820 +Stock-based compensation 2,890 3,401 +Amortization of intangible assets 3,179 3,240 +Loss on disposal of equipment 8 177 +Other ( 7 ) — +Changes in operating assets and liabilities, net of effects of discontinued operations and acquisitions: +Trade accounts receivable 1,819 ( 6,608 ) +Unbilled accounts receivable and deferred revenue 1,385 148 +Inventories ( 2,861 ) ( 2,914 ) +Prepaid expenses and other assets 1,300 ( 2,495 ) +Trade accounts payable and accrued expenses 1,253 2,683 +Operating lease liabilities ( 1,406 ) ( 2,569 ) +Net cash provided by (used in) operating activities - continuing operations ( 4,507 ) ( 5,593 ) +Net cash used in operating activities - discontinued operations ( 329 ) ( 128 ) +Net cash provided by (used in) in operating activities ( 4,836 ) ( 5,721 ) +Cash flows from investing activities +Purchases of property and equipment ( 528 ) ( 466 ) +Maturities of investments — 3,100 +Capitalized software development costs ( 1,346 ) ( 1,635 ) +Net cash provided by (used in) investing activities - continuing operations ( 1,874 ) 999 +Net cash provided by investing activities - discontinued operations — 1,500 +Net cash provided by (used in) investing activities ( 1,874 ) 2,499 +Cash flows from financing activities +Repurchases of common stock ( 884 ) — +Proceeds from stock option exercises 105 1,330 +Proceeds from ESPP purchases 490 436 +Tax withholding payments for net share settlements of restricted stock units ( 83 ) ( 203 ) +Net cash provided by (used in) financing activities - continuing operations ( 372 ) 1,563 +Net cash provided by (used in) financing activities ( 372 ) 1,563 +Increase (decrease) in cash, cash equivalents and restricted cash ( 7,082 ) ( 1,659 ) +Cash, cash equivalents and restricted cash at beginning of period 23,809 25,468 +Cash, cash equivalents and restricted cash at end of period $ 16,727 $ 23,809 +Supplemental cash flow information: +Cash paid during the year for: +Income taxes $ — $ 223 +Supplemental schedule of non-cash investing and financing activities: +Issuance of common stock for vested restricted stock units $ 14 $ 15 +Lease liabilities arising from obtaining right-of-use assets $ 313 $ 2,544 +Capitalized software development costs $ 243 $ — +See accompanying Notes to the Financial Statements. +42 +Table of Contents +Iteris, Inc. +Notes to Financial Statements +March 31, 2023 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to collectively in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services, and cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced sensors, mobility intelligence software, mobility data sets, mobility consulting services and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the “Pandemic”) materially adversely impacted global economic conditions. As COVID-19 has entered an endemic stage, COVID-19 may continue to have an unpredictable and unprecedented impact on the global economy, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. +Given the uncertainties surrounding the impacts of COVID-19 on the Company's future financial condition and results of operations, we have and may continue to identify and execute various actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions include, but are not limited to, reducing discretionary spending, reducing capital expenditures, and implementing restructuring activities (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate the impact of component shortages, we increased inventory levels for parts in short supply. In the event demand does not materialize, we would need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components, even from third-party brokers, at any price, to meet customer demand, resulting in high levels of backlog that we are unable to ship. The Company's tactics to mitigate the current global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and by accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 ("Fiscal 2023"). We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. +Due to the supply chain environment, the Company increased inventory by approximately $ 2.9 million as part of the Company’s supply chain strategy for Fiscal 2023. The cash flow used in operating activities of our continuing operations was approximately $ 4.5 million during the twelve months ended March 31, 2023. Cash used during Fiscal 2023 was primarily due to two factors. First, the planned increase in inventory during the first half of Fiscal 2023 and continued re-design of certain circuit boards as part of the Company’s supply chain strategy to help assure the Company has enough product to satisfy +Table of Contents +customer demand. Second, the net operating loss as a result of higher inventory component costs related to the global supply chain constraints. The increase in inventory purchases and in particular components purchased in the secondary markets was curtailed in the second half of Fiscal 2023, and the Company currently does not expect to continue to accumulate inventory, in the same magnitude, in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to have sufficient liquidity. +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company applied certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. As of March 31, 2023, the Company had repaid all amounts deferred under the CARES Act (see Note 5, Income Taxes , to the Financial Statements for more information). +COVID-19 has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility has remained open throughout the Pandemic, many of our employees worked remotely during the past three years. With the recent easing of COVID-19 restrictions imposed by local and state authorities, a larger portion of our workforce has returned to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. Additionally, we have been able to timely file financial reports. We believe we have the infrastructure to efficiently work remotely during COVID-19's current endemic stage and well into the future. +The Company assessed the impacts of COVID-19 on the estimates and assumptions used in preparing our financial statements. The estimates and assumptions used in our assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of COVID-19, which has entered an endemic stage, and its resulting impact on global economic conditions. If economic conditions caused by COVID-19 do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. The Company will continue to assess the effect on its operations by monitoring the impact of COVID-19 and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of COVID-19 may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business. +On May 6, 2022, approximately $ 0.9 million was paid to settle the balance of security hold back agreed to as part of the acquisition, net of approximately $ 0.1 million of post-closing adjustments. As of March 31, 2023, the achievement levels of the revenue targets with respect to the earnout were resolved and the balance remaining of approximately $ 0.6 million was accrued in accordance with the terms of the agreement. This item is included in accrued liabilities on the balance sheets. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that provided Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business used to support its real-time and predictive travel data and associated content until termination of these agreements on December 6, 2022. +Restructuring Activities +To help offset recent increases in supply chain costs, on May 12, 2022, the Board of Directors of Iteris, Inc. approved additional restructuring activities to better position the Company for increased profitability and growth. The Company incurred employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Basis of Presentation +Our financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP"). +Use of Estimates +The preparation of financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the +Table of Contents +date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Significant estimates made in the preparation of the financial statements include, but are not limited to, recoverability of long-lived and intangible assets; fair value of acquired intangible assets and goodwill; estimates of future cash flows used to assess the recoverability of the impairment of goodwill; collectability of accounts receivable and related allowance for doubtful accounts; projections of taxable income used to assess realizability of deferred tax assets; warranty reserves; costs to complete long-term contracts; indirect cost rates used in cost plus contracts; fair value of stock option awards and equity instruments; fair value of contingent consideration and capitalization and estimated useful life of the Company's internal-use software development costs. Estimates are based on historical experience and on various assumptions that the Company believes are reasonable under current circumstances. However, future events are subject to change and best estimates and judgments may require further adjustments, therefore, actual results could differ materially from those estimates. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. +Revenue Recognition +Revenues are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenue from contracts with customers, ranging from multi-year agreements to purchase orders. +Product revenue related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase orders are generally short-term in nature. Product revenue is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues sometimes consist of revenues derived from maintenance support and the use of the Company’s service platforms and Application Programming Interfaces ("APIs") on a subscription basis. We generate this revenue from fees for maintenance and support, monthly active user fees, SaaS fees, and hosting and storage fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprised of a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services in these situations as the customer obtains equal benefit from the service throughout the service period. +Service revenues are also derived from long-term engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. For fixed fee contracts, we recognize revenue over time using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportional cost incurred closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Other contracts can be based on a Time & Materials (“T&M”) and Cost Plus Fixed Fee (“CPFF”) structure, where such contracts are considered to involve variable consideration. However, contractual performance obligations with these fee types qualify for the “Right to Invoice” practical expedient. Under this practical expedient, the Company is allowed to recognize revenue, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company’s performance completed to date. +The Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer that combines the software functionality, maintenance and hosting into a single performance obligation. In product-related contracts, a purchase order may cover different products, each constituting a separate performance obligation. +The Company's typical performance obligations include the following: +Table of Contents +Performance Obligation When Performance +Obligation is Typically +Satisfied When Payment is +Typically Due How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product Upon shipment (point in time) Within 30 days of delivery Observable transactions +Engineering services where the deliverable is considered a product As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +Service Revenues +Engineering, managed services, and consulting services As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +SaaS Over the course of the SaaS service once the system is available for use (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Extended warranty service Over the course of the extended warranty period (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Disaggregation of Revenue +The Company disaggregates revenue from contracts with customers into product revenues and services revenues. +Trade Accounts Receivable and Contract Balances +We classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e., only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in the accompanying balance sheet at their net estimated realizable value. +The Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. If warranted, the allowance is increased by the Company's provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are deducted from the allowance. +A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable in the accompanying balance sheet. For example, we would record a contract asset if we record revenue on a professional services engagement, but are not entitled to bill until we achieve specified milestones. +Our contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The Company evaluates whether or not we should capitalize the costs of fulfilling a contract. Such costs would be capitalized when they are not within the scope of other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be recovered. As of March 31, 2023 and 2022, there was approximately $ 0.5 million and $ 0.6 million, respectively, of contract fulfillment costs which are presented in the accompanying balance sheets as prepaid and other current assets. These costs primarily relate to the satisfaction of performance obligations related to the set-up of SaaS platforms. These costs are amortized on a straight-line basis over the estimated useful life of the SaaS platform. +A contract loss is recorded if the expected costs of fulfilling the contract exceeds the expected consideration from the customer. During the twelve months ended March 31, 2022, due to delays in the completion of a software development contract with a customer, the Company recorded an estimated loss on the contract of approximately $ 3.4 million, charged to cost of sales, of which approximately $ 0.9 million related to previously capitalized software development costs and the remainder reduced the balance of the related contract fulfillment costs. The terms of the contract have since been amended to a time and materials structure, and no further additional contract losses are expected for this contract. During the twelve months ended March 31, 2023, no amounts were recorded for contract losses. The estimates and assumptions used in these assessments were based upon management's judgment and may be subject to change as new events occur and additional information is obtained. If the future estimated costs to fulfill a contract exceed the expected consideration from the customer, the Company's financial condition, cash flows, and results of operations may be materially impacted. +Transaction Price Allocated to the Remaining Performance Obligations +Table of Contents +As of March 31, 2023 and 2022, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial, primarily as a result of termination provisions within our contracts, which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. +The Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have recognized is one year or less. +The Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping and handling costs are included as cost of revenues in the period during which the products ship. +The Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net basis (excluded from revenues) in the accompanying statements of operations. +Deferred Revenue +Deferred revenue in the accompanying balance sheets is comprised of billings and consideration received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade accounts receivable. +Cash and cash equivalents consist primarily of demand deposits and money market funds maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal credit risk. Accounts at each institution are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $250,000. As of March 31, 2023, the Company had approximately $ 16.2 million of deposits at financial institutions in excess of the FDIC insured limit. +Our accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, South America and Asia. We generally do not require collateral or other security from our domestic customers. We maintain an allowance for doubtful accounts for potential credit losses, which losses have historically been within management's expectations. +We currently have, and historically have had, a diverse customer base. For Fiscal 2023 and the fiscal year ended March 31, 2022 ("Fiscal 2022"), no individual customer represented greater than 10 % of our total revenues. As of March 31, 2023 and 2022, no individual customer represented greater than 10 % of our total accounts receivable. +Fair Values of Financial Instruments +The accounting guidance provided in ASC 820, Fair Value Measurements ("ASC 820") for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit +Table of Contents +price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows: +Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date. +Level 2—Observable inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the assets or liabilities. +The Company applies fair value accounting for all financial instruments on a recurring basis. The Company's financial instruments, which include cash, cash equivalents, accounts receivable and accounts payable are recorded at their carrying amounts, which approximate their fair values due to their short-term nature. All marketable securities are considered to be available-for-sale and recorded at their estimated fair values. In valuing these items, the Company uses inputs and assumptions that market participants would use to determine their fair value, utilizing valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. +Cash, Cash Equivalents and Restricted Cash +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +As of March 31, 2023 and 2022 restricted cash was $ 0.1 million and $ 0.1 million, respectively, related to cash restricted for shares purchased under the Employee Stock Purchase Plan ("ESPP") (see Note 9, Employee Benefit Plans , to the Financial Statements for more information). +Cash, cash equivalents and restricted cash presented in the accompanying statements of cash flows consist of the following (in thousands): +March 31, +2023 2022 +Cash and cash equivalents $ 16,587 $ 23,689 +Restricted cash 140 120 +$ 16,727 $ 23,809 +Accounts Receivable and Allowance for Doubtful Accounts +Accounts receivable are recorded net of the allowance for doubtful accounts. The allowance for doubtful accounts is estimated based on the Company's assessment of its ability to collect on customer accounts receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our customers' financial condition. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. The Company writes-off accounts receivable against the allowance when a determination is made that the balance is uncollectible and collection of the receivable is no longer being actively pursued. The allowance for doubtful accounts was approximately $ 0.4 million and $ 0.9 million as of March 31, 2023 and 2022, respectively. +Inventories +Inventories consist of raw materials, work-in-process and finished goods and are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life of the related assets ranging from three to eight years . Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Table of Contents +Intangible Assets +Intangible assets with determinable economic lives are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful life of each asset on a straight-line basis. The Company determines the useful lives of identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. When determining useful life, the Company considers the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset and other economic factors, including competition and specific market conditions. Intangible assets without determinable economic lives are carried at cost, not amortized and reviewed for impairment at least annually. +Goodwill +Goodwill represents the excess of the aggregate purchase price over the fair value of net identifiable assets acquired in a business combination. Goodwill is not amortized and is tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In the valuation of goodwill, management must make assumptions regarding estimated future cash flows to be derived from the Company's business. If these estimates or their related assumptions change in the future, the Company may be required to record impairment for these assets. +The Company has the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value. However, the Company may elect to bypass the qualitative assessment and proceed directly to the quantitative impairment tests. The first step of the impairment test involves comparing the fair value of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, the Company would perform the second step of the goodwill impairment test to determine the amount of the impairment loss. We perform an annual quantitative assessment of our goodwill during the fourth fiscal quarter, or more frequently, to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further testing is required. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the amount by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. We monitor the indicators for goodwill impairment testing between annual tests. In prior years the Company had two operating and reportable segments, Roadway Sensors ("RWS") and Transportation Systems ("SYS"), which also represented the reporting units for purposes of goodwill impairment testing. In Fiscal 2021, the Company underwent a reorganization after which the Company also reassessed the reporting unit conclusion and determined that there are three reporting units and a single operating and reportable segment . As of March 31, 2023, there were no indicators of goodwill impairment. +Impairment of Long-Lived Assets +The Company evaluates its long-lived assets, including property, equipment and intangible assets (other than goodwill) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We determine whether the carrying value of an asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. During the twelve months ended March 31, 2022, approximately $ 0.9 million of previously capitalized software development costs was charged to cost of sales due to the expected modification of a contract with a customer. See discussion on contract fulfillment costs for further details. During the fiscal years ended March 31, 2023 and 2022, there was no additional impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. As such, we determined it was appropriate to maintain a full valuation allowance against our deferred tax assets for the fiscal years ended March 31, 2023 and 2022. We will continuously reassess the appropriateness of our valuation allowance. +Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in +Table of Contents +which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +Stock-Based Compensation +We record stock-based compensation in our statements of operations as an expense, based on the estimated grant date fair value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards are currently comprised of common stock options, restricted stock units and performance stock units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. The fair value of our performance stock unit awards is estimated on the grant date using a Monte Carlo simulation model. While the use of these models meets established requirements, the estimated fair values generated by the models may not be indicative of the actual fair values of our awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +Research and development expenditures are charged to expense in the period incurred. +Shipping and Handling Costs +Shipping and handling costs are included as cost of revenues in the period during which the products ship. +Sales Taxes +Sales taxes are presented on a net basis (excluded from revenues) in the statements of operations. +Right-of-Use Assets and Lease Liabilities +We determine if an arrangement contains a lease at inception and determine the classification of the lease, as either operating or finance, at commencement. +Right-of-use assets and lease liabilities are recorded based on the present value of future lease payments which factors in certain qualifying initial direct costs incurred as well as any lease incentives received. If an implicit rate is not readily determinable, we utilize inputs from third-party lenders to determine the appropriate discount rate. Lease expense for operating lease payments are recognized on a straight-line basis over the lease term. Finance leases incur interest expense using the effective interest method in addition to amortization of the leased asset on straight-line basis, both over the applicable lease term. Lease terms may factor in options to extend or terminate the lease. +We adhere to the short-term lease recognition exemption for all classes of assets (i.e., facilities and equipment). As a result, leases with an initial term of twelve months or less are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. In addition, for certain equipment leases, we account for lease and non-lease components, such as services, as a single lease component as permitted. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to various original equipment manufacturer customers sometimes carry longer warranties. Defective products will be either repaired or replaced, usually at our option, upon meeting certain criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of product revenues at the time revenue for that product is recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying balance sheets. We do not provide any service-type warranties. +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and maintenance costs are charged to expense as incurred. +Table of Contents +Comprehensive Income (Loss) +The difference between net income (loss) and comprehensive income (loss) was de minimis for Fiscal 2023 and Fiscal 2022. +Recent Accounting Pronouncements +In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This update requires that certain financial assets be measured at amortized cost net of an allowance for estimated credit losses such that the net receivable represents the present value of expected cash collection. In addition, this standard update requires that certain financial assets be measured at amortized cost reflecting an allowance for estimated credit losses expected to occur over the life of the assets. The estimate of credit losses must be based on all relevant information including historical information, current conditions and reasonable and supportable forecasts that affect the collectability of the amounts. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which defers the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting companies that are not smaller reporting companies. As a smaller reporting company, ASU 2016-13 will now be effective for our fiscal year 2024 beginning April 1, 2023; however, early adoption is permitted. We are currently evaluating the timing and impact of adopting ASU 2016-13 on our financial statements. +Immaterial Correction of Prior Period Financial Statements +Subsequent to the issuance of the financial statements for the year ended March 31, 2022, we identified misstatements in Unbilled accounts receivable and Deferred revenue related to contract activity prior to the fiscal year ended March 31, 2021. As described in Note 1, Description of Business and Summary of Significant Accounting Policies , to the Financial Statements, under the heading Trade Accounts Receivable and Contract Balances , contract assets and refund liabilities arise from time-to-time based on the difference in timing between the satisfaction of performance obligations and the receipt of consideration thereunder. Such misstatements relate to balances for contract assets and refund liabilities we determined should have previously been eliminated based on a combination of contract age and cessation of activity associated with certain contracts. +The Company evaluated the materiality of the errors both quantitatively and qualitatively in accordance with Staff Accounting Bulletin (“SAB”) No. 99 – Materiality , and SAB No. 108 – Considering the Effects of Prior Period Misstatements When Quantifying Misstatements in Current Year Financial Statements and determined the effect of the misstatements were not material to the previously issued financial statements. We determined to restate the accompanying financial statements as of and for the year ended March 31, 2022 to correct for this matter. +The cumulative impact of the corrections is shown in the tables below. Because these corrections occurred at a time preceding the periods presented herein, all corrections are limited to the balance sheet as shown below. +Table of Contents +Balance Sheet (in thousands): +March 31, 2022 +As Previously Reported Correction As Corrected +Assets +Current assets: +Unbilled accounts receivable $ 10,870 $ ( 2,400 ) $ 8,470 +Total current assets $ 72,363 $ ( 2,400 ) $ 69,963 +Total assets $ 126,383 $ ( 2,400 ) $ 123,983 +Liabilities and stockholders' equity +Current liabilities: +Deferred revenue $ 6,566 $ ( 787 ) $ 5,779 +Total current liabilities $ 35,687 $ ( 787 ) $ 34,900 +Total liabilities $ 49,520 $ ( 787 ) $ 48,733 +Stockholders' equity: +Accumulated deficit $ ( 114,099 ) $ ( 1,613 ) $ ( 115,712 ) +Total stockholders' equity $ 76,863 $ ( 1,613 ) $ 75,250 +Total liabilities and stockholders' equity $ 126,383 $ ( 2,400 ) $ 123,983 +The associated correction to the net operating losses and valuation allowance components of deferred tax assets as of March 31, 2022 are reflected in Note 5, Income Taxes, to the Financial Statements, which had no net impact to deferred tax assets. +2. Supplementary Financial Information +Inventories, net +The following table presents details regarding our inventories, net: +March 31, +2023 2022 +(In thousands) +Raw materials $ 7,840 $ 5,680 +Work in process 315 200 +Finished goods 2,686 2,100 +$ 10,841 $ 7,980 +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2023 2022 +(In thousands) +Equipment $ 6,359 $ 6,825 +Leasehold improvements 824 3,117 +Accumulated depreciation ( 5,886 ) ( 8,550 ) +$ 1,297 $ 1,392 +Depreciation expense was approximately $ 0.6 million and $ 0.8 million in Fiscal 2023 and Fiscal 2022, respectively. Approximately $ 0.2 million and $ 0.2 million of the depreciation expense was recorded to cost of revenues, and approximately $ 0.4 million and $ 0.6 million was recorded to operating expenses in Fiscal 2023 and Fiscal 2022, respectively, in the accompanying statements of operations. +Intangible Assets, net +Table of Contents +The following table presents details regarding our intangible assets, net: +March 31, 2023 March 31, 2022 +Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value +(In thousands) +Technology $ 4,986 $ ( 3,444 ) $ 1,542 $ 4,986 $ ( 2,519 ) $ 2,467 +Customer contracts / relationships 9,550 ( 4,371 ) 5,179 9,550 ( 2,959 ) 6,591 +Trade names and non-compete agreements +782 ( 770 ) 12 782 ( 753 ) 29 +Capitalized software development costs +7,489 ( 4,032 ) 3,457 5,900 ( 3,207 ) 2,693 +Total $ 22,807 $ ( 12,617 ) $ 10,190 $ 21,218 $ ( 9,438 ) $ 11,780 +Amortization expense for intangible assets subject to amortization was approximately $ 3.2 million and $ 3.2 million for Fiscal 2023 and Fiscal 2022, respectively. Approximately $ 0.5 million and $ 0.6 million of the intangible asset amortization was recorded to cost of revenues, and approximately $ 2.6 million and $ 2.7 million was recorded to amortization expense for Fiscal 2023 and Fiscal 2022, respectively, in the statements of operations. The weighted average remaining useful lives of the intangible assets as of March 31, 2023 is 3.4 years. +We have one indefinite useful life intangible asset, with de minimis carrying value, which was included in trade names and non-compete agreements. Our net customer contracts/relationships have a useful life of 6 years. Our net trade names and non-compete agreements have a useful life of 3 years. Our net capitalized software development costs of approximately $ 3.5 million and $ 2.7 million primarily consisted of our Oracle Enterprise Resource Planning system design and implementation of approximately $ 1.1 million and $ 1.4 million as of March 31, 2023 and 2022, respectively, which has a useful life of 10 years. +As of March 31, 2023, the future estimated amortization expense is as follows: +Year Ending March 31, +(In thousands) +2024 3,550 +2025 3,070 +2026 1,845 +2027 1,095 +2028 618 +Thereafter — +$ 10,178 +The future estimated amortization expense does not include the indefinite useful life intangible asset described above. +Goodwill +The following table presents the carrying value of our goodwill for Fiscal 2023 and Fiscal 2022: +Table of Contents +Total +Balance—March 31, 2023 +Goodwill $ 36,310 +Acquired goodwill — +Accumulated impairment losses ( 7,970 ) +$ 28,340 +Balance—March 31, 2022 +Goodwill $ 36,310 +Acquired goodwill — +Accumulated impairment losses ( 7,970 ) +$ 28,340 +Warranty Reserve Activity +The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2023 2022 +(In thousands) +Balance at beginning of fiscal year $ 616 $ 569 +Additions charged to cost of revenues 343 238 +Warranty claims ( 201 ) ( 191 ) +Balance at end of fiscal year $ 758 $ 616 +Earnings Per Share +The following table sets forth the computation of basic and diluted income (loss) from continuing operations per share: +Year Ended March 31, +2023 2022 +(In thousands, except per +share amounts) +Numerator: +Net income (loss) from continuing operations $ ( 14,855 ) $ ( 6,900 ) +Net income (loss) from discontinued operations, net of tax — ( 180 ) +Net income (loss) $ ( 14,855 ) $ ( 7,080 ) +Denominator: +Weighted average common shares used in basic computation 42,374 42,222 +Dilutive stock options — — +Weighted average common shares used in diluted computation 42,374 42,222 +Basic: +Net income (loss) per share from continuing operations: $ ( 0.35 ) $ ( 0.16 ) +Net income (loss) per share from discontinued operations: $ — $ — +Net income (loss) per basic share $ ( 0.35 ) $ ( 0.16 ) +Diluted: +Net income (loss) per share from continuing operations: $ ( 0.35 ) $ ( 0.16 ) +Net income (loss) per share from discontinued operations: $ — $ — +Net income (loss) per diluted share $ ( 0.35 ) $ ( 0.16 ) +Table of Contents +The following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted income (loss) per share from continuing operations as their effect would have been anti-dilutive for the years ended March 31, 2023 and 2022: +Year Ended March 31, +2023 2022 +(In thousands) +Stock options 5,886 3,857 +Restricted stock units 457 386 +3. Restructuring Activities +On May 12, 2022, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. During the twelve months ended March 31, 2023, the Company incurred approximately $ 0.7 million related to employee separation costs in relation to these activities which were included in restructuring charges on the unaudited condensed statement of operations. +As of March 31, 2023, we had accrued approximately $ 0.2 million for severance and benefits related to the restructuring activities in accrued payroll and related expenses in the accompanying balance sheet. Our restructuring activities during Fiscal 2023 were as follows (in thousands): +Balance at March 31, 2022 $ — +Charged to expenses 707 +Cash payments ( 465 ) +Balance at March 31, 2023 $ 242 +4. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a three tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets and liabilities; Level 2, defined as observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities or prices quoted in inactive markets; and Level 3, defined as unobservable inputs that are significant to the fair value of the asset or liability, and for which little or no market data exists, therefore requiring management to utilize its own assumptions to provide its best estimate of what market participants would use in valuing the asset or liability. +We did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2023 or 2022. Our non-financial assets, such as goodwill, intangible assets, property and equipment, securities held in the deferred compensation plan and the liabilities associated with the deferred compensation plan, and acquired assets and liabilities assumed are measured at fair value on a non-recurring basis, generally when there is a transaction involving those assets. In Fiscal 2023 and Fiscal 2022, Level 3 inputs were used to evaluate the goodwill of the Company. In Fiscal 2022, Level 3 inputs were used to evaluate the fair value of the contingent consideration related to the acquisition of TrafficCast. As of March 31, 2023, the inputs related to determination of the balance of the earnout were resolved and the final balance due of $ 0.6 million was accrued in accordance with the terms of the agreement. Accordingly, as of March 31, 2023, there were no items measured at fair value with Level 3 inputs. No other non-financial assets were measured at fair value as of March 31, 2023 and March 31, 2022. +The following tables present the Company's financial assets and liabilities that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +Table of Contents +As of March 31, 2023 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +Assets: (In thousands) +Level 1: +Securities held in deferred compensation plan (1) +$ 1,426 $ ( 437 ) $ 321 $ 1,310 +Total $ 1,426 $ ( 437 ) $ 321 $ 1,310 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) $ 1,201 $ ( 296 ) $ 563 $ 1,468 +Level 3: +Contingent Consideration (3) $ 600 $ — $ — $ 600 +Transfers out (3) ( 600 ) — — ( 600 ) +Subtotal — — — — +Total $ 1,201 $ ( 296 ) $ 563 $ 1,468 +As of March 31, 2022 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +(In thousands) +Level 1: +Money market funds $ 71 $ — $ — $ 71 +Securities held in deferred compensation plan (1) 998 ( 106 ) 73 965 +Subtotal 1,069 ( 106 ) 73 1,036 +Level 2: +Commercial paper 7,499 — — 7,499 +Corporate notes and bonds — — — — +US treasuries 7,798 — — 7,798 +Subtotal 15,297 — — 15,297 +Total $ 16,366 $ ( 106 ) $ 73 $ 16,333 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) $ 1,013 $ ( 106 ) $ 72 $ 979 +Level 3: +Contingent consideration (3) $ 600 $ — $ — $ 600 +Total $ 1,613 $ ( 106 ) $ 72 $ 1,579 +(1) Included in prepaid expenses and other current assets on the Company’s balance sheet. +(2) Included in accrued payroll and related expenses on the Company’s balance sheet. +(3) As of March 31, 2022, the short-term portion of the balance of contingent consideration was included in accrued liabilities and the long-term portion was included in other long-term liabilities on the Company’s balance sheet. As of March 31, 2023, the inputs related to determination of the balance of the earnout were resolved and the final balance due was all short-term and included in accrued liabilities on the Company's balance sheet. +Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2023. +Table of Contents +5. Income Taxes +The components of current and deferred federal and state income tax (benefit) provision are as follows: +Year Ended March 31, +2023 2022 +(In thousands) +Income (loss) from continuing operations before income taxes $ ( 14,720 ) $ ( 6,726 ) +Current income tax provision: +Federal — — +State 50 75 +Total current tax provision 50 75 +Deferred income tax provision: +Federal 34 33 +State 51 66 +Total deferred tax provision 85 99 +Provision for income taxes on continuing operations 135 174 +Income (loss) from continuing operations, net of taxes $ ( 14,855 ) $ ( 6,900 ) +The reconciliation of our income tax (benefit) provision to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2023 2022 +(In thousands) +Provision (benefit) for income taxes at statutory rates $ ( 3,091 ) $ ( 1,422 ) +State income taxes net of federal benefit ( 423 ) ( 559 ) +Tax credits ( 434 ) ( 141 ) +Compensation charges 156 34 +Change in valuation allowance 3,849 2,169 +Other 78 93 +Provision for income taxes $ 135 $ 174 +57 +Table of Contents +The components of deferred tax assets and liabilities are as follows: +March 31, +2023 2022 +(as corrected) +(In thousands) +Deferred tax assets: +Net operating losses $ 5,962 $ 4,320 +Capitalized R&D 2,866 1,808 +Credit carry-forwards 4,868 4,530 +Deferred compensation and payroll 3,290 2,902 +Bad debt allowance and other reserves 914 1,299 +Property and equipment 729 297 +Acquired intangibles 294 129 +Other, net 518 171 +Total deferred tax assets 19,441 15,456 +Valuation allowance ( 18,741 ) ( 14,892 ) +Total deferred tax assets, net of valuation allowance 700 564 +Deferred tax liabilities: +Goodwill ( 1,122 ) ( 901 ) +Total deferred tax liabilities ( 1,122 ) ( 901 ) +Net deferred tax liabilities $ ( 422 ) $ ( 337 ) +The impact to our fiscal year 2022 deferred tax assets as a result of the corrections described in Note 1, Description of Business and Summary of Significant Accounting Policies, to the Financial Statements, was an increase of $ 0.3 million to the net operating losses from $ 4.0 million to $ 4.3 million, and an equal increase to our valuation allowance from $ 14.6 million to $ 14.9 million. +At March 31, 2023, we had $ 3.7 million in federal research credits that begin to expire in 2031 and $ 1.4 million in state tax credits that begin to expire in 2023. We had $ 23.5 million of federal net operating loss carryforwards at March 31, 2023 that do not expire as a result of recent tax law changes. We also had $ 16.4 million of state net operating loss carryforwards at March 31, 2023 that begin to expire in 2031. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three years, we considered it appropriate to maintain valuation allowances of $ 18.7 million and $ 14.9 million against our deferred tax assets at March 31, 2023 and 2022, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Due to the magnitude of the impact of supply chain issues occurring during Fiscal 2023 and the addition to cumulative pre-tax loss, we currently cannot estimate when sufficient positive evidence may become available to allow us to reach a conclusion that any portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to the level of profitability that we are able to actually achieve. +On March 27, 2020, the CARES Act was enacted in response to the Pandemic. The CARES Act contains numerous income tax provisions, such as relaxing limitations on the deductibility of interest and the use of net operating losses arising in taxable years beginning after December 31, 2017. The income tax provisions of the CARES Act had an immaterial impact on our current taxes, deferred taxes, and uncertain tax positions of the Company in the year ended March 31, 2023. The CARES Act also allows for the deferral of payroll taxes, as well as the immediate refund of federal Alternative Minimum Tax credits, which had previously been made refundable over a period of four years by the Tax Cuts and Jobs Act of 2017. As of March 31, 2023, the Company had repaid all amounts deferred under the CARES Act. +Unrecognized Tax Benefits +Table of Contents +As of March 31, 2023 and 2022, our gross unrecognized tax benefits were approximately $ 1.3 million and $ 1.2 million, respectively, of which approximately $ 1.2 million and $ 1.1 million, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are approximately $ 1.2 million and $ 1.1 million, respectively. +A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2023 2022 +(In thousands) +Gross unrecognized tax benefits at beginning of year $ 1,198 $ 1,079 +Increases for tax positions taken in prior years 22 — +Decreases for tax positions taken in prior years ( 36 ) ( 29 ) +Increases for tax positions taken in the current year 116 159 +Lapse in statute of limitations ( 16 ) ( 11 ) +Gross unrecognized tax benefits at March 31 $ 1,284 $ 1,198 +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2020 or later, and state and local income tax examination for fiscal tax years ended March 31, 2019 or later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +6. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in litigation relating to claims arising out of its operations in the normal course of business. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any legal proceedings, the outcome of which, in management's opinion, individually or in the aggregate, would have a material effect on the Company's results of operations, financial position or cash flows. +7. Right-of-Use Assets and Lease Liabilities +We have various operating leases for our offices, office equipment and vehicles in the United States. These leases expire at various times through 2029. Certain lease agreements contain renewal options from 1 year to 5 years, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. +The table below presents lease-related assets and liabilities recorded on the balance sheet as follows: +Classification March 31, 2023 +(In thousands) +Assets +Operating lease right-of-use-assets Right-of-use assets $ 8,345 +Total operating lease right-of-use-assets $ 8,345 +Liabilities +Operating lease liabilities (short-term) Accrued liabilities $ 2,339 +Operating lease liabilities (long-term) Lease liabilities 7,641 +Total operating lease liabilities $ 9,980 +Lease Costs +For Fiscal 2023 and Fiscal 2022, lease costs totaled approximately $ 2.6 million and $ 2.9 million, respectively. The Company currently has no variable lease costs. +Supplemental Information +Table of Contents +The table below presents supplemental information related to operating leases during the fiscal year ended March 31, 2023 (in thousands, except weighted average information): +Cash paid for amounts included in the measurement of operating lease liabilities $ 1,755 +Right-of-use assets obtained in exchange for new operating lease liabilities 313 +Weighted average remaining lease term 3.9 +Weighted average discount rate 4.8 % +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and the total of the remaining years to the operating lease liabilities recorded on the balance sheet as of March 31, 2023: +Fiscal Year Ending March 31, Operating Leases +(In thousands) +2024 $ 2,739 +2025 2,479 +2026 2,149 +2027 2,178 +2028 1,286 +Thereafter 204 +Total lease payments 11,035 +Less imputed interest ( 1,055 ) +Present value of future lease payments 9,980 +Less current obligations under leases ( 2,339 ) +Long-term lease obligations $ 7,641 +8. Stockholders' Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2023 and 2022, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2023: +Number of Shares +(In thousands) +Stock options outstanding 6,287 +Restricted stock units outstanding 497 +Performance stock units outstanding 83 +Authorized for future issuance under stock incentive plans 2,398 +Total common stock reserved for future issuance at March 31, 2023 +9,265 +9. Employee Benefit Plans +Stock Incentive Plans +In September 2007, our stockholders approved the 2007 Omnibus Incentive Plan (the "2007 Plan"), which provides that options to purchase shares of our unissued common stock may be granted to our employees, officers, consultants and directors +Table of Contents +at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. +In December 2016, our stockholders approved the 2016 Omnibus Incentive Plan (the "2016 Plan") which allows for the issuance of stock options, stock appreciation rights, restricted stock, RSUs, cash incentive awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25 % on each of the first 4 years anniversaries of the grant date. Stock appreciation rights, restricted stock, RSUs and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2016 Plan. In September 2021, our stockholders approved an amendment of the 2016 Plan to increase the number of shares of common stock authorized for issuance under the 2016 Plan by an additional 3,360,000 shares. +We currently maintain two stock incentive plans, the 2007 Omnibus Incentive Plan (the "2007 Plan") and the 2016 Omnibus Incentive Plan (the "2016 Plan"). Of these plans, we may only grant future awards from the 2016 Plan. The 2016 Plan allows for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), cash incentive awards and other stock-based awards. At March 31, 2023, there were approximately 2.4 million shares of common stock available for grant or issuance under the 2016 Plan. Total stock options vested and expected to vest were approximately 6.3 million as of March 31, 2023. +Stock Options +A summary of activity in the Omnibus Incentive Plans with respect to our stock options for Fiscal 2023 is as follows: +Options Weighted +Average +Exercise +Price Per +Share Weighted +Average +Remaining +Contractual +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +Options outstanding at March 31, 2022 5,943 $ 4.32 6.5 974 +Granted 943 3.20 +Exercised ( 61 ) 2.93 +Forfeited ( 241 ) 4.90 +Expired ( 297 ) 5.02 +Options outstanding at March 31, 2023 6,287 4.11 6.2 4,976 +As of March 31, 2023, approximately 4,082,662 stock options were exercisable. +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under the 2007 Plan vest at the rate of 25 % on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs granted under the 2016 Plan vest at varying terms between 1 year and 3 year anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A summary of activity with respect to our RSUs for Fiscal 2023 is as follows: +Table of Contents +# of Shares Weighted +Average +Price Per +Share Weighted +Average +Remaining +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +RSUs outstanding at March 31, 2022 451 $ 4.12 7.5 1,271 +Granted 290 3.29 +Vested and released ( 202 ) 5.33 +Forfeited ( 42 ) 5.23 +RSUs outstanding at March 31, 2023 497 3.05 1.3 2,326 +Performance Stock Units +The Company has approved a total "target" number of 212,216 PSUs to our executive officers. Between 0 % and 160 % of the PSUs will be eligible to vest based on average annual performance during the three-year performance period relative to the revenues per share and cash flow from operations objectives to be established by the Compensation Committee at the beginning of each year. In addition, the final PSU vesting based on the revenues per share and cash flow from operations performance will be subject to a modifier between .75x-1.25x based on the Company's total shareholder return relative to the Russell 2000 during the performance period, for a maximum achievement percentage of 200 % of the "target" number of PSUs. The PSUs are amortized over a service period of 3 years. The value and the derived service period of the PSUs were estimated using the Monte-Carlo simulation model. The following table summarizes the details of the performance stock units: +# of Shares Weighted +Average +Price Per +Share Weighted +Average +Remaining +Life Aggregate +Intrinsic +Value +(In thousands) +PSUs outstanding at March 31, 2022 115 $ 6.33 1.2 343 +Granted 87 3.09 +Vested ( 119 ) 5.27 +Forfeited — — +PSUs outstanding at March 31, 2023 83 4.45 1.5 389 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our statements of operations: +Year Ended March 31, +2023 2022 +(In thousands) +Cost of revenues $ 352 $ 242 +General and administrative 1,626 2,574 +Sales and marketing 477 340 +Research and development expense 435 245 +Restructuring activities — — +Loss from discontinued operations — — +Total stock-based compensation $ 2,890 $ 3,401 +At March 31, 2023, there was approximately $ 3.9 million, $ 1.1 million and $ 0.1 million of unrecognized compensation expense related to unvested stock options, RSUs, and PSUs respectively. This expense is currently expected to be recognized over a weighted average period of approximately 2.7 years for stock options, 1.7 years for RSUs and 1.3 years for PSUs. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +The grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Table of Contents +Year Ended March 31, +2023 2022 +Expected life—years 7.5 7.2 +Risk-free interest rate 3.6 % 1.5 % +Expected volatility of common stock 51 % 49 % +Dividend yield 0 % 0 % +Expected Life: The Company's expected life represents the weighted-average period that the Company's stock options are expected to be outstanding. The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of grant for the expected term of the option. +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2023 2022 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted $ 1.67 $ 2.58 +Intrinsic value of options exercised $ 141 $ 1,966 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No contributions were made during the fiscal years ended March 31, 2023 and 2022. +We sponsor a defined contribution 401(k) plan (the "401(k) Plan"), adopted in 1990, under which eligible employees voluntarily contribute to the plan, up to IRS maximums, through payroll deductions. We match up to 50 % of contributions, up to a stated limit, with all matching contributions being fully vested after one month of service. Our matching contributions under the 401(k) Plan were approximately $ 1.8 million, and $ 1.8 million for Fiscal 2023 and Fiscal 2022, respectively. +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an ESPP which allows employees to withhold a percentage of their base compensation to purchase the Company's common stock at 95 % of the lower of the fair market at the beginning of the offering period and on the last trading day of the offering period. There are two offering periods during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may elect to contribute 1 - 15 % of their eligible gross pay up to a $ 0.03 million annual stock value limit. During Fiscal 2023 and Fiscal 2022, 180,000 and 95,000 shares, respectively, were purchased. +As of March 31, 2023, approximately $ 0.1 million of cash was restricted for the purchase of shares under the ESPP and is recorded as restricted cash in the accompanying balance sheets. +Deferred Compensation Plan +Effective October 1, 2020, the Company adopted the Iteris, Inc. Non-Qualified Deferred Compensation Plan (the "DC Plan"). The DC Plan consists of two plans, one that is intended to be an unfunded arrangement for eligible key employees who are part of a select group of management or highly compensated employees of the Company within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, and one for the benefit of non-employee members of our Board of Directors. Key employees, including our executive officers and our non-employee directors who are notified regarding their eligibility to participate and delivered the DC Plan enrollment materials, are eligible to participate in the DC Plan. Under the DC Plan, we will provide participants with the opportunity to make annual elections to defer a percentage of their eligible cash compensation +Table of Contents +and equity awards. A participant is always 100% vested in his or her own elective cash deferrals and any earnings thereon. Elective deferrals of equity awards are credited to a bookkeeping account established in the name of the participant with respect to an equivalent number of shares of our common stock, and such credited shares are subject to the same vesting conditions as are applicable to the equity award subject to the election. The Company established a rabbi trust to finance our obligations under the DC Plan with corporate-owned life insurance policies on participants regardless of employment status, and the assets held within this trust are subject to the claims of the Company's creditors. +As of March 31, 2023, the amount invested under the DC Plan totaled approximately $ 1.3 million and are classified as trading securities, which are recorded at fair market value with changes recorded as adjustments to other income. This amount is included in prepaid expenses and other current assets on the balance sheets. +As of March 31, 2023, the vested amounts under the DC Plan totaled $ 1.5 million and are included in accrued payroll and related expenses on the balance sheets. Changes in the deferred compensation plan liabilities are recorded as an adjustment to compensation expense. +As of March 31, 2023, 68,627 equity awards were deferred and held in the rabbi trust. The shares deferred and held in the rabbi trust are classified as treasury stock, and the liability to participating employees are classified as deferred compensation obligations in the stockholders' equity section of the balance sheets. The number of shares needed to settle the liability for deferred compensation obligations will be included in the denominator in both the basic and diluted earnings per share calculations. +Employment Inducement Incentive Plan +On December 4, 2020, the Board of Directors approved the Iteris, Inc. 2020 Employment Inducement Incentive Award Plan (the “Inducement Plan”) in conjunction with the TrafficCast acquisition. The terms of the Inducement Plan are substantially similar to the terms of the Company’s 2016 Omnibus Incentive Plan with the exception that incentive stock options may not be granted under the Inducement Plan. The Inducement Plan was adopted by the Board of Directors without stockholder approval pursuant to Rule 5635(c)(4) of the Nasdaq Listing Rules. +The Board of Directors initially reserved 300,000 shares of the Company’s common stock for issuance pursuant to awards granted under the Inducement Plan. In accordance with Rule 5635(c)(4) of the Nasdaq Listing Rules, awards under the Inducement Plan may only be made to an employee who has not previously been an employee or member of the Board of Directors of the Company or any parent or subsidiary, or following a bona fide period of non-employment by the Company or a parent or subsidiary, and only if he or she is granted such award in connection with his or her commencement of employment with the Company or a subsidiary and such grant is an inducement material to his or her entering into employment with the Company or such subsidiary. +There were no awards granted under the Inducement Plan during the fiscal years ended March 31, 2023 and 2022. No further awards will be granted under the Inducement Plan, although the outstanding awards under the Inducement Plan remain outstanding in accordance with their terms. +10. Stock Repurchase Program +On August 9, 2012, the Board approved a stock repurchase program pursuant to which we could acquire up to $ 3.0 million of our outstanding common stock for an unspecified length of time. Under the program, we could repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and could also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There was no guarantee as to the exact number of shares that would be repurchased. We reserved the right to modify or terminate the repurchase program at any time without prior notice. +On November 6, 2014, the Board approved a $ 3.0 million increase to the Company’s 2012 stock repurchase program, pursuant to which the Company could continue to acquire shares of its outstanding common stock from time to time for an unspecified length of time. From the inception of the 2012 stock repurchase program on through its termination on May 12, 2022, we repurchased approximately 2,458,000 shares of our common stock for an aggregate price of approximately $ 4.3 million, at an average price per share of $ 1.73 . As of March 31, 2023, these repurchased shares had been retired and resumed their status as authorized and unissued shares of our common stock. +On May 12, 2022 the Board of Directors terminated the 2012 stock repurchase program and approved a new plan for the company to acquire up to $ 10.0 million of our outstanding common stock for an unspecified length of time. Under the program, we may repurchase shares from time to time in the open market and privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the +Table of Contents +exact number of shares that will be repurchased. We may modify or terminate the repurchase program at any time without prior notice. During the fiscal year ended March 31, 2023, we repurchased 0.3 million shares, for an aggregate price of approximately $ 0.9 million, at an average price of $ 2.90 per share. As of March 31, 2023 approximately $ 9.1 million remained available for the repurchase of our common stock under our current program. +11. Business Segments, Significant Customer and Geographic Information +Business Segments +The Company's Chief Operating Decision Maker ("CODM"), who is our Chief Executive Officer, reviews the Company's results on a consolidated basis and our financial results are presented under a single reporting segment in order to provide the most accurate representation of Company's performance. +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance greater than 10% of our total trade accounts receivable balances as of March 31, 2023 and 2022. The Company had no long-lived assets located outside the U.S. as of March 31, 2023 and 2022. +The Company had approximately 0 % of revenues, derived from shipments to, or contract, service and other revenues, from external customers located outside the U.S. for the years ended March 31, 2023 and 2022. +12. Long-Term Debt +On January 25, 2022, Iteris, Inc., entered into a Credit Agreement (the “Credit Agreement”) with Capital One, National Association, as agent. +The Credit Agreement provided for a $ 20 million revolving credit facility with a maturity date of January 24, 2026. In addition, the Company had the ability from time to time to increase the revolving commitments up to an additional aggregate amount not to exceed $ 40 million, subject to receipt of lender commitments and certain conditions precedent. The Credit Agreement that evidenced the facility contained customary representations, warranties, covenants, and events of default. The Credit Agreement was collateralized by substantially all of our property and assets, including intellectual property. The Credit Agreement also contained certain restrictions and covenants that required the Company to maintain, on an ongoing basis, (i) a leverage ratio of no greater than 3.00 to 1.00 and (ii) a fixed charge coverage ratio of not less than 1.25 to 1.00 . The leverage ratio also determined the applicable interest rate under the Credit Agreement. Borrowings under the revolving credit facility accrued interest at a rate equal to either Secured Overnight Financing Rate ("SOFR") or a specified base rate, at the Company’s option, plus an applicable margin. The applicable margins ranged from 2.00 % to 2.80 % per annum for SOFR loans and 1.00 % to 1.80 % per annum for base rate loans. The revolving credit facility was subject to a commitment fee payable on the unused revolving credit facility commitments ranging from 0.25 % to 0.35 %, that was dependent on the Company’s leverage ratio. +On September 12, 2022, the Company voluntarily terminated the Credit Agreement and expensed the remaining capitalized deferred financing costs. The Company had not borrowed against the Credit Agreement since its inception, but the Company continued to incur customary fees thereunder prior to this termination. In connection with the termination of the Credit Agreement, all liens securing such obligations and guarantees of such obligations were released. Amortization of the deferred financing costs and commitment fees on the unused revolving credit facility commitments of $ 0.3 million are included in Interest Income (Expense), net on the statement of operations. As of March 31, 2023, no amounts of capitalized deferred financing costs remained. +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2023, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2023 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2023. +The effectiveness of our internal control over financial reporting as of March 31, 2023 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. (the “Company”) as of March 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements as of and for the year ended March 31, 2023, of the Company and our report dated June 29, 2023, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 29, 2023 +Table of Contents +ITEM 9B. OTHER INFORMATION +None. +Table of Contents +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K ("the Form 10-K Amendment") or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2023 Annual Meeting of Stockholders (the "2023 Proxy Statement") under the headings "Executive Compensation and Other Information—Executive Officers," "Election of Directors," "Corporate Governance," and "Delinquent Section 16(a) Reports." +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2023 Proxy Statement under the heading "Executive Compensation and Other Information" and "Election of Directors." +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2023 Proxy Statement under the heading "Equity Compensation Plan Information" and "Stock Ownership of Certain Beneficial Owners and Management." +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2023 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2023 Proxy Statement under the heading "Matters Related to Independent Registered Public Accounting Firm." +Table of Contents +PART IV +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +(a) Documents filed as part of this report: +1. Financial Statements. +Our financial statements are listed in the "Index to Financial Statements" under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our financial statements or the notes thereto. +3. Exhibits. +The following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit Number Description Reference +2.1 † +Asset Purchase Agreement, dated May 2, 2020, by and among Iteris, Inc., ClearAg, Inc., and DTN, LLC* +Exhibit 2.1 to the registrant's Current Report on Form 8-K as filed with the SEC on May 6, 2020 +4.1 +Restated Certificate of Incorporation of the registrant as filed with the Delaware Secretary of State on October 12, 2018 +Exhibit 3.1 to the Registrant’s Current Report on Form 8-K as filed with the Commission on October 15, 2018 +4.2 +Restated Bylaws of the Registrant, as amended through August 6, 2018 +Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 as filed with the Commission on August 7, 2018 +4.3 +Specimen common stock certificate +Exhibit 4.1 to the Registrant’s Registration Statement on Form 8-A (File No. 001-08762), as filed with the Commission on December 8, 2004 +4.4 +Description of Iteris, Inc. Securities Registered under Section 12 of the Exchange Act +Exhibit 4.2 to the Registrant’s Annual Report on Form 10-K for the year ended for the year ended March 31, 2020 as filed with the SEC on June 9, 2020 +10.1 † +Asset Purchase Agreement dated December 6, 2020, by and between Iteris, Inc. and TrafficCast International, Inc. +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.2 * +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease, dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014 +Table of Contents +Exhibit Number Description Reference +10.5 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway Acquisitions, LLC) and Iteris, Inc. +Exhibit 10.5 to registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.6 † +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.6 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 filed with the SEC on June 6, 2019 +10.7 +Fourth Amendment to Lease, dated May 17, 2021, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.7 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2021 filed with the SEC on June 1, 2021 +10.8 * +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.9 * +2007 Omnibus Incentive Plan +Exhibit 10.19 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.10 * +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.11 * +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.12 * +Amended and Restated 2016 Omnibus Incentive Plan +Exhibit 10.1 to registrant's Current Report on Form 8-K as filed with the SEC on September 16, 2021 +10.13 * +Form of Performance Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan** +Exhibit 10.1 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.14 * +Revised Form of Restricted Stock Unit Issuance for use with 2016 Omnibus Incentive Plan +Exhibit 10.2 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.15 * +Revised Form of Form of Notice of Grant of Stock Option and Form of Stock Option Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 10.3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.16 * +Employment Agreement dated September 8, 2015, between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.17 * +Employment Agreement, dated November 15, 2019, between Iteris, Inc. and Douglas Groves +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on December 4, 2019 +10.18 * +Letter Amendment to Employment Agreement, dated January 30, 2023, between Iteris, Inc. and Douglas Groves +Exhibit 10.2 to the registrant's Current Report on Form 8-K as filed with the SEC on February 2, 2023 +10.19 * +Iteris, Inc. Amended and Restated Executive Severance Plan +Exhibit 10.20 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.20 * +2020 Employment Inducement Incentive Award Plan +Exhibit 10.2 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +Table of Contents +Exhibit Number Description Reference +10.21 * +Form of Notice Grant of Stock Option and Form of Stock Option Agreement for use with 2020 Employment Inducement Incentive Plan +Exhibit 10.3 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.22 * +Form of Restricted Stock Unit Issuance Agreement for use with 2020 Employment Inducement Incentive Award Plan +Exhibit 10.4 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.23 * +Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.5 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.24 * +Form of Restricted Stock Unit Issuance Agreement for use with the Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.6 to the registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.25 * +2016 Omnibus Incentive Plan (Amended and Restated effective September 9, 2021) +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on September 9, 2021 +10.26 +Credit Agreement, dated as of January 25, 2022, by and between Iteris, Inc. and Capital One, National Association +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on January 28, 2022 +10.27 * +Severance Agreement, dated December 30, 2021, between Iteris, Inc. and Ramin Massoumi +Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2021 as filed with the SEC on February 3, 2022 +10.28 * +Employment Agreement, dated January 30, 2023, between Iteris, Inc. and Kerry Shiba +Exhibit 10.1 to the registrant's Current Report on Form 8-K as filed with the SEC on February 2, 2023 +23 +Consent of Independent Registered Public Accounting Firm, dated June 29, 2023 +Filed herewith +24 Power of Attorney Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +101.INS XBRL Instance Document Filed herewith +101.SCH XBRL Taxonomy Extension Schema Document Filed herewith +101.CAL XBRL Taxonomy Extension Calculation Linkbase Document Filed herewith +101.LAB XBRL Taxonomy Extension Label Linkbase Document Filed herewith +Table of Contents +Exhibit Number Description Reference +101.PRE XBRL Taxonomy Extension Presentation Linkbase Document Filed herewith +101.DEF XBRL Taxonomy Definition Presentation Linkbase Document Filed herewith +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) +Filed herewith +______________________________________ +† Pursuant to Item 601(a)(5) of Regulation S-K, certain appendices to this agreement have been omitted. The Company agrees to furnish supplementally to the Securities and Exchange Commission, upon its request, any or all of such omitted appendices. +* Indicates a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +ITEM 16. FORM 10-K SUMMARY +None. +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 29, 2023 ITERIS, INC. +(Registrant) +By /s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Kerry Shiba, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated: +Signature Title Date +/s/ JOE BERGERA Director, President and Chief Executive Officer (principal executive officer) June 29, 2023 +Joe Bergera +/s/ KERRY A. SHIBA Chief Financial Officer, Treasurer and Secretary (principal financial and accounting officer) June 29, 2023 +Kerry A. Shiba +/s/ THOMAS L. THOMAS Chairman of the Board June 29, 2023 +Thomas L. Thomas +/s/ GERARD M. MOONEY Director June 29, 2023 +Gerard M. Mooney +/s/ LAURA L. SIEGAL Director June 29, 2023 +Laura L. Siegal +/s/ DENNIS W. ZANK Director June 29, 2023 +Dennis W. Zank \ No newline at end of file diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/filing_metadata.csv b/raw/filings/0000350868/2022/0001628280-23-023849/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..ae2d7ee55bdea0eb144b86b4de45f0cc7e608df9 --- /dev/null +++ b/raw/filings/0000350868/2022/0001628280-23-023849/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2023-06-29,2023-03-31,2023-06-29T13:04:25.000Z,0001628280-23-023849,iti-20230331.htm,10-K,8552657,1,1,https://www.sec.gov/Archives/edgar/data/350868/000162828023023849/iti-20230331.htm,https://www.sec.gov/Archives/edgar/data/350868/000162828023023849/,2022,2022,1 diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/item1.txt b/raw/filings/0000350868/2022/0001628280-23-023849/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..cef64d4f6e3f480d649846c8148578b2a211e85d --- /dev/null +++ b/raw/filings/0000350868/2022/0001628280-23-023849/item1.txt @@ -0,0 +1,108 @@ +ITEM 1. BUSINESS +Overview +Iteris, Inc. (referred to collectively in this report as "Iteris", the "Company", "we", "our", and "us") is a provider of smart mobility infrastructure solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems ("ITS") technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service ("SaaS") offerings, mobility consulting services, and cloud-enabled managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States ("U.S.") and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, mobility intelligence software, mobility data sets, mobility consulting services, and cloud-enabled managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission ("SEC"). +Recent Developments +COVID-19 Update +The COVID-19 pandemic (the "Pandemic") materially adversely impacted global economic conditions. As COVID-19 has entered an endemic stage, COVID-19 may continue to have an unpredictable and unprecedented impact on the global economy, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. +Given the uncertainties surrounding the impacts of COVID-19 on the Company's future financial condition and results of operations, we have and may continue to identify and execute various actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions include, but are not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Our products require specialized parts which have become more difficult to source. In some cases, we have had to purchase such parts from third-party brokers at substantially higher prices. Additionally, to mitigate the impact of component shortages, we have increased inventory levels for parts in short supply. In the event demand does not materialize, we would need to hold excess inventory for several quarters. Alternatively, we may be unable to source sufficient components at any price, even from third-party brokers, to meet customer demand, resulting in high levels of backlog that we are unable to ship. The Company's tactics to mitigate the current global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and by accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 ("Fiscal 2023"). We have placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity and may need to continue to do so in the future. +Due to the supply chain environment, the Company increased inventory by approximately $2.9 million as part of the Company's supply chain strategy for Fiscal 2023. The cash flow used in operating activities of our continuing operations was approximately $4.5 million during the twelve months ended March 31, 2023. Cash used during Fiscal 2023 was primarily due to two factors. First, the planned increase in inventory during the first half of Fiscal 2023 and the continued re-design of certain +4 +Table of Contents +circuit boards as part of the Company’s supply chain strategy to help assure the Company has enough product to satisfy customer demand. Second, the net operating loss as a result of higher inventory component costs related to the global supply chain constraints. The increase in inventory purchases and in particular components purchased in the secondary markets was curtailed in the second half of Fiscal 2023, and the Company currently does not expect to continue to accumulate inventory, in the same magnitude, in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to have sufficient liquidity. +On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law in the United States. The CARES Act provides relief to U.S. corporations through financial assistance programs and modifications to certain income tax provisions. The Company applied certain beneficial provisions of the CARES Act, including the payroll tax deferral and the alternative minimum tax acceleration. As of March 31, 2023, the Company had repaid all amounts deferred under the CARES Act (see Note 5, Income Taxes , to the Financial Statements for more information). +COVID-19 has had an impact on the Company’s human capital. While our Santa Ana product and commercial operations facility remained open throughout the Pandemic, many of our employees worked remotely during the past three years. With the recent easing of COVID-19 related restrictions imposed by local and state authorities, a larger portion of our workforce has returned to our various facilities while others continue to work remotely. The Company’s information technology infrastructure has proven sufficiently flexible to minimize disruptions in required duties and responsibilities. We believe we have the infrastructure to efficiently work remotely during COVID-19's current endemic stage and well into the future. +The Company assessed the impacts of COVID-19 on the estimates and assumptions used in preparing our financial statements. The estimates and assumptions used in our assessments were based on management’s judgment and may be subject to change as new events occur and additional information is obtained. In particular, there is significant uncertainty about the duration and extent of the impact of COVID-19, which has entered an endemic stage, and its resulting impact on global economic conditions. If economic conditions caused by COVID-19 do not recover as currently estimated by management, the Company’s financial condition, cash flows and results of operations may be materially impacted. The Company will continue to assess the effect of COVID-19 on its operations and the actions implemented to combat the virus throughout the world. As a result, our assessment of the impact of COVID-19 may change. +Acquisition of the Assets of TrafficCast International, Inc. +On December 6, 2020, the Company entered into an Asset Purchase Agreement (the “TrafficCast Purchase Agreement”) with TrafficCast International, Inc. (“TrafficCast”), a privately held company headquartered in Madison, Wisconsin that provides travel information technology, applications and content to customers throughout North America in the media, mobile technology, automotive and public sectors. Under the TrafficCast Purchase Agreement, the Company agreed to purchase from TrafficCast substantially all of its assets, composed of its travel information technology, applications and content (the “TrafficCast Business”) and assume certain specified liabilities of the TrafficCast Business. +On May 6, 2022, approximately $0.9 million was paid to settle the balance of a security hold back agreed to as part of the acquisition, net of approximately $0.1 million of post-closing adjustments. As of March 31, 2023, the achievement levels of the revenue targets with respect to the earnout were resolved and the balance remaining of approximately $0.6 million was accrued in accordance with the terms of the agreement. This item is included in accrued liabilities on the balance sheets. +Simultaneous with closing the transaction, the parties entered into certain ancillary agreements that provided Iteris with ongoing access to mapping and monitoring services that the TrafficCast Business used to support its real-time and predictive travel data and associated content until termination of these agreements on December 6, 2022. +Restructuring Activities +To help offset recent increases in supply chain costs, on May 12, 2022, the Board of Directors of Iteris, Inc. approved additional restructuring activities to better position the Company for increased profitability and growth. The Company incurred $0.7 million of employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +Products and Services +Iteris provides comprehensive smart mobility infrastructure solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. +Software Solutions +5 +Table of Contents +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, commercial vehicle operations, TrafficCarma, VantageLive! and BlueARGUS as described below. +• ClearGuide, which is provided on a software-as-a-service basis ("SaaS"), is a state-of-the-art mobility intelligence and transportation performance measures solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement ("SPM"). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response ("IVR"). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial vehicle operations and vehicle safety compliance applications, which are provided on a SaaS basis include various applications branded as ClearFleet, CVIEWplus, CheckPoint, UCRLink, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for peoples’ daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +• VantageLive! is a SaaS solution that allows users to collect, process and analyze advanced intersection data from our Vantage sensors, as well as to view and understand intersection activity. +• BlueARGUS is a SaaS solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Cloud, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public-sector and private-sector customers via subscription-based direct data feeds or application programming interfaces ("APIs"), or through ClearGuide, our mobility intelligence and transportation performance measures software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary computerized algorithms and selective quality control from experienced traffic analysts. +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and BlueARGUS) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply +6 +Table of Contents +sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Fusion, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, SmartSpan, VersiCam, PedTrax, and P-Series products. +• Vantage Fusion is a connected-vehicle ("CV") focused detection product that tracks and reports vehicles and pedestrians in and around intersections. This product helps the industry bridge the currently fledgling CV market to an eventually CV-dominant world by providing non-CV vehicle locations (and details) to the CV network. This product is developed in partnership with Continental AG, a global automotive parts manufacturer and leading CV equipment provider. +• Vantage Apex is the industry’s first full 1080p high-definition ("HD") video and 4D/HD radar hybrid sensor with integrated artificial intelligence (AI) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Next uses a powerful processor that enables future functional growth while maintaining proven Iteris video detection performance and reliability. The architecture supports expanding ITS applications and easily integrates with existing technologies and is anticipated to integrate with future technologies. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased bicyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic to push pole-mounted buttons. +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +The BlueTOAD product family combines unique MAC Address capture with the latest CV technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra RSU, both of which we bundle with a Cloud-based software application branded as BlueARGUS. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra RSU is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +7 +Table of Contents +In select territories, the Company also sells certain complementary original equipment manufacturer ("OEM") products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products will be dependent, in part, on the continued replacement of adoption of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services include traffic management centers ("TMC") design, staffing, and operations services to public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ cloud-enabled managed services combine SaaS, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterial roads and highways along with their related in-field technology. These services include congestion and asset management areas of focus, combining innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators are provided the opportunity to save time and money while better keeping road users safe and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, we launched the ClearMobility Cloud that enables seamless interoperation among our solutions via a common mobility data management engine, API framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. ClearMobility Cloud is both horizontally scalable and third-party extensible. +Because we are now aligning, harmonizing, and optimizing our portfolio of individual solutions to a common platform, the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, beginning in the fiscal year ended March 31, 2022 ("Fiscal 2022") and throughout Fiscal 2023, we reported as a single operating segment. +Market Conditions +Currently, over 90% of our revenue is attributable to public-sector customers. Therefore, most of our revenue is dependent upon state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +8 +Table of Contents +We believe that overall demand for our solutions will continue to be dependent at least in part on the federal and local government's use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. The Infrastructure Investment and Jobs Act ("IIJA") became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. With that funding pool, areas of direct relevance to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the appropriation of annual funding and current debates related to the federal debt ceiling may cause some uncertainty regarding the availability of transportation funds in federal, state and local budgets. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +With the acquisition of the TrafficCast Business on December 7, 2020, we now sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For Fiscal 2023 and Fiscal 2022, no individual customer represented greater than 10% of our total revenues. As of March 31, 2023 and 2022, no individual customer accounted for more than 10% of our total trade accounts receivable. +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. These subassemblies and components are typically delivered to our Santa Ana, California facility where they go through final assembly and testing prior to shipment to our customers. Our key suppliers include Veris Manufacturing and MoboTrex, Inc. Our assembly and test activities are conducted in approximately 12,000 square feet of space at our Santa Ana, California facility. Production volume at our subcontractors typically is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization ("ISO") 9001:2015 international standard. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenue was not a material portion of our total revenues for Fiscal 2023 and Fiscal 2022. We believe customer support is a key competitive factor for our Company. +Backlog +9 +Table of Contents +Our total backlog of unfulfilled firm orders was approximately $114.2 million at March 31, 2023. We typically expect to recognize revenue in the range of approximately two-thirds to three-quarters of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2022, we had backlog of approximately $99.9 million. The 14% increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenue amounts believed to be firm and earned under existing agreements, but it does not represent the total contract award if a firm purchase order or task order has not yet been issued under the contract. Backlog is not included in deferred revenue on our balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly in view of budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often can be affected by a variety of factors including the scheduling and forecasting practices of our individual customers, as well as availability of installation labor and ancillary parts related to installation which we do not manufacture or supply. These factors can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of the timing of our future revenues. +Product Development +Our product development activities are mostly conducted at our facilities in Santa Ana, California, and Madison, Wisconsin as well as using additional employee and partner resources across North America. Our research and development costs and expenses were approximately $8.3 million for Fiscal 2023 and $7.4 million for Fiscal 2022. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors providing managed services and consulting include a mix of local, regional and international engineering services firms. Our competitors in software products (e.g., performance measurement and management, advanced traveler information systems, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, as well as other multi-disciplinary hardware and software corporations. +In the market for our detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our +10 +Table of Contents +new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets could have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights of protection for any potentially significant new technology acquired or developed by us. We currently have a total of 31 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 8 relating to our engineering and consulting services technologies and (iii) 6 related to our purchase of the TrafficCast Business. We have a total of 2 pending patent applications in the U.S. We currently have 5 issued foreign patents and 2 foreign patent applications related to our purchase of the TrafficCast Business. The expiration dates of our patents range from 2026 to 2040. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in litigation in the normal course of business related to our intellectual property rights and the intellectual property rights of others. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any litigation or other legal proceedings related to its intellectual property or the intellectual property of others, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on the Company’s results of operations, financial position or cash flows. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management's resources, regardless of whether the claim is valid, could be significant and could have a material adverse effect on our business, financial condition and results of operations. +Employees +As of March 31, 2023, we employed 450 full-time employees and 17 part-time employees, for a total of 467 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/item13.txt b/raw/filings/0000350868/2022/0001628280-23-023849/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..f4fa1f483fbc2eb2ab644749a74ba03e6f43b9dc --- /dev/null +++ b/raw/filings/0000350868/2022/0001628280-23-023849/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either included in the Form 10-K Amendment or is incorporated by reference to our 2023 Proxy Statement under the heading "Corporate Governance, Board Meetings and Committees" and "Additional Matters—Certain Transactions." \ No newline at end of file diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/item9a.txt b/raw/filings/0000350868/2022/0001628280-23-023849/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..c7901c77bcae56635584ecb1c12308bad475afb3 --- /dev/null +++ b/raw/filings/0000350868/2022/0001628280-23-023849/item9a.txt @@ -0,0 +1,28 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2023, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2023 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management's Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S generally accepted accounting principles. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2023. +The effectiveness of our internal control over financial reporting as of March 31, 2023 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. (the “Company”) as of March 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements as of and for the year ended March 31, 2023, of the Company and our report dated June 29, 2023, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 29, 2023 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/rp_note.txt b/raw/filings/0000350868/2022/0001628280-23-023849/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2022/0001628280-23-023849/rpt_disclosure.txt b/raw/filings/0000350868/2022/0001628280-23-023849/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..fa6a4896486b13dbe559faa96790e5dced5b96c3 --- /dev/null +++ b/raw/filings/0000350868/2022/0001628280-23-023849/rpt_disclosure.txt @@ -0,0 +1,2 @@ +Certain Transactions with Related 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2023-03-31 0000350868 us-gaap:EmployeeStockMember 2024-03-31 0000350868 us-gaap:EmployeeStockMember 2023-03-31 0000350868 iti:StockRepurchaseProgramMay2022Member 2022-05-12 0000350868 iti:StockRepurchaseProgramMay2022Member 2023-04-01 2024-03-31 0000350868 iti:StockRepurchaseProgramMay2022Member 2022-05-12 2024-03-31 0000350868 iti:StockRepurchaseProgramMay2022Member 2024-03-31 0000350868 iti:JoeBergeraMember 2024-01-01 2024-03-31 0000350868 2024-01-01 2024-03-31 0000350868 iti:JoeBergeraMember 2023-04-01 2024-03-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +___________________________________________ +(Mark One) +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended March 31 , 2024 +OR +o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission file number 001-08762 +ITERIS, INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-2588496 +(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) +1250 S. Capital of Texas Hwy., Building 1, Suite 330 , Austin , +Texas +78746 +(Address of Principal Executive Offices) (Zip Code) +Registrant’s Telephone Number, Including Area Code: ( 512 ) 716-0808 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which +registered +Common Stock, $0.10 par value ITI The Nasdaq Stock Market LLC +Securities registered pursuant to Section 12(g) of the Act. None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller reporting company x +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. x +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. o +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). o +Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of September 29, 2023 was approximately $ 147,728,051 . For the purposes of this calculation, shares owned by officers, directors, and greater than 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of June 11, 2024, there were 42,975,222 shares of our common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Part III of this report incorporates by reference certain information from the registrant’s definitive proxy statement for the 2024 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. +Table of Contents +ITERIS, INC. +ANNUAL REPORT ON FORM 10-K +FOR THE FISCAL YEAR ENDED MARCH 31, 2024 +TABLE OF CONTENTS +PART I +ITEM 1. +BUSINESS +4 +ITEM 1A. +RISK FACTORS +11 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +25 +ITEM 1C. +CYBERSECURITY +25 +ITEM 2. +PROPERTIES +26 +ITEM 3. +LEGAL PROCEEDINGS +26 +ITEM 4. +MINE SAFETY DISCLOSURES +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT ’ S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +27 +ITEM 6. +RESERVED +27 +ITEM 7. +MANAGEMENT ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +27 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +38 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +39 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +68 +ITEM 9A. +CONTROLS AND PROCEDURES +68 +ITEM 9B. +OTHER INFORMATION +70 +ITEM 9C . +DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +71 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +71 +ITEM 11. +EXECUTIVE COMPENSATION +71 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +71 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +71 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +71 +PART IV +ITEM 15. +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +72 +ITEM 16. +FORM 10-K SUMMARY +74 +SIGNATURES +75 +Unless otherwise indicated in this report, the “Company,” “we,” “us” and “our” refer to Iteris, Inc. BlueARGUS™, BlueTOAD®, ClearData®, ClearFleet®, ClearGuide®, ClearMobility®, ClearRoute®, CVIEWplus™, Inspect™, Iteris®, PedTrax®, SmartCycle®, SmartCycle Bike Indicator®, Spectra™, TrafficCarma®, TrafficCast®, UCRLink™, Vantage®, VantageARGUS CV™,Vantage Apex®, Vantage Next®, VantagePegasus®, VantageRadius®, VantageLive!®, Vantage Vector®, Velocity®, and VersiCam™ are among, but not all of, the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners. +2 +Table of Contents +Cautionary Statement Regarding Forward-Looking Statements +This report contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management’s beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words “expect,” “believe,” “intend,” “plan,” “should,” “will,” “may,” "might," “anticipate,” “estimate,” “could,” “should,” and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding our anticipated growth, sales, revenues, expenses, profitability, capital needs, backlog, manufacturing capabilities, the market acceptance of our products and services, competition, the impact of any current or future litigation, the impact of recent accounting pronouncements, the impacts of ongoing and new supply chain constraints, the status of our facilities and product development, reliance on key personnel, general economic conditions, including rising interest rates, the impact of any current or future volatility or instability in national or international political conditions, any shutdown of the United States federal government, future impacts of COVID-19 or other future pandemics, and other characterizations of future events or circumstances are forward-looking statements. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause our actual results to differ materially and adversely from those projected. We encourage you to carefully read this annual report on Form 10-K in its entirety, including the various disclosures made by us which describe certain factors which could affect our business, such as those set forth in the “Risk Factors” of Part 1, Item 1A of this report, before deciding to invest in our Company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, including to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. +3 +Table of Contents +PART I +ITEM 1. BUSINESS +Description of Business +Iteris, Inc. (referred to in this report as “Iteris”, the “Company”, “we”, “our”, and “us”) is a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient, and sustainable for everyone. +As a pioneer in intelligent transportation systems (“ITS”) technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service (“SaaS”) offerings, mobility consulting services, and managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States (“U.S.”) and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, SaaS portfolio, mobility data sets, mobility consulting services, and managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (“SEC”). +Developments Impacting our Business +COVID-19 +Although COVID-19 has entered an endemic stage, COVID-19 (including new variants of COVID-19) or other future pandemics may adversely affect the global economic conditions, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. When COVID-19 was considered a public health emergency, we took actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but were not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. +Our products require specialized parts, some of which became more difficult to source during the COVID-19 pandemic. In some cases, we had to purchase such parts from third-party brokers at substantially higher prices. The Company’s strategies to mitigate global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 (“Fiscal 2023”). We also placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity. +We curtailed the increase in inventory purchases and in particular components purchased in the secondary markets in the second half of Fiscal 2023, and the Company currently does not expect to accumulate inventory in the same magnitude in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to maintain sufficient liquidity. +Restructuring Activities +To help offset increases in supply chain costs in Fiscal 2023, on May 12, 2022, our Board of Directors approved restructuring activities to better position the Company for increased profitability and growth. The Company incurred employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +4 +Table of Contents +Products and Services +Iteris provides comprehensive smart mobility infrastructure management solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. +Software Solutions +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, Commercial Vehicle Operations (“CVO”), TrafficCarma, VantageLive! and VantageARGUS CV (previously known as BlueARGUS) as described below. +• ClearGuide, which is provided on a software-as-a-service basis (“SaaS”), is a state-of-the-art mobility intelligence and transportation performance analytics solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement (“SPM”). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response (“IVR”). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial Vehicle Operations and vehicle safety compliance applications, which are provided on a SaaS basis, include various applications branded as ClearFleet, CVIEWplus, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for people’s daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +• VantageLive! is a SaaS solution that allows users to collect, process and analyze advanced intersection data from our Vantage sensors, as well as to view and understand intersection activity. +• VantageARGUS CV (previously BlueARGUS) is a SaaS solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Platform, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public-sector and private-sector customers via subscription-based direct data feeds or application programming interfaces (“APIs”), or through ClearGuide, our mobility intelligence and transportation performance analytics software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary computerized algorithms and selective quality control from experienced traffic analysts. +5 +Table of Contents +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and VantageARGUS CV) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as a mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, VersiCam, PedTrax, and P-Series products. +• Vantage Apex is the industry’s first full 1080p high-definition (“HD”) video and 4D/HD radar hybrid sensor with integrated artificial intelligence (“AI”) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Next uses a powerful processor that enables future functional growth while maintaining proven Iteris video detection performance and reliability. The architecture supports expanding ITS applications and easily integrates with existing technologies and is anticipated to integrate with future technologies. +• VantagePegasus offers wireless broadband communications for transportation systems. VantagePegasus wireless networks are built with carrier grade radio components that deliver wireless connectivity and the bandwidth for communications from remote sites to a centralized host system. +• VantageRadius is the industry’s leading 4D high-definition radar detection system with an integrated high-resolution video camera for traffic monitoring and detection verification. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• Velocity takes advantage of the large number of vehicles that are driving with Bluetooth or Wi-Fi enabled devices such as smart phones. Each Velocity reader senses a device's unique “MAC” address as they pass a reader station and transmits the time and location of the device to a central host system. As devices are detected at successive Velocity readers, the Host System calculates average travel times and speeds for a roadway segment. The device specific network address remains totally anonymous. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased cyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic and without pushing pole-mounted buttons. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +6 +Table of Contents +• P-Series detection cameras are integrated machine vision processors and cameras, designed for use on all types of intersections outside of North America. +The BlueTOAD product family combines unique MAC address capture with the latest CV technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra CV, both of which we bundle with a cloud-based software application branded as VantageARGUS CV. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra CV is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds, it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +In select territories, the Company also sells certain complementary original equipment manufacturer (“OEM”) products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products will depend, in part, on the continued replacement of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services include traffic management centers (“TMC”) design, staffing, and operations services for public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ managed services combine SaaS, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterial roads and highways along with their related in-field technology. These services include arterial management and asset management managed services. Our asset management managed service combines innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators are provided the opportunity to save time and money while keeping road users safer and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS solutions that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the Company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, the ClearMobility Platform enables seamless interoperation among our solutions via a common mobility data management engine, API framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. Our ClearMobility Platform is both horizontally scalable and third-party extensible. +7 +Table of Contents +Our process of developing, enhancing, aligning, harmonizing, and optimizing our portfolio of individual solutions is an ongoing process, for which the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, we report as a single operating segment. +Market Conditions +Currently, over 90% of our revenues are attributable to public-sector customers. Therefore, most of our revenues depend on state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +We believe that overall demand for our solutions will continue to depend, at least in part, on the federal and local governments’ use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. The Infrastructure Investment and Jobs Act (“IIJA”) became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. Within that funding pool, areas of direct relevance to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the obligation of appropriated funding and debates related to the federal debt ceiling may cause uncertainty regarding the availability of transportation funds in federal, state and local budgets. Although the pace of actual spending of IIJA funds may lag behind the appropriation process, sometimes significantly, the funds appropriated can continue to be spent after the IIJA expires. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For the fiscal year ended March 31, 2024 (“Fiscal 2024”) and Fiscal 2023, no individual customer represented greater than 10% of our total revenues. As of March 31, 2024 and 2023, no individual customer accounted for more than 10% of our total trade accounts receivable. +8 +Table of Contents +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. Historically, Veris Manufacturing has served as our only contract manufacturing services (CMS) partner; however, in fiscal 2024, we entered into a contract with a second CMS partner, Creation Technologies. We believe the addition of a second CMS partner will help to mitigate potential business discontinuity should either CMS partner be unable to meet its commitments to Iteris. We also believe the addition of a second CMS partner will improve our ability to negotiate possible pricing concessions. Production volumes for our CMS partners typically is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Our CMS partners deliver manufactured subassemblies and components to our Santa Ana, California facility, which includes approximately 12,000 square feet of space, where they go through final assembly and testing prior to shipment to our customers. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization (“ISO”) 9001:2015 international standard. Additionally, we also purchase and resell certain third-party products at times in order to better service customer needs. These third-party products may be stored and shipped from our Santa Ana facility or one of our regional distribution centers, depending on the type of third-party product and the ultimate customer destination. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenues were not a material portion of our total revenues for Fiscal 2024 and Fiscal 2023. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $123.8 million at March 31, 2024. We typically expect to recognize revenues in the range of approximately two-thirds to three-quarters of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2023, we had backlog of approximately $114.2 million. The 8.4% increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenues believed to be firm and earned under existing agreements, but it does not represent the total contract award if a firm purchase order or task order has not yet been issued under the contract. Backlog is not included in deferred revenues on our balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly given budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often can be affected by a variety of factors including the scheduling and forecasting practices of our individual customers, as well as availability of installation labor and ancillary parts related to installation which we do not manufacture or supply. These factors can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date might not be indicative of the timing of our future revenues. +Product Development +Our product development activities are mostly conducted at our facilities in Santa Ana, California, and Madison, Wisconsin, as well as using additional employee and partner resources across North America. Our research and development costs and expenses were approximately $10.0 million for Fiscal 2024 and $8.3 million for Fiscal 2023. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +9 +Table of Contents +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors providing managed services and consulting include a mix of local, regional and international engineering services firms. Our competitors in software products (e.g., performance measurement and management, advanced traveler information systems, asset management software, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, and other multi-disciplinary hardware and software corporations. +In the market for our detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets could have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights of protection for any potentially significant new technology we acquire or develop. We currently have 34 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 10 relating to our engineering and consulting services technologies and (iii) 7 related to our traffic and mobility software. We have 2 pending patent applications in the U.S. We currently have 9 issued foreign patents and 1 foreign patent application related to our traffic and mobility software. The expiration dates of our patents range from 2026 to 2042. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +10 +Table of Contents +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in litigation in the normal course of business related to our intellectual property rights and the intellectual property rights of others. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any litigation or other legal proceedings related to its intellectual property or the intellectual property of others, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on the Company’s results of operations, financial position or cash flows. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management’s resources, could be significant and could have a material adverse effect on our business, financial condition and results of operations, regardless of a claim’s validity. +Employees +As of March 31, 2024, we employed 454 full-time employees and 18 part-time employees, for a total of 472 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental investigations or proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to spend funds in connection with our compliance with applicable environmental regulations. These expenditures have not been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. +ITEM 1A. RISK FACTORS +Our business is subject to a number of risks, some of which are discussed below. Other risks are presented elsewhere in this report and in the information incorporated by reference into this report. You should consider the following risks carefully in addition to the other information contained in this report and our other filings with the SEC, including our subsequent quarterly reports on Form 10-Q and current reports on Form 8-K, before deciding to buy, sell or hold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, our business, financial condition, or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. +Risk Related to Our Business +Because we depend on government contracts and subcontracts, we face additional risks related to contracting with federal, state and local governments, including budgetary issues and fixed price contracts, that could adversely impact our future revenues and profitability. +A significant portion of our revenues comes from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. We anticipate that revenues from government contracts will remain a significant portion of our revenues. Government business is, in general, subject to special risks and challenges, including: +• delays in funding and uncertainty regarding the allocation of funds to state and local agencies from the U.S. federal government, and delays or reductions in other state and local funding dedicated for transportation and ITS projects; +• other government personnel or budgetary constraints, including local governments not having sufficient personnel to pursue projects; reaching the current federal debt ceiling; and/or cut-backs, delays or reallocation of government funding, including without limitation, changes in the administration and repeal of government purchasing programs; +11 +Table of Contents +• audits, litigation or investigations that delay or otherwise negatively impact the funding for certain government projects; +• long purchase cycles or approval processes; +• competitive bidding and qualification requirements, as well as our ability to replace large contracts once they have been completed; +• changes in government policies and political agendas; +• maintenance of relationships with key government entities from whom a substantial portion of our revenues is derived; +• milestone deliverable requirements and liquidated damage and/or contract termination provisions for failure to meet contract milestone requirements; +• performance bond requirements; +• potential government shutdowns and related uncertainty with respect to the federal budget and debt ceiling; +• adverse weather conditions or other natural or health disasters or developments, such as COVID-19, and evacuations and flooding due to hurricanes, or severe storms, can result in our inability to perform work in affected areas; and +• international relations and international conflicts such as the war in Ukraine and the war in the Middle East, or other military operations that could cause the temporary or permanent diversion of government funding from transportation or other infrastructure projects. +Governmental budgets and plans are subject to change without warning. Certain risks of selling to governmental entities include dependence on appropriations and administrative allocation of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments or agendas, significant changes in contract scheduling, intense competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities and rescheduling or cancellation in purchase decisions by governmental entities, and the current constraints on government budgets at the federal, state and local level, and the ongoing uncertainty as to the timing and accessibility to government funding could cause our revenues and income to drop substantially or to fluctuate significantly between fiscal periods. +In addition, a number of our government contracts are fixed price contracts. As a result, we might not be able to recover any cost overruns we may incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs for these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs could adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our revenues in any given period. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations. +Our profitability could be adversely affected if we are not able to maintain adequate utilization of our engineering and consulting workforce. +The cost of providing our engineering and mobility consulting services, including the extent to which we utilize our workforce, affects our profitability. The rate at which we utilize our workforce is affected by a number of factors, including: +• our ability to transition employees from completed projects to new assignments and to hire and assimilate new employees; +• our ability to forecast demand for our services and thereby maintain an appropriate headcount in our various regions and related professional disciplines; +• the timing of new contract awards, the commencement of work under an awarded contract or the completion of large contracts; +12 +Table of Contents +• the availability of project funding or other project budget issues; +• our need to devote time and resources to training, business development, professional development and other non-chargeable activities; and +• our ability to match the skill sets of our employees to the needs of the marketplace. +An inability to properly and fully utilize our engineering and consulting workforce would reduce our profitability and could have an adverse effect on our results of operations. +Our management information systems and databases have been and could in the future be disrupted by data protection breaches, system security failures, cyber threats or by the failure of, or lack of access to, our internal operations, such as our enterprise resource planning (“ERP”) system, or services provided to our customers. These disruptions could negatively impact our sales, increase our expenses, significantly harm our reputation and/or adversely affect our stock price. +Experienced users and computer programmers may be able to penetrate, or “hack”, our network security and create system disruptions, cause shutdowns and compromise or misappropriate our confidential information or that of our employees and third parties. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our internal network, any of our systems, service offerings or otherwise exploit any security vulnerabilities of our network, systems or service offerings. In addition, sophisticated services, hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of a system. We could incur expenses addressing problems created by cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities, and our efforts to address these problems might not be successful. We must, and do, take precautions to secure customer information and prevent unauthorized access to our databases and systems containing confidential information. Any data security event, such as a breach, data loss or information security lapses, whether resulting in the compromise of personal information or the improper use or disclosure of confidential, sensitive or classified information, could result in interruptions, cessation of service(s), claims, remediation costs, regulatory sanctions against us, loss of current and future contracts, adverse effects to results of operations and financial condition, serious harm to our reputation and/or adverse effects to our stock price. We operate our ERP system and other key business systems on SaaS platforms, and we use these systems for reporting, planning, sales, audit, inventory control, loss prevention, purchase order management and business intelligence. Accordingly, we depend on these systems, and the third-party providers of these services, for a number of aspects of our operations. If these service providers or these systems fail, or if we are unable to continue to have access to these systems on commercially reasonable terms, or at all, operations could be severely disrupted until an equivalent system(s) could be identified, licensed or developed, and integrated into our operations. This disruption could have a material adverse effect on our business and due to the evolving nature of these cyber and other security threats, the potential impact of any future incident cannot be predicted. We carry insurance, including cyber insurance, commensurate with our size and the nature of our operations, although there is no certainty that such insurance will in all cases be sufficient to adequately cover us for all costs and losses incurred in connection with the occurrence of any of these system security risks, data protection breaches, cyber-attacks or other events. +If unauthorized access is obtained to our customer ’ s personal and/or proprietary data in connection with our web-based and mobile application solutions and services, we may suffer various negative impacts, including a loss of customer and market confidence, loss of customer loyalty, and significant liability to our customers and to individuals or businesses whose information was being stored. +Protecting our customers’ data is critical to our business, and if there is unauthorized access, we may incur significant costs or liabilities. In addition, we are required to comply with government contracting requirements and make investments in our systems to protect that data. If we are unable to do so, our customers may lose confidence in us, which would harm our sales, and we may incur significant expenses or liabilities. +Acquisitions, investments and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. +Acquisitions, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial conditions and results of operations. We expect to continue to evaluate and enter into discussions regarding potential strategic transactions, including acquiring complementary businesses, products, services, and technologies. Acquisitions may require significant capital infusions which could include debt, equity, or convertible securities. In general, strategic transactions also involve a number of special risks, including: +13 +Table of Contents +• the strategic benefits and opportunities from any planned or completed acquisition or divestiture by the Company might not be realized or may take longer to realize than expected; +• strategic benefits and opportunities related to past and ongoing restructuring actions might not be realized or may take longer to realize than expected; +• our ability to realize the expected financial benefits of an acquisition, divestiture or other strategic transaction might not be realized or may take longer to realize than expected; +• cost reductions might not occur as expected; +• management time and focus may be diverted from operating our business due to challenges related to acquisitions and other strategic transactions; +• the failure to retain or integrate key acquired personnel; +• the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information system of the acquired companies; +• increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; +• failure to successfully further develop the acquired business or technology; +• the incurrence of unforeseen obligations or liabilities; +• potential impairment of relationships with employees or customers as a result of changes in management; +• increased interest expense or increased share or equity dilution; and +• amortization of acquired intangible assets, as well as unanticipated accounting charges. +Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot ensure that we will be able to identify or consummate any additional acquisitions or other strategic transactions, successfully integrate any acquisitions or realize the benefits and opportunities anticipated from any acquisition or other strategic transaction. Our failure to address the risks and other issues in connection with our past or future acquisitions and other strategic transactions could cause us to not realize their anticipated benefits and opportunities, incur unanticipated liabilities, experience increased costs, and harm our business generally. +We participate in the software development market, which may be subject to various technical and commercial challenges. +We invest in software development and have in the past and may in the future experience development and technical challenges. Our business and results of operations could also be seriously harmed by any significant delays in our software development activities. Despite testing and quality control, we cannot be certain that errors will not exist in our software after its release. Any faults or errors in our existing products or in any new products may delay product introductions and shipments, require design modifications, or harm customer relationships or our reputation, any of which could adversely affect our business and competitive position. In addition, software companies are subject to litigation concerning intellectual property disputes, which could be costly and distract our management. No losses on contracts were recorded during Fiscal 2024 based on our assessment. The estimates and assumptions used in these assessments were based upon management’s judgment and may be subject to change as new events occur and additional information is obtained. If the future estimated costs to fulfill a contract exceed the expected consideration from the customer, the Company’s financial condition, cash flows, and results of operations may be adversely and materially impacted. +14 +Table of Contents +If we do not keep pace with rapid technological changes and evolving industry standards, we will not be able to remain competitive, and the demand for our products will likely decline. +In general, our markets are characterized by the following factors: +• rapid technological advances; +• downward price pressures in our target markets as technologies mature; +• changes in customer requirements; +• additional qualification requirements related to new products or components; +• frequent new product introductions and enhancements; +• obsolescence of certain parts and components from time to time that may require re-engineering of certain portions of our product or products; +• inventory issues related to transition to new or enhanced models; and +• evolving industry standards and changes in the regulatory environment. +Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. +If we are unable to develop and introduce new products and product enhancements in a cost-effective and timely manner, or are unable to achieve market acceptance of our new products, our operating results could be adversely affected. +We believe our revenues growth and future operating results will depend on our ability to complete development of new products and product enhancements, introduce these products and product enhancements in a timely, cost-effective manner, achieve broad market acceptance of these products and product enhancements, and reduce our production costs. During the past few fiscal years we have introduced, and we expect we will continue to introduce, both new and enhanced products. We cannot guarantee the success of these products, and we might not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products. +We believe that we must continue to make substantial investments to support ongoing research and development in order to develop new or enhanced products and software to remain competitive. We need to continue to prepare updates for existing products and develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, camera technologies, software and analysis in response to evolving customer requirements. In addition, we are continuing to migrate some of our products to a new platform. We cannot assure you that we will be able to adequately manage product transitions. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory requirements typically related to new product transitions and introductions. We cannot ensure that any such investments in research and development will lead to any corresponding increase in revenues. +We may need to raise additional capital in the future, which might not be available on terms acceptable to us, or at all. +We have historically experienced volatility in our earnings and cash flows from operations from year to year. We may need or choose to raise additional capital to fund our operations, to repay indebtedness, pursue acquisitions or expand our operations. Such additional capital may be raised through bank borrowings, other debt or equity financings, or some combination of capital sources. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders. +Our capital requirements will depend on many factors, including, but not limited to: +• market acceptance of our products and product enhancements, and the overall level of sales of our products; +• our ability to control costs and achieve profitability; +15 +Table of Contents +• the supply of key components for our products; +• our ability to increase revenues and net income; +• increased research and development expenses and sales and marketing expenses; +• our need to respond to technological advancements and our competitors’ introductions of new products or technologies; +• capital improvements to new and existing facilities and enhancements to our infrastructure and systems; +• any acquisitions of businesses, technologies, product lines, or possible strategic transactions or dispositions; +• our relationships with customers and suppliers; +• government budgets, political agendas and other funding issues, including potential delays in government contract awards or commencement of work for a project; +• our ability to successfully secure credit arrangements with banks or other lenders and/or negotiate equity arrangements subject to the state of the financial markets in general; and +• general economic conditions, including the effects of economic slowdowns and international conflicts. +If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the issuance of equity or convertible debt securities, the beneficial ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional equity or debt financing might not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms when needed, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures. +The markets in which we operate are highly competitive with many companies more established than we are. +Our competitors tend to vary across the various product categories in which we participate. +The engineering and consulting market is highly fragmented and is subject to evolving national and regional quality and safety standards. Our competitors vary in size, number, scope and breadth of the products and services they offer, and include large multi-national engineering firms and smaller local or regional firms. +Our sensors line of business competes with existing, well-established companies and technologies, both domestically and abroad. Only a portion of the traffic intersection market has adopted advanced above-ground detection technologies, and our future success will depend in part upon gaining broader market acceptance for such technologies. Certain technological barriers to entry make it difficult for new competitors to enter the market with competing video or other technologies; however, we are aware of new market entrants from time to time. Increased competition could result in loss of market share, price reductions and reduced gross margins, any of which could seriously harm our business, financial condition and results of operations. +Many of our competitors have greater name recognition and greater financial, technological, marketing and customer service resources than we do. This may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, promotion, sale and support of their products and services than we can. Consolidations of end users, distributors and manufacturers in our target markets exacerbate this problem. As a result of the foregoing factors, we might not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations. +16 +Table of Contents +Our failure to successfully secure new contracts and renew existing contracts could reduce our revenues and profitability. +Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector customers. We continually bid on new contracts and negotiate contract renewals on expiring contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. As a condition to contract award, customers typically require us to provide a surety bond or letter of credit to protect the client should we fail to perform under the terms of the contract. Government entities are also taking more time between contract award and approval to commence work under the contract, which delays our ability to recognize revenues under the contract. If negative market conditions materialize, or if we fail to secure adequate financing arrangements or the required governmental approval or fail to meet other required conditions, we might not be able to pursue, obtain or perform particular projects, which could reduce or eliminate our profitability. +We may be unable to attract and retain key personnel, including senior management, which could seriously harm our business. +Due to the specialized nature of our business and the current tight labor market, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. We believe that our success will depend on the continued employment of a highly qualified and experienced senior management team to retain existing business and generate new business. The loss of any of our officers, or any of our other executives or key members of management could adversely affect our business, financial condition, or results of operations (e.g., loss of customers or loss of new business opportunities). Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified and productive engineering and other highly skilled technical personnel. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our employee needs in a timely manner, which may adversely affect our growth in the current fiscal year and in future years. This situation is exacerbated by pressure from agency customers to contain our costs, while salaries for employees are on the rise. Although we intend to continue to devote significant resources to recruit, train and retain qualified skilled personnel, we might not be able to attract and retain such employees, which could impair our ability to perform our contractual obligations, meet our customers’ needs, win new business, and adversely affect our future results. Likewise, the future success of our consulting services will depend on our ability to hire additional qualified engineers, planners and technical personnel. Competition for qualified employees, particularly development engineers and software developers, is intense and has become more so over time. We might not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations. +Industry consolidation may lead to increased competition and may harm our operating results. +There is a continuing trend toward industry consolidation in our markets. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, some of our current and potential competitors for transportation infrastructure solutions have made acquisitions, or announced new strategic alliances, designed to position them with the ability to provide end-to-end technology solutions for the transportation industry. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for public transportation agencies, municipalities, and commercial entities. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results, and financial condition. +17 +Table of Contents +International conflicts could adversely affect our business, financial condition and results of operations. +Sustained conflict and disruption in Ukraine and the Middle East is likely and although the lengths, impacts and outcomes of the ongoing wars in Ukraine and the Middle East are highly unpredictable, these conflicts could lead to significant market and other disruptions, including significant volatility in commodity prices and supply of energy resources, instability in financial markets, supply chain interruptions, political and social instability, changes in government agency budgets and funding preferences as well as increase in cyberattacks and cyber and corporate espionage. To date we have not experienced any material interruptions in our infrastructure, supplies, technology systems or networks needed to support our operations. We are actively monitoring the situations in Ukraine and the Middle East and assessing the potential impacts on our business. The extent and duration of the wars and resulting market disruptions could be significant and could potentially have substantial impact on the global economy and our business for an unknown period of time. Any such disruptions may also magnify the impact of other risks described in this Annual Report on Form 10-K. +Increased frequency of severe and extreme weather events associated with climate change could adversely impact our facilities, interfere with intersection construction projects, and have a material impact on our financial condition, cash flows and results of operations +We take climate change and its associated risks seriously. More extreme and volatile temperatures, increased storm intensity and flooding, and more volatile precipitation are among the climate-related events that are most likely to impact our business. We are unable to predict the timing or magnitude of these events. However, we perform ongoing assessments of physical risk, including physical climate risk, to our business and efforts to mitigate these physical risks continue to be implemented on an ongoing basis. Increased frequency of severe and extreme weather events associated with climate change could adversely impact our and our clients’ businesses and facilities, interfere with intersection construction projects, cause work stoppages and project delays or cancellations, and have a material impact on our financial condition, cash flows and results of operations. +The availability and regulation of data we purchase and use in certain of our Mobility Data Sets may become more restrictive, and adversely affect performance of our products or the cost of data purchased. +The announcement by Wejo Group Limited to appoint an administrator due to insolvency, and the change in strategy of Otonomo Technologies Ltd. after being acquired, both reduced the number of suppliers provisioning data to us for use in some of our Mobility Data sets. Although similar data can be supplied from other sources, reductions in the number of, or other future changes in, key data sources or availability could adversely affect the breadth, quality and value of our Mobility Data Sets and/or the cost to purchase data. In addition, any future increased data privacy regulation, which could be impacted by which political party controls Congress and/or the White House after the 2024 elections, could constrain our Mobility Data business by limiting data availability and sources and reduce quality of roadway traffic analysist. Any of these occurrences could have a material adverse effect on our reputation, profitability or revenue. +Our business could be negatively affected as a result of actions of activist stockholders or others. +We may be subject to actions or proposals from stockholders or others that might not align with our business strategies or the interests of our other stockholders. Responding to such actions can be costly and time-consuming, disrupt our business and operations, and divert the attention of our Board of Directors, management, and employees from the pursuit of our business strategies. Such activities could interfere with our ability to execute our strategic plan. Activist stockholders or others may create perceived uncertainties as to the future direction of our business or strategy which may be exploited by our competitors and may make it more difficult to attract and retain qualified personnel and potential customers, and may affect our relationships with current customers, vendors, investors, and other third parties. In addition, a proxy contest for the election of directors at our annual meeting would require us to incur significant legal fees and proxy solicitation expenses and require significant time and attention by management and our Board of Directors. The perceived uncertainties as to our future direction also could affect the market price and volatility of our securities. +Our stock repurchase program may adversely affect our liquidity and cause fluctuations in our stock price. +On May 12, 2022, the Board of Directors approved a plan for the Company to acquire up to $10.0 million of our outstanding common stock for an unspecified length of time (the “2022 Stock Repurchase Program”). During the fiscal year ended Fiscal 2024, we repurchased 39,861 shares for an aggregate price of approximately $0.2 million, at an average price of $4.54 per share. From the inception of the 2022 Stock Repurchase Program through March 31, 2024, we repurchased approximately 339,861 shares of our common stock for an aggregate price of approximately $1.1 million, at an average price per share of $3.14. As of March 31, 2024, approximately $8.9 million remained available for the repurchase of our common stock under the 2022 Stock Repurchase Program. +18 +Table of Contents +Potential future stock repurchases under the stock share repurchase program could be funded by operating cash flow or excess cash balances. Repurchases under the stock repurchase program may adversely affect our liquidity, which in turn could impact our profitability, financial condition and results of operations. In addition, repurchases under the stock repurchase program will reduce the number of shares of our common stock available for purchase and sale in the public market, which could affect the market price of our common stock. Furthermore, the Inflation Reduction Act of 2022, which was signed into law in August 2022, imposes a non-deductible 1% excise tax on the fair market value of stock repurchases after December 31, 2022, that exceed $1.0 million in a taxable year, which may impact the tax efficiency of our stock repurchase program. +COVID-19, or other future pandemics, could continue to have an adverse effect on our business. +Although COVID-19 has entered an endemic stage, COVID-19 (including new variants of COVID-19) or other future pandemics may adversely affect the global economic conditions, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. When COVID-19 was considered a public health emergency, we took actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but were not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. +Our products require specialized parts, some of which became more difficult to source during the COVID-19 pandemic. In some cases, we had to purchase such parts from third-party brokers at substantially higher prices. The Company’s strategies to mitigate global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and accumulating inventory in the first two quarters of Fiscal 2023. We also placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity. If the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to maintain sufficient liquidity. +Legal and Regulatory Risks +We might not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position. +If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may be able to access our proprietary technology and our business, financial condition and results of operations may be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or illegally use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. As a result, we might not be able to protect our proprietary rights adequately in the U.S. or internationally. +Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. Presently and historically, we have been subject to litigation regarding our intellectual property rights and the intellectual property rights of others, and we might continue to be in the future. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or using certain products, product features, or technologies. In addition, in the event of an adverse outcome in litigation or any similar proceedings we may find ourselves at a competitive disadvantage to others who need not incur the substantial expense, time, and effort required to market or use certain products, product features, or technologies. We might not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have infringed upon or misappropriated another party’s intellectual property. Our continued expansion into software development activities might expose us to more litigation. Any of the foregoing could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and expenses, and the diversion of management’s attention and resources, could be significant and could seriously harm our business, financial condition and results of operations, regardless of whether the claim is valid. +19 +Table of Contents +We may continue to be subject to traffic-related litigation. +In general, participants in the traffic industry are subject to frequent litigation claims due to the nature of personal injuries that can result from traffic accidents. As a provider of traffic engineering services, products and solutions, we are, and could from time to time in the future continue to be, subject to litigation for traffic related accidents, even if our products or services did not cause the particular accident. While we generally carry insurance against these types of claims, some claims might not be covered by insurance or the damages resulting from such litigation could exceed our insurance coverage limits. In the event that we are required to pay significant damages as a result of one or more lawsuits that are not covered by insurance or exceed our coverage limits, it could materially harm our business, financial condition or cash flows. Even defending against unsuccessful claims could cause us to incur significant expenses and result in a diversion of management's attention. +We may experience adverse impacts related to Artificial Intelligence (“AI”) laws. +While we are working to increase our use of AI with initiatives, such as further enhancing our hybrid sensor technologies with integrated AI algorithms to provide precise and detailed detection, tracking and classification of traffic, there is also increasing regulatory scrutiny in the use of machine learning and AI. AI presents risks and challenges that could affect its adoption, such as uncertainty in the legal regulatory environment relating to AI may require significant resources to modify or change our business or product offerings to comply with U.S. and non-U.S. laws, the scale and nature are unknown at this time. For example, on October 30, 2023, the Biden administration issued an Executive Order to, among other things, establish extensive new standards for AI safety and security. Other jurisdictions may decide to adopt similar or more restrictive legislation that may render the use of such technologies challenging or prohibited. These obligations may make it harder for us to use AI in our business, and require us to change our product offerings, or prevent or limit our use of AI. If we cannot use AI, or that use is restricted, our product offerings may be less efficient, or we may be less competitive, which could adversely affect our business, reputation, financial conditions, and results of operations. +Financial and Market Risks +We might not be able to consistently achieve profitability on a quarterly or annual basis in the future. +We had GAAP net income of approximately $3.1 million in Fiscal 2024 and net loss of $14.9 million in Fiscal 2023. We cannot ensure that we will be able to maintain profitability in the future. Our ability to operate at a profit could be impacted by governmental budgetary constraints, government and political agendas, economic instability, supply chain constraints and other items that are beyond our control. Furthermore, we rely on operating profits to fund investments in sales and marketing and research and development initiatives. We cannot ensure that our financial performance will sustain a sufficient level to completely support those investments. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues or increases in planned investments. +20 +Table of Contents +If we experience declining or flat revenues and we fail to manage such declines effectively, we may be unable to execute our business plan and may experience future weaknesses in our operating results. +Based on our business objectives, and in order to achieve future growth, we will need to continue to hire additional qualified and productive personnel, and invest in additional research and development and sales and marketing activities, which could increase our expenses and cause declines in our operating results. In addition, our past expansion has placed, and future expansion is expected to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage these activities or any revenues declines successfully, our growth, our business, our financial condition and our results of operations could be adversely affected. +Our use of estimates in conjunction with the input method of measuring progress to completion of performance obligations for our engineering and consulting services revenues could result in a reduction or reversal of previously recorded revenues and profits. +A portion of our engineering and consulting services revenues is measured and recognized over time using the input method of measuring progress to completion. Our use of this accounting method results in recognition of revenues and profits proportionally over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to estimated costs and resulting revenues recognized are recorded when the amounts are known or can be reasonably estimated based on updated information. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction contracts, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates which may result in reductions or reversals of previously recorded revenues and profits. +If our internal controls over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected. +Section 404 of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports. We are required to obtain our auditors’ attestation pursuant to Section 404(b) of the Sarbanes-Oxley Act. Going forward, we might not be able to complete the work required for such attestation on a timely basis and, even if we timely complete such requirements, our independent registered public accounting firm may still conclude that our internal controls over financial reporting are not effective. +A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that technology, decision-making and other processes can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls also can possibly be circumvented by individuals, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot ensure that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and go undetected. If we are not able to maintain effective internal controls over financial reporting, we may lose the confidence of investors and analysts and our stock price could decline. +Our quarterly operating results fluctuate as a result of many factors. Therefore, we may fail to meet or exceed the expectations of securities analysts and investors, which could cause our stock price to decline. +Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. Factors that could affect our revenues and operating results include, among others, the following: +• delays in government contracts and funding from time to time and budgetary constraints at the federal, state and local levels; +• our customers' or our ability to access stimulus funding, funding from the federal transportation bills or other government funding; +21 +Table of Contents +• declines in new home and commercial real estate construction and related road and other infrastructure construction; +• changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as increased price competition in general; +• the long lead times associated with government contracts; +• the size, timing, rescheduling or cancellation of significant vendor and customer orders; +• our ability to control costs, including costs associated with strategic alternatives; +• the mix of our products and services sold in a quarter, which has varied and is expected to continue to vary from time to time; +• our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely manner, or at all; +• market acceptance of the products incorporating our technologies and products; +• the introduction of new products by competitors; +• the availability and cost of components used in the manufacture of our products; +• our success in expanding and implementing our sales and marketing programs; +• the effects of technological changes in our target markets; +• the amount of our backlog at any given time; +• timing of backlog fulfillment; +• the nature of our government contracts; +• decrease in revenues derived from key or significant customers; +• deferrals of customer orders in anticipation of new products, applications or product enhancements; +• interruptions or other significant disruption in our supply chain which may negatively impact our ability to ship products and/or the cost of our products; +• risks and uncertainties associated with our international business; +• market condition changes such as industry consolidations that could threaten our ability to procure new business; +• general economic and political conditions; +• our ability to raise additional capital; +• pandemic and epidemic events, such as COVID-19, which may have a continuing impact on our future operating results; +• international wars, conflicts, and acts of terrorism; and +• other factors beyond our control, including but not limited to, natural disasters. +Due to the factors listed above, as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors, which could cause the trading price of our common stock to decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance. +22 +Table of Contents +Supply shortages or production gaps could materially and adversely impact our sales and financial results. +We have experienced, and may from time to time in the future continue to experience parts shortages, end of life events, sharp increases in component costs and unforeseen quality control issues by our suppliers that may impact our ability to meet demand for our products. COVID-19 increased the occurrence of such shortages and increased costs for materials. Although we have transitioned to using multi-sourcing strategies when technically and economically feasible to mitigate supply risk, we historically used, and in some cases continue to use, single suppliers for certain key components in our products. Additionally, we have had to reengineer products from time to time to address discontinued, obsolete or unavailable components. Our products are also deployed with other traffic intersection products that also could experience supply issues for their products, which in turn could result in delays in orders for our products. Should any such supply delay or disruption occur, or should a key supplier discontinue operations, our future sales and costs may be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products and do not have any long-term contracts to guarantee supply of such products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources for many of our products, if necessary, we could experience a production gap should our contract manufacturers become unable to meet our production requirements and the cost of our products could increase, adversely affecting our margins. Further, foreign imports of components in our products subject the Company to risks of changes in, or the imposition of new, export/import requirements, tariffs, work stoppages, delays in shipment, product cost increases due to component shortages, public health issues, such as COVID-19, that could lead to temporary closures of facilities or shipping ports, and other economic uncertainties affecting trade between the U.S. and other countries where we source components for our products. Any such actions could increase the cost to us of such products and cause increases in the prices at which we sell such products, which could adversely affect our financial performance. Similarly, these actions could result in cost increases or supply chain delays that impact third party products (e.g., steel poles) which could lead our customers to delay or cancel planned purchases of our products. +Our international business operations may be threatened by many factors that are outside of our control. +While we historically have had limited international sales, revenues and operational experience, we have been expanding our distribution capabilities for our products internationally, particularly in Europe and South America. We plan to continue to expand our international efforts, but we cannot ensure that we will be successful in such efforts. International operations subject us to various inherent risks including, among others: +• political, social and economic instability, as well as international conflicts and acts of terrorism; +• bonding requirements for certain international projects; +• longer accounts receivable payment cycles; +• import and export license requirements and restrictions of the U.S., as well as requirements and restrictions in the other countries in which we operate; +• currency exchange rate fluctuations and restrictions, and our ability to repatriate currency from certain foreign regions; +• unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions; +• required compliance with existing and new foreign regulatory requirements and laws, more restrictive labor laws and obligations, including but not limited to the U.S. Foreign Corrupt Practices Act; +• difficulties in managing and staffing international operations; +• potentially adverse tax consequences; +• reduced protection for intellectual property rights in some countries; and +• pandemic and epidemic events, such as COVID-19, and related government responses, including travel restrictions, quarantines and “stay-at-home” orders. +23 +Table of Contents +Substantially all of our international product sales are denominated in U.S. dollars. As a result, an increase in the relative value of the U.S. dollar could make our products more expensive and potentially less price competitive in international markets. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency exchange rate fluctuations. +Any of the factors mentioned above may adversely affect our future international revenues and, consequently, affect our business, financial condition and operating results. Additionally, as we pursue the expansion of our international business, certain fixed and other overhead costs could outpace our revenues, thus adversely affecting our results of operations. We may likewise face local competitors in certain international markets who are more established, have greater economies of scale and stronger customer relationships. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and certain other parts of the world. +The trading price of our common stock is highly volatile. +The trading price of our common stock has historically fluctuated widely. From March 31, 2021 through March 31, 2024, our common stock has traded at prices as low as $2.40 per share and as high as $7.77 per share. The market price of our common stock could continue to fluctuate in the future in response to various factors, including, but not limited to: +• quarterly variations in operating results; +• our ability to control costs, improve cash flow and sustain profitability; +• statements made by third parties or speculation regarding our strategic alternatives; +• our ability to raise additional capital; +• shortages announced by suppliers; +• announcements of technological innovations or new products or applications by our competitors, customers or us; +• transitions to new products or product enhancements; +• acquisitions of businesses, products or technologies, or other strategic transactions or dispositions; +• the impact of any litigation or other legal proceedings; +• changes in investor perceptions; +• government funding, political agendas and other budgetary constraints; +• changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry in general; +• changes in earnings estimates or investment recommendations by securities analysts; and +• international conflicts, political unrest and acts of terrorism. +The stock market is currently experiencing and has from time-to-time experienced volatility, which has often affected and may continue to affect the market prices of equity securities of many technology and smaller companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management’s attention and resources from other matters. +24 +Table of Contents +Provisions of our charter documents may discourage a third party from acquiring us and may adversely affect the price of our common stock. +Provisions of our certificate of incorporation could make it difficult for a third party to influence or acquire us, even though that might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For example, under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. In addition, our bylaws contain provisions governing the ability of stockholders to submit proposals or make nominations for directors. We may also adopt provisions and agreements from time to time that could make it harder for a potential acquirer. +Our bylaws include a forum selection clause, which may impact the ability of our stockholders to bring actions against us. +Subject to certain limitations, and to the fullest extent permitted by law, our bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery in the State of Delaware (or, in the event that the Chancery Court does not have jurisdiction, the federal district court for the District of Delaware or other state courts of the State of Delaware) will be the sole and exclusive forum for: (a) any derivative action or proceeding brought on our behalf; (b) any action asserting a claim of breach of fiduciary duty owed by any of our directors, officers or other employees or our stockholders; (c) any action asserting a claim arising pursuant to any provision of the Delaware General Corporate Law or our certificate of incorporation or bylaws; (d) any action to interpret, apply, enforce or determine the validity of our certificate of incorporation or bylaws; or (e) any action asserting a claim governed by the internal affairs doctrine. These limitations on the forum in which stockholders may initiate action against us could create costs or, inconvenience or otherwise adversely affect our stockholders’ ability to seek legal redress. If a court were to find the forum-selection provisions contained in our bylaws to be unenforceable, we may incur additional costs associated with resolving proceedings in forums other than the Court of Chancery in the State of Delaware and the federal district courts of the United States. +ITEM 1B. UNRESOLVED STAFF COMMENTS +None. +ITEM 1C. CYBERSECURITY +Risk Management and Strategy +We have established processes to assess, identify, and manage risks from cybersecurity threats as part of our broader enterprise-wide risk management system and processes, which is overseen by our Board of Directors through our Audit Committee, along with our executive management. +To assess and manage risks from cybersecurity threats, we maintain a cybersecurity risk management program (the “Cybersecurity Program”) that employs the Critical Security Controls framework developed by the Center for Internet Security as the foundation. Our Information Security team, composed of members of the Company’s Corporate Information Technology (“IT”) Department and Software Product Operations team, is tasked with monitoring and assessing, and the day-to-day management of, cybersecurity and operational risks related to information security and system disruption. The Cybersecurity Program includes, among other elements: +• ongoing identification and assessment of cybersecurity threats based on periodic internal and external assessments and monitoring; +• technical and organizational measures designed to protect against, detect, and respond to cybersecurity threats, including documented processes, procedures and technical controls aligned with our information security management system; +• an incident management and response program that continuously monitors the Company’s information systems for vulnerabilities, threats, and incidents; manages and takes action to contain incidents that occur; remediates vulnerabilities; and communicates the details of threats and incidents to management, as deemed necessary or appropriate; and +25 +Table of Contents +• organization-wide cybersecurity training and compliance exercises, including formal educational material and compliance testing that is administered to all employees on an annual basis, as well as ad hoc testing and awareness exercises. +The Company also engages external experts to assist in its assessment, identification, and management of risks from cybersecurity threats. These experts include cybersecurity consultants that we engage as part of our continuing efforts to evaluate and improve the effectiveness of our Cybersecurity Program, and other cybersecurity service providers that help secure our systems and networks. The Company also uses specialized third-party software tools to identify, monitor and mitigate risks from cybersecurity risks. +Our Cybersecurity Program also addresses cybersecurity risks associated with our use of third-party service providers, in particular those identified as critical to the functioning of our business. To that end, we take cybersecurity considerations into account in the selection of our third-party service providers. We perform cybersecurity diligence on third parties that have access to our systems, data or facilities that house such systems or data, and continually monitor cybersecurity risks identified through such diligence, and we require those third parties to implement appropriate cybersecurity controls with respect to the services they provide to us. +As of the date of this Annual Report, the Company has not identified any risks from cybersecurity threats, including as the result of any previous cybersecurity incidents, that have materially affected or are reasonably likely to materially affect the Company, including our business strategy, results of operations or financial condition, but there can be no assurance that any such risk will not materially affect the Company in the future. For further information about the cybersecurity risks we face, and potential impacts, see Part I, Item 1A, “Risk Factors.” +Governance +The Board of Directors is responsible for overseeing our enterprise risk management program. The Audit Committee, which consists solely of independent directors, has been designated by our Board to oversee cybersecurity risks and our processes to identify, prioritize, assess, manage, and mitigate those risks. The Audit Committee receives quarterly updates, or more frequently as needed, on cybersecurity and information technology matters and related risk exposures from our Chief Financial Officer (“CFO”). +The CFO works in conjunction with the Chief Technology Officer (“CTO”) to oversee the Information Security Team and the operation of the Cybersecurity Program. Our Information Security team in conjunction with the CTO have an average of 15 years of professional IT and software development management experience, including in the areas of incident response, vulnerability management, network security administration and other governance, risk and compliance areas. +Our executive management, the Audit Committee, and the Board of Directors are notified of any significant cybersecurity incidents through an escalation process that is established in our incident response plan. Pursuant to that plan, upon detection incidents are first reported to and assessed by the Information Security Team. Depending on the nature and severity of an incident, and considering the actual or potential impact, significance, and scope, the plan calls for the Information Security team to notify the executive team, who may in turn notify the Audit Committee and Board of Directors, regarding the detection, mitigation, and remediation of cybersecurity incidents. +ITEM 2. PROPERTIES +Our largest facility is located in Santa Ana, CA where we lease approximately 47,000 square feet of office, manufacturing and warehouse space pursuant to a lease which terminates in March 2027 (see Note 7, Right-of-Use Assets and Lease Liabilities, to the Financial Statements for more information). +ITEM 3. LEGAL PROCEEDINGS +The information is set forth under the heading “Litigation and Other Contingencies” (see Note 6, Commitments and Contingencies, to the Financial Statements for more information). +ITEM 4. MINE SAFETY DISCLOSURES +Not applicable. +26 +Table of Contents +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information for Common Stock +Our common stock has traded on the Nasdaq Capital Market under the symbol “ITI” since February 8, 2016. Prior to that, our common stock traded on the New York Stock Exchange under the same symbol. +As of June 11, 2024, we had 266 holders of record of our common stock according to information furnished by our transfer agent. The actual number of stockholders is greater than this number of record holders, as the total number includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. +Securities Authorized for Issuance under Equity Compensation Plans +Information regarding securities authorized for issuance can be found under Part III, “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” +Dividend Policy +We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. We currently intend to retain any earnings for working capital, investment and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business conditions, and such other factors as the Board of Directors may deem relevant. +Recent Sales of Unregistered Securities +Not applicable. +Use of Proceeds from Registered Securities +Not applicable. +Issuer Purchases of Equity Securities +No shares were purchased by the Company during the three months ended March 31, 2024. See Note 10, Stock Repurchase Program, to the Financial Statements for more information. +ITEM 6. RESERVED +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +You should read the following discussion and analysis in conjunction with our Financial Statements and related Notes thereto included in Part II, Item 8 of this report and the “Risk Factors” section in Part I, Item 1A, as well as the other cautionary statements and risks described elsewhere in this report before deciding to purchase, hold or sell our common stock. +Overview +General +We are a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient, and sustainable for everyone. +27 +Table of Contents +Developments Impacting our Business +COVID-19 +Although COVID-19 has entered an endemic stage, COVID-19 (including new variants of COVID-19) or other future pandemics may adversely affect the global economic conditions, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. When COVID-19 was considered a public health emergency, we took actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but were not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. +Our products require specialized parts, some of which became more difficult to source during the COVID-19 pandemic. In some cases, we had to purchase such parts from third-party brokers at substantially higher prices. The Company’s strategies to mitigate global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and accumulating inventory in the first two quarters of Fiscal 2023. We also placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity. We curtailed the increase in inventory purchases and in particular components purchased in the secondary markets in the second half of Fiscal 2023, and the Company currently does not expect to accumulate inventory in the same magnitude in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to maintain sufficient liquidity. +Climate Change +We take climate change and its associated risks seriously. Increased frequency of severe and extreme weather events associated with climate change could adversely impact our facilities, interfere with intersection construction projects, cause work stoppages and project delays or cancellations, and have a material impact on our financial condition, cash flows and results of operations. More extreme and volatile temperatures, increased storm intensity and flooding, and more volatile precipitation are among the weather events that are most likely to impact our business. We are unable to predict the timing or magnitude of these events. However, we perform ongoing assessments of physical risk, including physical climate risk, to our business and efforts to mitigate these physical risks continue to be implemented on an ongoing basis. +As a global leader in smart mobility infrastructure management, we are committed to a cleaner, healthier and more sustainable future. Our core business aims to reduce climate impact through our work with public and private-sector partners to improve the efficiency of mobility, which, among other things, has the benefit of reducing carbon emissions. For example, by reducing vehicle delays and stops through traffic signal timing projects, improving the efficiency and fuel consumption of public transit via signal priority programs, and reducing time spent roadside for heavy-emitting commercial freight vehicles during inspection, our industry-leading portfolio of smart mobility infrastructure management solutions is currently helping cities and states to reduce their carbon footprint. Additionally, we continue to enhance the design of our sensors to withstand increasingly extreme weather conditions. +Non-GAAP Financial Measures +In addition to results presented in accordance with generally accepted accounting principles in the United States (“GAAP”), we have included the following non-GAAP financial measures: net income (loss) before interest, taxes, depreciation, amortization, stock-based compensation expense, restructuring charges, other legal expenses, and acquisition earnout payments (“Adjusted EBITDA”); and net income (loss) before depreciation, amortization, stock-based compensation expense, restructuring charges, other legal expenses, acquisition earnout payments and the tax effect of adjustments (“Adjusted Net Income (Loss)”). Basic and Diluted Adjusted Net Income (Loss) Per Share (“Basic Adjusted EPS” and “Diluted Adjusted EPS”, collectively, “Adjusted EPS”) are calculated as Adjusted Net Income (Loss) divided by our basic and diluted weighted-average number of shares outstanding, respectively. Components of these non-GAAP financial measures may be adjusted from time to time to reflect specific events and circumstances as they occur. +Adjusted EBITDA was $12.9 million, and $(6.6) million for the fiscal years ended March 31, 2024 and 2023, respectively. +Adjusted Net Income (Loss) was $12.7 million and $(7.0) million for the fiscal years ended March 31, 2024 and 2023, respectively. +28 +Table of Contents +When viewed with our financial results prepared in accordance with GAAP and accompanying reconciliations, we believe Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and the related financial ratios provide additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define these measures, explain how they are calculated and provide reconciliations of these measures to the most comparable GAAP measure in the tables below. Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and the related financial ratios, as presented in this Annual Report on Form 10-K (“Form 10-K”), are supplemental measures of our performance that are not required by or presented in accordance with GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income (loss) or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by (used in) operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items. +We use Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We present Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and the related financial ratios, as applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our operating commitments. +Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and the related financial ratios have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include: +• They generally do not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments; +• They do not reflect changes in, or cash requirements for, our working capital needs; +• Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and our non-GAAP measures do not reflect any cash requirements for such replacements; +• They are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; +• They do not reflect the impact on earnings of charges resulting from matters unrelated to our ongoing operations; and +• Other companies in our industry may calculate similarly-titled non-GAAP measures differently than we do, thereby limiting their usefulness as comparative measures. +Because of these limitations, Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS, and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS and the related financial ratios only as supplemental information. See our audited financial statements contained in this Form 10-K. However, despite the above limitations, we believe that Adjusted EBITDA, Adjusted Net Income (Loss), Adjusted EPS, and the related financial ratios are useful to an investor in evaluating our results of operations because these measures: +• Are widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors; +• Help investors evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and +• Are used by our management team for various other purposes including presentations to our Board of Directors as a basis for strategic planning and forecasting. +29 +Table of Contents +The following financial items have been added back to or subtracted from our net income (loss) when calculating Adjusted EBITDA or Adjusted Net Income (Loss): +• Income taxes . This amount may be useful to investors because it represents the taxes that might be payable for the period and the change in deferred taxes during the period, and therefore could reduce cash flow available for use in our business. +• Depreciation expense . Iteris excludes depreciation expense primarily because it is a non-cash expense. These amounts may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations. +• Amortization expense . Iteris incurs amortization expense of intangible assets in connection with acquisitions. Iteris also incurs amortization expense related to capitalized software development costs. Iteris excludes these items because it does not believe that these expenses reflect our ongoing operating results in the period incurred. These amounts may be useful to investors because they represent the estimated attrition of our acquired customer base and the diminishing value of product rights. +• Interest income and expense . Iteris excludes interest income and expense because it does not believe this item reflects our ongoing business and operating results. This amount may be useful to investors for determining current cash flow. For Fiscal 2023 interest expense includes amortization of the remaining capitalized deferred financing costs due to the termination of the Credit Agreement. For Fiscal 2024 interest income was due to interest earned from cash held with banks. +• Stock-based compensation . These expenses consist primarily of expenses from employee and director equity-based compensation plans. Iteris excludes stock-based compensation primarily because they are non-cash expenses and Iteris believes that it is useful to investors to understand the impact of stock-based compensation to its results of operations and current cash flow. +• Restructuring charges . These expenses consist primarily of employee separation expenses, facility termination costs, and other expenses associated with Company restructuring activities. Iteris excludes these expenses as it does not believe that these expenses reflect our ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Other legal expenses . Iteris excludes legal expenses that it believes are infrequent, unusual and not reflective of ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. We do not adjust for any ordinary course legal expenses. For the fiscal year ended March 31, 2024, other legal expenses consist of costs related to a specific breach of contract dispute for which the Company previously expected a settlement to be reached, however, due to a change in facts and circumstances that now point to a more protracted and costly process, we included the legal costs of $2.8 million incurred during the year. The matter is currently scheduled to go to trial in September 2024, so related costs will likely increase in the near term. The Company believes that the probability of an outcome resulting in a loss is remote. There were no such costs in the prior year periods. +• Acquisition earnout payments . These expenses are a result of the TrafficCast International, Inc. acquisition in December, 2020 and are the final earnout payments per the acquisition agreement. Iteris excluded these expenses as it does not believe that these expenses reflect our ongoing operating results in the period incurred. These amounts may be useful to our investors in evaluating our core operating performance. +• Tax effect of adjustments . This amount represents the income tax impact of the adjustments to net income (loss), as the Company believes that its GAAP income tax expense (benefit) as reported is not representative of the income tax impact of the adjustments. The tax effect was determined by recalculating the Company’s current and deferred income tax expense after incorporating the non-GAAP adjustments listed on the Adjusted Net Income (Loss) table. These amounts may be useful to our investors in evaluating our core operating performance. +The following tables present a reconciliation of historical net income (loss) to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of net revenues, and a reconciliation of historical net income (loss) to Adjusted Net Income (Loss) and the presentation of Adjusted EPS. +30 +Table of Contents +Adjusted EBITDA +Year Ended March 31, +2024 2023 +(Amounts in thousands) +Net income (loss) $ 3,131 $ (14,855) +Provision for income taxes 332 135 +Depreciation expense 558 615 +Amortization expense 3,286 3,179 +Interest (income) expense (221) 329 +Stock-based compensation 2,965 2,890 +Other adjustments: +Restructuring charges — 707 +Other legal expense 2,843 — +Acquisition earnout payments — 376 +Adjusted EBITDA $ 12,894 $ (6,624) +Percentage of total revenues 7.5 % (4.2) % +Adjusted Net Income (Loss) and Adjusted EPS +Year Ended March 31, +2024 2023 +(In thousands, except for share amounts) +Net income (loss) $ 3,131 $ (14,855) +Adjustments to net income (loss): +Depreciation expense 558 615 +Amortization expense 3,286 3,179 +Stock-based compensation 2,965 2,890 +Restructuring charges — 707 +Other legal expense 2,843 — +Acquisition earnout payments — 376 +Tax effect of adjustments (66) 83 +Adjusted Net Income (Loss) $ 12,717 $ (7,005) +Adjusted Net Income (Loss) per share: +Basic $ 0.30 $ (0.17) +Diluted $ 0.29 $ (0.17) +Weighted-average shares used in computing Adjusted Net Income (Loss) per share: +Basic 42,867 42,374 +Diluted 43,904 42,374 +31 +Table of Contents +Year Ended March 31, +2024 2023 +Net income (loss) per share - basic $ 0.07 $ (0.35) +Adjusted Net Income (Loss) adjustments 1 +0.23 0.18 +Adjusted Net Income (Loss) per share - basic $ 0.30 $ (0.17) +Year Ended March 31, +2024 2023 +Net income (loss) per share - diluted $ 0.07 $ (0.35) +Adjusted Net Income (Loss) adjustments 1 +0.22 0.18 +Adjusted Net Income (Loss) per share - diluted $ 0.29 $ (0.17) +1 Reflects the aggregate adjustments made to net income (loss) to Adjusted Net Income (Loss), as presented in the above table, divided by the GAAP weighted-average number of shares outstanding for the relevant period, as presented above. Due to rounding, some amounts may not compute as shown. +Key Business Metrics +We define Annual Recurring Revenue (“ARR”) as revenues recognized under GAAP during a reporting period for our software as a service (“SaaS”), data as a service (“DaaS”), and managed services we provide to our customers. These services typically are secured through binding multi-year contracts or are subject to annual renewals. ARR is an important key performance metric we use in managing our business because it reflects a more predictable and stable component of our revenues, as well as a base from which we can expand our relationships with existing customers. Fluctuations in ARR can reflect a variety of factors including increases or decreases in multi-year contracts, as well as specific contract inception and termination dates because we do not annualize revenues included in ARR. +Backlog is an operational measure representing future unearned revenues amounts believed to be firm that are to be earned under our existing agreements, but it does not represent the total contract award if a firm commitment, purchase order or task order has not yet been issued under the contract and are not included in deferred revenues on our balance sheets. Backlog includes new bookings but does not include announced orders for which definitive contracts have not been executed. We typically expect to recognize revenues in the range of approximately two-thirds to three-quarters of our backlog as of the end of a fiscal year in the subsequent fiscal year. We believe backlog is a useful metric for investors, given its relevance to total orders, although there can be no assurances we will recognize revenues from bookings or backlog timely. +Critical Accounting Policies and Estimates +“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on our financial statements included herein, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period (see Note 1, Description of Business and Summary of Significant Accounting Policies, to the Financial Statements for more information). In preparing our financial statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and other factors that we believe are reasonable. We evaluate our estimates, assumptions and judgments on a regular basis and apply our accounting policies on a consistent basis. We believe that the estimates, assumptions and judgments involved in the accounting for revenues recognition, goodwill, and income taxes have the most potential impact on our financial statements. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. +The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements. +32 +Table of Contents +Revenue Recognition. Our revenues arrangements are complex in nature and require significant judgement in determining the performance obligation structure. Because each contract is unique in nature, we assess each individually for appropriate accounting treatment. +Revenues are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenues from contracts with customers, ranging from multi-year agreements to purchase orders. +Product revenues related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase orders are generally short-term in nature. Product revenues is recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods because transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues sometimes consist of revenues derived from the use of the Company’s service platforms and APIs on a subscription basis as well as from maintenance and support. We generate these revenues from monthly active user fees, SaaS fees, hosting and storage fees, and maintenance and support fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprising a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services in these situations as the customer obtains equal benefit from the service throughout the service period. +Service revenues are also derived from engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. For fixed fee contracts, we recognize revenues over time using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportional cost incurred closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Other contracts can be based on a Time & Materials (“T&M”) and Cost Plus Fixed Fee (“CPFF”) structure, where such contracts are considered to involve variable consideration. However, contractual performance obligations with these fee types qualify for the “Right to Invoice” practical expedient. Under this practical expedient, the Company is allowed to recognize revenues, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company’s performance completed to date. +Goodwill. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment in accordance with the provisions of Accounting Standard Codification (“ASC”) 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. +33 +Table of Contents +The events and circumstances we consider in performing the qualitative assessment include macroeconomic conditions, industry and market considerations, overall financial performance of the reporting units and other relevant entity-specific events. If, after assessing the totality of events or circumstances, an entity determines that the fair value of a reporting unit is not more likely than not, less than its carrying value, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. The estimates of fair value of the reporting units used in the impairment test are computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of the reporting units. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including future gross margin rates, expense rates, capital expenditures and other estimates), and a rate used to discount estimated future cash flow projections to their present value (or estimated fair value) based on estimated weighted average cost of capital (i.e., the selected discount rate). We select assumptions used in the financial forecasts by using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses (i.e., guideline companies). The selection of comparable businesses is based on the markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity of products and services. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of a reporting unit is less than its book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. +During the fourth quarter of fiscal 2024, we performed a qualitative assessment for our annual goodwill impairment testing. After assessing the totality of events and circumstances, we concluded that it was not more likely than not that the fair values of our reporting units were less than their carrying values. Consequently, we did not perform a step one quantitative analysis and determined goodwill was not impaired for any of our reporting units. +Income Taxes . Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss over the trailing three fiscal years, we considered it appropriate to maintain valuation allowances of $18.5 million and $18.7 million against our deferred tax assets at March 31, 2024 and March 31, 2023, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Due to the magnitude of the impact of supply chain issues occurring during Fiscal 2023 and the addition to cumulative pre-tax loss, we currently cannot estimate when sufficient positive evidence may become available to allow us to reach a conclusion that any portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to the level of profitability that we are able to actually achieve. +Recent Accounting Pronouncements +Refer to Note 1, Description of Business and Summary of Significant Accounting Policies, to the Financial Statements, included in Part II, Item 8 of this report for a discussion of recent accounting pronouncements. +Analysis of Fiscal 2024 and Fiscal 2023 Results of Operations +Total Revenues. The following table presents details of total revenues for Fiscal 2024 as compared to Fiscal 2023: +Year Ended March 31, +2024 2023 $ Increase % Change +(In thousands, except percentage) +Product revenues $ 91,781 $ 85,097 $ 6,684 7.9 % +Service revenues 80,206 70,955 9,251 13.0 % +Total revenues $ 171,987 $ 156,052 $ 15,935 10.2 % +Product revenues primarily consist of product sales, but also include third-party products for the traffic signal markets, as well as third-party product sales for installation under certain construction-type contracts. Product revenues for Fiscal 2024 increased approximately 7.9% to $91.8 million, compared to $85.1 million in Fiscal 2023. The increase reflects continued strong demand for our sensors, with revenues growth experienced across most of the product portfolio. +34 +Table of Contents +Service revenues consist of revenues from our software, managed services, systems integration, and consulting services. In certain instances, the lack of third-party product availability can impact the timing of systems integration projects and associated revenues recognition. Service revenues for Fiscal 2024 increased approximately 13.0% to $80.2 million, compared to $71.0 million in Fiscal 2023. This increase was primarily due to the continued increase of consulting services revenues from both new and existing projects, with growth supported by increased direct and subcontractor headcount to work on consulting projects, as well as continued growth of software revenues. ARR was approximately 25% of total revenues for each of Fiscal 2024 and Fiscal 2023. +Total revenues for Fiscal 2024 increased approximately 10.2% to $172.0 million, compared to $156.1 million in Fiscal 2023 due to the aforementioned reasons. +The Company added approximately $181.6 million of net new bookings, or potential revenues under binding agreements, during Fiscal 2024. The Company’s total ending backlog increased approximately 8.4% to approximately $123.8 million as of March 31, 2024, as compared to approximately $114.2 million as of March 31, 2023. +Gross Profit. The following tables present details of our gross profit for Fiscal 2024 compared to Fiscal 2023: +Year Ended March 31, +2024 2023 $ Increase % Change +(In thousands, except percentage) +Product gross profit $ 41,234 $ 22,084 $ 19,150 86.7 % +Service gross profit 23,352 19,934 3,418 17.1 % +Total gross profit $ 64,586 $ 42,018 $ 22,568 53.7 % +Product gross margin as a % of product revenues 44.9 % 26.0 % +Service gross margin as a % of service revenues 29.1 % 28.1 % +Total gross margin as a % of total revenues 37.6 % 26.9 % +Our product gross margin as a percentage of product revenues for Fiscal 2024 increased approximately 1,890 basis points compared to Fiscal 2023. The increase was primarily due to alleviating the Company’s supply chain issues experienced in the previous fiscal year and realizing the gross margin benefits from the introduction of our alternative circuit boards and other elements of our supply chain improvement plan. +Our service gross margin as a percentage of service revenues for Fiscal 2024 increased 100 basis points compared to Fiscal 2023 primarily due to a slightly lower proportion of cost of revenues related to subcontractors and cost of data we purchased during current year. +Our total gross margin as a percentage of total revenues for Fiscal 2024 increased 1,070 basis points compared to Fiscal 2023 primarily as a result of the aforementioned reasons. +We plan to continue to focus on securing new contracts and to extend and/or continue our existing relationships with both key public-sector and private-sector customers. While we believe our ability to obtain additional large contracts will contribute to overall revenues growth, the mix of subcontractor revenues and third-party product sales to our public-sector customers will likely affect the related total gross profit from period to period, as total revenues derived from subcontractors and third-party product sales generally have lower gross margins than revenues generated by our own professional services consultants and products. +General and Administrative Expense +General and administrative expense for Fiscal 2024 increased approximately 8% to $23.9 million, compared to $22.1 million in Fiscal 2023. The increase was primarily due to additional legal fees described above under “Non-GAAP Financial Measures-Other legal expenses,” and the use of consulting services for various areas of assistance, partially offset by lower salaries and wages attributable to general and administrative activities. +35 +Table of Contents +Sales and Marketing Expense +Sales and marketing expense for Fiscal 2024 increased approximately 11% to $25.3 million, compared to $22.8 million in Fiscal 2023. The increase was primarily due to an increase in headcount and higher sales commissions resulting from revenues increases. +Research and Development Expense +Research and development expense for Fiscal 2024 increased approximately 20% to $10.0 million, compared to $8.3 million in Fiscal 2023. The overall increase was primarily due to the continued investment in research and development activities largely focused on redesigning printed circuit boards for our sensors, improving our existing software related offerings, and the development of new products. +We plan to continue to invest in the development of further enhancements and new functionality of our Iteris ClearMobility Platform, which includes among other things our software portfolio and our Vantage sensors. +We capitalized certain development costs into intangible assets on the Company’s balance sheets in both the current and prior year periods; however, certain development costs did not meet the criteria for capitalization under GAAP and are included in research and development expense. Going forward, we expect to continue to invest in our software solutions. This continued investment may result in increases in research and development costs, as well as additional capitalized software assets in future periods. +Amortization of Intangible Assets +Amortization expense for intangible assets is recorded in both cost of revenues and operating expenses. Total amortization was approximately $3.3 million for Fiscal 2024 and $3.2 million for Fiscal 2023. Approximately $0.7 million and $0.6 million of the intangible asset amortization was recorded to cost of revenues, and approximately $2.6 million and $2.6 million was recorded to amortization expense for Fiscal 2024 and Fiscal 2023, respectively, in the statement of operations. +Other Income (Expense), Net +Net other income (expense) was approximately $0.4 million and $0.1 million in Fiscal 2024 and Fiscal 2023, respectively. The increase in net other income in the current year was primarily due to an increase in gains related to our Non-qualified Deferred Compensation plan. +Interest Income (Expense) +Net interest income (expense) was approximately $0.2 million and $(0.3) million in Fiscal 2024 and Fiscal 2023, respectively. The increase in net interest income in the current year was primarily due to a decrease in amortization of capitalized deferred financing costs and commitment fees upon termination of our Credit Agreement with Capital One, coupled with an increased cash balance and the interest rates associated with those accounts. +Income Taxes +The following table presents our provision for income taxes for Fiscal 2024 and Fiscal 2023: +Year Ended +March 31, +2024 +2023 +(In thousands, +except percentage) +Provision for income taxes $ 332 $ 135 +Effective tax rate 9.6 % (0.9) % +For Fiscal 2024 and Fiscal 2023, the difference between the statutory and the effective tax rate was primarily attributable to the valuation allowance recorded against our deferred tax assets. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has a cumulative pre-tax loss, we considered it appropriate to maintain valuation +36 +Table of Contents +allowances of $18.5 million and $18.7 million against our deferred tax assets at March 31, 2024 and 2023, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. +As we update our estimates in future periods, adjustments to our deferred tax asset and valuation allowance may be necessary. We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. We utilize the liability method of accounting for income taxes. We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. +At March 31, 2024, we had $7.9 million of federal net operating loss carryforwards that do not expire. We also had $10.0 million of state net operating loss carryforwards that begin to expire in 2031. Although the impact cannot be precisely determined at this time, we believe that our net operating loss carryforwards will provide reductions in our future income tax payments, that would otherwise be higher using statutory tax rates. +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time be, involved in disputes, proceedings, or litigation relating to claims arising out of its operations in the normal course of business, such as intellectual property infringement and contractual matters. In addition, as noted under “Non-GAAP Financial Measures” above, we have been incurring legal expenses, related to a specific breach of contract dispute, that we believe are infrequent, unusual and not reflective of ongoing operating results. While the Company cannot accurately predict the outcome of any such disputes, proceedings, or litigation, including the matter described below, the Company is not a party to any legal dispute, proceeding or litigation, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on the Company’s business, results of operations, financial position or cash flows. +The Company agreed to accept a $1.0 million return of inventory sold by the Company during Fiscal 2023, at the request of a prime contractor and related to a project that has been delayed. The Company is a subcontractor to the prime contractor on the delayed project, and there currently are no known issues with the product, nor is there currently any contention that there are issues with the product. Up to mid-July 2023 the Company believed the probability of the occurrence of a loss associated with this matter was remote. After meeting with the prime contractor beginning in mid-July 2023, the Company agreed to reassess the situation and agreed on August 7, 2023, to accept the inventory return. For the year ended March 31, 2024, we recognized a pretax loss contingency of $0.2 million, comprised of $1.0 million in accrued liabilities representing the sale value of the inventory and $0.8 million in prepaid expenses and other current assets representing the estimated value of the inventory to be returned in the future. The inventory was returned, and the accrued liability was paid. As of March 31, 2024, there were no outstanding contingencies related to this inventory. +Liquidity and Capital Resources +Cash Flows +We have historically financed our operations with a combination of cash flows from operations and the sale of equity securities. We expect to continue to rely on cash flows from operations and our cash reserves to fund our operations, which we believe to be sufficient to fund our operations for at least the next twelve months. However, we may need or choose to raise additional capital to fund potential future acquisitions and our future growth. We may raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders may experience significant dilution, and any equity securities that may be issued may have rights senior to our existing stockholders. There is no assurance that we will be able to secure additional funding on a timely basis, on terms acceptable to us, or at all. +At March 31, 2024, we had $32.6 million in working capital, which included $26.0 million in cash and cash equivalents and restricted cash. This compares to working capital of $24.8 million at March 31, 2023, which included $16.7 million in cash and cash equivalents and restricted cash. +37 +Table of Contents +The following table summarizes our cash flows from continuing operations for Fiscal 2024 and Fiscal 2023: +Year Ended +March 31, +2024 +2023 +(In thousands) +Net cash provided by (used in): +Operating activities $ 11,378 $ (4,507) +Investing activities $ (3,035) $ (1,874) +Financing activities $ 905 $ (372) +Operating Activities. Net cash provided by operating activities for Fiscal 2024 was $11.4 million and primarily reflects our net income from operations of $3.1 million, which included $9.0 million of non-cash items including lease expense, depreciation expense, stock-based compensation, and amortization of intangible assets, coupled with $0.7 million of outflows from changes in working capital. +Net cash used in operating activities of our continuing operations for Fiscal 2023 of $4.5 million was primarily the result of our net loss from continuing operations of $14.9 million, which included $8.9 million of non-cash items including lease expense, depreciation expenses, stock-based compensation, and amortization of intangible assets, coupled with $1.5 million of inflows from changes in working capital. Net cash used in operating activities in Fiscal 2023 included $0.3 million used in discontinued operations. +Investing Activities. Net cash used in investing activities during Fiscal 2024 was primarily the result of approximately $0.6 million of property and equipment purchases, and $2.5 million of capitalized software development costs, primarily in VantageARGUS CV and ClearGuide. +Net cash used in investing activities during Fiscal 2023 was primarily the result of approximately $0.5 million of property and equipment purchases, and $1.3 million of capitalized software development costs, primarily in VantageLive! and ClearGuide. +Financing Activities. Net cash provided by financing activities during Fiscal 2024 was primarily the result of $0.5 million and $0.6 million of cash proceeds from the exercise of stock options and purchases of Employee Stock Purchase Plan (“ESPP”) shares, respectively, offset partially by repurchases of common stock of approximately $0.2 million. +Net cash used in financing activities during Fiscal 2023 was primarily the result of $0.1 million and $0.5 million of cash proceeds from the exercise of stock options and purchases of ESPP shares, respectively, offset by repurchases of common stock of $0.9 million. +Off-Balance Sheet Arrangements +We do not have any other material off-balance sheet arrangements at March 31, 2024. +Seasonality +We have historically experienced seasonality, particularly with respect to our products, which adversely affects such sales in our third and fourth fiscal quarters due to a reduction in intersection construction and repairs during the winter months due to inclement weather conditions, with the third fiscal quarter generally impacted the most by inclement weather. We have also experienced seasonality, which adversely impacts our third fiscal quarter due to the increased number of holidays, causing a reduction in available billable hours. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item. +38 +Table of Contents +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Iteris, Inc. +Index to Financial Statement +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +40 +Balance Sheets as of March 31, 202 4 and 202 3 +42 +Statements of Operations for the fiscal years ended March 31, 202 4 and 202 3 +43 +Statements of Stockholders ’ Equity for the fiscal years ended March 31, 202 4 and 202 3 +44 +Statements of Cash Flows for the fiscal years ended March 31, 202 4 and 202 3 +45 +Notes to Financial Statements +47 +39 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on the Financial Statements +We have audited the accompanying balance sheets of Iteris, Inc. (the "Company") as of March 31, 2024 and 2023, the related statements of operations, stockholders' equity, and cash flows, for each of the two years in the period ended March 31, 2024, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2024 and 2023, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 2024, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of March 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 13, 2024, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue from Contracts with Customers – Determination of Distinct Performance Obligations Relating to Service Revenues – Refer to Note 1 to the financial statements +Critical Audit Matter Description +The Company's service revenues within the Services and Software revenue streams, primarily derive revenue from long-term engineering & consulting services and software as a service ("SaaS"). The Company accounts for individual services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the services, the solution provided and the structure of the sales contract. During the year ended March 31, 2024, the Company recognized service revenues from contracts with customers of $80.2 million. +We identified the determination of distinct performance obligations in contracts with customers relating to service revenues as a critical audit matter. Significant judgment is required to determine whether the performance obligations in these sales contracts are distinct; that is, if a service is separately identifiable from other items in the sales contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer. Auditing these aspects include especially challenging auditor judgment due to the nature and extent of audit effort required to address this matter. +40 +Table of Contents +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures related to the Company’s determination of distinct performance obligations relating to service revenues for these contracts included the following, among others: +· We tested the effectiveness of controls related to management’s identification and assessment of distinct performance obligations in contracts with customers. +· We selected a sample of customer contracts to evaluate the appropriateness of management’s determination of distinct performance obligations. +· We selected a sample of invoices and determined whether amounts invoiced were in accordance with the related contract terms. Further, we inspected line items on the invoice to verify that all line items were included in management's evaluation of performance obligations. +· We selected a sample of customer contracts and investigated changes in current forecasted cost to original forecasted cost to evaluate if changes in estimate are indicative of existing services known by operations personnel, but not previously considered as distinct performance obligations by management. +· We investigated offsets to revenue to determine that they represent a valid purpose and a service was not previously unidentified. +· We selected a sample of expenditures and determined whether the service represented by the selected transaction was properly identified and evaluated by management as a distinct performance obligation. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 13, 2024 +We have served as the Company's auditor since 2016. +41 +Table of Contents +Iteris, Inc. +Balance Sheets +(In thousands, except par value) +March 31, +2024 2023 +Assets +Current assets: +Cash and cash equivalents $ 25,850 $ 16,587 +Restricted cash 125 140 +Trade accounts receivable, net of allowance of $ 351 and $ 357 at March 31, 2024 and 2023, respectively +25,672 23,809 +Unbilled accounts receivable 7,271 8,349 +Inventories 13,432 10,841 +Prepaid expenses and other current assets 3,581 3,128 +Total current assets 75,931 62,854 +Property and equipment, net 1,296 1,297 +Right-of-use assets 7,237 8,345 +Intangible assets, net 9,602 10,190 +Goodwill 28,340 28,340 +Other assets 1,039 768 +Total assets $ 123,445 $ 111,794 +Liabilities and stockholders’ equity +Current liabilities: +Trade accounts payable $ 15,852 $ 12,943 +Accrued payroll and related expenses 12,812 12,923 +Accrued liabilities 6,596 5,453 +Deferred revenues 8,070 6,720 +Total current liabilities 43,330 38,039 +Lease liabilities 6,210 7,641 +Deferred income taxes 515 422 +Unrecognized tax benefits 39 79 +Other long-term liabilities 3,444 2,707 +Total liabilities 53,538 48,888 +Commitments and contingencies (Note 6) +Stockholders’ equity: +Preferred stock, $ 1.00 par value: +Authorized shares— 2,000 issued and outstanding shares— none +— — +Common stock, $ 0.10 par value: +Authorized shares— 70,000 at March 31, 2024 and 2023 issued and outstanding shares— 42,972 at March 31, 2024 and 42,808 at March 31, 2023 +4,298 4,282 +Treasury stock ( 15 ) ( 891 ) +Additional paid-in capital 194,093 190,082 +Accumulated deficit ( 128,469 ) ( 130,567 ) +Total stockholders’ equity 69,907 62,906 +Total liabilities and stockholders’ equity $ 123,445 $ 111,794 +See accompanying Notes to the Financial Statements. +42 +Table of Contents +Iteris, Inc. +Statements of Operations +(In thousands, except per share amounts) +Year Ended March 31, +2024 2023 +Product revenues $ 91,781 $ 85,097 +Service revenues 80,206 70,955 +Total revenues 171,987 156,052 +Cost of product revenues 50,547 63,013 +Cost of service revenues 56,854 51,021 +Cost of revenues 107,401 114,034 +Gross profit 64,586 42,018 +Operating expenses: +General and administrative 23,866 22,083 +Sales and marketing 25,334 22,802 +Research and development 9,964 8,321 +Amortization of intangible assets 2,603 2,620 +Restructuring charges — 707 +Total operating expenses 61,767 56,533 +Operating income (loss) 2,819 ( 14,515 ) +Non-operating income (expense): +Other income, net 423 124 +Interest income (expense) 221 ( 329 ) +Income (loss) before income taxes 3,463 ( 14,720 ) +Provision for income taxes ( 332 ) ( 135 ) +Net income (loss) $ 3,131 $ ( 14,855 ) +Net income (loss) per share: +Basic $ 0.07 $ ( 0.35 ) +Diluted $ 0.07 $ ( 0.35 ) +Weighted-average shares used in computing net income (loss) per share: +Basic 42,867 42,374 +Diluted 43,904 42,374 +See accompanying Notes to the Financial Statements. +43 +Table of Contents +Iteris, Inc. +Statements of Stockholders’ Equity +(In thousands) +Common Stock Treasury Stock Additional +Paid-In +Capital Accumulated +Deficit Total +Stockholders’ +Equity +Shares Amount Shares Amount +Balance at March 31, 2022 42,416 4,242 — — 186,720 ( 115,712 ) 75,250 +Stock option exercises 60 7 — — 98 — 105 +Issuance of shares pursuant to Employee Stock Purchase Plan 180 19 — — 471 — 490 +Stock-based compensation — — — — 2,890 — 2,890 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 152 14 — — ( 97 ) — ( 83 ) +Treasury stock purchases — — 300 ( 884 ) — — ( 884 ) +Deferred shares held within rabbi trust — — 69 ( 7 ) — — ( 7 ) +Net loss — — — — — ( 14,855 ) ( 14,855 ) +Balance at March 31, 2023 42,808 4,282 369 ( 891 ) 190,082 ( 130,567 ) 62,906 +Stock option exercises 173 18 — — 519 — 537 +Issuance of shares pursuant to Employee Stock Purchase Plan 173 17 — — 564 — 581 +Stock-based compensation — — — — 2,965 — 2,965 +Issuance of shares pursuant to vesting of restricted stock units, net of payroll withholding taxes 118 11 — — ( 27 ) — ( 16 ) +Issuance of shares pursuant to vesting of performance stock units, net of payroll withholding taxes 40 4 — — ( 18 ) — ( 14 ) +Treasury stock purchases — — 40 ( 183 ) — — ( 183 ) +Retirement of treasury stock ( 340 ) ( 34 ) ( 340 ) 1,067 — ( 1,033 ) — +Deferred shares held within rabbi trust — — 79 ( 8 ) 8 — — +Net income — — — — — 3,131 3,131 +Balance at March 31, 2024 42,972 $ 4,298 148 $ ( 15 ) $ 194,093 $ ( 128,469 ) $ 69,907 +See accompanying Notes to the Financial Statements. +44 +Table of Contents +Iteris, Inc. +Statements of Cash Flows +(In thousands) +Year Ended March 31, +2024 2023 +Cash flows from operating activities +Net income (loss) $ 3,131 $ ( 14,855 ) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Right-of-use asset non-cash expense 2,105 2,114 +Deferred income tax 53 59 +Depreciation of property and equipment 558 615 +Stock-based compensation 2,965 2,890 +Amortization of intangible assets 3,286 3,179 +Loss on disposal of equipment — 8 +Other — ( 7 ) +Changes in operating assets and liabilities: +Trade accounts receivable ( 1,863 ) 1,819 +Unbilled accounts receivable and deferred revenues 3,165 1,385 +Inventories ( 2,591 ) ( 2,861 ) +Prepaid expenses and other assets ( 724 ) 1,300 +Trade accounts payable and accrued expenses 3,721 1,253 +Operating lease liabilities ( 2,428 ) ( 1,406 ) +Net cash provided by (used in) operating activities - continuing operations 11,378 ( 4,507 ) +Net cash used in operating activities - discontinued operations — ( 329 ) +Net cash provided by (used in) in operating activities 11,378 ( 4,836 ) +Cash flows from investing activities +Purchases of property and equipment ( 557 ) ( 528 ) +Capitalized software development costs ( 2,478 ) ( 1,346 ) +Net cash used in investing activities ( 3,035 ) ( 1,874 ) +Cash flows from financing activities +Repurchases of common stock ( 183 ) ( 884 ) +Proceeds from stock option exercises 537 105 +Proceeds from ESPP purchases 581 490 +Tax withholding payments for net share settlements of restricted stock units ( 16 ) ( 83 ) +Tax withholding payments for net share settlements of performance stock units ( 14 ) — +Net cash provided by (used in) financing activities 905 ( 372 ) +Increase (decrease) in cash, cash equivalents and restricted cash 9,248 ( 7,082 ) +Cash, cash equivalents and restricted cash at beginning of period 16,727 23,809 +Cash, cash equivalents and restricted cash at end of period $ 25,975 $ 16,727 +See accompanying Notes to the Financial Statements. +45 +Table of Contents +Iteris, Inc. +Statements of Cash Flows +(In thousands) +(Continued) +Year Ended March 31, +2024 2023 +Supplemental cash flow information: +Cash paid during the year for: +Income taxes $ 247 $ — +Supplemental schedule of non-cash investing and financing activities: +Lease liabilities arising from obtaining right-of-use assets $ 997 $ 313 +Capitalized software development costs in accounts payable and accrued liabilities $ 220 $ 243 +See accompanying Notes to the Financial Statements. +46 +Table of Contents +Iteris, Inc. +Notes to Financial Statements +March 31, 2024 +1. Description of Business and Summary of Significant Accounting Policies +Description of Business +Iteris, Inc. (referred to in this report as “Iteris”, the “Company”, “we”, “our”, and “us”) is a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient and sustainable for everyone. +As a pioneer in intelligent transportation systems (“ITS”) technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service (“SaaS”) offerings, mobility consulting services, and managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States (“U.S.”) and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced sensors, mobility intelligence software, mobility data sets, mobility consulting services and managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. +Developments Impacting our Business +COVID-19 +Although COVID-19 has entered an endemic stage, COVID-19 (including new variants of COVID-19) or other future pandemics may adversely affect the global economic conditions, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. When COVID-19 was considered a public health emergency, we took actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but were not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities +Our products require specialized parts, some of which became more difficult to source during the COVID-19 pandemic. In some cases, we had to purchase such parts from third-party brokers at substantially higher prices. The Company’s strategies to mitigate global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 (“Fiscal 2023”). We also placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity. +The Company curtailed the increase in inventory purchases and in particular components purchased in the secondary markets in the second half of Fiscal 2023, and the Company currently does not expect to continue to accumulate inventory in the same magnitude in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to maintain sufficient liquidity. +Restructuring Activities +To help offset recent increases in supply chain costs, on May 12, 2022, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. The Company incurred employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +47 +Table of Contents +Basis of Presentation +Our financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). +Use of Estimates +The preparation of financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Significant estimates made in the preparation of the financial statements include, but are not limited to, recoverability of long-lived and intangible assets; estimates of future cash flows used to assess the recoverability of the impairment of goodwill; collectability of accounts receivable; projections of taxable income used to assess realizability of deferred tax assets; warranty reserves; costs to complete long-term contracts; indirect cost rates used in cost plus contracts; fair value of stock option awards and equity instruments; capitalization and estimated useful life of the Company’s internal-use software development costs. Estimates are based on historical experience and on various assumptions that the Company believes are reasonable under current circumstances. However, future events are subject to change and best estimates and judgments may require further adjustments, therefore, actual results could differ materially from those estimates. Management periodically evaluates such estimates, and they are adjusted prospectively based upon such evaluation. +Revenue Recognition +Our revenue arrangements are complex in nature and require significant judgement in determining the performance obligation structure. Each contract is unique in nature and therefore is assessed individually for appropriate accounting treatment. +Revenues are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services. We generate all of our revenues from contracts with customers, ranging from purchase orders to multi-year agreements. +Product revenue-related contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase orders are generally short-term in nature. Product revenues are recognized at a point in time upon shipment or upon customer receipt of the product, depending on shipping terms. The Company determined that this method best represents the transfer of goods as transfer of control typically occurs upon shipment or upon customer receipt of the product. +Service revenues include revenues derived from the use of the Company’s service platforms and APIs on a subscription basis as well as from maintenance and support. We generate these revenues from monthly active user fees, SaaS fees, hosting and storage fees, and maintenance and support fees. In most cases, the subscription or transaction arrangement is a single performance obligation comprising a series of distinct services that are substantially the same and that have the same pattern of transfer (i.e., distinct days of service). The Company applies a time-based measure of progress to the total transaction price, which results in ratable recognition over the term of the contract. The Company determined that this method best represents the transfer of services in these situations as the customer obtains equal benefit from the service throughout the service period. +Service revenues are also derived from engineering and consulting service contracts with governmental agencies. These contracts generally include performance obligations in which control is transferred over time. For fixed fee contracts, we recognize revenues over time using the proportion of actual costs incurred to the total costs expected to complete the contract performance obligation. The Company determined that this method best represents the transfer of services as the proportional cost incurred closely depicts the efforts or inputs completed towards the satisfaction of a fixed fee contract performance obligation. Other contracts can be based on a Time & Materials (“T&M”) and Cost Plus Fixed Fee (“CPFF”) structure, where such contracts are considered to involve variable consideration. However, contractual performance obligations with these fee types qualify for the “Right to Invoice” practical expedient. Under this practical expedient, the Company is allowed to recognize revenues, over time, in the amount to which the Company has a right to invoice. In addition, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. The Company determined that this method best represents the transfer of services as, upon billing, the Company has a right to consideration from a customer in an amount that directly corresponds with the value to the customer of the Company’s performance completed to date. +48 +Table of Contents +The Company accounts for individual goods and services separately if they are distinct performance obligations, which often requires significant judgment based upon knowledge of the products and/or services, the solution provided and the structure of the sales contract. In SaaS agreements, we provide a service to the customer that combines the software functionality, maintenance and hosting into a single performance obligation. In product-related contracts, a purchase order may cover different products, each constituting a separate performance obligation. +We generally estimate variable consideration at the most likely amount to which we expect to be entitled and in certain cases based on the expected value, which requires judgment. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenues recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We review and update these estimates on a quarterly basis. +The Company’s typical performance obligations include the following: +Performance Obligation When Performance +Obligation is Typically +Satisfied When Payment is +Typically Due How Standalone +Selling Price is +Typically Estimated +Product Revenues +Standard purchase orders for delivery of a tangible product Upon shipment (point in time) Within 30 days of delivery Observable transactions +Engineering services where the deliverable is considered a product As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +Service Revenues +Engineering, managed services, and consulting services As work is performed (over time) Within 30 days of services being invoiced Estimated using a cost-plus margin approach +SaaS Over the course of the SaaS service once the system is available for use (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Extended warranty service Over the course of the extended warranty period (over time) At the beginning of the contract period Estimated using a cost-plus margin approach +Disaggregation of Revenues +The Company disaggregates revenues from contracts with customers into product revenues and services revenues. +Trade Accounts Receivable and Contract Balances +We classify our right to consideration in exchange for goods and services as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e., only the passage of time is required before payment is due). We present such receivables in trade accounts receivable, net in the accompanying balance sheet at their net estimated realizable value. +The Company maintains an allowance for credit losses to provide for the estimated amount of receivables that will not be collected. The Company estimates allowances for expected credit losses on trade accounts receivable and contract assets as required by the Current Expected Credit Loss (“CECL”) model, as per Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326). If warranted, the allowance is increased by the Company’s provision for doubtful accounts, which is charged against income. All recoveries on receivables previously charged off are included in income, while direct charge-offs of receivables are deducted from the allowance. +A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented as unbilled accounts receivable in the accompanying balance sheet. For example, we would record a contract asset if we record revenues on a professional services engagement, but are not entitled to bill until we achieve specified milestones. +49 +Table of Contents +Our contract assets and refund liabilities are reported in a net position on a contract basis at the end of each reporting period. Refund liabilities are consideration received in advance of the satisfaction of performance obligations. +Contract Fulfillment Costs +The Company evaluates whether to capitalize the costs of fulfilling a contract. Such costs are capitalized when they are not within the scope of other standards and: (1) are directly related to a contract; (2) generate or enhance resources that will be used to satisfy performance obligations; and (3) are expected to be recovered. As of both March 31, 2024 and 2023, there was approximately $ 0.5 million of contract fulfillment costs, which are presented in the accompanying balance sheets as prepaid and other current assets. These costs primarily relate to the satisfaction of performance obligations related to the set-up of SaaS platforms. These costs are amortized on a straight-line basis over the estimated useful life of the SaaS platform. +Transaction Price Allocated to the Remaining Performance Obligations +As of March 31, 2024 and 2023, the aggregate amount of transaction price allocated to remaining performance obligations was immaterial, primarily as a result of termination provisions within our contracts, which make the duration of the accounting term of the contract one year or less. +Practical Expedients and Exemptions +T&M and CPFF contracts are considered variable consideration. However, performance obligations with an underlying fee type of T&M or CPFF qualify for the "Right to Invoice" Practical Expedient under ASC 606-10-55-18. Under this practical expedient, the Company is not required to estimate such variable consideration upon inception of the contract or reassess the estimate each reporting period. +The Company utilizes the practical expedient under ASC 606-10-50-14 of not disclosing information about its remaining performance obligations for contracts with an original expected duration (i.e., contract term, determined based on the analysis of termination provisions described above) of 12 months or less. +The Company pays sales commissions on certain sales contracts. These costs are accrued in the same period that the revenues are recorded. Using the practical expedient under ASC 340-40-25-4, the Company recognizes the incremental costs of obtaining a contract as an expense when incurred since the amortization period of the asset that the Company otherwise would have recognized is one year or less. +The Company utilizes the practical expedient under ASC 606-10-25-18B to account for shipping and handling as fulfillment costs, and not a promised service (a revenue element). Shipping and handling costs are included as cost of revenues in the period during which the products ship. +The Company excludes from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-producing transaction and collected from a customer (for example, sales, use, value added, and some excise taxes). This employs the practical expedient under ASC 606-10-32-2A. Sales taxes are presented on a net basis (excluded from revenues) in the accompanying statements of operations. +Deferred Revenues +Deferred revenues in the accompanying balance sheets is comprised of consideration received in advance of the satisfaction of performance obligations. +Concentration of Credit Risk +Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents and trade accounts receivable. +Cash and cash equivalents consist primarily of demand deposits and money market funds maintained with two financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with high quality financial institutions, and therefore are believed to have minimal credit risk. Accounts at each institution are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. As of March 31, 2024, the Company had approximately $ 25.4 million of deposits at financial institutions in excess of the FDIC insured limit. +50 +Table of Contents +Our accounts receivable are primarily derived from billings with customers located throughout North America, as well as in Europe, Asia, and Central and South America. We generally do not require collateral or other security from our domestic customers. We maintain an allowance for credit losses for potential credit losses, which losses have historically been within management’s expectations. +We currently have, and historically have had, a diverse customer base. For Fiscal 2024 and the fiscal year ended March 31, 2023 (“Fiscal 2023”), no individual customer represented greater than 10% of our total revenues. As of March 31, 2024 and 2023, no individual customer represented greater than 10% of our total accounts receivable. +Fair Values of Financial Instruments +The accounting guidance provided in ASC 820, Fair Value Measurements (“ASC 820”) for fair value provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows: +Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date. +Level 2—Observable inputs other than quoted prices in active markets for identical assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. +Level 3—Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the assets or liabilities. +The Company applies fair value accounting for all financial instruments on a recurring basis. The Company’s financial instruments, which include cash, cash equivalents, accounts receivable and accounts payable are recorded at their carrying amounts, which approximate their fair values due to their short-term nature. All marketable securities are considered to be available-for-sale and recorded at their estimated fair values. In valuing these items, the Company uses inputs and assumptions that market participants would use to determine their fair value, utilizing valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. +Cash, Cash Equivalents and Restricted Cash +Cash and cash equivalents consist of cash and short-term investments with initial maturities of 90 days or less. +As of both March 31, 2024 and 2023 restricted cash was $ 0.1 million related to cash restricted for shares purchased under the Employee Stock Purchase Plan (“ESPP”) (see Note 9, Employee Benefit Plans , to the Financial Statements for more information). +Cash, cash equivalents and restricted cash presented in the accompanying statements of cash flows consist of the following: +March 31, +2024 2023 +(In thousands) +Cash and cash equivalents $ 25,850 $ 16,587 +Restricted cash 125 140 +$ 25,975 $ 16,727 +51 +Table of Contents +Allowance for Credit Loss +We record accounts receivable net of the allowance for credit losses. The allowance is established in accordance with the CECL model. We estimate the allowance for credit losses based on the Company’s assessment of its ability to collect on customer accounts receivable. The collectability of our accounts receivable is evaluated through review of outstanding invoices and ongoing credit evaluations of our customers’ financial condition. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized accounts receivable to the amount we reasonably believe will be collected. The allowance reflects our best estimate of probable losses associated with the accounts receivable balance. Our assessment is based on historical experience, current information and reasonable and supportable forecasts. Accounts receivables with similar risk characteristics are evaluated collectively and accounts receivables that do not share similar risk characteristics are evaluated individually. Risk characteristics relevant to the Company’s accounts receivable include account balance and aging status. Adjustments to the allowance for credit losses are recorded through bad debt expense, which is included in operating expenses on the accompanying statements of operations. The Company writes off accounts receivable against the allowance when it determines that the balance is uncollectible and collection of the receivable is no longer being actively pursued. +Inventories +Inventories consist of raw materials, work-in-process and finished goods and are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. +Property and Equipment +Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful life of the related assets ranging from three to eight years . Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. +Intangible Assets +Intangible assets with determinable economic lives are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful life of each asset on a straight-line basis. The Company determines the useful lives of identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. When determining useful life, the Company considers the contractual term of any agreement related to the asset, the historical performance of the asset, the Company’s long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset and other economic factors, including competition and specific market conditions. Intangible assets without determinable economic lives are carried at cost, not amortized, and reviewed for impairment at least annually. +Capitalized Software Development Cost +The Company accounts for costs incurred to develop software for internal use in accordance with ASC 350-40, Intangibles — Internal Use Software (“ASC 350-40”). Under ASC 350-40, the costs incurred during the application development stage, which include costs of software configuration and interface design, coding, installation and testing are required to be capitalized. Costs incurred during the preliminary project design along with post-implementation stages of internal use software are expensed as incurred and included in research and development in the statements of operations. +Goodwill +Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. We test goodwill for impairment in accordance with the provisions of Accounting Standard Codification (“ASC”) 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. +52 +Table of Contents +The events and circumstances we consider in performing the qualitative assessment include macroeconomic conditions, industry and market considerations, overall financial performance of the reporting units and other relevant entity-specific events. If, after assessing the totality of events or circumstances, an entity determines that the fair value of a reporting unit is not more likely than not, less than its carrying value, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. The estimates of fair value of the reporting units used in the impairment test are computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of the reporting units. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including future gross margin rates, expense rates, capital expenditures and other estimates), and a rate used to discount estimated future cash flow projections to their present value (or estimated fair value) based on estimated weighted average cost of capital (i.e., the selected discount rate). We select assumptions used in the financial forecasts by using historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses (i.e., guideline companies). The selection of comparable businesses is based on the markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity of products and services. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of a reporting unit is less than its book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. +During the fourth quarter of fiscal 2024, we performed a qualitative assessment for our annual goodwill impairment testing. After assessing the totality of events and circumstances, we concluded that it was not more likely than not that the fair values of our reporting units were less than their carrying values. Consequently, we did not perform a step one quantitative analysis and determined goodwill was not impaired for any of our reporting units. +Impairment of Long-Lived Assets +The Company evaluates its long-lived assets, including property, equipment and intangible assets (other than goodwill) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. We determine whether the carrying value of an asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows the asset or asset group is expected to generate. If an asset is not recoverable, we record an impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. During the fiscal years ended March 31, 2024 and 2023, there was no impairment to our long-lived and intangible assets. +Income Taxes +We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more-likely-than-not that some or all of the deferred tax assets will not be realized, which increases our income tax expense in the period such determination is made. As such, we determined it was appropriate to maintain a full valuation allowance against our deferred tax assets for the fiscal years ended March 31, 2024 and 2023. We will continuously reassess the appropriateness of our valuation allowance. +Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. +53 +Table of Contents +Stock-Based Compensation +We record stock-based compensation in our statements of operations as an expense, based on the estimated grant date fair value of our stock-based awards, whereby such fair values are amortized over the requisite service period. Our stock-based awards currently comprise common stock options, restricted stock units and performance stock units. The fair value of our common stock option awards is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. The fair value of our performance stock unit awards is estimated on the grant date using a Monte Carlo simulation model. While the use of these models meets established requirements, the estimated fair values generated by the models might not be indicative of the actual fair values of our awards as it does not consider certain factors important to those awards to employees, such as continued employment and periodic vesting requirements, as well as limited transferability. The fair value of our restricted stock units is based on the closing market price of our common stock on the grant date. If there are any modifications or cancellations of the underlying unvested stock-based awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. +Research and Development Expenditures +We expense research and development expenditures in the period incurred. +Shipping and Handling Costs +We include shipping and handling costs in the cost of revenues in the period during which the products ship. +Sales Taxes +We present sales taxes on a net basis (excluded from revenues) in the statements of operations. +Right-of-Use Assets and Lease Liabilities +We determine if an arrangement contains a lease at inception and determine the classification of the lease, as either operating or finance, at commencement. +Right-of-use assets and lease liabilities are recorded based on the present value of future lease payments which factors in certain qualifying initial direct costs incurred as well as any lease incentives received. If an implicit rate is not readily determinable, we utilize inputs from third-party lenders to determine the appropriate discount rate. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term. Finance leases incur interest expense using the effective interest method in addition to amortization of the leased asset on straight-line basis, both over the applicable lease term. Lease terms may factor in options to extend or terminate the lease. +We adhere to the short-term lease recognition exemption for all classes of assets (i.e., facilities and equipment). As a result, leases with an initial term of twelve months or less are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. In addition, for certain equipment leases, we account for lease and non-lease components, such as services, as a single lease component as permitted. +Warranty +We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship. Products sold to various original equipment manufacturer customers sometimes carry longer warranties. We will either repair or replace defective products, usually at our option, upon meeting certain criteria. We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of product revenues at the time revenues for that product is recognized. The accrued warranty reserve is included within accrued liabilities in the accompanying balance sheets. We do not provide any service-type warranties. +Loss Contingencies +We are subject to legal actions that arise in the ordinary course of business. The Company recognizes a liability for a contingency when it is probable that liability has been incurred and when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, the Company accrues the most likely amount of such loss at no less than the minimum of the range. The Company expenses legal defense costs as incurred. +54 +Table of Contents +Repair and Maintenance Costs +We incur repair and maintenance costs in the normal course of business. Should the repair or maintenance result in a permanent improvement to one of our leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter. Non-permanent repair and maintenance costs are charged to expense as incurred. +Comprehensive Income (Loss) +Net income (loss) was the same as comprehensive income (loss) for Fiscal 2024 and Fiscal 2023. +Recent Accounting Pronouncements +In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This standard update requires that certain financial assets be measured at amortized cost net of an allowance for estimated credit losses such that the net receivable represents the present value of expected cash collection. In addition, this standard update requires that certain financial assets be measured at amortized cost reflecting an allowance for estimated credit losses expected to occur over the life of the assets. The estimate of credit losses must be based on all relevant information including historical information, current conditions and reasonable and supportable forecasts that affect the collectability of the amounts. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which deferred the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting companies that are not smaller reporting companies. As a smaller reporting company, ASU 2016-13 is now effective for our Fiscal 2024. The Company adopted the standard with an immaterial expected credit loss and no adjustment to the opening balance. +In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280), which is intended to improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant expenses. This ASU is applicable to our Annual Report on Form 10-K for the fiscal year ending March 31, 2025, and subsequent interim periods. Early adoption is permitted and the amendments in this ASU should be applied retroactively. We are currently evaluating the impact of this ASU on our financial statement disclosures. +In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740), which includes amendments that further enhance income tax disclosures, primarily through standardization and disaggregation of rate reconciliation categories and income taxes paid by jurisdictions. This ASU is applicable to our Annual Report on Form 10-K for the fiscal year ending March 31, 2026. Early adoption is permitted and the amendments in this ASU should be applied prospectively. Retrospective application is permitted. We are currently evaluating the impact of this ASU on our financial statement disclosures. +2. Supplementary Financial Information +Inventories, net +The following table presents details regarding our inventories, net: +March 31, +2024 2023 +(In thousands) +Raw materials $ 9,063 $ 7,840 +Work in process 468 315 +Finished goods 3,901 2,686 +$ 13,432 $ 10,841 +55 +Table of Contents +Property and Equipment, net +The following table presents details of our property and equipment, net: +March 31, +2024 2023 +(In thousands) +Equipment $ 6,871 $ 6,359 +Leasehold improvements 828 824 +Accumulated depreciation ( 6,403 ) ( 5,886 ) +$ 1,296 $ 1,297 +Depreciation expense was approximately $ 0.6 million for each of Fiscal 2024 and Fiscal 2023. For each of Fiscal 2024 and Fiscal 2023, $ 0.2 million of the depreciation expense was recorded to cost of revenues, and $ 0.4 million was recorded to operating expenses in the accompanying statements of operations. +Intangible Assets, net +The following table presents details regarding our intangible assets, net: +March 31, 2024 March 31, 2023 +Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value Gross +Carrying +Amount Accumulated +Amortization Net +Book +Value +(In thousands) +Technology $ 5,009 $ ( 4,369 ) $ 640 $ 4,986 $ ( 3,444 ) $ 1,542 +Customer contracts / relationships 9,550 ( 5,783 ) 3,766 9,550 ( 4,371 ) 5,179 +Trade names and non-compete agreements 782 ( 770 ) 12 782 ( 770 ) 12 +Capitalized software development costs 10,164 ( 4,980 ) 5,184 7,489 ( 4,032 ) 3,457 +Total $ 25,505 $ ( 15,902 ) $ 9,602 $ 22,807 $ ( 12,617 ) $ 10,190 +Amortization expense for intangible assets subject to amortization was approximately $ 3.3 million and $ 3.2 million for Fiscal 2024 and Fiscal 2023, respectively. Approximately $ 0.7 million and $ 0.6 million of the intangible asset amortization was recorded to cost of revenues, and approximately $ 2.6 million and $ 2.6 million was recorded to amortization expense for Fiscal 2024 and Fiscal 2023, respectively, in the statements of operations. The weighted average remaining useful lives of the intangible assets as of March 31, 2024 is 3.4 years. +We have one indefinite useful life intangible asset, with de minimis carrying value, which was included in trade names and non-compete agreements. Our net customer contracts/relationships have a useful life of 6 years. Our net trade names and non-compete agreements have a useful life of 4 years. Our net capitalized software development costs of approximately $ 5.2 million as of March 31, 2024 primarily consisted of VantageARGUS CV software development costs of $ 3.1 million and Oracle Enterprise Resource Planning system design and implementation costs of approximately $ 0.9 million, which have useful lives of 5 and 10 years, respectively. Our net capitalized software development costs of approximately $ 3.5 million as of March 31, 2023, primarily consisted of Oracle Enterprise Resource Planning system design and implementation costs of $ 1.1 million, which has a useful life of 10 years. +56 +Table of Contents +As of March 31, 2024, the future estimated amortization expense is as follows (in thousands): +Year Ending March 31, +2025 3,527 +2026 2,305 +2027 1,982 +2028 1,281 +2029 495 +Thereafter — +$ 9,590 +The future estimated amortization expense does not include the indefinite useful life intangible asset described above. +Goodwill +Goodwill was $ 28.3 million as of March 31, 2024 and 2023. There was no change to the goodwill carrying value during Fiscal 2024 or Fiscal 2023. +Warranty Reserve Activity +Warranty reserve is recorded as accrued liabilities in the accompanying balance sheets. The following table presents activity with respect to the warranty reserve: +Year Ended March 31, +2024 2023 +(In thousands) +Balance at beginning of fiscal year $ 758 $ 616 +Additions charged to cost of revenues 498 343 +Warranty claims ( 442 ) ( 201 ) +Balance at end of fiscal year $ 814 $ 758 +Earnings (Loss) Per Share +The following table sets forth the computation of basic and diluted net income (loss) per share: +Year Ended March 31, +2024 2023 +(In thousands, except per +share amounts) +Numerator: +Net income (loss) $ 3,131 $ ( 14,855 ) +Denominator: +Weighted average common shares used in basic computation 42,867 42,374 +Dilutive stock options and other dilutive awards 1,037 — +Weighted average common shares used in diluted computation 43,904 42,374 +Net income (loss) per basic share $ 0.07 $ ( 0.35 ) +Net income (loss) per diluted share $ 0.07 $ ( 0.35 ) +57 +Table of Contents +The following instruments were excluded for purposes of calculating weighted average common share equivalents in the computation of diluted net income (loss) per share as their effect would have been anti-dilutive for the years ended March 31, 2024 and 2023: +Year Ended March 31, +2024 2023 +(In thousands) +Stock options 3,425 5,886 +Restricted stock units 241 457 +3. Restructuring Activities +On May 12, 2022, the Board of Directors of Iteris, Inc. approved restructuring activities to better position the Company for increased profitability and growth. +Payments made during Fiscal 2024 towards the restructuring liability at March 31, 2023 were as follows (in thousands): +Balance at March 31, 2023 $ 242 +Cash payments ( 242 ) +Balance at March 31, 2024 $ — +4. Fair Value Measurements +We measure fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. As described in more detail in Note 1, Description of Business and Summary of Significant Accounting Policies, fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. +We did not have any material financial assets or liabilities measured at fair value on a recurring basis using Level 3 inputs as of March 31, 2024 or 2023. Our non-financial assets, such as goodwill, intangible assets and property and equipment, are measured at fair value on a nonrecurring basis, generally when there is a transaction involving those assets such as a purchase transaction, a business combination or an adjustment for impairment. No non-financial assets were measured at fair value as of March 31, 2024 and March 31, 2023. +The following tables present the Company’s financial assets and liabilities that are recorded at fair value on a recurring basis, segregated among the appropriate levels within the fair value hierarchy: +As of March 31, 2024 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +(In thousands) +Assets: +Level 1: +Securities held in deferred compensation plan (1) +$ 1,539 $ ( 542 ) $ 650 $ 1,647 +Total $ 1,539 $ ( 542 ) $ 650 $ 1,647 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) +$ 1,415 $ ( 485 ) $ 633 $ 1,563 +Total $ 1,415 $ ( 485 ) $ 633 $ 1,563 +58 +Table of Contents +As of March 31, 2023 +Amortized +Cost Gross +Unrealized +Loss Gross +Unrealized +Gain Estimated +Fair Value +(In thousands) +Assets: +Level 1: +Securities held in deferred compensation plan (1) +$ 1,426 $ ( 437 ) $ 321 $ 1,310 +Total $ 1,426 $ ( 437 ) $ 321 $ 1,310 +Liabilities: +Level 1: +Deferred compensation plan liabilities (2) +$ 1,201 $ ( 296 ) $ 563 $ 1,468 +Level 3: +Contingent consideration (3) +600 — — 600 +Transfers out (3) +( 600 ) — — ( 600 ) +Subtotal — — — — +Total $ 1,201 $ ( 296 ) $ 563 $ 1,468 +(1) Included in prepaid expenses and other current assets on the Company’s balance sheets. +(2) Included in accrued payroll and related expenses on the Company’s balance sheets. +(3) As of March 31, 2023, the inputs related to determination of the balance of the earnout were resolved and the final balance due was all short-term and included in accrued liabilities on the Company's balance sheet. As of March 31, 2024, the balance had been paid in full. +Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, nor is it more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2024. +5. Income Taxes +The components of current and deferred federal and state income tax provision are as follows: +Year Ended March 31, +2024 2023 +(In thousands) +Income (loss) before income taxes $ 3,463 $ ( 14,720 ) +Current income tax provision: +Federal 149 — +State 89 50 +Total current tax provision 238 50 +Deferred income tax provision: +Federal 20 34 +State 74 51 +Total deferred tax provision 94 85 +Provision for income taxes 332 135 +Income (loss), net of taxes $ 3,131 $ ( 14,855 ) +59 +Table of Contents +The reconciliation of our income tax provision (benefit) to taxes computed at U.S. federal statutory rates is as follows: +Year Ended March 31, +2024 2023 +(In thousands) +Provision for (benefit from) income taxes at statutory rates $ 727 $ ( 3,091 ) +State income taxes net of federal benefit 195 ( 423 ) +Tax credits ( 981 ) ( 434 ) +Compensation charges 612 156 +Change in valuation allowance ( 271 ) 3,849 +Other 50 78 +Provision for income taxes $ 332 $ 135 +The components of deferred tax assets and liabilities are as follows: +March 31, +2024 2023 +(In thousands) +Deferred tax assets: +Net operating losses $ 2,317 $ 5,962 +Capitalized R&D 4,733 2,866 +Credit carry-forwards 5,366 4,868 +Deferred compensation and payroll 3,660 3,290 +Bad debt allowance and other reserves 1,237 914 +Property and equipment 860 729 +Lease liabilities 2,203 — +Acquired intangibles 214 294 +Other, net 547 518 +Total deferred tax assets 21,137 19,441 +Valuation allowance ( 18,470 ) ( 18,741 ) +Total deferred tax assets, net of valuation allowance 2,667 700 +Deferred tax liabilities: +Goodwill ( 1,294 ) ( 1,122 ) +Right-of-use assets ( 1,888 ) — +Total deferred tax liabilities ( 3,182 ) ( 1,122 ) +Net deferred tax liabilities $ ( 515 ) $ ( 422 ) +At March 31, 2024, we had $ 4.2 million in federal research credits that begin to expire in 2031 and $ 1.3 million in state tax credits that began to expire in 2024. We had $ 7.9 million of federal net operating loss carryforwards at March 31, 2024 that do not expire as a result of recent tax law changes. We also had $ 10.0 million of state net operating loss carryforwards at March 31, 2024 that begin to expire in 2031. +In assessing the realizability of our deferred tax assets, we review all available positive and negative evidence, including reversal of deferred tax liabilities, potential carrybacks, projected future taxable income, tax planning strategies and recent financial performance. As the Company has sustained a cumulative pre-tax loss, we considered it appropriate to maintain valuation allowances of $ 18.5 million and $ 18.7 million against our deferred tax assets at March 31, 2024 and 2023, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. +60 +Table of Contents +Unrecognized Tax Benefits +As of March 31, 2024 and 2023, our gross unrecognized tax benefits were approximately $ 1.5 million and $ 1.3 million, respectively, of which approximately $ 1.5 million and $ 1.2 million, respectively, are netted against certain noncurrent deferred tax assets. The amounts that would affect our effective tax rate if recognized are approximately $ 1.4 million and $ 1.2 million, respectively. +A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: +Year Ended March 31, +2024 2023 +(In thousands) +Gross unrecognized tax benefits at beginning of year $ 1,284 $ 1,198 +Increases for tax positions taken in prior years 81 22 +Decreases for tax positions taken in prior years ( 12 ) ( 36 ) +Increases for tax positions taken in the current year 196 116 +Lapse in statute of limitations ( 27 ) ( 16 ) +Gross unrecognized tax benefits $ 1,522 $ 1,284 +We do not anticipate a significant change in gross unrecognized tax benefits within the next twelve months. We are subject to taxation in the U.S. and various state tax jurisdictions. We are subject to U.S. federal tax examination for fiscal tax years ended March 31, 2021 or later, and state and local income tax examination for fiscal tax years ended March 31, 2020 or later. However, if net operating loss carryforwards that originated in earlier tax years are utilized in the future, the amount of such NOLs from such earlier years remain subject to review by tax authorities. +6. Commitments and Contingencies +Litigation and Other Contingencies +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in disputes, proceedings, or litigation relating to claims arising out of its operations in the normal course of business, such as intellectual property infringement and contractual matters. While the Company cannot accurately predict the outcome of any such disputes, proceedings, or litigation, including the matter below, the Company is not a party to any legal dispute, proceedings, or litigations, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on the Company’s business, results of operations, financial position or cash flows. +The Company agreed to accept a $ 1.0 million return of inventory sold by the Company during Fiscal 2023, at the request of a prime contractor and related to a project that has been delayed. The Company is a subcontractor to the prime contractor on the delayed project, and there currently are no known issues with the product, nor is there currently any contention that there are issues with the product. Up to mid-July 2023 the Company believed the probability of the occurrence of a loss associated with this matter was remote. After meeting with the prime contractor beginning in mid-July 2023, the Company agreed to reassess the situation and agreed on August 7, 2023, to accept the inventory return. For the year ended March 31, 2024, we recognized a pretax loss contingency of $ 0.2 million, comprised of $ 1.0 million in accrued liabilities representing the sale value of the inventory and $ 0.8 million in prepaid expenses and other current assets representing the estimated value of the inventory to be returned in the future. The inventory was returned, and the accrued liability was paid. As of March 31, 2024, there were no outstanding contingencies related to this inventory. +7. Right-of-Use Assets and Lease Liabilities +We have various operating leases for our offices, office equipment and vehicles in the United States. These leases expire at various times through 2030. Certain lease agreements contain renewal options from 1 year to 5 years, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. +61 +Table of Contents +The table below presents lease-related assets and liabilities recorded on the balance sheet as follows (in thousands): +Classification March 31, 2024 March 31, 2023 +Assets +Operating lease right-of-use-assets Right-of-use assets $ 7,237 $ 8,345 +Total operating lease right-of-use-assets $ 7,237 $ 8,345 +Liabilities +Operating lease liabilities (short-term) Accrued liabilities $ 2,233 2,339 +Operating lease liabilities (long-term) Lease liabilities 6,210 7,641 +Total operating lease liabilities $ 8,443 $ 9,980 +Lease Costs +For each of Fiscal 2024 and Fiscal 2023, lease costs totaled $ 2.6 million. +Supplemental Information +The table below presents supplemental information related to operating leases during the fiscal year ended March 31, 2024 and 2023: +March 31, 2024 March 31, 2023 +(Dollars in thousands) +Cash paid for amounts included in the measurement of operating lease liabilities $ 2,727 $ 1,755 +Right-of-use assets obtained in exchange for new operating lease liabilities $ 997 $ 313 +Weighted average remaining lease term 3.7 3.9 +Weighted average discount rate 5.0 % 4.8 % +Undiscounted Cash Flows +The table below reconciles the undiscounted cash flows for each of the first five years and the total of the remaining years to the operating lease liabilities recorded on the balance sheet as of March 31, 2024 (in thousands): +Fiscal Year Ending March 31, Operating Leases +2025 $ 2,588 +2026 2,404 +2027 2,467 +2028 1,415 +2029 260 +Thereafter 174 +Total lease payments 9,308 +Less imputed interest ( 865 ) +Present value of future lease payments 8,443 +Less current obligations under leases ( 2,233 ) +Long-term lease obligations $ 6,210 +62 +Table of Contents +8. Stockholders’ Equity +Preferred Stock +Our certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. Our Board of Directors is authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion, voting, redemption and liquidation rights. As of March 31, 2024 and 2023, there were no outstanding shares of preferred stock, and we do not currently have plans to issue any shares of preferred stock. +Common Stock Reserved for Future Issuance +The following summarizes common stock reserved for future issuance at March 31, 2024: +Number of Shares +(In thousands) +Stock options outstanding 5,858 +Restricted stock units outstanding 793 +Performance stock units outstanding 117 +Authorized for future grant under stock incentive plan 1,598 +Total common stock reserved for future issuance at March 31, 2024 +8,366 +9. Employee Benefit Plans +Stock Incentive Plans +We currently maintain two stock incentive plans, the 2007 Omnibus Incentive Plan (the “2007 Plan”) and the 2016 Omnibus Incentive Plan (the “2016 Plan”). Each of these plans allows for the issuance of stock options, stock appreciation rights, restricted stock (“RSUs”), performance-based restricted stock units (“PSUs”), cash incentive awards and other stock-based awards to our employees, officers, consultants and directors at exercise prices which are equal to or greater than the market value of our common stock on the date of grant. Options expire no more than ten years after the date of grant and generally vest at the rate of 25 % on each of the first 4 years anniversaries of the grant date. Stock appreciation rights, RSUs, and other stock-based awards are based on the value of our common stock. New shares are issued to satisfy option exercises and shares issuance under the plans although we may only grant future awards from the 2016 Plan. +In September 2007, our stockholders approved the 2007 Plan. In September 2009, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 1,650,000 shares. In September 2012, our stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2007 Plan by 800,000 shares to a total of 2,450,000 shares. In October 2014, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,500,000 shares to a total of 3,950,000 shares. In September 2015, our stockholders approved an amendment of the 2007 Plan to increase the number of shares of common stock authorized for issuance under the 2007 Plan by an additional 1,000,000 shares to a total of 4,950,000 shares. +In December 2016, our stockholders approved the 2016 Plan. In September 2021, our stockholders approved an amendment of the 2016 Plan to increase the number of shares of common stock authorized for issuance under the 2016 Plan by an additional 3,360,000 shares to a total of 9,263,602 shares. +At March 31, 2024, there were approximately 1.6 million shares of common stock available for future grant under the 2016 Plan. Total stock options vested and expected to vest were approximately 5.9 million as of March 31, 2024. +63 +Table of Contents +Stock Options +A summary of activity in the Omnibus Incentive Plans with respect to our stock options for Fiscal 2024 is as follows: +Options Weighted +Average +Exercise +Price Per +Share Weighted +Average +Remaining +Contractual +Life Aggregate +Intrinsic +Value +(In thousands) (Years) (In thousands) +Options outstanding at March 31, 2023 6,287 $ 4.11 +Granted 475 4.13 +Exercised ( 173 ) 3.03 +Forfeited ( 417 ) 4.04 +Expired ( 314 ) 4.77 +Options outstanding at March 31, 2024 5,858 4.11 5.5 $ 5,410 +Options vested and exercisable at March 31, 2024 +4,268 4.16 4.4 $ 3,879 +Restricted Stock Units +RSU awards are stock-based awards that entitle the holder to receive one share of our common stock for each RSU upon vesting. RSUs granted under the 2007 Plan vest at the rate of 25 % on each of the first four anniversaries of the grant date provided that the holder remains in service (as defined by the 2007 Plan) as of the vesting date. RSUs granted under the 2016 Plan vest at varying terms between 1 year and 3 year anniversaries of the grant date provided that the holder remains in service (as defined by the 2016 Plan) as of the vesting date. The fair value per RSU is determined based on the closing market price of our common stock on the grant date. +A summary of activity with respect to our RSUs for Fiscal 2024 is as follows: +# of Shares Weighted +Average +Price Per +Share +(In thousands) +RSUs outstanding at March 31, 2023 497 $ 3.05 +Granted 460 4.35 +Vested and released ( 118 ) 3.85 +Forfeited ( 46 ) 4.12 +RSUs outstanding at March 31, 2024 793 4.18 +Performance Stock Units +The Company approves a “target” number of PSUs for our executive officers with performance and service-based vesting conditions. The actual number of units that ultimately vest will range from 0 % to 200 % of the original units awarded based on level of achievement. Between 0 % and 160 % of the PSUs will be eligible to vest based on average annual performance during the three-year performance period relative to the revenues per share and cash flow from operations objectives to be established by the Compensation Committee at the beginning of each year. In addition, the final PSU vesting based on the revenues per share and cash flow from operations performance will be subject to a modifier between .75 x- 1.25 x based on the Company’s total shareholder return relative to the Russell 2000 during the performance period, for a maximum achievement percentage of 200 % of the “target” number of PSUs. The PSUs are amortized over a service period of 3 years. We estimated the value and the derived service period of the PSUs using the Monte-Carlo simulation model. +In accordance with ASC 718 - Compensation – Stock Compensation, grant date is a date at which a grantor and a grantee reach a mutual understanding of the key terms and conditions of a share-based payment award. For PSU awards with performance conditions to be established by the Compensation Committee at a future date, the grant date does not occur until the vesting conditions are established and communicated to the employees. +64 +Table of Contents +The following table summarizes the details of the performance stock units: +# of Shares Weighted +Average +Price Per +Share +(In thousands) +PSUs outstanding at March 31, 2023 83 $ 4.45 +Granted 119 4.57 +Vested ( 43 ) 5.59 +Forfeited ( 42 ) 5.46 +PSUs outstanding at March 31, 2024 117 4.75 +Stock-Based Compensation +The following table presents stock-based compensation expense that is included in each functional line item in our statements of operations: +Year Ended March 31, +2024 2023 +(In thousands) +Cost of revenues $ 315 $ 352 +General and administrative 1,596 1,626 +Sales and marketing 579 477 +Research and development expense 475 435 +Total stock-based compensation $ 2,965 $ 2,890 +At March 31, 2024, there was approximately $ 2.9 million, $ 1.7 million and $ 0.2 million of unrecognized compensation expense related to unvested stock options, RSUs, and PSUs respectively. This expense is currently expected to be recognized over a weighted average period of approximately 2.5 years for stock options, 1.8 years for RSUs and 1.8 years for PSUs. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock options, RSUs or other stock-based awards. +The grant date fair value of stock options granted was estimated using the following weighted-average assumptions: +Year Ended March 31, +2024 2023 +Expected life—years 6.3 7.5 +Risk-free interest rate 4.2 % 3.6 % +Expected volatility of common stock 52 % 51 % +Dividend yield 0 % 0 % +Expected Life: The Company’s expected life represents the weighted-average period that the Company’s stock options are expected to be outstanding. The expected life is based on expected time to post-vesting exercise of options by employees. The Company uses historical exercise patterns of previously granted options to derive employee behavioral patterns used to forecast expected exercise patterns. +Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury zero coupon yield curve in effect at the time of grant for the expected term of the option. +65 +Table of Contents +Expected Volatility: The Company uses historical volatility as it provides a reasonable estimate of the expected volatility. Historical volatility is based on the most recent volatility of the stock price over a period of time equivalent to the expected term of the option. +A summary of certain fair value and intrinsic value information pertaining to our stock options is as follows: +Year Ended March 31, +2024 2023 +(In thousands, except +per share amounts) +Weighted average grant date fair value per share of options granted $ 2.34 $ 1.67 +Intrinsic value of options exercised $ 254 $ 141 +Employee Incentive Programs +Under the terms of a Profit Sharing Plan, we may contribute to a trust fund such amounts as determined annually by the Board of Directors. No contributions were made during the fiscal years ended March 31, 2024 and 2023. +We sponsor a defined contribution 401(k) plan (the “401(k) Plan”), adopted in 1990, under which eligible employees voluntarily contribute to the plan, up to IRS maximums, through payroll deductions. We match up to 50 % of contributions, up to a stated limit, with all matching contributions being fully vested after one month of service. Our matching contributions under the 401(k) Plan were approximately $ 2.0 million and $ 1.8 million for Fiscal 2024 and Fiscal 2023, respectively. +Other Stock-Based Compensation Plans +Beginning January 1, 2018, the Company adopted an ESPP which allows employees to withhold a percentage of their base compensation to purchase the Company’s common stock at 95 % of the lower of the fair market price at the beginning of the offering period and on the last trading day of the offering period. There are two offering periods during a calendar year, which consist of the six months beginning each January 1 and July 1. Employees may elect to contribute 1 - 15 % of their eligible gross pay up to a $ 0.03 million annual stock value limit. During Fiscal 2024 and Fiscal 2023, 173,273 and 180,000 shares, respectively, were purchased. +As of March 31, 2024 and 2023, approximately $ 0.1 million of cash was restricted for the purchase of shares under the ESPP and is recorded as restricted cash in the accompanying balance sheets. +Deferred Compensation Plan +Effective October 1, 2020, the Company adopted the Iteris, Inc. Non-Qualified Deferred Compensation Plan (the “DC Plan”). The DC Plan consists of two plans, one that is intended to be an unfunded arrangement for eligible key employees who are part of a select group of management or highly compensated employees of the Company within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, and one for the benefit of non-employee members of our Board of Directors. Key employees, including our executive officers and our non-employee directors who are notified regarding their eligibility to participate and delivered the DC Plan enrollment materials, are eligible to participate in the DC Plan. Under the DC Plan, we will provide participants with the opportunity to make annual elections to defer a percentage of their eligible cash compensation and equity awards. A participant is always 100% vested in his or her own elective cash deferrals and any earnings thereon. Elective deferrals of equity awards are credited to a bookkeeping account established in the name of the participant with respect to an equivalent number of shares of our common stock, and such credited shares are subject to the same vesting conditions as are applicable to the equity award subject to the election. The Company established a rabbi trust to finance our obligations under the DC Plan with corporate-owned life insurance policies on participants regardless of employment status, and the assets held within this trust are subject to the claims of the Company’s creditors. +As of March 31, 2024, the amount invested under the DC Plan totaled approximately $ 1.6 million and is classified as trading securities, which are recorded at fair market value with changes recorded as adjustments to other income. This amount is included in prepaid expenses and other current assets on the balance sheets. +As of March 31, 2024, the vested amounts under the DC Plan totaled $ 1.6 million and are included in accrued payroll and related expenses on the balance sheets. Changes in the deferred compensation plan liabilities are recorded as an adjustment to compensation expense. +66 +Table of Contents +As of March 31, 2024, 147,991 equity awards were deferred and held in the rabbi trust. The shares deferred and held in the rabbi trust are classified as treasury stock, and the liability to participating employees is classified as deferred compensation obligations in the stockholders’ equity section of the balance sheets. The number of shares needed to settle the liability for deferred compensation obligations will be included in the denominator in both the basic and diluted earnings per share calculations. +10. Stock Repurchase Program +On May 12, 2022, the Board of Directors terminated the 2012 stock repurchase program and approved a new plan for the Company to acquire up to $ 10 million of our outstanding common stock for an unspecified length of time (the “2022 Stock Repurchase Program”). Under the 2022 Stock Repurchase Program, we may repurchase shares from time to time in the open market and in privately negotiated transactions and block trades, and may also repurchase shares pursuant to a 10b5-1 trading plan during our closed trading windows. There is no guarantee as to the exact number of shares that will be repurchased. We may modify or terminate the 2022 Stock Repurchase Program at any time without prior notice. During the fiscal year ended March 31, 2024, we repurchased 39,861 shares, for an aggregate price of approximately $ 0.2 million, at an average price of $ 4.54 per share. From the inception of the 2022 Stock Repurchase Program through March 31, 2024, we repurchased approximately 339,861 shares of our common stock for an aggregate price of approximately $ 1.1 million, at an average price per share of $ 3.14 . As of March 31, 2024, these repurchased shares had been retired and resumed their status as authorized and unissued shares of our common stock. As of March 31, 2024 approximately $ 8.9 million remained available for the repurchase of our common stock under our 2022 Stock Repurchase Program. +11. Business Segments, Significant Customer and Geographic Information +Business Segments +The Company’s Chief Operating Decision Maker (“CODM”), who is our Chief Executive Officer, reviews the Company’s results on a consolidated basis and our financial results are presented under a single reportable segment in order to provide the most accurate representation of the Company’s performance. +Significant Customer and Geographic Information +No individual customer or government agency had a receivable balance greater than 10% of our total trade accounts receivable balances as of March 31, 2024 and 2023. The Company had no long-lived assets located outside the U.S. as of March 31, 2024 and 2023. +The Company had de minimis revenues, derived from shipments to, or contract, service and other revenues, from external customers located outside the U.S. for the years ended March 31, 2024 and 2023. +67 +Table of Contents +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2024, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2024 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management ’ s Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2024. +The effectiveness of our internal control over financial reporting as of March 31, 2024 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +68 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. (the “Company”) as of March 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements as of and for the year ended March 31, 2024, of the Company and our report dated June 13, 2024, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 13, 2024 +69 +Table of Contents +ITEM 9B. OTHER INFORMATION +(a) None. +(b) During the three months ended March 31, 2024 , none of the Company’s directors or officers adopted , modified or terminated a Rule 10b5-1 trading arrangement, and none of the Company’s directors or officers adopted , modified or terminated a non-Rule 10b5-1 trading arrangement (as such terms are defined in Item 408 of Regulation S-K of the Securities Act of 1933, as amended), except that Joe Bergera terminated the Rule 10b5-1 trading arrangement he had previously adopted as disclosed in our Form 10-Q for the quarter ended December 31, 2023. +70 +Table of Contents +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by Item 10 will be either (i) included in an amendment to this Annual Report on Form 10-K (“Form 10-K Amendment”) or (ii) incorporated by reference to our Definitive Proxy Statement to be filed with the SEC in connection with our 2024 Annual Meeting of Stockholders (the “2024 Proxy Statement”) under the headings “Executive Compensation and Other Information—Executive Officers,” “Election of Directors,” “Corporate Governance, Board Meetings and Committees,” and “Delinquent Section 16(a) Reports.” +ITEM 11. EXECUTIVE COMPENSATION +The information required by Item 11 will be either (i) included in a Form 10-K Amendment or (ii) incorporated by reference to our 2024 Proxy Statement under the heading “Executive Compensation and Other Information” and “Election of Directors.” +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by Item 12 will be either (i) included in a Form 10-K Amendment or (ii) incorporated by reference to our 2024 Proxy Statement under the heading “Equity Compensation Plan Information” and “Stock Ownership of Certain Beneficial Owners and Management.” +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either (i) included in a Form 10-K Amendment or (ii) incorporated by reference to our 2024 Proxy Statement under the heading “Corporate Governance, Board Meetings and Committees” and “Additional Matters—Transactions with Related Persons.” +ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by Item 14 will be either (i) included in a Form 10-K Amendment or (ii) incorporated by reference to our 2024 Proxy Statement under the heading “Matters Related to Independent Registered Public Accounting Firm.” +71 +Table of Contents +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) Documents filed as part of this report: +1. Financial Statements. +Our financial statements are listed in the “Index to Financial Statements” under Part II, Item 8, of this Annual Report. +2. Financial Statement Schedules. +All financial statement schedules have been omitted because they are not required or are not applicable, or the required information is shown in our financial statements or the notes thereto. +3. Exhibits. +The following table sets forth the exhibits either filed herewith or incorporated herein by reference: +Exhibit Index +Exhibit Number Description Reference +2.1 † +Asset Purchase Agreement, dated May 2, 2020, by and among Iteris, Inc., ClearAg, Inc., and DTN, LLC +Exhibit 2.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on May 6, 2020 +3.1 +Restated Certificate of Incorporation of Iteris, Inc. as filed with the Delaware Secretary of State on October 12, 2018 +Exhibit 3.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on October 15, 2018 +3.2 +Restated Bylaws of the Registrant, as amended through August 6, 2018 +Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 as filed with the SEC on August 7, 2018 +4.1 +Specimen common stock certificate +Exhibit 4.1 to the registrant’s Registration Statement on Form 8-A (File No. 001-08762), as filed with the SEC on December 8, 2004 +4.2 +Description of Iteris, Inc. Securities Registered under Section 12 of the Exchange Act +Filed herewith +10.1 † +Asset Purchase Agreement dated December 6, 2020, by and between Iteris, Inc. and TrafficCast International, Inc. +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 7, 2020 +10.2 * +Form of Indemnification Agreement entered into by the registrant and certain of its officers and directors +Exhibit 10.5 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2004 as filed with the SEC on June 29, 2004 +10.3 +Office Lease A greement , dated May 24, 2007, by and between the registrant and Realty Associates Fund X, L.P. (as the successor to Crown Carnegie Associates, LLC) +Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 as filed with the SEC on August 14, 2007 +10.4 +First Amendment to Lease, dated February 21, 2014, by and between RREF II Freeway Acquisitions, LLC and Iteris, Inc. +Exhibit 10.29 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2014 as filed with the SEC on September 4, 2014 +72 +Table of Contents +Exhibit Number Description Reference +10.5 +Second Amendment to Lease, dated September 29, 2014, by and between Realty Associates Fund X, L.P. and Iteris, Inc. (as the successor to Realty Associate RREF II Freeway Acquisitions, LLC) and Iteris, Inc. +Exhibit 10.5 to registrant’s Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.6 +Third Amendment to Lease, dated December 15, 2016, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.6 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2019 filed with the SEC on June 6, 2019 +10.7 +Fourth Amendment to Lease, dated May 17, 2021, by and between Realty Associates Fund X, L.P. and Iteris, Inc. +Exhibit 10.7 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2021 filed with the SEC on June 1, 2021 +10.8 * +Iteris, Inc. Employee Stock Purchase Plan +Exhibit 10.4 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2018 as filed with the SEC on June 7, 2018 +10.9 * +2007 Omnibus Incentive Plan (Amended and Resta ted as of July 2015) +Appendix A to the registrant’s Definitive Proxy Statement as filed with the SEC on July 29, 2015 +10.10 * +Forms of Stock Option Agreements under the 2007 Omnibus Incentive Plan +Exhibit 10.20 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2012 as filed with the SEC on June 11, 2012 +10.11 * +Form of Restricted Stock Unit Award Agreement under the 2007 Omnibus Incentive Plan +Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 as filed with the SEC on July 28, 2010 +10.12 * +Amended and Restated Iteris, Inc. 2016 Omnibus Incentive Plan +Exhibit 99.1 to registrant's Registration Statement on Form S-8 (File No. 333-228210) as filed with the SEC on November 6, 2018 +10.13 * +Form of Performance Stock Unit Issuance Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.14 * +Revised Form of Restricted Stock Unit Issuance for use with 2016 Omnibus Incentive Plan +Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.15 * +Revised Form of Form of Notice of Grant of Stock Option and Form of Stock Option Agreement for use with 2016 Omnibus Incentive Plan +Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 as filed with the SEC on August 4, 2020 +10.16 * +Employment Agreement dated September 8, 2015, between Iteris, Inc. and Joe Bergera +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on September 22, 2015 +10.17 * +Iteris, Inc. Amended and Restated Executive Severance Plan +Exhibit 10.20 to the registrant’s Annual Report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on June 6, 2019 +10.18 * +Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.19 * +Form of Restricted Stock Unit Issuance Agreement for use with the Iteris, Inc. Deferred Compensation Plan Effective Date October 1, 2020 +Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2020 as filed with the SEC on February 2, 2021 +10.20 * +2016 Omnibus Incentive Plan (Amended and Restated effective September 9, 2021) +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on September 9, 2021 +73 +Table of Contents +Exhibit Number Description Reference +10.21 * +Employment Agreement, dated January 30, 2023, between Iteris, Inc. and Kerry Shiba +Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on February 2, 2023 +23 +Consent of Independent Registered Public Accounting Firm, dated June 13, 2024 +Filed herewith +24 +Power of Attorney +Filed herewith (included on the Signature page) +31.1 +Certification of the Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +31.2 +Certification of the Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.1 +Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +32.2 +Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +Filed herewith +97 +Incentive Compensation Clawback Policy +Filed herewith +101.INS Inline XBRL Instance Document Filed herewith +101.SCH Inline XBRL Taxonomy Extension Schema Document Filed herewith +101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document Filed herewith +101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document Filed herewith +101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document Filed herewith +101.DEF Inline XBRL Taxonomy Definition Presentation Linkbase Document Filed herewith +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) +Filed herewith +______________________________________ +† Certain confidential portions and/or the schedules and attachments to this exhibit have been omitted from this filing pursuant to a confidential treatment request filed with the SEC, or Item 601(a)(5) or 601(b)(10)of Regulation S-K, as applicable. The Company agrees to furnish supplementally an unredacted copy of the exhibit to the SEC upon request. +* Indicates a contract, compensatory plan or arrangement in which directors or executive officers of the registrant are eligible to participate. +ITEM 16. FORM 10-K SUMMARY +None. +74 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: June 13, 2024 ITERIS, INC. +(Registrant) +By /s/ JOE BERGERA +Joe Bergera +Chief Executive Officer +(Principal Executive Officer) +POWER OF ATTORNEY +We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint Joe Bergera and Kerry Shiba, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated: +Signature Title Date +/s/ JOE BERGERA Director, President and Chief Executive Officer (Principal Executive Officer) June 13, 2024 +Joe Bergera +/s/ KERRY A. SHIBA Senior Vice President and Chief Financial Officer, Treasurer, and Secretary (Principal Financial and Accounting officer) June 13, 2024 +Kerry A. Shiba +/s/ THOMAS L. THOMAS Chair of the Board June 13, 2024 +Thomas L. Thomas +/s/ GARY HALL Director June 13, 2024 +Gary Hall +/s/ GERARD M. MOONEY Director June 13, 2024 +Gerard M. Mooney +/s/ LAURA L. SIEGAL Director June 13, 2024 +Laura L. Siegal +/s/ KIMBERLY VALENTINE-POSKA Director June 13, 2024 +Kimberly Valentine-Poska +/s/ DENNIS W. ZANK Director June 13, 2024 +Dennis W. Zank +75 \ No newline at end of file diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/filing_metadata.csv b/raw/filings/0000350868/2023/0000350868-24-000016/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..8413e93f24d2e79ae213d4a1600523a5392519a4 --- /dev/null +++ b/raw/filings/0000350868/2023/0000350868-24-000016/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000350868,ITI,"ITERIS, INC.",10-K,2024-06-13,2024-03-31,2024-06-13T20:41:27.000Z,0000350868-24-000016,iti-20240331.htm,10-K,7648175,1,1,https://www.sec.gov/Archives/edgar/data/350868/000035086824000016/iti-20240331.htm,https://www.sec.gov/Archives/edgar/data/350868/000035086824000016/,2023,2023,1 diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/item1.txt b/raw/filings/0000350868/2023/0000350868-24-000016/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..baa5c4cd05760d02b03eb1227c4dd804fff51151 --- /dev/null +++ b/raw/filings/0000350868/2023/0000350868-24-000016/item1.txt @@ -0,0 +1,100 @@ +ITEM 1. BUSINESS +Description of Business +Iteris, Inc. (referred to in this report as “Iteris”, the “Company”, “we”, “our”, and “us”) is a provider of smart mobility infrastructure management solutions. Our cloud-enabled solutions help public transportation agencies, municipalities, commercial entities and other transportation infrastructure providers monitor, visualize, and optimize mobility infrastructure to make mobility safe, efficient, and sustainable for everyone. +As a pioneer in intelligent transportation systems (“ITS”) technology, our intellectual property, advanced detection sensors, mobility and traffic data, software-as-a-service (“SaaS”) offerings, mobility consulting services, and managed services represent a comprehensive range of smart mobility infrastructure management solutions that we distribute to customers throughout the United States (“U.S.”) and internationally. +We believe our products, solutions and services increase vehicle and pedestrian safety and decrease congestion within our communities, while also reducing environmental impact, including vehicle carbon emissions. +We continue to make significant investments to leverage our existing technologies and further enhance our advanced detection sensors, SaaS portfolio, mobility data sets, mobility consulting services, and managed services. As we are always mindful of capital allocation, we apply significant effort to evaluate and prioritize these investments. Likewise, we are always exploring strategic alternatives intended to optimize the value of our Company. +Iteris was incorporated in Delaware in 1987 and has operated in its current form since 2004. Our principal executive offices are located at 1250 S Capital of Texas Hwy, Bldg. 1, Suite 330, Austin TX 78746, and our telephone number at that location is (512) 716-0808. Our website address is www.iteris.com. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on, or accessible through, our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, together with amendments to these reports, are available on the "Investor Relations" section of our website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (“SEC”). +Developments Impacting our Business +COVID-19 +Although COVID-19 has entered an endemic stage, COVID-19 (including new variants of COVID-19) or other future pandemics may adversely affect the global economic conditions, including possible additional supply chain disruptions, workplace dislocations, economic contraction, and negative pressure on customer budgets and customer sentiment. When COVID-19 was considered a public health emergency, we took actions to preserve our liquidity, manage cash flow and strengthen our financial flexibility. Such actions included, but were not limited to, reducing our discretionary spending, reducing capital expenditures, and implementing restructuring activities. +Our products require specialized parts, some of which became more difficult to source during the COVID-19 pandemic. In some cases, we had to purchase such parts from third-party brokers at substantially higher prices. The Company’s strategies to mitigate global supply chain issues included re-designing certain circuit boards to accommodate computer chips that are more readily available in the market at more reasonable prices, and accumulating inventory in the first two quarters of the fiscal year ended March 31, 2023 (“Fiscal 2023”). We also placed non-cancellable inventory orders for certain products in advance of our normal lead times to secure normal and incremental future supply and capacity. +We curtailed the increase in inventory purchases and in particular components purchased in the secondary markets in the second half of Fiscal 2023, and the Company currently does not expect to accumulate inventory in the same magnitude in future periods. However, if the Company encounters additional supply chain constraints again in the future, it may need to further adjust its operations to maintain sufficient liquidity. +Restructuring Activities +To help offset increases in supply chain costs in Fiscal 2023, on May 12, 2022, our Board of Directors approved restructuring activities to better position the Company for increased profitability and growth. The Company incurred employee separation costs in relation to these activities, which were included in restructuring charges on the statement of operations (see Note 3, Restructuring Activities , to the Financial Statements for more information). +4 +Table of Contents +Products and Services +Iteris provides comprehensive smart mobility infrastructure management solutions for public-sector and private-sector customers primarily located in North America. These solutions include traveler information systems, transportation performance measurement software, traffic analytics software, transportation operations software, transportation-related data sets, advanced sensing devices, managed services, traffic engineering services, and mobility consulting services. +Software Solutions +Iteris offers our public-sector and private-sector customers a portfolio of industry-leading smart mobility infrastructure software solutions. These software solutions include ClearGuide, ClearRoute, Commercial Vehicle Operations (“CVO”), TrafficCarma, VantageLive! and VantageARGUS CV (previously known as BlueARGUS) as described below. +• ClearGuide, which is provided on a software-as-a-service basis (“SaaS”), is a state-of-the-art mobility intelligence and transportation performance analytics solution. It utilizes a wide range of data resources and analytical techniques to determine current and future traffic patterns to enable the effective performance analysis and management of traffic infrastructure resources at various levels – highway, arterial (i.e., corridor), or intersection. At times, we refer to intersection performance analytics as signal performance measurement (“SPM”). ClearGuide users can measure how a transportation network is performing and identify potential areas of improvement. These applications are also capable of providing users with predictive traffic analytics, and easy-to-use visualization and animation features based on historical traffic conditions. +• ClearRoute delivers contextual, real-time, actionable mobility intelligence and traveler information services on a platform-as-a-service basis. ClearRoute provides multimodal, multilingual, traveler information via mobile apps, websites, email and text alerts, and Interactive Voice Response (“IVR”). The ClearRoute solution benefits from a powerful, flexible and streamlined infrastructure to help reduce congestion and improve safety and mobility for transportation networks across the country, and facilitates frictionless interoperability, flexible provisioning, and robust management of customer focused data. +• Commercial Vehicle Operations and vehicle safety compliance applications, which are provided on a SaaS basis, include various applications branded as ClearFleet, CVIEWplus, and Inspect. Collectively, these software applications support state-based commercial vehicles operations by storing and distributing intrastate and interstate commercial vehicle information for local, state, and federal agency roadside and enforcement operations. +• TrafficCarma, which is easily white labeled, is the first mobile application focused on the 120 million U.S. daily commuters and their journeys to and from work, train stations, airports, sporting events and other destinations. TrafficCarma provides advice on known route choices, not turn-by-turn navigation. It is personalized for people’s daily commutes and the roads they drive most. Verified crowdsourced content is combined with road speed data, public agency reports, camera imaging and other metrics and delivers users information relevant to their commute and other personal routes. +• VantageLive! is a SaaS solution that allows users to collect, process and analyze advanced intersection data from our Vantage sensors, as well as to view and understand intersection activity. +• VantageARGUS CV (previously BlueARGUS) is a SaaS solution that collects, analyzes, and visualizes various information related to travel times, speeds, and origin-destination from our BlueTOAD Spectra sensors and connected vehicle information from our BlueTOAD Spectra RSU sensors. +Mobility Data Sets +ClearData is the enhanced mobility data output of the Iteris ClearMobility Platform, a suite of data integration and analytics engines that aggregates and validates both proprietary and diversely sourced data inputs, including incidents, construction and connected vehicle GPS probes. Following processing and quality assurance, ClearData reflects real-time road conditions and is delivered to public-sector and private-sector customers via subscription-based direct data feeds or application programming interfaces (“APIs”), or through ClearGuide, our mobility intelligence and transportation performance analytics software solution. The complex, dynamic nature of roadway traffic cannot be explained by any single data source. ClearData resolves data conflicts through proprietary computerized algorithms and selective quality control from experienced traffic analysts. +5 +Table of Contents +Advanced Sensors +Iteris offers advanced intersection detection and other fixed traffic sensors that collectively comprise our two sensor families – Vantage and BlueTOAD. Increasingly, we bundle communications systems and traffic data collection applications (e.g., VantageLive! and VantageARGUS CV) with our sensor products. +The Vantage family of sensors uses advanced image processing technology, radar technology and other techniques to observe multi-modal traffic (e.g., vehicle, bicycle, and pedestrian), translate these observations into structured data, and apply sophisticated, proprietary algorithms to this structured data to optimize traffic signal performance in real-time. Certain Vantage sensors apply machine learning techniques for enhanced object classification. In addition to detecting the presence of objects, our Vantage systems record vehicle count, speed and other traffic information used in traffic management systems. Thus, our Vantage systems give traffic managers the tools to mitigate roadway congestion by visualizing and analyzing traffic patterns, allowing them to modify traffic signal timing to improve traffic flow. Our various software components complement our Vantage detection systems by providing integrated platforms to manage and view detection assets remotely over a network connection, as well as a mobile application for viewing anywhere. The Vantage family of sensors includes Vantage Apex, Vantage Next, VantagePegasus, VantageRadius, Vantage Vector, Velocity, SmartCycle, SmartCycle Bike Indicator, VersiCam, PedTrax, and P-Series products. +• Vantage Apex is the industry’s first full 1080p high-definition (“HD”) video and 4D/HD radar hybrid sensor with integrated artificial intelligence (“AI”) algorithms. Vantage Apex provides precise and detailed detection, tracking and classification of traffic. +• Vantage Next uses a powerful processor that enables future functional growth while maintaining proven Iteris video detection performance and reliability. The architecture supports expanding ITS applications and easily integrates with existing technologies and is anticipated to integrate with future technologies. +• VantagePegasus offers wireless broadband communications for transportation systems. VantagePegasus wireless networks are built with carrier grade radio components that deliver wireless connectivity and the bandwidth for communications from remote sites to a centralized host system. +• VantageRadius is the industry’s leading 4D high-definition radar detection system with an integrated high-resolution video camera for traffic monitoring and detection verification. +• Vantage Vector is a hybrid video and radar detection sensor with a wide range of capabilities, including stop bar and advanced zone detection, which enable advanced safety and adaptive control applications. +• Velocity takes advantage of the large number of vehicles that are driving with Bluetooth or Wi-Fi enabled devices such as smart phones. Each Velocity reader senses a device's unique “MAC” address as they pass a reader station and transmits the time and location of the device to a central host system. As devices are detected at successive Velocity readers, the Host System calculates average travel times and speeds for a roadway segment. The device specific network address remains totally anonymous. +• SmartCycle capability, which can effectively differentiate between bicycles and other vehicles with a single video detection camera, is available with all of our Vantage systems. SmartCycle enables more efficient signalized intersections, improved traffic throughput and increased cyclist safety. Agencies using bicycle timing benefit from bicycle-specific virtual detection zones that can be placed anywhere within the approaching traffic lanes, eliminating the need for separate bicycle-only detection systems. +• SmartCycle Bike Indicator, which leverages the SmartCycle bicycle detection algorithm, is a device that mounts onto traffic signals and illuminates when cyclists waiting at an intersection have been detected, allowing cyclists to avoid interacting with vehicle traffic and without pushing pole-mounted buttons. +• VersiCam, an integrated camera and processor video detection system, is a cost-efficient video detection system for smaller intersections that require only a few detection points. +• PedTrax capability, which is also available with all of our Vantage systems, provides bi-directional pedestrian counting and speed tracking within the crosswalk to help improve signal timing efficiency, as well as providing an additional data stream to existing vehicle and bicycle counts. +6 +Table of Contents +• P-Series detection cameras are integrated machine vision processors and cameras, designed for use on all types of intersections outside of North America. +The BlueTOAD product family combines unique MAC address capture with the latest CV technologies. The combination of these two technologies provides customers with a market leading sensor along with a comprehensive data set that enables advanced analytics through our SaaS offerings. The BlueTOAD family of sensors includes BlueTOAD Spectra and BlueTOAD Spectra CV, both of which we bundle with a cloud-based software application branded as VantageARGUS CV. +• BlueTOAD Spectra is a complete system for identifying the travel times of vehicles using advanced Bluetooth re-identification techniques. This provides traffic flow information for vehicle travel as well as Origin-Destination information. +• BlueTOAD Spectra CV is a full-featured connected vehicle and travel time information system. In addition to travel times and vehicle speeds, it communicates vital safety and mobility information via both DSRC and C-V2X from infrastructure to vehicles and other users. +In select territories, the Company also sells certain complementary original equipment manufacturer (“OEM”) products for the traffic intersection market, which include, among other things, traffic signal controllers and traffic signal equipment cabinets. +We believe that future growth domestically and internationally for our Vantage family of products will depend, in part, on the continued replacement of traditional in-pavement loop technology with above-ground video and radar detection technologies to manage traffic. +Managed Services +Iteris Managed Services include traffic management centers (“TMC”) design, staffing, and operations services for public agencies, whether they need to create a new TMC or migrate an existing TMC network to a virtual environment. Iteris partners with agencies to augment their internal capability and provide the foundation and expertise required to successfully implement virtual TMCs to support goals such as capital or recurring cost savings, operation from any location, and staff security and flexibility. +Additionally, Iteris’ managed services combine SaaS, smart sensors and consulting expertise to proactively address the challenges of monitoring and maintaining intersections, arterial roads and highways along with their related in-field technology. These services include arterial management and asset management managed services. Our asset management managed service combines innovative traffic optimization with hardware inventory and maintenance. +With Iteris Managed Services, public transportation agencies, real estate developers, construction firms, and event operators are provided the opportunity to save time and money while keeping road users safer and ensuring that traffic flows efficiently. +Traffic Engineering and Mobility Consulting +Our traffic engineering and mobility consulting services include planning, design, development and implementation of software and hardware-based ITS solutions that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews, and distribute real-time information about traffic conditions. Our services also include planning, design, implementation, operation and management of surface transportation infrastructure systems. We perform analysis and study goods movement, provide travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. +ClearMobility Platform +With the Company’s introduction of the ClearMobility Platform, we aligned our entire portfolio of solutions under a common branding structure. We believe this alignment will drive internal synergies, increase our cross-sell rate, enhance sales productivity, and increase market awareness of our entire solutions portfolio. Additionally, the ClearMobility Platform enables seamless interoperation among our solutions via a common mobility data management engine, API framework, and microservices ecosystem that provides standardized data ingestion, cleansing, and analytics, as well as authentication and policy-based security for each component of the ClearMobility Platform. Our ClearMobility Platform is both horizontally scalable and third-party extensible. +7 +Table of Contents +Our process of developing, enhancing, aligning, harmonizing, and optimizing our portfolio of individual solutions is an ongoing process, for which the Company’s chief operating decision maker (“CODM”) evaluates financial and operational performance holistically. As such, we report as a single operating segment. +Market Conditions +Currently, over 90% of our revenues are attributable to public-sector customers. Therefore, most of our revenues depend on state and local government funding, and to a lesser extent federal governmental funding. In some cases, this funding is appropriated annually through the respective legislative process. In other cases, various dedicated funding mechanisms exist to support transportation infrastructure and related projects, including, but not limited to dedicated sales and gas tax measures, vehicle and permit fees, and other alternative dedicated funding sources. Additionally, some of our activities may be funded through bond measures. +We believe that overall demand for our solutions will continue to depend, at least in part, on the federal and local governments’ use of funds, and as in the past, our business may be, at times, adversely affected by governmental budgetary issues. The Infrastructure Investment and Jobs Act (“IIJA”) became effective on November 15, 2021. The IIJA will contribute $1.2 trillion to fund physical infrastructure and public works, adding $550 billion to existing levels of transportation-specific funding. Within that funding pool, areas of direct relevance to Iteris include $110 billion for roads, bridges and major projects, $39 billion for public transit, and $11 billion for transportation safety. However, delays in the obligation of appropriated funding and debates related to the federal debt ceiling may cause uncertainty regarding the availability of transportation funds in federal, state and local budgets. Although the pace of actual spending of IIJA funds may lag behind the appropriation process, sometimes significantly, the funds appropriated can continue to be spent after the IIJA expires. +Sales and Marketing +We market and sell our software, mobility data, managed services, traffic engineering, and mobility consulting services to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts are with federal, state and local municipal customers, and generally provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We generally use selected members of our traffic engineering, mobility consulting, data science and product management teams on a regional basis to serve in sales and business development functions. Our traffic engineering and mobility consulting service contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations. +We sell our Vantage and BlueTOAD product families along with their related software bundles through both direct and indirect sales channels. Where we sell direct, we use a combination of our own sales personnel and outside sales organizations to sell, oversee installations, and support our products. Our indirect sales channel comprises a network of independent distributors in the U.S. and select international locations, which sell integrated systems and related products to the traffic management market. Our independent distributors are trained in and primarily responsible for the sales, installation, set-up and support of our products. They maintain an inventory of demonstration traffic products from various manufacturers, who sell directly to government agencies and installation contractors. These distributors often have long-term arrangements with local government agencies in their respective territories for the supply of various products for the construction and renovation of traffic intersections, as they are generally well-known suppliers of various high-quality ITS products to the traffic management market. We periodically hold technical training classes for our distributors and end-users, and we maintain a full-time staff of customer support technicians throughout the U.S. to provide technical assistance when needed. When appropriate, we modify or make changes to our distributor network to accommodate the needs of the market and our customer base. +We sell traffic and mobility data and software through a direct sales model to commercial enterprises, such as media companies involved in providing real-time traffic data and traffic incident data to insurance companies, automotive OEMs and the traveling public. +We have historically had a diverse customer base. For the fiscal year ended March 31, 2024 (“Fiscal 2024”) and Fiscal 2023, no individual customer represented greater than 10% of our total revenues. As of March 31, 2024 and 2023, no individual customer accounted for more than 10% of our total trade accounts receivable. +8 +Table of Contents +Manufacturing and Materials +We use contract manufacturers to build subassemblies that are used in our products. Additionally, we procure certain components for our products from qualified suppliers, both in the U.S. and internationally, and generally use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. Historically, Veris Manufacturing has served as our only contract manufacturing services (CMS) partner; however, in fiscal 2024, we entered into a contract with a second CMS partner, Creation Technologies. We believe the addition of a second CMS partner will help to mitigate potential business discontinuity should either CMS partner be unable to meet its commitments to Iteris. We also believe the addition of a second CMS partner will improve our ability to negotiate possible pricing concessions. Production volumes for our CMS partners typically is based upon bi-annual forecasts that we generally adjust on a monthly basis to control inventory levels. Our CMS partners deliver manufactured subassemblies and components to our Santa Ana, California facility, which includes approximately 12,000 square feet of space, where they go through final assembly and testing prior to shipment to our customers. Our production facility maintains a Quality Management System that is currently certified as conforming to all requirements of the International Organization for Standardization (“ISO”) 9001:2015 international standard. Additionally, we also purchase and resell certain third-party products at times in order to better service customer needs. These third-party products may be stored and shipped from our Santa Ana facility or one of our regional distribution centers, depending on the type of third-party product and the ultimate customer destination. +Customer Support and Services +We provide warranty service and support for our products, as well as follow-up service and support for which we charge separately. Such service revenues were not a material portion of our total revenues for Fiscal 2024 and Fiscal 2023. We believe customer support is a key competitive factor for our Company. +Backlog +Our total backlog of unfulfilled firm orders was approximately $123.8 million at March 31, 2024. We typically expect to recognize revenues in the range of approximately two-thirds to three-quarters of our backlog as of the end of a fiscal year in the subsequent fiscal year. At March 31, 2023, we had backlog of approximately $114.2 million. The 8.4% increase in backlog in the current fiscal year was generally attributable to overall strong demand for our products and services, as well as the timing of the receipt of some large contracts. +Backlog is an operational measure representing future unearned revenues believed to be firm and earned under existing agreements, but it does not represent the total contract award if a firm purchase order or task order has not yet been issued under the contract. Backlog is not included in deferred revenues on our balance sheets. Backlog does not include contract awards for which definitive contracts have not been executed. We believe backlog is a useful metric for investors, given its relevance to total orders. +The timing and realization of our backlog is subject to the inherent uncertainties of doing business with federal, state and local governments, particularly given budgetary constraints, cut-backs and other delays or reallocations of funding that these entities typically face. In addition, pursuant to the customary terms of our agreements with government contractors and other customers, our customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often can be affected by a variety of factors including the scheduling and forecasting practices of our individual customers, as well as availability of installation labor and ancillary parts related to installation which we do not manufacture or supply. These factors can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date might not be indicative of the timing of our future revenues. +Product Development +Our product development activities are mostly conducted at our facilities in Santa Ana, California, and Madison, Wisconsin, as well as using additional employee and partner resources across North America. Our research and development costs and expenses were approximately $10.0 million for Fiscal 2024 and $8.3 million for Fiscal 2023. We expect to continue to pursue various product development programs and incur research and development expenditures in future periods. +We believe our engineering and product development capabilities are a competitive strength. We strive to continuously develop new products, technologies, features and functionalities to meet the needs of our ever-changing markets, as well as to enhance, improve upon, and refine our existing product lines. We plan to continue to invest in the development of further enhancement and functionality of our ClearMobility Platform. +9 +Table of Contents +Competition +Generally, we face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. +The markets in which we operate are highly fragmented and subject to evolving national and regional quality, operations and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors providing managed services and consulting include a mix of local, regional and international engineering services firms. Our competitors in software products (e.g., performance measurement and management, advanced traveler information systems, asset management software, and our commercial vehicle operations and vehicle safety compliance platforms) include university affiliated software organizations, venture backed software companies, and other multi-disciplinary hardware and software corporations. +In the market for our detection products, we compete with manufacturers and distributors of other above-ground video camera and radar detection systems and manufacturers and distributors of other non-intrusive detection devices (e.g., microwave, infrared, radar, ultrasonic and magnetic detectors), as well as manufacturers and installers of in-pavement inductive loop products, which have historically been, and currently continue to be, the predominant vehicle detection system in this market. Additionally, products such as BlueTOAD and VantagePegasus compete against various competitors in the travel-time and data communications markets, respectively. +In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases, and significantly greater financial, technical, manufacturing, distribution and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging standards or technologies, or to devote greater resources to the promotion and sale of their products. It is also possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price and service, and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets could have a material adverse effect on our business, financial condition and results of operations. +Intellectual Property and Proprietary Rights +Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is to obtain appropriate proprietary rights of protection for any potentially significant new technology we acquire or develop. We currently have 34 issued U.S. patents, including: (i) 17 relating to our advanced sensor technologies, (ii) 10 relating to our engineering and consulting services technologies and (iii) 7 related to our traffic and mobility software. We have 2 pending patent applications in the U.S. We currently have 9 issued foreign patents and 1 foreign patent application related to our traffic and mobility software. The expiration dates of our patents range from 2026 to 2042. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective. +In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets and other proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, and other similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will be successful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value, rapidly evolving technology makes our future success dependent largely upon our ability to successfully achieve continuing innovation. +10 +Table of Contents +As a provider of traffic engineering services, hardware products, software and other various solutions for the traffic industry, the Company is, and may in the future from time to time, be involved in litigation in the normal course of business related to our intellectual property rights and the intellectual property rights of others. While the Company cannot accurately predict the outcome of any such litigation, the Company is not a party to any litigation or other legal proceedings related to its intellectual property or the intellectual property of others, the outcome of which, in management’s opinion, individually or in the aggregate, would have a material effect on the Company’s results of operations, financial position or cash flows. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, both in legal fees and expenses, as well as from the diversion of management’s resources, could be significant and could have a material adverse effect on our business, financial condition and results of operations, regardless of a claim’s validity. +Employees +As of March 31, 2024, we employed 454 full-time employees and 18 part-time employees, for a total of 472 employees. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe our relations with our employees are good. +Government Regulation +Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental investigations or proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to spend funds in connection with our compliance with applicable environmental regulations. These expenditures have not been significant in the past, and we do not expect any significant expenditure in the near future. Currently, compliance with foreign laws has not had a material impact on our business; however, as we expand internationally, foreign laws and regulations could have a material impact on our business in the future. \ No newline at end of file diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/item13.txt b/raw/filings/0000350868/2023/0000350868-24-000016/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..d5e8795b3cd2ca84e88114f01035e77e3058a91c --- /dev/null +++ b/raw/filings/0000350868/2023/0000350868-24-000016/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by Item 13 will be either (i) included in a Form 10-K Amendment or (ii) incorporated by reference to our 2024 Proxy Statement under the heading “Corporate Governance, Board Meetings and Committees” and “Additional Matters—Transactions with Related Persons.” \ No newline at end of file diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/item9a.txt b/raw/filings/0000350868/2023/0000350868-24-000016/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..4b559a09e06ed7714f36ab7c19c62414e97b93e9 --- /dev/null +++ b/raw/filings/0000350868/2023/0000350868-24-000016/item9a.txt @@ -0,0 +1,30 @@ +ITEM 9A. CONTROLS AND PROCEDURES +(a) Evaluation of disclosure controls and procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2024, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management was required to apply its judgment in evaluating the cost-benefit relationship of such controls and procedures. +(b) Changes in internal control +There was no significant change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of Fiscal 2024 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. +(c) Inherent Limitations on Internal Control +A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of management override or improper acts, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to management override, error or improper acts may occur and not be detected. Any resulting misstatement or loss may have an adverse and material effect on our business, financial condition and results of operations. +(d) Management ’ s Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, to provide reasonable assurance regarding the reliability of financing reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective at a reasonable assurance level as of March 31, 2024. +The effectiveness of our internal control over financial reporting as of March 31, 2024 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein. +68 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Iteris, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Iteris, Inc. (the “Company”) as of March 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements as of and for the year ended March 31, 2024, of the Company and our report dated June 13, 2024, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Costa Mesa, CA +June 13, 2024 +69 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/rp_note.txt b/raw/filings/0000350868/2023/0000350868-24-000016/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000350868/2023/0000350868-24-000016/rpt_disclosure.txt b/raw/filings/0000350868/2023/0000350868-24-000016/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/filing.txt b/raw/filings/0001065837/2014/0001193125-15-068511/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..af83fbeac9d147d54458bd4372d3331195ff8b49 --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/filing.txt @@ -0,0 +1,5130 @@ +10-K +1 +d846076d10k.htm +10-K +10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from +to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-4376145 +(State or Other Jurisdiction of +Incorporation or Organization) +(I.R.S. Employer +Identification No.) +228 Manhattan Beach Blvd., Manhattan Beach, California +90266 +(Address of Principal Executive Offices) +(Zip Code) +Registrant’s telephone number, including area code: (310) 318-3100 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on +Which Registered +Class A Common Stock, $0.001 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: +None +(Title of Class) +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes x No ¨ +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes ¨ No x +Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the +Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 +days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every interactive Data +File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such +files). Yes x No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405) is not contained herein, +and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated +filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +x +Accelerated filer +¨ +Non-accelerated filer +¨ +Smaller reporting company +¨ +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange +Act). Yes ¨ No x +As of June 30, 2014, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates +of the Registrant was approximately $1.831 billion based upon the closing price of $45.70 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 17, 2015: 41,551,376. +The number of shares of Class B Common Stock outstanding as of February 17, 2015: 10,469,918. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2015 Annual Meeting of the Stockholders of the +Registrant are incorporated by reference into Part III. +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K +FOR THE YEAR ENDED DECEMBER 31, 2014 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +17 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +24 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +25 +ITEM 4. +MINE SAFETY DISCLOSURES +29 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +30 +ITEM 6. +SELECTED FINANCIAL DATA +32 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +33 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +46 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +48 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +73 +ITEM 9A. +CONTROLS AND PROCEDURES +73 +ITEM 9B. +OTHER INFORMATION +76 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +76 +ITEM 11. +EXECUTIVE COMPENSATION +76 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +76 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +76 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +76 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +76 +This annual report includes our trademarks, including Skechers®, Skechers Performance™, Skechers GOrun®, Skechers +GOwalk®, +®, +®, Skechers Cali™, Relaxed Fit®, Skechers Memory Foam™, Skech-Air®, BOBS®, Hot Lights®, Twinkle Toes®, each of which is our property. This report contains additional trademarks of other +companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +Table of Contents +SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of +the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected 2015 results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future +growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without +limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” +“expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of +such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered +an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +• +international economic, political and market conditions including the uncertainty of sustained recovery in our European markets; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the +products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China, which could be adversely affected by various economic, +political or trade conditions, or a natural disaster in China; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of +reasons, many of which are beyond our control; and +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely +impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess +the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing +risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release +any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +Table of Contents +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated +in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as +“we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our Internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current +reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of +1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You +can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and +women under the Skechers GO brand name. Our footwear reflects a combination of style, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, +boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2015, we owned and operated 119 concept stores, 146 factory outlet +stores and 98 warehouse outlet stores in the United States, and 51 concept stores, 33 factory outlet stores, and three warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our +recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of fashionable footwear that satisfies their active, casual, dress casual and athletic +footwear needs. Our core consumers are style-conscious men and women attracted to our youthful brand image and fashion-forward designs, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and +core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed +our brands through comprehensive marketing campaigns for men, women and children. During 2014, our Skechers brand was supported by print, television and outdoor campaigns for men and women; animated kids’ television campaigns featuring our own +action heroes and characters; marathons and other events for our Skechers Performance Division; donation events surrounding our BOBS from Skechers charitable footwear program; and print, television, online and outdoor campaigns featuring our +Skechers Performance and Skechers lifestyle endorsees. These endorsees included television personality multi-platinum recording artist Demi Lovato, baseball legend Pete Rose, Brooke Burke-Charvet, Hall of Fame quarterbacks Joe Montana and Joe +Namath, Dallas Mavericks owner Mark Cuban, Dodgers baseball legend Tommy Lasorda, Olympians Kara Goucher and Meb Keflezighi, and legendary drummer and recording artist Ringo Starr. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and +grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s Skechers-branded product lines benefit from the Skechers reputation for contemporary and progressive +styling, quality, comfort and affordability. Our Performance lines benefit from our marketing, product development and manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately +by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide +array of Skechers-branded product lines for men, women, and children. Within these product lines, we also have numerous categories, many of which have developed into well-known names. Most of these categories are marketed and packaged with unique +shoe boxes, hangtags and in-store support. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Table of Contents +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Casuals, (ii) Dress Casuals, +(iii) Relaxed Fit from Skechers, (iv) Casual Fusion, and (v) seasonal sandals and boots. This category is generally sold through mid-tier retailers, department stores and some footwear specialty shops. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the +Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design — some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and +brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress +details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casual line for women is comprised of trend-influenced stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or +trim, and water-resistant materials. +• +Relaxed Fit from Skechers is a line of trend-right casuals with a wider toe box for men and women who want all-day comfort without compromising +style. Characteristics of the product line include comfortable outsoles, Skechers Memory Foam insoles and quality leather uppers. We market and package Relaxed Fit from Skechers styles in a unique shoe box that is distinct from other categories in +the Skechers USA line of footwear. +• +Our Casual Fusion line is comprised of low-profile, sport-influenced Euro casuals targeted to trend-conscious young men and women. The outsoles are +primarily rubber and adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles for our Casuals, Dress Casuals and +Casual Fusion lines, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials and faux fur and Sherpa +linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and +women includes: (i) Skechers Memory Foam styles, (ii) lightweight performance-inspired athletics, (iii) classic athletic-inspired styles and (iv) sport sandals and boots. Our Skechers Sport category is distinguished by its +technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Skechers Sport is typically sold through specialty shoe stores, department stores and athletic footwear retailers. +• +Skechers Memory Foam styles are designed with a high-volume memory foam insole that will contour to your foot and provide greater comfort. The +lightweight and ultra-soft looks also feature a flexible outsole and soft uppers, some of which feature bio-engineered mesh, soft knit fabrics, and stretchable woven materials. This category features bright, multi-colored and solid basic-colored +uppers. +• +Our lightweight performance-inspired athletics are designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, +weight, materials, design and construction of the outsoles. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features leather and trubuck uppers in both bright and classic athletic colors. +• +Classic athletic-inspired styles are core proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these +shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and boots are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our +sneakers with the addition of new technologies geared toward making a comfortable sport sandal. Sport sandals and boots are designed as seasonal footwear for the consumer who already wears our Skechers Sport sneakers. +3 +Table of Contents +Skechers Active and Skechers Sport Active. A natural companion to +Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-up, Mary Janes, sandals and +open back styles, is available in a multitude of colors as well as solid white or black, in fabrics, leathers and meshes, and with various closures – traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line +includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Memory Foam. Skechers Active and Skechers Sport Active shoes are typically available through specialty casual shoe stores and department stores. +BOBS from Skechers. The BOBS from Skechers line has grown into a year-round product offering with +the addition of vulcanized looks and an “at Home” line. Primarily marketed to young women, the BOBS collection also includes footwear for kids, and men to a smaller degree. BOBS are available at department stores, specialty shoe stores and +online retailers. +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede, and patterned +fabrics. Many styles now include Skechers Memory Foam. +• +BOBS vulcanized looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line +features both classic retro looks and fresh colors and materials for a relevant style. Many styles now include Skechers Memory Foam. +• +The BOBS at Home collection for women is designed with our flexible rubber Keepsakes outsole, and features faux fur linings for the ultimate dorm +or winter shoe. The uppers are primarily designed with tweeds, knits or suede. +• +The BOBS for Kids line is inspired by the successful women’s styles, designed with bright and patterned fabrics and embellished uppers for +girls. +• +BOBS for men features basic slip-on and lace-up canvas styles as well as vulcanized designs. Some styles include Skechers Memory Foam. +Skechers donates new shoes to children in need when consumers purchase BOBS. By the end of 2014, we had +donated over 10 million pairs primarily to SolesforSouls and Fashion Delivers, our charity donation partners, who in turn donate the shoes to various reputable charity organizations in the United States and around the world. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a +specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Design Team, the footwear utilizes the latest advancements in materials and innovative design, including an ultra-lightweight Resalyte +compound for the midsole and GOimpulse sensors for responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. The footwear is +available at athletic footwear retailers, department stores and specialty running stores. +• +Skechers GOrun. Skechers GOrun 4 and Skechers GOrun 3 are the latest in a collection of lightweight, flexible running shoes that +features a midfoot strike design for efficient running. Skechers GOrun Ride 4 and Skechers GOrun Ride 3 feature similar designs as its GOrun counterpart with enhanced cushioning for elevated comfort and support. Skechers GOrun Ultra offers +maximum cushioning with the most support making it perfect for distance or recovery runs. Skechers GOmeb Speed 3 is the high-performance racing shoe worn by elite marathon runner Meb. These flagship lines as well as other Skechers GOrun products are +marketed to serious runners and recreational runners alike. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual +slip-on. The product line features a lightweight and flexible design to promote natural foot movement when walking. Skechers GOwalk 3 incorporates more advanced performance technologies including a high-rebound GOga Mat insole, adaptive GO Pillars +on the outsole and Memory Form Fit for a custom-fit experience. Skechers GOwalk 2 incorporates more performance technologies with a unique V-Stride outsole designed specifically to promote a natural walking stride. Skechers on-the-GO footwear fuses +iconic designs and premium materials with Skechers Performance technologies for comfort and style. +4 +Table of Contents +• +Skechers GObionic. Designed for trail running, Skechers GObionic is engineered with 18 fully articulated bio-responsive zones that +offer flexibility, feel and ground conformity. A proprietary Resagrip outsole increases the durability to handle wear-and-tear from tougher terrain. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum +stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOgolf. Skechers GOgolf is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral +position that is low to the ground to promote a solid foundation while playing golf. A Resagrip outsole helps with traction control and a soft Resamax cushioned insole delivers comfort. +Skechers Kids +The +Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes and sneakers, (ii) Skechers Lightweight Sport, (iii) Skechers GOrun and Skechers GOwalk, +(iv) S-Lights, Hot Lights by Skechers and Luminators by Skechers, (v) Skechers Cali for Girls, (vi) Airators by Skechers, (vii) Skechers Super Z-Strap, (viii) Elastika by Skechers, (ix) Bella Ballerina by Skechers, +(x) Twinkle Toes by Skechers, (xi) Air-Mazing by Skechers, and (xii) Foamies by Skechers. +• +The Skechers Kids line includes embellishments or adornments such as fresh colors and fabrics from our Skechers adult shoes. Some of these styles +are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. +• +Skechers Lightweight Sport styles with Skechers Memory Foam are sneakers designed with many of the same meshes, knits and weaves as the adult +Skechers Sport styles in bright colors and patterns. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Skechers GOrun and Skechers GOwalk for boys and girls are casual adaptations of our popular Skechers Performance styles for the kids’ market, +designed in bright and bold colors for daily play. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +• +S-Lights, Hot Lights by Skechers and Luminators by Skechers are lighted sneakers and sandals for boys and girls. The S-Lights combine patterns of +lights on the outsoles and sides of the shoes while Hot Lights feature lights on the front of the toe to simulate headlights as well as on other areas of the shoes. Luminators by Skechers feature glowing green lights and a marketing campaign with +the Luminators character. +• +Skechers Cali for Girls is a line of sandals inspired by our women’s line of the same name with bright colors, textiles and adornments. +• +Airators by Skechers is a line of boys’ sneakers with a foot-cooling system designed to pump air from the heel through to the toes. The +product line is marketed with the character, Kewl Breeze. +• +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z” shaped closure system. The product line is marketed with +the character, Z-Strap. +• +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +• +Bella Ballerina by Skechers is a line of girls’ shoes with a disc that spins on the outsole, allowing girls to twirl like a ballerina. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also +include lights. The product line is marketed with the character, Twinkle Toes. +• +Air-Mazing by Skechers is a lightweight line of colorful sneakers designed for older boys. The product line is marketed with the character, +Air-Mazing Kid, who performs air tricks in his sneakers. +5 +Table of Contents +• +Foamies by Skechers is a colorful line of lightweight, flexible boys’ and girls’ sneakers constructed with Skechers Memory Foam that can +easily be washed in a washing machine. +Skechers Kids, Skechers Kids Memory Foam, Skechers GO for kids, +and Skechers Cali for Girls are comprised primarily of shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and +schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions +from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and +packaged separately with a distinct shoe box. Skechers Kids shoes are available at department stores and specialty and athletic retailers. +Skechers +Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and +athletic shoes, many of which may also include Skechers Memory Foam. The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and +slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature +breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of +high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, +hikers, athletics, casuals and clogs are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing +method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, as well as marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate new and exciting footwear in all of our product lines with contemporary and +progressive styles and comfort-enhancing performance features. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be fashionable and marketable to the 12- to 24-year-old consumer, while substantially all of our lines +appeal to the broader range of 5- to 50-year olds, with an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical +fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear +markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting +current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers from various sources, including the review and analysis of modern music, television, cinema, clothing, and other trend-setting media; +traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay +abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our +brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our +products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s +and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the +heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate +these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications +are created and forwarded to our manufacturers for a design prototype. The design prototypes are then sent back to our design teams. Our major retail customers +6 +Table of Contents +may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more +collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product +design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 — The Company and +Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and +Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of +managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A +of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we +believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2014, five of our contract +manufacturers accounted for approximately 58.9% of total purchases. One manufacturer accounted for 37.5%, and another accounted for 6.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with +the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open +purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us +additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers; however, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is +substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be +discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and +allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and +inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ +orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee +the key aspects of production from initial prototype manufacture through initial production runs to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through an +approximately 230-person staff working from our offices in China. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time and ensure timely delivery of +finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production +process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality +and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality +control personnel located in China perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various +stages of production and final products prior to shipment. Our employees are on site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on site during significant production runs or we +will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +7 +Table of Contents +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, +build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. The +focus of our marketing plan is print and television advertising, which is supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store support. In addition, we utilize celebrity endorsers +in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, +methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes +for our lifestyle lines, and technology with runners and athletes for our performance lines. Our ads are designed to provide merchandise flexibility and to facilitate the Skechers brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with +celebrities whom we believe will reach new markets. Our Skechers lifestyle endorsees Demi Lovato, Brooke Burke-Charvet, Mark Cuban, Joe Montana, Joe Namath, Pete Rose and Tommy Lasorda all appeared in advertising campaigns in 2014. Additionally, we +signed Mariano Riviera and Ringo Starr, who are set to appear in campaigns in 2015. Our Skechers Performance Division endorsees are elite runner and Olympic medalist Meb and elite runner Kara Goucher, who both appeared in marketing campaigns during +2014. Competing in Skechers GO speed footwear, Meb won the Boston Marathon in 2014. To launch our Skechers GO golf line, we signed leading golfer Matt Kuchar, who has and will continue to appear in marketing campaigns in 2015. From time to time, we +may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear regularly in popular fashion, lifestyle and pop culture publications, including +Runner’s World, Shape, Seventeen, Men’s Fitness, Women’s Fitness, Women’s Health, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar +with our brands. In 2014, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes. We also have many commercials for our performance lines that feature elite +athletes and for our lifestyle lines that feature retired athletes, musicians, and actors. We have found these to be a cost-effective way to advertise on key national and cable programming during high selling seasons. In 2014, many of our television +commercials were translated into multiple languages and aired in Brazil, Canada, the United Kingdom, France, the Benelux Region, Germany, Spain, Italy, Chile, Japan, Austria, Switzerland, China and Mexico, among other countries. +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from +work, we continued our outdoor campaign that included mall and telephone kiosks, billboards, and transportation systems in the Americas, Asia, the Middle East and across Europe. In addition, we advertised on perimeter boards at soccer matches in +several European countries. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Trend-Influenced Marketing/Public Relations. Our public relations objectives are to secure product placement in +key fashion and lifestyle magazines and television shows, place our footwear on the feet of trend-setting celebrities and their children, and gain positive and accurate press about our brands, our Company and our products. We have amassed an array +of prominent product placements in magazines including OK!, Us Weekly, Runner’s World and Competitor , and have been featured on leading business shows with interviews of our executives providing exposure of our brand to +consumers who might not be familiar with our products. In addition, our brands have been associated with cutting edge events and various celebrities. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings, and +relaying the latest news, we have built communities on Facebook, Twitter, and Instagram in the United States and in many countries around the world. The social platforms are divided into Skechers and Skechers Performance sites as well as a BOBS page +to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. +8 +Table of Contents +Promotions and Events. By applying creative sales techniques via a +broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers’ retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store +specials, charity events, product tie-ins and giveaways, and collaborations with national retailers and radio stations. In 2014, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with +Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2014, the Skechers Performance Division became the footwear and apparel sponsor for the Houston Marathon. Our products were made available to +consumers directly or through key accounts at many of these events. In addition, we partnered with many key accounts for BOBS donation events in cities throughout the United States, Puerto Rico and Spain, building both our relationships with these +accounts, as well as with the community as we donated footwear to children in need. +Visual Merchandising. +Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, +graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image as well as draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to +ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our +merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To better showcase our diverse products to footwear buyers in the United States and Europe and to +distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at WSA’s The Shoe Show, FFANY, ASR, MAGIC and Outdoor Retailer in the United States; GDS, MICAM, ISPO, Mess Around and +Who’s Next in Europe; and Couromoda and Francal in Brazil. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual +rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Internet. We promote and sell our brands through our domestic website, www.skechers.com , as well as our +foreign e-commerce sites, which enables fans and customers to shop, browse, find store locations, socially interact, post a shoe review, photo, video, or question and immerse themselves in our brands. Our website is a venue for dialog and feedback +from customers about our products which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have four reportable segments — domestic wholesale sales, international wholesale sales, retail sales and e-commerce +sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in +more than 160 countries and territories via our global network of distributors in addition to our subsidiaries in Asia, Europe, Canada and South America. Skechers owns and operates retail stores both domestically and internationally through three +integrated retail formats — concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. Twenty-three distributors and 15 licensees have opened 374 +distributor-owned or -licensed Skechers retail stores and 118 licensee-owned Skechers retail stores, respectively, in over 60 countries as of December 31, 2014. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: +department stores, specialty stores, athletic specialty shoe stores and independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of +wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each +of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing retail locations and new locations of each customer. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated +by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are +9 +Table of Contents +knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national +sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal customer base through exceptional customer service. We believe that our close +relationships with these accounts help us to maximize their retail sell-throughs. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise +personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts as well as to ensure that appropriate inventory levels are carried at each store. Such +information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale +customers and attract potential new wholesale customers. +Retail Stores. We pursue our retail store strategy +through our three integrated retail formats: the concept store, the factory outlet store and the warehouse outlet store. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a +broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2014, we upgraded the technologies in many of our stores, which provides visibility to our merchandise in other +stores and at our distribution center in order to better serve our customers with an omnichannel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess +potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, +we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 15, 2015, we owned and operated 119 concept stores, 146 +factory outlet stores and 98 warehouse outlet stores in the United States, and 51 concept stores, 33 factory outlet stores, and three warehouse outlet stores internationally. During 2015, we plan to open 50 to 60 new stores. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in +metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer +carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations +are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, Union Square and 34th Street in New York, +Powell Street in San Francisco, Hollywood and Highland in Hollywood, Santa Monica’s Third Street Promenade, Ala Moana Center in Hawaii and Las Vegas’ Fashion Show Mall. International locations include Westfield London and Westfield +Stratford in London, Buchanan Street in Glasgow, Toronto’s Eaton Centre, Vancouver’s Pacific Centre, and Kalverstraat Street in Amsterdam. The stores are typically designed to create a distinctive Skechers look and feel, and enhance +customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback +derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns +and allowances. +The typical Skechers concept store is approximately 2,500 square feet, although in certain +markets we have opened concept stores as large as 7,800 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, South +America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If +we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name +has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +10 +Table of Contents +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the +United States. In addition, we have 33 international factory outlet stores – seven each in England and Canada, four in Spain, three each in Chile and Japan, two each in Germany and Italy, and one each in Austria, the Netherlands, Portugal, +Wales and Scotland. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the +Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,400 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail +price points. +• +Warehouse Outlet Stores +Our free-standing warehouse outlet stores, which are primarily located throughout the United States, enable us +to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 5,000 to +24,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek +to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and joint venture stores are as follows: +December 31, 2013 +December 31, 2014 +Number of Store +Locations +Opened during 2014 +Closed during 2014 +Number of Store +Locations +Domestic stores +Concept +123 +2 +(5 +) +120 +Factory Outlet +130 +17 +(1 +) +146 +Warehouse Outlet +68 +29 +(1 +) +96 +Domestic stores total +321 +48 +(7 +) +362 +International stores +Concept +43 +9 +(1 +) +51 +Factory Outlet +26 +7 +— +33 +Warehouse Outlet +— +3 +— +3 +International stores total +69 +19 +(1 +) +87 +Joint venture stores +China Concept +18 +9 +(3 +) +24 +China Factory Outlet +17 +7 +(3 +) +21 +Hong Kong Concept +20 +3 +— +23 +South East Asia Concept +19 +— +— +19 +Joint venture stores total +74 +19 +(6 +) +87 +Joint venture shop-in-shops +China +135 +80 +— +215 +Hong Kong +12 +— +(1 +) +11 +South East Asia +72 +15 +(6 +) +81 +Joint venture shop-in-shops total +219 +95 +(7 +) +307 +Total domestic, international and joint venture stores and shop-in-shops +683 +181 +(21 +) +843 +11 +Table of Contents +International Wholesale. Our products are sold in more than 160 +countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores in Canada, France, Germany, Spain, Portugal, +Italy, Switzerland, Austria, Malaysia, Thailand, Singapore, Hong Kong, China, Japan, India, the Benelux Region, the United Kingdom, Brazil and Chile through our subsidiaries and joint ventures; (ii) sales to foreign distributors who distribute +our footwear to department stores and specialty retail stores in countries and territories across Eastern Europe, Asia, Central America, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from +licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that +international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which +we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently distribute product in most of Western Europe through the following subsidiaries: Skechers USA +Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and +showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; and Skechers USA Italia S.r.l., with its offices +and showrooms in Milan, Italy. Skechers-owned retail stores in Europe include 12 concept stores and 20 factory outlet stores located in 10 countries. +To accommodate our European subsidiaries’ operations, we operate an approximately 490,000 square-foot +distribution center in Liege, Belgium. During 2014, we completed the initial phase of automation upgrades of our European Distribution Center equipment, allowing us to more efficiently receive and ship product to our subsidiaries and retail stores +throughout Europe. Also in 2014, we agreed to lease an additional 290,000 square foot adjoining facility which we expect to occupy by the end of 2015. This additional space will consolidate off-site storage facilities into a single on-site location +that will further increase efficiencies and offer storage capacity of up to four million pairs of shoes. +Canada +Merchandising and marketing of our product in Canada is managed by our wholly-owned subsidiary, Skechers USA +Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. In 2014, we transitioned three licensed stores to +company-owned locations. We have 12 concept stores, seven factory outlet stores, and three warehouse outlet stores. +Brazil +Merchandising and marketing of our product in Brazil is managed by our wholly-owned subsidiary, Skechers Do +Brasil Calcados LTDA, with its offices located in Sao Paulo, Brazil. Product sold in Brazil is primarily shipped directly from our contract manufacturers’ factories in Vietnam and occasionally from China. +Chile +Our wholly-owned subsidiary, Comercializadora Skechers Chile Limitada, with its offices and showrooms located +in Santiago, Chile supports our 29 retail stores and wholesale accounts in Chile. Product sold in Chile is primarily shipped directly from our contract manufacturers’ factories in China and occasionally from Vietnam. +12 +Table of Contents +Japan +Merchandising and marketing of our product in Japan is managed by our wholly-owned subsidiary, Skechers Japan +GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have one concept store in Osaka and three factory outlet stores, one each in +Osaka, Narita and Toki. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that +generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Shanghai, Beijing, Guangzhou, +Xiamen, Hong Kong, Macau, and other cities. These joint ventures are included in our consolidated financial statements. +Malaysia and +Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that generate net sales +in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Singapore, Kuala Lumpur, Penang and other cities. +These joint ventures are included in our consolidated financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and a 49% interest in Skechers Retail India +Private Limited, which are both joint ventures, that generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key +locations in Mumbai, New Delhi, and Pune. These joint ventures are included in our consolidated financial statements. +13 +Table of Contents +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is +distributed through an extensive network of more than 30 distributors who sell our products to department, athletic and specialty stores in more than 160 countries around the world. As of December 31, 2014, we also had agreements with 23 of +these distributors and 15 licensees regarding 374 distributor-owned or -licensed Skechers retail stores and 118 licensee-owned Skechers retail stores, respectively, that are open in over 60 countries. Our distributors and licensees own and operate +the following retail stores: +December 31, 2013 +December 31, 2014 +Number of Store +Locations +Opened during 2014 +Closed during 2014 +Number of Store +Locations +Distributor and licensee stores +North America Concept +36 +12 +(4 +) +44 +North America Factory Outlet +8 +5 +(2 +) +11 +Central America Concept +8 +2 +— +10 +Central America Factory Outlet +1 +— +— +1 +South America Concept +39 +2 +(15 +) +26 +South America Factory Outlet +1 +— +— +1 +Africa Concept +15 +11 +— +26 +Asia Concept +169 +50 +(5 +) +214 +Asia Factory Outlet +16 +4 +(2 +) +18 +Australia/New Zealand Concept +11 +10 +— +21 +Australia/New Zealand Factory Outlet +11 +1 +(1 +) +11 +Europe Concept +33 +28 +(1 +) +60 +Europe Factory Outlet +3 +2 +(1 +) +4 +Middle East Concept +36 +11 +(4 +) +43 +Middle East Factory Outlet +1 +1 +— +2 +Total distributor and licensee stores +388 +139 +(35 +) +492 +Distributor and licensee shop-in-shops +International shop-in-shops +2,258 +— +(366 +) +1,892 +Total Distributor and licensee stores and shop-in-shops +2,646 +139 +(401 +) +2,384 +Distributors and licensees are responsible for their respective stores’ operations, have +ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and +materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to +foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +Electronic Commerce. Our domestic website, www.skechers.com , as well as our foreign e-commerce sites, are +virtual storefronts that promote the Skechers brands. Our websites are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our +footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience. These websites are an additional efficient and effective retail distribution channel, and has improved our customer service. +14 +Table of Contents +For disclosure of financial information about geographic areas and segment +information for our four reportable segments – domestic wholesale sales, international wholesale sales, retail sales and e-commerce sales — see Note 13 — Segment Information in the consolidated financial statements included in this +annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and +enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with +licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with +reputable non-footwear brands to design and market their footwear. +As of January 31, 2015, we had 25 active domestic +and international licensing agreements in which we are the licensor. These include Skechers branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear and watches, Skechers Performance sport apparel, socks and wearable +technology, BOBS from Skechers apparel, and Twinkle Toes apparel, dolls, toys, and fashion accessories. We have international licensing agreements for the design and distribution of men’s and women’s apparel in Chile, Israel, the +Philippines, the United Kingdom, and South Korea; bags, backpacks and luggage in Mexico; and watches in the Philippines. +DISTRIBUTION FACILITIES AND +OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our +products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximately 490,000 square-foot +European Distribution Center (“EDC”) located in Liege, Belgium, (iii) our company operated distribution centers or third-party distribution centers in South America and Asia or (vi) directly from third-party manufacturers to our +other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to +customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, +and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system, or EDI system, to which some of our larger customers are linked. This system allows these customers to automatically +place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, +2014, our backlog was $988.7 million, compared to $616.1 million as of December 31, 2013. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to the weakened +U.S. economy and shifting footwear trends. For a variety of reasons, including changes in the economy, customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards +tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both +registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 124 foreign countries. We also have design patents and pending design and +utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally where necessary to protect valuable +intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in the marketing of our products. We vigorously protect our trademarks against infringement, including +through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, +copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we +15 +Table of Contents +believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our +intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, +violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if +proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention to and legal costs +associated with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have +been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, +as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful or the costs associated with protecting our rights in +certain jurisdictions may be prohibitive. From time to time we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to +establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as violating trademarks and intellectual +property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the +Skechers brand, result in the shift of consumer preferences away from our products and generally have a material adverse effect on our business, financial condition and results of operations. +COMPETITION +The footwear +industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as +with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor +Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., +adidas AG, Reebok International Ltd., Puma AG, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the +markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including Payless Holdings, and +with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other +considerations. These and other competitors pose challenges to our market share in our major domestic markets and may make it more difficult to establish our products in Europe, Asia and other international regions. We also compete with numerous +manufacturers, importers and distributors of footwear for the limited shelf space available for the display of such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market +entrants. Many of our competitors are larger, have been in existence for a longer period of time, have achieved greater recognition for their brand names, have captured greater market share and/or have substantially greater financial, distribution, +marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial +condition and results of operations. +EMPLOYEES +As of January 31, 2015, we employed 7,772 persons, 2,944 of whom were employed on a full-time basis and 4,828 of whom were +employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +16 +Table of Contents +ITEM 1A. +RISK FACTORS +In addition to the other information in this annual +report, the following factors should be considered in evaluating us and our business. +Our Future Success Depends On Our Ability To +Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of +the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and +fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with +consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to +receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition and results of operations could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, +And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The +continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing +consumer trends and preferences, and to correctly respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, +and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing +consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in +responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, +experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development +of products that achieve market acceptance, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition and results of +operations could be materially and adversely affected. +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our +customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any +unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in +advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image +and have a material adverse effect on our operating results and financial condition. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need +them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +17 +Table of Contents +We Face Intense Competition, Including Competition From Companies With Significantly Greater +Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition in the footwear industry from other established companies. Our competitors’ product +offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may +decline significantly. In addition, a number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable +them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, and more quickly develop new products. New companies may also enter the markets in which we compete, further +increasing competition in the footwear industry. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to +generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +We Continue To Face Many New Challenges In The Highly Competitive Performance Footwear Market. +Although the design and aesthetics of our products have traditionally been the most important factors in consumer acceptance +of our footwear, we began incorporating technical innovations into certain of our product offerings in late 2008 and since then have continued to develop and introduce new performance footwear. The performance footwear market is keenly competitive +in the United States and worldwide, and the newer entrants in that market including our company face many challenges. Negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear +company, product offerings and technologies from our competitors, and failure to keep up with rapid changes in footwear technology and consumer preferences may constitute significant risk factors in our strategy and may negatively impact our +business. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our net +sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale +sales during 2014 or 2013. However, this may change in the future and fluctuations in sales of any given style that represents a significant portion of our future net sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial +Condition. +While global economic conditions have recently improved slightly, its uncertain state continues to +negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the +current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, +maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of net sales. Additionally, if there is an unexpected decline in sales, our results of operations will +depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the +appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, +financial condition, and cash flows could be materially adversely affected. +Our Business Could Be Adversely Affected By Changes In The +Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial +crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. There could be a +number of follow-on effects from the credit crisis on our business, including insolvency of certain of our key distributors, which could impair our distribution channels, or our significant customers, including our distributors, may experience +diminished liquidity or an inability to obtain credit to finance purchases of our product. Our customers may also experience weak demand for our products or +18 +Table of Contents +other difficulties in their businesses. If conditions in the global financial markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated +financial results. Any of these events would likely harm our business, results of operations and financial condition. +We Depend Upon A +Relatively Small Group Of Customers For A Large Portion Of Our Sales. +During 2014, 2013 and 2012, our net sales to +our five largest customers accounted for approximately 15.7%, 18.1% and 18.1% of total net sales, respectively. No customer accounted for more than 10.0% of our net sales during 2014, 2013 and 2012. No customer accounted for more than 10.0% of net +trade receivables at December 31, 2014 and 2013. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to +retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we +lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For +Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the +future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders, and may change delivery schedules or change the mix of products ordered +with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature with the strongest sales generally +occurring in our second and third quarters for the back-to-school selling season. Back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our +wholesale customers could negatively impact our net sales and results of operations for our second or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, +which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future net sales, our expenses may be disproportionately large relative to our revenues, and we may be +unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we +review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our +quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter and the results for any particular quarter may not be necessarily indicative of results for the full +year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +Our Business Could Be Adversely Affected By A Labor Dispute At Ports In Los Angeles And Long Beach. +The International Longshoremen and Warehouse Union’s labor agreement with the Pacific Maritime Association regarding the +dockworkers at 29 West Coast ports, including Los Angeles and Long Beach, expired on June 30, 2014. The parties were engaged in a long-running dispute while the dockworkers were working without an agreement until a tentative agreement +following mediation was reached on February 20, 2015. However, as of February 27, 2015, the new five-year agreement had not been officially ratified by both parties. All product that is sent from third-party manufacturers to our domestic +distribution center in Rancho Belago, California arrives via cargo ship at the ports in Los Angeles and Long Beach. If the new agreement is not officially ratified by the parties and a slow-down, strike or other disruption occurs that interrupts +operations at the ports in Los Angeles and Long Beach, shipping container charges on cargo shipped from Asia to these ports can be expected to increase. If operations at the ports are interrupted for an extended period of time, we would also be +forced to consider more costly shipping alternatives such as air transportation or shipping to ports located outside of the Los Angeles area, in which case we would have to incur additional trucking charges to transport product over longer distances +from those ports to our domestic distribution center. Extended delays at the Los Angeles and Long Beach ports could also lead to backlogs at other ports, which could slow the delivery of our product. While we are currently only 7-10 days behind in the receipt of incoming product from overseas, any extended delays could result in missed sales due to a potential backlog of product for the back-to-school selling season that typically +starts in June. If the parties fail to officially ratify the new agreement, any subsequent slow-downs, strikes or other disruptions at these ports, especially for an extended period of time, may have a material adverse effect on our business, +relationships with our customers and results of operations. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China, Which Could +Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our net sales during the year ended December 31, 2014 were derived from sales of footwear +manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and +sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; +labor shortages and work stoppages; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, +import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have +not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations or financial condition. +In particular, because most of our products are manufactured in China, the possibility of adverse changes in trade or +political relations with China, political instability in China, increases in labor costs, the occurrence of prolonged adverse weather conditions or +19 +Table of Contents +a natural disaster such as an earthquake or typhoon in China, or the outbreak of a pandemic disease in China could severely interfere with the manufacturing and/or shipment of our products and +would have a material adverse effect on our operations. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may +have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to +collect those charges. +The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An +Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United +States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict +whether additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions may be imposed on the importation of our products in the future. Such actions could +result in increases in the cost of our products generally and might adversely affect the sales and profitability of Skechers and the imported footwear industry as a whole. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls and some of our factory outlet stores are located in +manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other +retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic +slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or +hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Rely On Independent +Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear +products are currently manufactured by independent contract manufacturers. During 2014 and 2013, the top five manufacturers of our products produced approximately 58.9% and 59.9% of our total purchases, respectively. One manufacturer accounted for +37.5% and 37.8% of total purchases during 2014 and 2013, respectively. One other manufacturer accounted for 6.1% and 7.1% of our total purchases during 2014 and 2013, respectively. We do not have long-term contracts with manufacturers and we compete +with other footwear companies for production facilities. We could experience difficulties with these manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet +production deadlines or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm +our business. +If our current manufacturers cease doing business with us, we could experience an interruption in the +manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new +manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our +footwear is delayed or becomes more expensive, our business would be harmed. +Our Business Could Be Harmed If Our Contract +Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract +manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as +defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical +business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract +manufacturers, suppliers or +20 +Table of Contents +licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our +reputation in the United States or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be +subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could +include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas or labor violations. The effects of these factors +could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. +The Toning Footwear Category Has Come Under Public And Regulatory Scrutiny That May Have A Material Negative Impact On Our Business And +Results Of Operations. +Since 2010, the toning footwear product category, including our Shape-ups products, has come +under significant public scrutiny, such as highly publicized negative professional opinions, negative publicity and media attention, personal injury lawsuits and attorneys publicly marketing their services to consumers allegedly injured by toning +products, including Shape-ups. In addition, we have been responding to inquiries by state, federal, and foreign governmental and quasi-governmental regulators regarding the claims, advertising, and safety of our toning products, and are engaged as +defendants in civil lawsuits that involve similar claims. This public and regulatory scrutiny has included the questioning of our advertising, promotional claims, and the overall safety of these products, as well as allegations of personal injuries. +We believe that Shape-ups and our other toning products are safe, but the negative publicity from this public and regulatory scrutiny appears to have had a negative impact on sales of toning footwear generally and our Shape-ups products in +particular. We are not able to predict whether such negative publicity, regulatory review and related litigation will continue or what the continued effect will be on the sales of our Shape-up products, our business, and our results of operations +beyond that included in this annual report. Further details regarding these legal and regulatory matters are discussed in greater detail under “Legal Proceedings” in Part I, Item 3 of this annual report. +It Is Difficult To Predict The Effect Of Regulatory Inquiries About Advertising And Promotional Claims Related To Our Toning Shoe Products. +The toning footwear market is dominated by a handful of competitors who design, market and advertise their products +to promote fitness benefits associated with wearing the footwear. Advertising that promotes fitness benefits associated with the toning footwear market has come under review from state, federal, and foreign governmental and quasi-governmental +regulators. As discussed in greater detail under “Legal Proceedings” in Part I, Item 3 of this annual report, we announced on May 16, 2012 that we had settled all domestic legal proceedings relating to advertising claims +made in connection with the marketing of our toning shoe products. Under the terms of the global settlement—without admitting any fault or liability, with no findings being made that our company had violated any law, and with no fines or +penalties being imposed—we made payments in the aggregate amount of $50 million to settle all domestic advertising class action lawsuits and related claims brought by the FTC and the SAGs. On November 8, 2012, we were served with a Grand +Jury Subpoena (“Subpoena”) that was issued by a Grand Jury of the United States District Court for the Northern District of Ohio, in Cleveland, Ohio for documents and information relating to past advertising claims for our toning footwear, +including Shape-ups and Resistance Runners. The Subpoena, which seeks documents and information related to outside studies conducted on our toning footwear, appears related to the FTC’s inquiry into our claims and advertising for Shape-ups and +our other toning shoe products. The Grand Jury investigation is in its early stages and we are fully cooperating in the process of producing documents and other information requested. The Assistant United States Attorney has informed us that neither +we nor our employees are targets at the present time. Although we do not believe this Grand Jury investigation will have a material adverse impact on our results of operations or financial position, it is too early to predict the timing and outcome +of this investigation, if there will be any additional regulatory inquiries or whether the final resolution of these matters could have a material adverse impact on our advertising, promotional claims, business, results of operations and financial +position. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As +Negatively Impact The Performance Of Our Existing Stores. +Our ability to open and operate new stores successfully +depends on many factors, including, among others: our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source +sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +21 +Table of Contents +In addition, some or a substantial number of new stores could be opened in +regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. +Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced net sales volumes in existing stores in those markets. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing +Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, +Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer, Chief Financial Officer and a member of our Board of +Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our +industry is intense and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential +Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations And Financial Condition. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation +arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability +our company may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and +settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or +more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any +unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses +resulting from these unanticipated future claims could have a material adverse effect on our business, consolidated financial statements and financial condition. +For a discussion of risks related to regulatory inquiries, see the risks discussed on page 21 under “It Is Difficult To +Predict The Effect Of Regulatory Inquiries About Advertising And Promotional Claims Related To Our Toning Shoe Products.” +Our +Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive +position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the +goods of others. We consider our Skechers®, S in Shield Design, Performance-S Shifted Design, Shape-ups®, Twinkle Toes®, Bella Ballerina™, Skechers GOrun® and Skechers GOwalk® trademarks to be among our most valuable assets, +and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and +features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee +that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued for patent and trademark infringement and cannot be sure +that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by +others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +22 +Table of Contents +In addition, the laws of foreign countries where we source and distribute our +products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside +the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis +of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection +with the protection of our intellectual property rights outside the United States, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely +affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To +Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +We utilize information security and information technology systems and websites that allow for the secure storage and +transmission of proprietary or private information regarding our customers, employees, and others, including credit card information and personal identification information. A security breach may expose us to a risk of loss or misuse of this +information, litigation, and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks. Attacks may be targeted at us, our customers, or others who have entrusted +us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. Advances in computer +capabilities, new technological discoveries, or other developments may result in the technology used by us to protect transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of +non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our cyber security systems could +result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could have an +adverse effect on our business, financial condition and reputation. +Natural Disasters Or A Decline In Economic Conditions In +California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2014, +a substantial portion of our operations are located in California, including 82 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our net sales is +derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, +such as an earthquake or wild fires affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are +not as concentrated in California. +One Principal Stockholder Is Able To Control Substantially All Matters Requiring Approval By Our +Stockholders And Another Stockholder Is Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2014, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned +38.8% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 14.6% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by +Mr. Greenberg and his wife for estate planning purposes, beneficially owned 45.9% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of +Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2014, +Mr. Greenberg beneficially owned 27.8% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family +beneficially owned 39.1% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 32.9% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, +Mr. Greenberg and Mr. Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the +approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such +23 +Table of Contents +influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other +transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ +from the interests of the other stockholders, their ability to significantly influence or substantially control, respectively, actions requiring stockholder approval may result in our company taking action that is not in the interests of all +stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchaser view the superior voting rights of our Class B common shares to +have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to +acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our +Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in +control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at three properties +in Manhattan Beach, California, which consist of an aggregate of approximately 143,000 square feet. We own our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, +California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The +lease for this facility expires in 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is included in our consolidated financial statements. +Our European Distribution Center consists of 483,000 square-foot facilities in Liege, Belgium currently under two concurrent +operating leases that expire in 2029, with base rent of approximately $2.5 million per year. The lease agreements also provide for early termination rights at five-year intervals upon 12-month advance notice in writing to terminate the lease. We did +not exercise the first such early termination right prior to April 1, 2013. +All of our domestic retail stores and +showrooms are leased with terms expiring between March 2015 and July 2026. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant +geographical area or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $52.9 million for the year ended December 31, 2014. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in +Canada, Switzerland, the United Kingdom, Germany, France, Spain, Italy, the Netherlands, Brazil, Malaysia, China, Hong Kong, Japan, Chile, Singapore, India and Portugal. The property leases expire at various dates between March 2015 and March 2030. +Total base rent for the leased administrative properties aggregated approximately $36.0 million for the year ended December 31, 2014. +24 +Table of Contents +ITEM 3. +LEGAL PROCEEDINGS +Our claims and advertising for our toning products +including for our Shape-ups are subject to the requirements of, and routinely come under review by regulators including the U.S. Federal Trade Commission (“FTC”), states’ Attorneys General and government and quasi-government +regulators in foreign countries. We have responded to requests for information regarding our claims and advertising from regulatory and quasi-regulatory agencies in several countries and are fully cooperating with such requests. While we believe +that our claims and advertising with respect to our core toning products are supported by scientific tests, expert opinions and other relevant data, and while we have been successful in defending our claims and advertising in several different +countries, we have discontinued using certain test results and we periodically review and update our claims and advertising. The regulatory inquiries may conclude in a variety of outcomes, including the closing of the inquiry with no further +regulatory action, settlement of any issues through changes in its claims and advertising, settlement of any issues through payment to the regulatory entity, or litigation. +As we disclosed in previous periodic SEC filings, the FTC and Attorneys General for 44 states and the District of Columbia +(“SAGs”) had been reviewing the claims and advertising for Shape-ups and our other toning shoe products. We also disclosed that we had been named as a defendant in multiple consumer class actions challenging our claims and advertising for +our toning shoe products, including Shape-ups. On May 16, 2012, we announced that we had settled all domestic legal proceedings relating to advertising claims made in connection with the marketing of our toning shoe products. Under the terms of +the global settlement — without admitting any fault or liability, with no findings being made that our company had violated any law, and with no fines or penalties being imposed — we made payments in the aggregate amount of $50 million to +settle and finally resolve the domestic advertising class action lawsuits and related claims brought by the FTC and the SAGs. The FTC Stipulated Final Judgment was approved by the United States District Court for the Northern District of Ohio on +July 12, 2012. Consent judgments in the 45 SAG actions were approved and entered by courts in those jurisdictions. On May 13, 2013, the United States District Court for the Western District of Kentucky entered an order finally approving +the nationwide consumer class action settlement, and the time for any appeals from that final approval order has expired. +On November 8, 2012, we were served with a Grand Jury Subpoena (“Subpoena”) for documents and information +relating to our past advertising claims for our toning footwear, including Shape-ups and Resistance Runners. The Subpoena was issued by a Grand Jury of the United States District Court for the Northern District of Ohio, in Cleveland, Ohio. The +Subpoena seeks documents and information related to outside studies conducted on our toning footwear. This Subpoena appears to grow out of the FTC’s inquiry into our claims and advertising for Shape-ups and our other toning shoe products, which +we settled with the FTC, SAGs and consumer class as part of a global settlement, as set forth above. We are fully cooperating and are in the process of producing documents and other information requested in the Subpoena. The Assistant United States +Attorney has informed us that neither our company nor our employees are targets at the present time. Although we do not believe this matter will have a material adverse impact on our results of operations or financial position, it is too early to +predict the timing and outcome of this matter or reasonably estimate a range of potential losses, if any. +The toning +footwear category, including our Shape-ups products, has also been the subject of some media attention arising from a number of consumer complaints and lawsuits alleging injury while wearing Shape-ups. We believe our products are safe and are +defending ourselves from these media stories and injury lawsuits. It is too early to predict the outcome of any case or inquiry, whether there will be future personal injury cases filed, whether adverse results in any single case or in the aggregate +would have a material adverse impact on our results of operations, financial position, or result in a material loss in excess of a recorded accrual and whether insurance coverage will be adequate to cover any losses. +Patty Tomlinson v. Skechers U.S.A., Inc. — On January 13, 2011, Patty Tomlinson filed a lawsuit against our +company in Circuit Court in Washington County, Arkansas, Case No. CV11-121-7. The complaint alleges, on her behalf and on behalf of all others similarly situated, that our advertising for Shape-ups violates Arkansas’ Deceptive Trade +Practices Act, constitutes a breach of certain express and implied warranties, and is resulting in unjust enrichment (the “ Tomlinson action”). The complaint seeks certification of a statewide class, compensatory damages, prejudgment +interest, and attorneys’ fees and costs. On February 18, 2011, we removed the case to the United States District Court for the Western District of Arkansas, where it was pending as Patty Tomlinson v. Skechers U.S.A., Inc. , CV +11-05042 JLH. On March 21, 2011, Ms. Tomlinson moved to remand the action back to Arkansas state court, which motion we opposed. On May 25, 2011, the Court ordered the case remanded to Arkansas state court and denied our motion to +dismiss or transfer as moot, but stayed the remand pending completion of appellate review. On September 11, 2012, the District Court lifted its stay and remanded this case to the Circuit Court of Washington County, Arkansas. On October 11, +2012, by stipulation of the parties, the state Circuit Court issued an order staying the case. On August 13, 2012, the United States District Court for the Western District of Kentucky granted preliminary approval of the nationwide consumer +class action settlement in Grabowski v. Skechers U.S.A. , Inc. Case No. 3:12-CV-00204, and Morga v. Skechers U.S.A., Inc. , Case No. 3:12-CV-00205 (the “ Grabowski/Morga class +25 +Table of Contents +actions”), and issued a preliminary injunction enjoining the continued prosecution of the Tomlinson action, among other cases. On May 13, 2013, the Court in the +Grabowski/Morga class actions entered an order finally approving the nationwide consumer class action settlement, and the time for any appeals therefrom has expired. The settlement in the Grabowski/Morga class actions is expected +entirely to resolve the class claims brought by the plaintiff in Tomlinson . +Elma Boatright and Sharon White v. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group — On February 15, 2012, Elma Boatright and Sharon White filed a lawsuit against our company in the United States District Court for the Western District of +Kentucky, Case No. 3:12-cv-87-S. The complaint alleges, on behalf of the named plaintiffs and all others similarly situated, that our advertising for Shape-ups is false and misleading, thereby constituting a breach of contract, breach of +implied and express warranties, fraud, and resulting in unjust enrichment. The complaint seeks certification of a nationwide class, compensatory damages, and attorneys’ fees and costs. On March 6, 2012, the named plaintiffs filed a motion +to consolidate this action with In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. On August 13, 2012, the United States District Court for the Western District of Kentucky granted preliminary approval of +the consumer class action settlement agreement in the Grabowski/Morga class actions (described above), and issued a preliminary injunction enjoining the continued prosecution of this action. On May 13, 2013, the Court in the +Grabowski/Morga class actions entered an order finally approving the nationwide consumer class action settlement, and the time for any appeals therefrom has expired. The settlement in the Grabowski/Morga class actions is expected +entirely to resolve the class claims brought by the plaintiff in Boatright . +Jason Angell v. Skechers U.S.A., +Inc., Skechers U.S.A., Inc. II and Skechers U.S.A. Canada, Inc. — On April 12, 2012, Jason Angell filed a motion to authorize the bringing of a class action in the Superior Court of Québec, District of Montréal. +Petitioner Angell seeks to bring a class action on behalf of all residents of Canada (or in the alternative, all residents of Québec) who purchased Skechers Shape-ups footwear. Petitioner’s motion alleges that we have marketed Shape-ups +through the use of false and misleading advertisements and representations about the products’ ability to provide health benefits to users. The motion requests the Court’s authorization to institute a class action seeking damages +(including damages for bodily injury), punitive damages, and injunctive relief. Petitioner’s motion was formally presented to the Court on June 29, 2012. At a mediation held on February 28, 2013, the parties reached an agreement in +principle to settle the Angell action (as well as the Niras and Dedato actions described below) through authorization by the Québec Superior Court of a nationwide settlement class. That agreement was finalized by the +parties in December 2013 and thereafter presented to the Québec Superior Court for approval. On November 5, 2014, the Court issued its formal judgment approving the settlement. Notwithstanding, if approval of the class action settlement +is reversed on appeal, we cannot predict the outcome of the Angell action or a reasonable range of potential losses or whether the outcome of the Angell action would have a material adverse impact on our results of operations, +financial position or result in a material loss in excess of the settlement or a recorded accrual. +Brenda +Davies/Kourtney Smith v. Skechers U.S.A., Inc., Skechers U.S.A., Inc. II, and Skechers U.S.A. Canada Inc. — On September 5, 2012, Brenda Davies filed a Statement of Claim in the Court of Queen’s Bench in Edmonton, Alberta, on +behalf of all residents of Canada who purchased Skechers Shape-ups footwear. The Statement of Claim alleges that Skechers marketed Shape-ups through the use of false and misleading advertisements and representations about the products’ ability +to provide fitness benefits to users. The Statement of Claim seeks damages (including damages for bodily injury), restitution, punitive damages, and injunctive relief. On or about November 21, 2013, an Amended Statement of Claim was filed to +substitute a new representative plaintiff, Kourtney Smith, in place of Ms. Davies and to allege substantially the same claims as in the original Statement of Claim with respect to all Skechers toning footwear sold to residents of Canada. On or +about February 28, 2014, representative plaintiff Smith agreed to the terms and conditions of the settlement reached in the Angell , Niras , and Dedato class actions (described above and below), and agreed to discontinue the +Davies/Smith action once the settlement in the Angell , Niras , and Dedato class actions is finally approved by the Court and affirmed on appeal in the event an appeal is taken. On November 5, 2014, the Québec +Superior Court issued its formal judgment approving the settlement in the Angell class action. On January 16, 2015, the Court in the Davies/Smith action issued an order effectively dismissing that action. Notwithstanding, if +approval of the class action settlement is reversed on appeal, we cannot predict the outcome of the Davies/Smith action or a reasonable range of potential losses or whether the outcome of the Davies/Smith action would have a material +adverse impact on our results of operations, financial position or result in a material loss in excess of the settlement or a recorded accrual. +George Niras v. Skechers U.S.A., Inc., Skechers U.S.A., Inc. II, and Skechers U.S.A. Canada Inc. — On +September 21, 2012, George Niras filed a Statement of Claim in the Ontario Superior Court of Justice on behalf of all residents of Canada who purchased Shape-ups, Resistance Runner, Shape-ups Toners/Trainers, or Tone-ups. The Statement of Claim +alleges that Skechers marketed these toning shoes through the use of false and misleading advertisements and representations about the products’ ability to provide health benefits to users. The Statement seeks damages, restitution, punitive +damages, and injunctive relief. Skechers has not yet responded to the Statement. At a mediation held on February 28, 2013, the parties reached an agreement in principle to settle the Niras action (as +26 +Table of Contents +well as the Angell action described above and the Dedato action described below) through authorization by the Québec Superior Court of a nationwide settlement class. That +agreement was finalized by the parties in December 2013 and thereafter presented to the Québec Superior Court for approval. On November 5, 2014, the Québec Superior Court issued its formal judgment approving the settlement. On +November 20, 2014, the Ontario Superior Court issued an order effectively dismissing the Niras action. Notwithstanding, if approval of the class action settlement is reversed on appeal, we cannot predict the outcome of the Niras +action or a reasonable range of potential losses or whether the outcome of the Niras action would have a material adverse impact on our results of operations, financial position or result in a material loss in excess of the settlement or a +recorded accrual. +Frank Dedato v. Skechers U.S.A., Inc. and Skechers U.S.A. Canada, Inc. — On or about +November 5, 2012, Frank Dedato filed a Statement of Claim in Ontario Superior Court of Justice on behalf of all residents of Canada who purchased Shape-ups, Tone-ups or Resistance Runner footwear. The Statement of Claim alleges that Skechers +has allegedly made misleading statements about its footwear products’ ability to provide fitness benefits to users. The Statement of Claim seeks damages, restitution, punitive damages, and injunctive relief. Skechers has not yet responded to +the Statement of Claim. At a mediation held on February 28, 2013, the parties reached an agreement in principle to settle the Dedato action (as well as the Angell and Niras actions described above) through authorization by +the Québec Superior Court of a nationwide settlement class. That agreement was finalized by the parties in December 2013 and thereafter presented to the Québec Superior Court for approval. On November 5, 2014, the Québec +Superior Court issued its formal judgment approving the settlement. On November 19, 2014, the Ontario Superior Court in issued an order effectively dismissing the Dedato action. Notwithstanding, if approval of the class action settlement +is reversed on appeal, we cannot predict the outcome of the Dedato action or a reasonable range of potential losses or whether the outcome of the Dedato action would have a material adverse impact on our results of operations, +financial position or result in a material loss in excess of the settlement or a recorded accrual. +Susan Cooper et al. +v. Ontrea Inc. et al. — On October 22, 2014, the Company was named as a third-party defendant in a lawsuit pending in the Court of Queen’s Bench in Calgary, Alberta, Case No. 1301 10673. The third party notice asserts claims +for indemnification and contribution arising from injuries plaintiff allegedly sustained as a result of wearing Shape-ups shoes. The class action settlement in the Angell action, described above, is expected to resolve the Cooper +action. However, if approval of the class action settlement is reversed on appeal, we cannot predict the outcome of the Cooper action or a reasonable range of potential losses or whether the outcome of the Cooper action would have a +material adverse impact on our results of operations, financial position or result in a material loss in excess of the settlement or a recorded accrual. +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., +Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups are defective and unreasonably dangerous, negligently designed and/or manufactured, and do not conform +to representations made by our company, and that we failed to provide adequate warnings of alleged risks associated with Shape-ups. In total, we are named as a defendant in 1,171 currently pending cases (some on behalf of multiple plaintiffs) filed +in various courts that assert further varying injuries but employ similar legal theories and assert similar claims to the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are +some variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict +litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2011, a total of 1,081 +personal injury cases have been filed in or transferred to the MDL proceeding and 414 individuals have submitted claims by plaintiff fact sheets. The Company has resolved 432 personal injury claims in the MDL proceedings, comprised of 62 that were +filed as formal actions and 370 that were submitted by plaintiff fact sheets. Skechers has also settled 8 claims in principle — 6 filed cases and 2 claims submitted by plaintiff fact sheets — and anticipates that those settlements will be +finalized in the near term. Thirty-four cases in the MDL proceeding have been dismissed either voluntarily or on motions by Skechers and 38 unfiled claims submitted by plaintiff fact sheet have been abandoned. The MDL currently encompasses 979 +personal injury cases (which include the claims of 939 individuals who filed court approved questionnaires) and 4 claims submitted by plaintiff fact sheets. Under a mediation procedure authorized by the District Court, a total of 2,353 settlement +questionnaires were submitted by persons who had yet to file a lawsuit or who were already participants in the MDL or related coordinated proceedings pending in California state court (described in greater detail below). Mediations were held on +October 4, 2014 and December 16, 2014, but no settlements were reached. On December 29, 2014, the District Court ordered that a total of sixty cases be selected by the parties for staggered, accelerated discovery and then either be +remanded to their originating districts or set for trial. The sixty cases were selected in January 2015 and both written and deposition discovery is proceeding. To the extent that the sixty selected cases are not resolved by dispositive motions or +otherwise, trials are expected to be set for dates in early to mid-2016. +27 +Table of Contents +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also +have been named as defendants in a total of 70 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 913 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires +for mediation purposes in the MDL proceeding). Of those cases, 67 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition +by the Company to coordinate all personal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other +counties were transferred to and coordinated with the LASC Coordinated Cases. Four of the actions originally filed as LASC cases, brought on behalf of a total of 6 plaintiffs, have been dismissed. The claims of 44 additional plaintiffs have been +dismissed entirely from certain of the lawsuits, either voluntarily, on motion by Skechers, or as pursuant to settlement agreement. The claims of 21 persons have been dismissed in part, either voluntarily or on motions by Skechers. Thus, the LASC +Coordinated Cases currently involve 66 pending personal injury lawsuits brought on behalf of a total of 863 plaintiffs. On March 12, 2014, the Superior Court selected twelve plaintiffs as bellwether cases to be set for one or more trials +starting in March 2015. To date, extensive written discovery and document productions have taken place in the LASC cases. Over twenty fact witness depositions have been taken (all of which were cross-noticed in the MDL), as have eight expert +depositions. Two of the bellwether cases have settled and one bellwether plaintiff dismissed her action after Skechers filed a motion for summary judgment. On January 7, 2015, the Court vacated the March 2015 initial bellwether trial date and +granted Skechers’ motions for summary adjudication in five bellwether cases with respect to those plaintiffs’ advertising-related claims, including their claims for breach of warranty, fraud, and violations of consumer protection laws. On +February 25, 2015, the Court granted Skechers’ motions for summary adjudication in the four remaining bellwether cases with respect to those plaintiffs’ advertising-related claims, including their claims for breach of warranty, fraud, +and violations of consumer protection laws; the Court also granted Skechers’ summary adjudication motions as to two of the four plaintiffs’ products liability claims for an alleged failure to warn, and took under submission the portion of +Skechers’ motions seeking summary adjudication of all four plaintiffs’ products liability claims for alleged design defects. The Court also set trial dates of October 26, 2015 and January 25, 2016 for the first two bellwether +cases, but deferred selection of the specific individual bellwether plaintiff to go forward on those two dates to a later time. +In other state courts, a total of 136 personal injury actions (some on behalf of numerous plaintiffs) have been filed that +were not removed to federal court and transferred to the MDL. Ten of those actions have been resolved and dismissed. The remaining 126 actions include the claims of 539 plaintiffs, 533 of whom had submitted court-approved settlement questionnaires +in the MDL. Sixteen of those personal injury actions have been removed to various federal courts and are expected to be transferred to the MDL in the near term. It is further expected that removal petitions and requests for transfer to the MDL will +be filed for the other 110 state court personal injury actions. No discovery has taken place in these actions and no trial dates have been set. +The personal injury cases in the MDL and LASC Coordinated Cases and in other state courts are in many instances solicited and +handled by the same plaintiffs law firms. It is too early to predict the outcome of any case, whether there will be future personal injury cases filed, whether adverse results in any single case or in the aggregate would have a material adverse +impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. Notwithstanding, we believe we have meritorious defenses, vehemently deny the allegations and intend to defend each of these cases +vigorously. +Gloria Basaraba v. Robert Greenberg, et al. — On July 15, 2013, plaintiff Gloria Basaraba +moved to file under seal a shareholder derivative complaint against Skechers, nine individual members of its Board of Directors and a former employee in the United States District Court for the Central District of California, Case No. CV13-5061. The +complaint included allegations of breach of fiduciary duties, gross mismanagement, waste of corporate assets and unjust enrichment based on the development of Skechers’ toning footwear products, advertising and marketing activities relating +thereto, and subsequent litigation involving those issues. The complaint sought compensatory damages, a court order directing Skechers to reform and improve their corporate governance and internal procedures, and attorneys’ fees, costs and +expenses. On August 26, 2013, the Court denied plaintiff’s motion to seal and ordered that she file an operative complaint. On September 5, 2013, plaintiff filed the operative complaint against the same defendants, except for the +former employee. The operative complaint seeks to recover under the same causes of action as in the prior complaint on the basis of many of the same allegations. On November 12, 2013 and November 15, 2013, the individual defendants and +Skechers respectively moved to dismiss the complaint. The motions to dismiss were subsequently taken off calendar in light of the parties’ settlement discussions. A settlement eventually was reached and, on September 16, 2014, the Court +granted preliminary approval thereof. On October 10, 2014, plaintiff moved for final approval of the settlement. On that same day, plaintiff also moved for approval of attorneys’ fees and expenses and an incentive award pursuant to the +settlement agreement. On November 10, 2014, the Court granted plaintiff’s motion +28 +Table of Contents +for final settlement approval, finding the settlement fair, reasonable, and adequate. On November 12, 2014, the Court granted plaintiff’s motion for attorneys’ fees and expenses +and an incentive award. This settlement is now final and it did not have a material adverse impact on our operations, financial position or result in a material loss in excess of a recorded accrual. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against our company +in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices +arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, +Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission, Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United +States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. While it is too early to predict the outcome of these legal +proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +Deckers Outdoor Corporation v. Skechers U.S.A., Inc. — On November 20, 2014, Deckers filed an action against +our company in the United States District Court for the Central District of California, Case 2:14-cv-08988-SJO-FFM, alleging trademark infringement, patent infringement, trade dress infringement, and unfair competition arising out of our alleged use +of certain names and design elements. The complaint seeks, among other things, injunctive relief, an accounting of profits, compensatory damages, statutory, treble and punitive damages, costs and attorneys’ fees. While it is too early to +predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these +legal matters vigorously. +In addition to the matters included in its reserve for loss contingencies, we occasionally +become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a +reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and +assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an +amount for loss contingencies, if one or more of these legal matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our condensed consolidated financial statements of a particular reporting +period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +29 +Table of Contents +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” The following table sets +forth, for the periods indicated, the high and low sales prices of our Class A Common Stock. +LOW +HIGH +YEAR ENDED DECEMBER 31, 2014 +First Quarter +$ +26.46 +$ +36.78 +Second Quarter +33.14 +47.53 +Third Quarter +44.46 +64.69 +Fourth Quarter +47.76 +62.34 +YEAR ENDED DECEMBER 31, 2013 +First Quarter +$ +17.02 +$ +22.61 +Second Quarter +19.99 +24.50 +Third Quarter +23.93 +31.56 +Fourth Quarter +26.62 +34.95 +HOLDERS +As of February 17, 2015, there were 101 holders of record of our Class A Common Stock (including holders who are +nominees for an undetermined number of beneficial owners) and 29 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded but each +share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Earnings have been and will be retained for the foreseeable future in the operations of our business. We have not declared or +paid any cash dividends on our Class A Common Stock and do not anticipate paying any cash dividends in the foreseeable future. Our current policy is to retain all of our earnings to finance the growth and development of our business. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report. +30 +Table of Contents +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our company’s Class A Common Stock from +December 31, 2009 to December 31, 2014, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to +ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2009 in each of our company’s Class A Common Stock and +the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our company’s Class A Common Stock shown on the graph is not +necessarily indicative of future performance. We will not make nor endorse any predictions as to our future stock performance. +12/09 +12/10 +12/11 +12/12 +12/13 +12/14 +Skechers U.S.A., Inc. +100.00 +68.00 +41.21 +62.90 +112.65 +187.86 +Russell 2000 +100.00 +126.86 +121.56 +141.43 +196.34 +205.95 +Peer Group +100.00 +133.14 +145.52 +165.04 +251.16 +252.38 +31 +Table of Contents +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our +company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2014 and should be read in conjunction with our audited consolidated financial statements and notes thereto included +under Part II, Item 8 of this annual report. +(In thousands, except net earnings (loss) per share) +YEARS ENDED DECEMBER 31, +STATEMENT OF OPERATIONS DATA: +2014 +2013 +2012 +2011 +2010 +Net sales +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +$ +1,606,016 +$ +2,006,868 +Gross profit +1,071,905 +818,792 +683,326 +623,748 +911,906 +Earnings (loss) from operations +209,071 +93,609 +22,319 +(133,793 +) +195,568 +Earnings (loss) before income taxes (benefit) +191,380 +82,215 +10,473 +(131,047 +) +196,603 +Net earnings (loss) attributable to Skechers U.S.A., Inc. +138,811 +54,788 +9,512 +(67,484 +) +136,148 +Net earnings (loss) per share:(1) +Basic +2.74 +1.09 +0.19 +(1.39 +) +2.87 +Diluted +2.72 +1.08 +0.19 +(1.39 +) +2.78 +Weighted average shares:(1) +Basic +50,613 +50,363 +49,495 +48,491 +47,433 +Diluted +51,026 +50,563 +49,942 +48,491 +49,050 +AS OF DECEMBER 31, +BALANCE SHEET DATA: +2014 +2013 +2012 +2011 +2010 +Working capital +$ +779,277 +$ +704,506 +$ +647,771 +$ +578,885 +$ +666,054 +Total assets +1,674,918 +1,408,570 +1,340,220 +1,281,888 +1,304,794 +Long-term borrowings, excluding current installments +15,081 +116,488 +128,517 +76,531 +51,650 +Skechers U.S.A., Inc. equity +1,075,249 +930,322 +875,969 +852,561 +908,203 +(1) +Basic earnings per share represents net earnings (loss) divided by the weighted-average number of common shares outstanding for the period. Diluted +earnings (loss) per share, in addition to the weighted average determined for basic earnings (loss) per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. +32 +Table of Contents +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +GENERAL +We design, market and +sell contemporary footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own retail stores, distributor +and licensee-owned international retail stores and our e-commerce websites. Our objective is to continue to profitably grow our domestic operations while leveraging our brand name to expand internationally. +Our operations are organized along our distribution channels and we have the following four reportable sales segments: +domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, retail sales and e-commerce sales. We evaluate segment performance based primarily on net sales and +gross margins. See detailed segment information in Note 13 – Segment Information in our consolidated financial statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our net +sales for 2014 increased $531.2 million, or 28.8%, to $2.378 billion, compared to net sales of $1.846 billion in 2013. The increase in net sales was broad based across our domestic wholesale, international wholesale and retail segments, with the +largest increases across our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions, which was partially offset by reduced sales of our BOB’s products during 2014. Net earnings attributable to +Skechers U.S.A., Inc. were $138.8 million for 2014, an increase of $84.0 million, or 153.4%, compared to net earnings of $54.8 million in 2013. Diluted income per share for 2014 was $2.72, which reflected a 151.1% increase from the $1.08 diluted +income per share reported in the prior year. The increase in net earnings attributable to Skechers U.S.A., Inc. for 2014 was primarily the result of increased sales in our domestic wholesale and international direct subsidiary sales segments +following the introduction of new products and increased margins in our retail and international direct subsidiary sales segments attributable to sales of product mix with higher margins. Our working capital was $779.3 million at December 31, +2014, which was an increase of $74.8 million from working capital of $704.5 million at December 31, 2013. Our cash increased $94.7 million to $466.7 million at December 31, 2014 from $372.0 million at December 31, 2013. This increase +in cash of $94.7 million was primarily the result of our increased net earnings and increased payables, which were partially offset by increased inventories and increased accounts receivables. +2014 OVERVIEW +In 2014, we +focused on product development, domestic and international growth, development of our global infrastructure, and balance sheet and expense management. +New product design and delivery . Our success depends on our ability to design and deliver trend-right, affordable +product to consumers across a broad range of demographics. In 2014, we focused on continuously updating our core styles, by adding fresh looks to our existing lines, and developing new lines that included lifestyle and performance footwear, such as +Skechers GOrun 4, which has broadened and diversified our collection of product offerings. +Grow our domestic business. +In 2014, our focus was on maintaining our core Skechers business in our domestic wholesale accounts, while finding new opportunities to add shelf space and expand into new locations with new Skechers categories. We also focused on expanding our +domestic retail distribution channel by opening 48 additional domestic stores. +Further develop our international +businesses. In 2014, we continued to focus on improving our international operations by increasing our customer base within our existing subsidiary business and increasing our product offering to accounts within each country. We also focused on +expanding our international retail distribution channel by opening 19 additional international stores. +Develop our +global infrastructure. In 2014, we completed the first phase of the automation upgrade of our European Distribution Center equipment as well as the transition in Chile from a third-party warehouse to a distribution center operated by us. We +continue to upgrade our distribution facilities to increase our capacity and efficiency and to better manage our growth worldwide. +Balance sheet and expense management. During 2014, we continued to focus on managing our inventory levels and bringing +our marketing expenses and general and administrative expenses in line with expected sales. +33 +Table of Contents +OUTLOOK FOR 2015 +During 2015, we will continue to develop new lifestyle and performance product at affordable prices. The global footwear market +is competitive; however, we believe our new styles and lines that we will be launching in the spring and fall seasons will enable us to continue to broaden the targeted demographic profile of our consumer base, increase our shelf space and open 50 +to 60 new retail locations, predominantly in the United States, without detracting from existing business. In addition, we will continue to develop our product distribution infrastructure by completing additional phases of equipment upgrades at our +European Distribution Center and Rancho Belago distribution center. These upgrades will allow us to be more efficient and to support expected future growth. We expect these equipment upgrades to be substantially complete by the end of 2015. +DEFINITIONS +Comparable Sales +As part of our discussion of our results of operations, we disclose comparable store sales, which exclude the impact of +e-commerce sales. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting +period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for +the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful +comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable +store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +Cost of Sales or Gross Margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, quota costs, inbound freight +(including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may +include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, +advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative +expenses +General and administrative expenses consist primarily of the following: salaries, wages and related +taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs associated with our Rancho Belago, European +and other foreign distribution centers, professional fees related to both legal and accounting, insurance, depreciation and amortization, and asset impairment, legal settlements, amongst other expenses. Our distribution network related costs are +included in general and administrative expenses and are not allocated to specific segments. +34 +Table of Contents +YEAR ENDED DECEMBER 31, 2014 COMPARED TO THE YEAR ENDED DECEMBER 31, 2013 +Net sales +Net +sales for 2014 were $2.378 billion, which was an increase of $531.2 million, or 28.8%, compared to net sales of $1.846 billion for 2013. The increase in net sales broad based and was attributable to higher sales in our domestic wholesale segment, +international wholesale segment and our retail segment primarily due to the introduction of new styles and lines of footwear. +Our domestic wholesale net sales increased $195.8 million, or 24.4%, to $998.0 million for 2014 compared to $802.2 million for +2013. The increase in our domestic wholesale segment was attributable to strong sales and significant growth in several key divisions including our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA +divisions, which was partially offset by reduced sales of our BOB’s products during 2014. The increase in the domestic wholesale segment’s net sales also resulted from a 19.1% unit sales volume increase to 44.9 million pairs in 2014 +from 37.7 million pairs in 2013. The average selling price per pair within the domestic wholesale segment increased 4.4%, to $22.20 per pair for 2014 from $21.26 for 2013, which was primarily the result of increased selling prices for our +Women’s Sport, Women’s Active and Men’s USA divisions. +Our international wholesale segment net sales +increased $210.4 million, or 43.9%, to $689.2 million for 2014 compared to sales of $478.8 million for 2013. Our international wholesale sales consist of direct sales by our foreign subsidiaries — those sales we make to department stores and +specialty retailers — and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries increased $143.0 million, or 40.4%, to $497.1 million +for 2014 compared to sales of $354.1 million for 2013. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany, and Canada and our joint ventures in China and Hong Kong. The increases are primarily +attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $67.3 million, or 54.1%, to $192.0 million for 2014, compared to sales of $124.7 million +for 2013. This was primarily attributable to increased sales to our distributors in Australia and New Zealand, South Korea, Taiwan, and the United Arab Emirates (“UAE”). +Our retail segment sales increased $125.3 million to $663.5 million for the year ended December 31, 2014, a 23.3% +increase over sales of $538.2 million for 2013. The increase in retail sales was primarily attributable to increased comparable sales of 10.6%, which included increased sales of our Women’s Go, Women’s Active, Men’s and Women’s +Sport, and Men’s USA divisions and a net increase of 41 domestic and 18 international stores compared to 2013. For the year ended December 31, 2014, our domestic retail sales increased 16.2% compared to 2013, which was attributable to +positive comparable domestic store sales of 8.9% and increased domestic store count, and our international retail store sales increased 64.2% compared to 2013, which was attributable to increased international store count and positive comparable +international store sales of 20.8%. During 2014, we opened two new domestic concept stores, 17 domestic factory outlet stores, 29 domestic warehouse outlet stores, nine international concept stores, seven international factory outlet stores and +three international warehouse outlet stores. +We believe that we have established our presence in most major domestic +retail markets. We had 363 domestic stores and 84 international retail stores as of February 15, 2015, and we currently plan to open approximately 50 to 60 stores in 2015. We opened 48 domestic retail stores and 19 international retail stores +in 2014, while closing seven underperforming domestic stores and one international concept store. We opened 31 domestic retail stores and 16 international retail stores in 2013, while closing 10 underperforming domestic stores and one international +store. We periodically review all of our stores for impairment. During 2014 and 2013, we did not record an impairment charge. Further, we carefully review our under-performing stores and may consider the non-renewal of leases upon completion of the +current term of the applicable lease. +Our e-commerce net sales decreased $0.3 million to $26.9 million for 2014, a 1.3% +decrease compared to sales of $27.2 million for 2013. Our e-commerce sales made up approximately 1.1% and 1.5% of our consolidated net sales for 2014 and 2013, respectively. +Gross profit +Gross profit for 2014 increased $253.1 million to $1.072 billion from $818.8 million for 2013. Gross profit as a percentage of +net sales, or gross margin, increased to 45.1% in 2014 from 44.4% for 2013. Our domestic wholesale segment gross profit increased $79.2 million, or 27.4%, to $368.0 million for 2014 from $288.8 million for 2013 attributable to increased sales +volume. Domestic wholesale margins increased to 36.9% for 2014 from 36.0% for 2013. The increase in domestic wholesale margins was primarily attributable to higher margins in our Men’s USA and Women’s Sport lines. +35 +Table of Contents +Gross profit for our international wholesale segment increased $93.8 million, or +47.2%, to $292.7 million for 2014 compared to $198.9 million for 2013. Gross margins were 42.5% for 2014 compared to 41.5% for 2013. The increase in gross margins for our international wholesale segment was primarily attributable to increased sales +by our subsidiaries, which historically have achieved higher gross margins attributable to direct sales to customers than our international wholesale sales through our foreign distributors. Gross margins for our international direct subsidiary sales +were 48.6% for 2014 as compared to 47.3% for 2013 primarily attributable to increased sales of our newer products. Gross margins for our international distributor sales were 26.5% for 2014 as compared to 25.1% for 2013. +Gross profit for our retail segment increased $79.6 million, or 24.9%, to $398.6 million for 2014 as compared to $319.0 +million for 2013. Gross margins for all stores were 60.1% for 2014 compared to 59.3% for 2013. Gross margins for our domestic stores were 60.8% for 2014 as compared to 59.6% for 2013. Gross margins for our international stores were 57.2% for 2014 +and 2013. The increases in domestic and overall retail margins were primarily attributable to increased sales of our newer products at higher margins. +Selling expenses +Selling expenses increased by $27.5 million, or 17.9%, to $181.0 million for 2014 from $153.5 million for 2013, although +selling expenses decreased as a percentage of net sales to 7.6% for 2014 from 8.3% for 2013 attributable to increased net sales. The increase in selling expenses was primarily the result of higher advertising expenses, which also decreased as a +percentage of net sales to 5.3% in 2014 from 5.6% in 2013 attributable to increased net sales. +General and administrative expenses +General and administrative expenses increased by $111.5 million, or 19.2%, to $690.9 million for 2014 from $579.4 million for +2013. As a percentage of sales, general, administrative and legal expenses were 29.1% and 31.4% for 2014 and 2013, respectively. The increase in general, administrative and legal expenses was primarily attributable to $41.6 million related to +supporting our growing international operations, increased store operating costs of $31.6 million primarily attributable to an additional 59 stores in comparison to the prior year, increased salaries and wages of $19.9 million, which includes +incentive compensation, $7.5 million from bad debt write-offs and increased warehouse and distribution costs of $11.9 million. In addition, the expenses related to our distribution network, including the functions of purchasing, receiving, +inspecting, allocating, warehousing and packaging of our products totaled $134.8 million and $122.9 million for 2014 and 2013, respectively. +Other +income (expense) +Interest income was $0.8 million for each of 2014 and 2013. Interest expense for 2014 increased +$0.6 million to $12.5 million compared to $11.9 million in 2013. The increase was primarily attributable to increased interest expense of $1.3 million attributable to interest incurred on purchases from our foreign manufacturers that increased +compared to the prior year, which was offset by reduced interest paid on loans for our domestic distribution center equipment. Loss on foreign currency transactions for 2014 increased $4.6 million to $5.4 million compared to $0.8 million in 2013. +This increased foreign currency exchange loss was primarily attributable to higher short-term intercompany investments balances in our foreign subsidiaries and a stronger U.S. dollar. Gain on disposal of assets for 2014 decreased $1.3 million to a +loss of $0.9 million as compared to a gain of $0.4 million in 2013. +Income taxes +Our provision for income tax expense (benefit) and our effective income tax rate are significantly impacted by the mix of our +domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. Our provision for income +tax expense (benefit) was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense +(benefit) by earnings (loss) before income taxes. +36 +Table of Contents +Our earnings (loss) before income taxes and income tax expense (benefit) for +2014, 2013 and 2012 are as follows (in thousands): +Years Ended December 31, +2014 +2013 +2012 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +United States +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +$ +(27,379 +) +$ +(5,867 +) +Canada +6,241 +1,572 +4,091 +1,187 +2,564 +545 +Chile +629 +138 +9,622 +1,920 +5,971 +1,043 +Peoples Republic of China (“China”) +15,201 +1,179 +6,148 +1,646 +1,278 +319 +Jersey (1) +77,555 +0 +25,348 +0 +25,162 +0 +Non-benefited loss operations (2) +(13,021 +) +0 +(15,841 +) +0 +(13,492 +) +0 +Other jurisdictions (3) +21,997 +3,795 +14,142 +3,787 +16,369 +3,921 +Earnings before income taxes +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +$ +10,473 +$ +(39 +) +Effective tax rate (4) +20.5 +% +26.0 +% +(0.4 +)% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of +offsetting valuation allowances: Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5%, of 2014 consolidated earnings (loss) before +taxes: UK, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +For 2014, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39% +primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2014, as reflected in the table above, earnings (loss) before income taxes in the U.S. +was earnings of $82.8 million, with income tax expense of $32.5 million, an average rate of 39.3%, while earnings (loss) before income taxes in non-U.S. jurisdictions was earnings of $108.6 million, with aggregate income tax expense of $6.7 million, +an average rate of 6.2%. Combined, this results in consolidated earnings before income taxes for the period of $191.4 million, and consolidated income tax expense for the period of $39.2 million, resulting in an effective tax rate of 20.5%. We +estimate our annual effective tax rate for 2015 to be between 20 percent and 25 percent. The estimated effective tax rate for 2015 is subject to management’s ongoing review and revision, if necessary. +For 2014, of our $108.6 million in earnings before income tax earned outside the U.S., $77.6 million was earned in Jersey, +which does not impose a tax on corporate earnings. In addition, there were foreign losses of $13.0 million for which no tax benefit was recognized during the year ended December 31, 2014 because of the provision of offsetting valuation +allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of our 2014 consolidated earnings (loss) before taxes. +Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings +would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of +December 31, 2014, we had approximately $466.7 million in cash and cash equivalents, of which $193.2 million, or 41.4%, was held outside the U.S. Of the $193.2 million held by our non-U.S. subsidiaries, approximately $42.8 million is available +for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our financial statements as of December 31, 2014. We believe our cash and cash equivalents +held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months and we do not expect that we will need to repatriate any of the funds presently designated as indefinitely +reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and +applicable non-U.S. income and withholding taxes. As of December 31, 2014 and 2013, U.S. income taxes have not been provided on cumulative total earnings of approximately $318.2 million and $226.0 million, respectively. +37 +Table of Contents +Non-controlling interest in net income and loss of consolidated subsidiaries +Non-controlling interest for 2014 increased $7.3 million to expense of $13.4 million as compared expense of $6.1 million for +2013. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +YEAR ENDED DECEMBER 31, +2013 COMPARED TO THE YEAR ENDED DECEMBER 31, 2012 +Net sales +Net sales for 2013 were $1.846 billion, which was an increase of $286.0 million, or 18.3%, compared to net sales of $1.560 +billion for 2012. The increase in net sales was primarily attributable to higher sales in our domestic wholesale, international subsidiaries and retail segments of new styles and lines of footwear that we launched in the second half of 2012. +Our domestic wholesale net sales increased $149.5 million, or 22.9%, to $802.2 million for 2013 compared to $652.7 million for +2012. The increase in our domestic wholesale segment was attributable to strong sales and significant growth in several key divisions including our Women’s Go, and Men’s and Women’s Sport and BOBS divisions, which were offset by +reduced sales in our Women’s Active and Women’s USA divisions. The increase in the domestic wholesale segment’s net sales also resulted from a 24.3% unit sales volume increase to 37.7 million pairs in 2013 from 30.4 million +pairs in 2012. The average selling price per pair within the domestic wholesale segment decreased slightly to $21.26 per pair for 2013 from $21.50 for 2012, which was primarily the result of lower selling prices in our BOBS and Men’s lines and +increased closeouts as compared to 2012. +Our international wholesale segment net sales increased $46.6 million, or 10.8%, +to $478.8 million for 2013 compared to sales of $432.2 million for 2012. Direct sales by our foreign subsidiaries increased $59.7 million, or 20.3%, to $354.1 million for 2013 compared to sales of $294.4 million for 2012. The largest sales increases +during the year came from our subsidiaries in Canada and France and our joint ventures in Hong Kong, China, Singapore and India, which were offset by decreases in Spain and Italy. The increases are primarily attributable to sales of our Women’s +and Men’s Go, Women’s Active, Women’s Sport and Twinkle Toes’ lines. Our distributor sales decreased $13.0 million, or 9.5%, to $124.7 million for 2013, compared to sales of $137.7 million for 2012. This was primarily +attributable to decreased sales to our distributors in Panama, South Korea, Ukraine and the United Arab Emirates. +Our +retail segment net sales increased $84.6 million, or 18.7%, to $538.2 million for 2013, compared to sales of $453.6 million for 2012. The increase in retail sales was attributable to positive comparable store sales and a net increase of 21 domestic +stores and 15 international stores. For 2013, we realized positive comparable store sales of 14.8% in our domestic retail stores and 15.2% in our international retail stores. The comparable store sales increase was principally driven by increased +sales of our newer products. During 2013, we opened 10 new domestic concept stores, 13 domestic factory outlet stores, eight domestic warehouse outlet stores, eight international concept stores and eight international factory outlet stores. Our +domestic retail sales increased 17.8% for 2013 in comparison to 2012 as the result of the positive comparable store sales and the net increase of 21 domestic stores. Our international retail sales increased 24.1% for 2013 compared to 2012, which was +primarily attributable to increases in net sales in Canada, Chile and the United Kingdom as well as a net increase of 15 international stores. +We believe that we have established our presence in most major domestic retail markets. We had 324 domestic stores and 70 +international retail stores as of February 15, 2014. We opened 31 domestic retail stores and 16 international retail stores in 2013, while closing 10 underperforming domestic stores and one international store. In 2012, we closed five domestic +stores and two international concept stores. We periodically review all of our stores for impairment. During 2013 and 2012, we did not record an impairment charge. Further, we carefully review our under-performing stores and may consider the +non-renewal of leases upon completion of the current term of the applicable lease. +Our e-commerce net sales increased +$5.3 million to $27.2 million for 2013, a 24.2% increase compared to sales of $21.9 million for 2012. Our e-commerce sales made up approximately 1.5% and 1.4% of our consolidated net sales for 2013 and 2012, respectively. +Gross profit +Gross profit for 2013 increased $135.5 million to $818.8 million from $683.3 million for 2012. Gross profit as a percentage of +net sales, or gross margin, increased to 44.4% in 2013 from 43.8% for 2012. Our domestic wholesale segment gross profit increased $45.9 million, or 18.9%, to $288.8 million for 2013 from $242.9 million for 2012 attributable to increased sales +volume. Domestic wholesale margins decreased to 36.0% for 2013 from 37.2% for 2012. The decrease in domestic wholesale margins was primarily +38 +Table of Contents +attributable to lower margins in our Men’s and Women’s Active lines as well as increased non-toning closeouts, which were partially offset by reduced sales of discounted toning products +as compared to the same period in the prior year. +Gross profit for our international wholesale segment increased $32.4 +million, or 19.5%, to $198.9 million for 2013 compared to $166.5 million for 2012. Gross margins were 41.5% for 2013 compared to 38.5% for 2012. The increase in gross margins for our international wholesale segment was primarily attributable to +increased sales by our European subsidiaries, which historically have achieved higher gross margins attributable to direct sales to customers than our international wholesale sales through our foreign distributors. Gross margins for our direct +foreign subsidiary sales were 47.3% for 2013 as compared to 44.7% for 2012 primarily attributable to reduced sales of discounted toning products and increased sales of our newer products. Gross margins for our international distributor sales were +25.1% for 2013 as compared to 25.3% for 2012. +Gross profit for our retail segment increased $55.0 million, or 20.8%, to +$319.0 million for 2013 as compared to $264.0 million for 2012. Gross margins for all stores were 59.3% for 2013 compared to 58.2% for 2012. Gross margins for our domestic stores were 59.6% for 2013 as compared to 58.6% for 2012. Gross margins for +our international stores were 57.2% for 2013 as compared to 56.1% for 2012. The increases in domestic and overall retail margins were primarily attributable to increased sales of our newer products at higher margins and reduced sales of discounted +toning products at lower margins. +Selling expenses +Selling expenses increased by $18.6 million, or 13.8%, to $153.5 million for 2013 from $134.9 million for 2012, although +selling expenses decreased as a percentage of net sales to 8.3% for 2013 from 8.7% for 2012 attributable to increased net sales. The increase in selling expenses was primarily the result of higher advertising expenses, which also decreased as a +percentage of net sales to 5.6% in 2013 from 5.8% in 2012 attributable to increased net sales. +General, administrative and legal expenses +General, administrative and legal expenses increased by $46.2 million, or 8.7%, to $579.4 million for 2013 from +$533.2 million for 2012. As a percentage of sales, general, administrative and legal expenses were 31.4% and 34.2% for 2013 and 2012, respectively. The increase in general, administrative and legal expenses was primarily attributable to increased +salaries and wages of $14.3 million, which includes incentive compensation, increased warehouse and distribution costs of $8.1 million and increased rent expense of $5.3 million primarily attributable to an additional 36 stores in comparison to the +prior year. In addition, the expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products totaled $122.9 million and $119.3 million for 2013 and +2012, respectively. +Interest income +Interest income for 2013 increased $0.2 million to $0.8 million as compared to $0.6 million for 2012. The increase in interest +income was primarily attributable to higher cash balances. +Interest expense +Interest expense for 2013 decreased $1.4 million to $11.9 million compared to $13.3 million in 2012. The decrease was primarily +attributable to decreased interest expense of $0.3 million attributable to reduced principal balances on loans related to equipment in our domestic distribution center and reduced interest expense of $0.5 million attributable to lower interest rates +on loans related to our domestic distribution center that we refinanced in November 2012. Interest expense was also incurred on amounts owed to our foreign manufacturers. +Gain on disposal of assets +Gain on disposal of assets for 2013 increased $0.6 million to a gain of $0.4 million as compared to a loss of $0.2 million in +2012. +Income taxes +Our provision for income tax expense (benefit) and our effective income tax rate are significantly impacted by the mix of our +domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 41%. Our provision for income +tax expense +39 +Table of Contents +(benefit) was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is +calculated by dividing income tax expense (benefit) by earnings (loss) before income taxes. +Our earnings (loss) before +income taxes and income tax expense (benefit) for 2013, 2012 and 2011 are as follows (in thousands): +Years Ended December 31, +2013 +2012 +2011 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +United States +$ +38,705 +$ +12,807 +$ +(27,379 +) +$ +(5,867 +) +$ +(161,976 +) +$ +(66,355 +) +Canada +4,091 +1,187 +2,564 +545 +945 +309 +Chile +9,622 +1,920 +5,971 +1,043 +9,321 +2,030 +Peoples Republic of China (“China”) +6,148 +1,646 +1,278 +319 +1,416 +354 +Jersey (1) +25,348 +0 +25,162 +0 +25,109 +0 +Non-benefited loss operations (2) +(15,841 +) +0 +(13,492 +) +0 +(16,844 +) +0 +Other jurisdictions (3) +14,142 +3,787 +16,369 +3,921 +10,982 +195 +Earnings (loss) before income taxes +$ +82,215 +$ +21,347 +$ +10,473 +$ +(39 +) +$ +(131,047 +) +$ +(63,467 +) +Effective tax rate (4) +26.0 +% +(0.4 +%) +48.4 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of +offsetting valuation allowances: Japan, Brazil, China, Hong Kong and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5%, of 2013 consolidated earnings (loss) before +taxes: UK, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, China, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense (benefit) by earnings (loss) before income taxes. +For 2013, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 40% +primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2013, as reflected in the table above, earnings (loss) before income taxes in the U.S. +was earnings of $38.7 million, with income tax expense of $12.8 million, an average rate of 33.1%, while earnings (loss) before income taxes in non-U.S. jurisdictions was earnings of $43.5 million, with aggregate income tax expense of $8.5 million, +an average rate of 19.6%. Combined, this results in consolidated earnings (loss) before income taxes for the period of $82.2 million, and a consolidated income tax expense for the period of $21.3, resulting in an effective tax rate of 26.0%. +For 2013, of our $43.5 million in earnings before income tax earned outside the U.S., $25.3 million was earned in Jersey, +which does not impose a tax on corporate earnings. In addition, there were foreign losses of $15.8 million for which no tax benefit was recognized during the year ended December 31, 2013 because of the provision of offsetting valuation +allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of our 2013 consolidated earnings (loss) before taxes. +Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings +would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of +December 31, 2013, we had approximately $372.0 million in cash and cash equivalents, of which $166.5 million, or 44.8%, was held outside the U.S. Of the $166.5 million held by our non-U.S. subsidiaries, approximately $51.2 million is available +for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our financial statements as of December 31, 2013. We believe our cash and cash equivalents +held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months and we do not expect that we will need to repatriate any of the funds presently designated as indefinitely +reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and +applicable non-U.S. income and withholding taxes. As of December +40 +Table of Contents +31, 2013 and 2012, U.S. income taxes have not been provided on cumulative total earnings of approximately $226.0 million and $171.2 million, respectively. +Non-controlling interest in net income and loss of consolidated subsidiaries +Non-controlling interest for 2013 increased $5.1 million to expense of $6.1 million as compared expense of $1.0 million for +2012. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +LIQUIDITY AND CAPITAL +RESOURCES +Cash Flows +Our working capital at December 31, 2014 was $779.3 million, an increase of $74.8 million from working capital of $704.5 +million at December 31, 2013. Our cash and cash equivalents at December 31, 2014 was $466.7 million compared to $372.0 million at December 31, 2013. This increase in cash of $94.7 million, after consideration of the effect of exchange +rates, was the result of our net earnings of $152.2 million, depreciation of property and equipment of $47.6 million and increased payables of $98.7 million, which was partially offset by capital expenditures of $56.9 million, increased receivables +of $70.7 million and increased inventory levels of $100.2 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and +administrative expenses and debt service payments. +Net cash provided by operating activities was $163.9 million for 2014 +and net cash provided by operating activities was $99.0 million for 2013. On a comparative year-to-year basis, the $64.9 million increase in cash flows from operating activities in 2014 from cash used in operating activities in 2013 primarily +resulted from an increase in net earnings of $91.3 million and an increase in accounts payable balances of $81.1 million primarily attributable to increased unpaid balances to our contract manufactures due to increased purchases at the end of the +year when compared to the same period in the prior year. The increase in net earnings and accounts payable balances were partially offset by a $127.0 million increase in inventories to support increased worldwide backlogs and increased accounts +receivable balances as of December 31, 2014 as compared to December 31, 2013. +Net cash used in investing +activities was $56.9 million for 2014 as compared to $41.4 million in 2013. The increase in cash used in investing activities in 2014 as compared to 2013 was the result of increased capital expenditures. Capital expenditures for 2014 were +approximately $56.9 million, which consisted of $28.4 million for new store openings and remodels, $13.9 million for the initial phase of automation upgrades for our European Distribution Center equipment, $2.5 million in domestic warehouse +equipment upgrades, $1.8 million for equipment costs for our new distribution center in Chile and $2.1 million related to a property purchase for potential future corporate development. This was compared to capital expenditures of $41.3 million in +the prior year, which primarily consisted of development costs for our Rancho Belago distribution center and new store openings and remodels. We expect our ongoing capital expenditures for 2015 to be between $35.0 million and $45.0 million, which +includes opening 50 to 60 retail stores, store remodels, a property purchase for potential future corporate development and investments in information technology. In addition, we are currently in the process of designing and installing additional +phases of equipment upgrades for our European Distribution Center and Rancho Belago distribution center and estimate the remaining cost of these equipment upgrades to be approximately $25.0 million. We expect these upgrades to be substantially +complete by the end of 2015. We believe our current cash, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a +portion of these expenditures. +Net cash used in financing activities was $9.0 million during 2014 compared to $9.9 +million during 2013. The increase in cash used by financing activities was primarily attributable to decreased contributions received from the non-controlling interest which were offset by increased short-term borrowings. +Sources of Liquidity +On April 30, 2010, we entered into a construction loan agreement (the “Loan Agreement”), by and among HF +Logistics-SKX T1, LLC, a wholly-owned subsidiary of the JV (“HF-T1”), Bank of America, N.A. and Raymond James Bank, FSB. Borrowings made pursuant to the Loan Agreement were up to a maximum limit of $55.0 million (the “Loan”), +which were used to construct our domestic distribution facility in Rancho Belago, California. Borrowings bore interest based on LIBOR, and the Loan Agreement’s original maturity date was April 30, 2012, which was extended to +November 30, 2012. On November 16, 2012, HF-T1 executed a modification to the Loan Agreement (the “Modification”), which increased the borrowings under the Loan to $80.0 million and extended the maturity date of the Loan to +October 31, 2015. The $80.0 million was used to (i) repay $54.7 million in outstanding +41 +Table of Contents +borrowings under the original Loan, (ii) repay a loan of $18.3 million including accrued interest from HF to the JV, (iii) repay a loan to the JV of $2.5 million including accrued +interest from Skechers RB, LLC, a wholly-owned subsidiary of our company (iv) pay a deferred management fee of $1.9 million to HF, and (iv) pay distributions of $0.9 million to each of HF and Skechers RB, LLC, with (v) $0.8 million +used for loan fees and other closing costs. Under the Modification, OneWest Bank, FSB is an additional lender that funded in part the increase to the Loan, and the interest rate on the Loan is the daily British Bankers Association LIBOR rate plus a +margin of 3.75%, which is no longer subject to a minimum rate. The Loan Agreement and the Modification are subject to customary covenants and events of default. We were in compliance with all debt covenant provisions related to the Loan Agreement as +of the date of this annual report. We had $77.9 million outstanding under the Loan Agreement and the Modification, which is included in short-term borrowings on December 31, 2014. We paid commitment fees of $0.6 million on the Modification, +which are being amortized to interest expense over the three-year life of the Modification. +On December 29, 2010, we +entered into a master loan and security agreement (the “Master Agreement”), by and between us and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan +Documents”), by and among us, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (“Agent”). We used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in our +Rancho Belago distribution facility. Borrowings made pursuant to the Master Agreement may be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 +million and each for a term of 60 months. The Note entered into on the same date as the Master Agreement represents a borrowing of approximately $39.3 million. Interest accrues at a fixed rate of 3.54% per annum. On June 30, 2011, we +entered into another Note agreement for approximately $36.3 million. Interest accrues at a fixed rate of 3.19% per annum. As of December 31, 2014, an aggregate of $37.1 million was outstanding under the Notes, of which $23.2 million is +included in long-term borrowings and $13.9 million is included in short-term borrowings. We paid commitment fees of $0.8 million on this loan, which are being amortized to interest expense over the five-year life of the Notes. +On June 30, 2009, we entered into a $250.0 million secured credit agreement, (the “Credit Agreement”) with a +syndicate of banks, of which six currently remain as participants. On November 5, 2009, March 4, 2010, May 3, 2011, and September 30, 2013, we entered into four successive amendments to the Credit Agreement +(collectively, the “Amended Credit Agreement”). The Amended Credit Agreement matures in June 2015. The Amended Credit Agreement permits us and certain of our subsidiaries to borrow up to $250.0 million based upon a borrowing base of +eligible accounts receivable and inventory, which amount can be increased to $300.0 million at our request and upon satisfaction of certain conditions including obtaining the commitment of existing or prospective lenders willing to provide the +incremental amount. Borrowings bear interest at our election based on LIBOR or a Base Rate (defined as the greatest of the base LIBOR plus 1.00%, the Federal Funds Rate plus 0.5% or one of the lenders’ prime rate), in each case, plus an +applicable margin based on the average daily principal balance of revolving loans under the credit agreement (0.50%, 0.75% or 1.00% for Base Rate loans and 1.50%, 1.75% or 2.00% for LIBOR loans). We pay a monthly unused line of credit fee of 0.25% +or 0.375% per annum, which varies based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Amended Credit Agreement further provides for a limit on +the issuance of letters of credit to a maximum of $50.0 million. The Amended Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including a fixed charge coverage ratio that applies when +excess availability is less than $40.0 million. In addition, the Amended Credit Agreement places limits on additional indebtedness that we are permitted to incur as well as other restrictions on certain transactions. We paid syndication and +commitment fees of $6.7 million on this facility, which are being amortized over the six-year life of the facility. +As of +December 31, 2014, outstanding short-term and long-term borrowings were $118.3 million, of which $37.1 million relates to notes payable for warehouse equipment for our domestic distribution center that are secured by the equipment, and $79.4 +million primarily relates to our construction loans for our domestic distribution center and $1.7 million relates to our joint venture in India. +We believe that existing cash balances, anticipated cash flows from operations, available borrowings under our secured line of +credit, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements through at least March 31, 2016 and for the foreseeable future. We did not +provide for deferred income taxes on accumulated undistributed earnings of our non-U.S. subsidiaries on approximately $318.2 million of cumulative undistributed earnings as of December 31, 2014. However, in connection with our current +strategies, we will face significant working capital requirements and capital expenditures. Our future capital requirements will depend on many factors, including, but not limited to, the sustained pace and strength of the economic recovery in our +markets, costs associated with upgrading the equipment in both our European Distribution Center and Rancho Belago distribution center, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of +our footwear, the success of our international operations, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, any potential +acquisitions of other brands or companies, and the number and timing of new store +42 +Table of Contents +openings. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. Recently, +we have been successful in raising additional funds through financing activities however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on terms favorable to our stockholders and us. +Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition and results of operations. In addition, if additional capital is raised through the sale of additional +equity or convertible securities, dilution to our stockholders could occur. +DISCLOSURE ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2014 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +1,810 +$ +1,810 +$ +— +$ +— +$ +— +Long-term borrowings (1) +116,488 +101,407 +14,525 +556 +— +Operating lease obligations (2) +1,069,447 +142,695 +255,399 +209,997 +461,356 +Purchase obligations (3) +733,578 +733,578 +— +— +— +Rancho Belago and EDC equipment +24,016 +24,016 +— +— +— +Minimum payments related to other arrangements +6,509 +4,748 +1,761 +— +— +Total (4) +$ +1,951,848 +$ +1,008,254 +$ +271,685 +$ +210,553 +$ +461,356 +(1) +Amounts include anticipated interest payments based on interest rates currently in effect. +(2) +Operating lease obligations consists primarily of real property leases for our retail stores, corporate offices, European and other international +distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $171.5 million, +(ii) outstanding letters of credit of $3.4 million and (iii) open purchase commitments with our foreign manufacturers for $558.7 million. We currently expect to fund these commitments with cash flows from operations and existing cash +balances. +(4) +Our consolidated balance sheet as of December 31, 2014, included $7.9 million in unrecognized tax benefits. The future payments related to +these unrecognized tax benefits have not been presented in the table above due to the uncertainty of the amounts and potential timing of cash settlements with the tax authorities, and whether any settlement would occur. +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as +structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, +liquidity, market or credit risk that could arise if we had engaged in such relationships. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated +financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make difficult, subjective and complex estimates +and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. +43 +Table of Contents +We base our estimates and judgments on historical experience, other available +information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. In determining whether an estimate is +critical, we consider if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and if the impact of the estimates and assumptions on financial condition +or operating performance is material. Actual results may differ from these estimates under different assumptions or conditions. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our +consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of long-lived assets, litigation reserves, and valuation of deferred income taxes. +Revenue Recognition . We derive income from the sale of footwear and royalties earned from licensing +the Skechers brand. Domestically, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For our international wholesale customers in the European community, +product is shipped FOB shipping point direct from our distribution center in Liege, Belgium. For our distributor sales, the goods are generally delivered directly from the independent factories to our distributors’ freight forwarders on a Free +Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an +arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. We recognize revenue from retail sales at the point of +sale. Sales and value added taxes collected from retail customers are excluded from reported revenues. While customers do not have the right to return goods, we periodically decide to accept returns or provide customers with credits. Allowances for +estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. +Royalty income is earned from our licensing arrangements. Upon signing a new licensing agreement, we receive up-front fees, +which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The first +calculated royalty payment is based on actual sales of the licensed product or, in some cases minimum royalty payments. Typically, at each quarter-end we receive correspondence from our licensees indicating what the actual sales for the period were. +This information is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our +receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed periodically based on external credit reporting services, +financial statements issued by the customer and our experience with the account, and it is adjusted accordingly. When a customer’s account becomes significantly past due, we generally place a hold on the account and discontinue further +shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses +and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded +against revenue. Allowances for bad debts are recorded to general and administrative expenses. +We also reserve for +potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectibility percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also +reserve for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an +uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically +identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. Gross trade accounts receivable were $293.1 million and $241.9 million, and the allowance for bad debts, returns, sales allowances and +customer chargebacks were $21.0 million and $15.9 million, at December 31, 2014 and 2013, respectively. Our credit losses charged to expense for the years ended December 31, 2014, 2013 and 2012 were $11.8 million, $2.6 million and $1.5 +million, respectively. In addition, we recorded sales return and allowance expense (recoveries) for the years ended December 31, 2014, 2013 and 2012 of $2.3 million, $0.2 million and $(0.4) million, respectively. +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our +inventory for excess and slow moving inventory. Our review is based on inventory on hand, prior sales and our expected net realizable value. Our analysis includes a review of inventory quantities on hand at period end in relation to year-to-date +sales, existing orders from customers and +44 +Table of Contents +projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based upon historical sales +experience on a style by style basis. A write-down of inventory is considered permanent and creates a new cost basis for those units. The likelihood of any material inventory write-down is dependent primarily on our expectation of future consumer +demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, +compared to the requirement determined to be appropriate as of the balance sheet date. Our gross inventory value was $457.1 million and $361.9 million and our inventory reserve was $3.3 million and $3.8 million, at December 31, 2014 and 2013, +respectively. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test +for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate +whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based upon our assessment of the following events or changes in circumstances: +• +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange +rates, or other developments in equity and credit markets; +• +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a +decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +• +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +• +overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual +and projected results of relevant prior periods; +• +other relevant entity-specific events such as changes in management, key personnel, strategy, or customers, contemplation of bankruptcy, or +litigation; +• +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of +selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a +component of a reporting unit; +• +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the +assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. In addition, we +prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows opened in excess of twenty-four months are then reviewed in detail to +determine if impairment exists. Management reviews both quantitative and qualitative factors to asses if a triggering event occurred. For the years ended December 31, 2014, 2013 and 2012, respectively we did not record an impairment charge. +Litigation reserves . Estimated amounts for claims that are probable and can be +reasonably estimated are recorded as liabilities in our consolidated balance sheets. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise and the favorable or +unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could +result from unfavorable in outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates +of the potential liability could materially impact our results of operations and financial position. +Valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred +tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies +amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. As of +December 31, 2014, we had net deferred tax assets of $26.4 million reduced by a valuation allowance of $17.5 million against loss carry-forwards not expected to be utilized by certain foreign subsidiaries. +45 +Table of Contents +INFLATION +We do not believe that the relatively moderate rates of inflation experienced in the United States over the last three years +have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in +which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the +past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales as well as our +royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars; however, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local +currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2014 and 2013, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging +activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +In May 2014, the Financial Accounting Standards Board (“FASB”) amended the FASB Accounting Standards Codification and +created a new Topic 606, “ Revenue from Contracts with Customers ” (“ASC 606”). This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount +that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition”, and most +industry-specific guidance throughout the Industry Topics of the Codification. For annual and interim reporting periods the mandatory adoption date of ASC 606 is January 1, 2017, and there will be two methods of adoption allowed, either a full +retrospective adoption or a modified retrospective adoption. The Company is currently evaluating the impact of ASC 606, but at the current time does not know what impact the new standard will have on revenue recognized and other accounting decisions +in future periods, if any, nor what method of adoption will be selected if the impact is material. +In August 2014, the +FASB amended the FASB Accounting Standards Codification and amended Subtopic 205-40, “ Presentation of Financial Statements — Going Concern. ” This amendment prescribes that an entity’s management should evaluate whether +there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will +become effective for the Company’s annual and interim reporting periods beginning January 1, 2017. The Company is evaluating the impact on its consolidated financial statements, however, the Company does not expect that the adoption of +this standard will have a material impact on the Company’s consolidated financial statements. +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Market risk +is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in +foreign currency exchange rates have and will have an impact on our results of operations. We do not hold any derivative securities that require fair value presentation under ASC 815-10. +Interest rate fluctuations. Interest rates charged on our long-term debt are based on either the prime rate of +interest or the LIBOR, and changes in either of these rates of interest could have an effect on the interest charged on our outstanding balances. At December 31, 2014 we had $1.8 million and $77.9 million of outstanding short-term and long-term +borrowings, respectively subject to changes in interest rates; however, we do not expect that any changes will have a material impact on our financial condition or results of operations. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange +rates affect our non-U.S. dollar functional currency foreign subsidiary’s revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of +our products may be impacted by +46 +Table of Contents +fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. +We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not currently engage in hedging activities with respect to such exchange rate risks. A 200 basis point reduction in the exchange rates used to +calculate foreign currency translations at December 31, 2014 would have reduced the values of our net investments by approximately $11.0 million. +47 +Table of Contents +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +INDEX TO +CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +49 +CONSOLIDATED BALANCE SHEETS +50 +CONSOLIDATED STATEMENTS OF EARNINGS +51 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +52 +CONSOLIDATED STATEMENTS OF EQUITY +53 +CONSOLIDATED STATEMENTS OF CASH FLOWS +54 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +55 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +77 +48 +Table of Contents +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited the +accompanying consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2014 and 2013 and the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in +the period ended December 31, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the +responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards +require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the +financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable +basis for our opinion. +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, +the financial position of Skechers U.S.A., Inc. and subsidiaries at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with +accounting principles generally accepted in the United States of America. +Also, in our opinion, the financial statement schedule, when +considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Skechers U.S.A., Inc. +and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the +Treadway Commission (COSO) and our report dated February 27, 2015 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 27, 2015 +49 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +2014 +December 31, +2013 +ASSETS +Current Assets: +Cash and cash equivalents +$ +466,685 +$ +372,011 +Trade accounts receivable, less allowances of $21,007 in 2014 and $15,926 in 2013 +272,103 +225,941 +Other receivables +16,510 +10,599 +Total receivables +288,613 +236,540 +Inventories +453,837 +358,168 +Prepaid expenses and other current assets +57,015 +26,094 +Deferred tax assets +18,864 +22,115 +Total current assets +1,285,014 +1,014,928 +Property, plant and equipment, at cost, less accumulated depreciation and amortization +373,183 +361,755 +Goodwill and other intangible assets, less accumulated amortization +1,630 +2,377 +Deferred tax assets +2,044 +9,950 +Other assets, at cost +13,047 +19,560 +Total non-current assets +389,904 +393,642 +TOTAL ASSETS +$ +1,674,918 +$ +1,408,570 +LIABILITIES AND EQUITY +Current Liabilities: +Current installments of long-term borrowings +$ +101,407 +$ +12,028 +Short-term borrowings +1,810 +87 +Accounts payable +352,815 +258,183 +Accrued expenses +49,705 +40,124 +Total current liabilities +505,737 +310,422 +Long-term borrowings, excluding current installments +15,081 +116,488 +Other long-term liabilities +19,993 +1,740 +Total non-current liabilities +35,074 +118,228 +Total liabilities +540,811 +428,650 +Commitments and contingencies +Stockholders’ equity: +Preferred Stock, $.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $.001 par value; 100,000 shares authorized; 40,287 and 39,688 shares issued and outstanding at +December 31, 2014 and 2013, respectively +40 +40 +Class B Common Stock, $.001 par value; 60,000 shares authorized; 10,470 and 10,870 shares issued and outstanding at December 31, +2014 and 2013, respectively +10 +11 +Additional paid-in capital +355,636 +342,143 +Accumulated other comprehensive loss +(16,077 +) +(8,701 +) +Retained earnings +735,640 +596,829 +Skechers U.S.A., Inc. equity +1,075,249 +930,322 +Noncontrolling interests +58,858 +49,598 +Total equity +1,134,107 +979,920 +TOTAL LIABILITIES AND EQUITY +$ +1,674,918 +$ +1,408,570 +See accompanying notes to consolidated financial statements. +50 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Years Ended December 31, +2014 +2013 +2012 +Net sales +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +Cost of sales +1,305,656 +1,027,569 +876,995 +Gross profit +1,071,905 +818,792 +683,326 +Royalty income +9,107 +7,734 +7,104 +1,081,012 +826,526 +690,430 +Operating expenses: +Selling +181,018 +153,491 +134,920 +General and administrative +690,923 +579,426 +533,191 +871,941 +732,917 +668,111 +Earnings from operations +209,071 +93,609 +22,319 +Other income (expense): +Interest income +837 +841 +559 +Interest expense +(12,466 +) +(11,890 +) +(13,324 +) +Other, net +(662 +) +447 +(216 +) +Gain (loss) on foreign currency transactions +(5,400 +) +(792 +) +1,135 +(17,691 +) +(11,394 +) +(11,846 +) +Earnings before income tax expense +191,380 +82,215 +10,473 +Income tax expense (benefit) +39,184 +21,347 +(39 +) +Net earnings +152,196 +60,868 +10,512 +Less: Net earnings attributable to noncontrolling interests +13,385 +6,080 +1,000 +Net earnings attributable to Skechers U.S.A., Inc. +$ +138,811 +$ +54,788 +$ +9,512 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +2.74 +$ +1.09 +$ +0.19 +Diluted +$ +2.72 +$ +1.08 +$ +0.19 +Weighted average shares used in calculating earnings per share attributable to Skechers U.S.A., Inc.: +Basic +50,613 +50,363 +49,495 +Diluted +51,026 +50,563 +49,942 +See accompanying notes to consolidated financial statements. +51 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2014 +2013 +2012 +Net earnings +$ +152,196 +$ +60,868 +$ +10,512 +Other comprehensive income, net of tax: +Loss on foreign currency translation adjustment, net of tax +(7,954 +) +(6,363 +) +(1,251 +) +Comprehensive income +144,242 +54,505 +9,261 +Less: Comprehensive income attributable to noncontrolling interests +12,807 +6,018 +1,255 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +131,435 +$ +48,487 +$ +8,006 +See accompanying notes to consolidated financial statements. +52 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +COMMON +STOCK +CLASS B +COMMON +STOCK +CLASS A +COMMON +STOCK +CLASS B +COMMON +STOCK +ADDITIONAL +PAID-IN +CAPITAL +OTHER +COMPREHENSIVE +LOSS +RETAINED +EARNINGS +SKECHERS +U.S.A., INC. +EQUITY +NON +CONTROLLING +INTERESTS +TOTAL +STOCKHOLDERS’ +EQUITY +Balance at December 31, 2011 +37,959 +11,297 +$ +38 +$ +11 +$ +320,877 +$ +(894 +) +$ +532,529 +$ +852,561 +$ +39,966 +$ +892,527 +Net earnings +— +— +— +— +— +— +9,512 +9,512 +1,000 +10,512 +Foreign currency translation adjustment +— +— +— +— +— +(1,506 +) +— +(1,506 +) +255 +(1,251 +) +Contribution from noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +3,501 +3,501 +Distribution to noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +(1,602 +) +(1,602 +) +Stock compensation expense +— +— +— +— +11,527 +— +— +11,527 +— +11,527 +Proceeds from issuance of common stock under the employee stock purchase plan +186 +— +— +— +2,374 +— +— +2,374 +— +2,374 +Proceeds from issuance of common stock under the employee stock option plan +853 +— +1 +— +1,050 +— +— +1,051 +— +1,051 +Tax benefit of stock options exercised +— +— +— +— +450 +— +— +450 +— +450 +Conversion of Class B Common Stock into Class A Common Stock +23 +(23 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2012 +39,021 +11,274 +$ +39 +$ +11 +$ +336,278 +$ +(2,400 +) +$ +542,041 +$ +875,969 +$ +43,120 +$ +919,089 +Net earnings +— +— +— +— +— +— +54,788 +54,788 +6,080 +60,868 +Foreign currency translation adjustment +— +— +— +— +— +(6,301 +) +— +(6,301 +) +(62 +) +(6,363 +) +Contribution from noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +3,635 +3,635 +Distribution to noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +(3,175 +) +(3,175 +) +Stock compensation expense +— +— +— +— +2,388 +— +— +2,388 +— +2,388 +Proceeds from issuance of common stock under the employee stock purchase plan +149 +— +— +— +2,614 +— +— +2,614 +— +2,614 +Proceeds from issuance of common stock under the employee stock option plan +114 +— +1 +— +332 +— +— +333 +— +333 +Tax benefit of stock options exercised +— +— +— +— +531 +— +— +531 +— +531 +Conversion of Class B Common Stock into Class A Common Stock +404 +(404 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2013 +39,688 +10,870 +$ +40 +$ +11 +$ +342,143 +$ +(8,701 +) +$ +596,829 +$ +930,322 +$ +49,598 +$ +979,920 +Net earnings +— +— +— +— +— +— +138,811 +138,811 +13,385 +152,196 +Foreign currency translation adjustment +— +— +— +— +— +(7,376 +) +— +(7,376 +) +(578 +) +(7,954 +) +Contribution from noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +503 +503 +Distribution to noncontrolling interest of consolidated entity +— +— +— +— +— +— +— +— +(4,050 +) +(4,050 +) +Stock compensation expense +— +— +— +— +8,684 +— +— +8,684 +— +8,684 +Proceeds from issuance of common stock under the employee stock purchase plan +102 +— +— +— +3,363 +— +— +3,363 +— +3,363 +Proceeds from issuance of common stock under the employee stock option plan +97 +— +— +— +— +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +1,446 +— +— +1,446 +— +1,446 +Conversion of Class B Common Stock into Class A Common Stock +400 +(400 +) +— +(1 +) +— +— +— +(1 +) +— +(1 +) +Balance at December 31, 2014 +40,287 +10,470 +$ +40 +$ +10 +$ +355,636 +$ +(16,077 +) +$ +735,640 +$ +1,075,249 +$ +58,858 +$ +1,134,107 +See accompanying notes to consolidated financial statements +53 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Years Ended December 31, +2014 +2013 +2012 +Cash flows from operating activities: +Net earnings +$ +152,196 +$ +60,868 +$ +10,512 +Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: +Depreciation of property, plant and equipment +47,557 +42,397 +41,542 +Amortization of deferred financing costs +1,201 +1,201 +1,195 +Amortization of intangible assets +747 +912 +906 +Provision for bad debts, returns and allowances +14,153 +2,868 +1,112 +Tax benefit from share-based compensation +— +(201 +) +(78 +) +Non-cash share-based compensation +8,684 +2,388 +11,527 +Deferred income taxes (benefits) +22,411 +11,583 +(7,538 +) +Loss (gain) on disposal of property, plant and equipment +837 +(447 +) +216 +(Increase) decrease in assets: +Receivables +(70,695 +) +(21,279 +) +(36,989 +) +Inventories +(100,162 +) +(22,589 +) +(111,813 +) +Prepaid expenses and other current assets +(31,788 +) +1,205 +60,266 +Other assets +4,548 +(3,239 +) +(4,955 +) +Increase (decrease) in liabilities: +Accounts payable +98,686 +17,596 +9,958 +Accrued expenses +15,507 +5,714 +20,692 +Net cash provided by (used in) operating activities +163,882 +98,977 +(3,447 +) +Cash flows from investing activities: +Capital expenditures +(56,905 +) +(41,294 +) +(52,452 +) +Intangible additions +— +(87 +) +— +Net cash used in investing activities +(56,905 +) +(41,381 +) +(52,452 +) +Cash flows from financing activities: +Net proceeds from the issuances of stock through employee stock purchase plan and the exercise of stock options +3,363 +2,947 +3,425 +Contribution from non-controlling interest of consolidated entity +503 +3,635 +3,501 +Distributions to non-controlling interest of consolidated entity +(4,050 +) +(3,175 +) +(1,602 +) +Excess tax benefits from share-based compensation +1,446 +732 +528 +Proceeds (payments) on short-term borrowings +1,723 +(2,382 +) +(47,998 +) +Proceeds from long-term debt +— +— +82,143 +Payments on long-term debt +(12,028 +) +(11,667 +) +(10,243 +) +Net cash (used in) provided by financing activities +(9,043 +) +(9,910 +) +29,754 +Net increase (decrease) in cash and cash equivalents +97,934 +47,686 +(26,145 +) +Effect of exchange rates on cash and cash equivalents +(3,260 +) +(1,501 +) +827 +Cash and cash equivalents at beginning of year +372,011 +325,826 +351,144 +Cash and cash equivalents at end of year +$ +466,685 +$ +372,011 +$ +325,826 +Supplemental disclosures of cash flow information: +Cash paid (received) during the year for: +Interest +$ +10,822 +$ +10,624 +$ +11,812 +Income taxes paid (recovered) +29,499 +5,480 +(48,706 +) +See accompanying notes to consolidated financial statements. +54 +Table of Contents +SKECHERS U.S.A., INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2014, 2013 and 2012 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The +Company also operates 362 domestic and 87 international retail stores and an e-commerce business as of December 31, 2014. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the +United States and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and +expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates +relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves and valuation of deferred income taxes. +Actual results could differ from those estimates. +(c) +Revenue Recognition +The Company recognizes revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of +loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Wholesale sales, which include amounts billed +for shipping and handling costs, are recognized net of allowances for estimated returns, sales allowances, discounts, chargebacks. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are recorded when related revenue is +recorded. Related costs paid to third-party shipping companies are recorded as cost of sales. The Company recognizes revenue from retail and e-commerce sales at the point of sale. Sales and value added taxes collected from retail customers are +excluded from reported revenues. +Royalty income is earned from licensing arrangements. Upon signing a new licensing +agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned. In addition, the Company receives royalty payments based on actual sales of +the licensed products. Typically, at each quarter-end the Company receives correspondence from licensees indicating the actual sales for the period. This information is used to calculate and record the related royalties based on the terms of the +agreement. +(d) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic +wholesale, international wholesale, retail and e-commerce sales. Information regarding these segments is summarized in Note 13 — Segment Information. +(e) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the +Company’s products throughout Asia or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) +810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has +determined for its VIE’s the Company is the primary beneficiary because it has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the +55 +Table of Contents +entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive +benefits from the entity that could potentially be significant to the variable interest entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated financial statements, even +though the Company may not hold a majority equity interest. There have been no changes during 2014 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The +assets of these joint ventures are restricted in that they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Company does +not have a variable interest in any unconsolidated VIEs. +(f) +Fair Value of Financial Instruments +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, +investments, accounts receivable, accounts payable and accrued expenses approximate fair value due to the relatively short maturity of such instruments. +The carrying amount of the Company’s long-term borrowings are considered Level 2 liabilities, which approximates the fair +value based upon current rates and terms available to the Company for similar debt. +(g) +Cash and Cash Equivalents +Cash and cash equivalents consist primarily of certificates of deposit with an initial term of less than three months. For +purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +(h) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve charged against revenue and its receivables for estimated losses that may result from its +customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed periodically based on external credit reporting services, financial statements issued by the customer and the +Company’s experience with the account, and it is adjusted accordingly. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, +minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its +customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback +reserve is based on a collectibility percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on +historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on +deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, the Company provides a +reserve based upon its historical loss rate as a percentage of sales. +(i) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market +(net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories and writes down the cost of inventory at +the time such determinations are made. Reserves are estimated based upon inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined based upon +estimated sales prices of such inventory through off-price or discount store channels. +56 +Table of Contents +(j) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method based on the +following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for +impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company reviews both quantitative and qualitative factors to assess if a triggering event occurred. The Company prepares +a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows opened in excess of 24 months are then reviewed in detail to determine if impairment +exists. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its +estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. The Company did not record impairment charges during the years ended December 31, +2014, December 31, 2013 or December 31, 2012. +(k) +Goodwill, Intangible Assets, Purchased Intangibles and Deferred Financing Costs +Goodwill and other intangible assets are measured for impairment at least annually and more often when events indicate that +impairment exists. Intellectual property, which include purchased intellectual property, artwork and designs, trade names and trademarks are amortized over their useful lives ranging from 1–10 years, generally on a straight-line basis. +Intangible assets, which were primarily allocated to the domestic wholesale segment, as of December 31, 2014 and 2013, are as follows (in thousands): +2014 +2013 +Intellectual property +$ +7,887 +$ +7,887 +Goodwill +1,575 +1,575 +Less accumulated amortization +(7,832 +) +(7,085 +) +Total intangible assets +$ +1,630 +$ +2,377 +The Company recorded, in general and administrative expenses, amortization expense of $0.7 +million, $0.9 million and $0.9 million for the years ended December 31, 2014, 2013 and 2012, respectively. The Company recorded, in interest expense, amortization of deferred financing costs of $1.2 million, $1.2 million and $1.2 million for +the years ended December 31, 2014, 2013 and 2012, respectively. The Company did not record impairment charges during the years ended December 31, 2014, December 31, 2013 or December 31, 2012. +(l) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax +liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry-forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax +benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +(m) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional +currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. +Translation adjustments for these subsidiaries are included in other comprehensive income. Additionally, one international subsidiary, Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Resulting +re-measurement gains and losses from this subsidiary are included in the determination of net earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet +date. Revenues and expenses are translated at the weighted average rate of +57 +Table of Contents +exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +(n) +Net Earnings Per Share Attributable to Skechers U.S.A., Inc. +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the +period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential common shares which would arise from the exercise of stock options using the treasury stock method. +The Company has two classes of issued and outstanding common stock, Class A Common Stock +and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property and the +right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while +holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted net earnings per +share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, +shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon any transfer to any person or entity which is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating +earnings per share (in thousands): +Years Ended December 31, +Basic earnings per share +2014 +2013 +2012 +Net earnings attributable to Skechers U.S.A., Inc. +$ +138,811 +$ +54,788 +$ +9,512 +Weighted average common shares outstanding +50,613 +50,363 +49,495 +Basic earnings per share +$ +2.74 +$ +1.09 +$ +0.19 +Years Ended December 31, +Diluted earnings per share +2014 +2013 +2012 +Net earnings attributable to Skechers U.S.A., Inc. +$ +138,811 +$ +54,788 +$ +9,512 +Weighted average common shares outstanding +50,613 +50,363 +49,495 +Dilutive stock options +413 +200 +447 +Weighted average common shares outstanding +51,026 +50,563 +49,942 +Diluted earnings per share +$ +2.72 +$ +1.08 +$ +0.19 +There were no options excluded from the computation of diluted earnings per share for the +years ended December 31, 2014, 2013 or 2012. +(o) +Comprehensive Income +Comprehensive income consists of net earnings and foreign currency translation adjustments. Comprehensive income is presented +in the consolidated statements of comprehensive income. Components of accumulated other comprehensive income consist of foreign currency translation adjustments and income attributable to non-controlling interests. The Company operates +internationally through several foreign subsidiaries. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the +weighted average rate of exchange during the period of translation. The resulting translation adjustments along with translation adjustments related to intercompany loans of a long-term nature are included in the translation adjustment in other +comprehensive income. +58 +Table of Contents +(p) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run or over the life of the endorsement +contract. Advertising expense for the years ended December 31, 2014, 2013 and 2012 was approximately $141.7 million, $118.5 million and $103.9 million, respectively. Prepaid advertising costs were $13.0 million and $5.5 million at +December 31, 2014 and 2013, respectively. Prepaid amounts outstanding at December 31, 2014 and 2013, represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created which had not +run as of December 31, 2014 and 2013, respectively. +(q) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses when incurred. Product +design and development costs aggregated approximately $10.3 million, $9.2 million, and $9.5 million during the years ended December 31, 2014, 2013 and 2012, respectively. +(r) +Warehouse and Distribution Costs +The Company’s distribution network related costs are included in general and administrative expenses and are not allocated +to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $134.8 million, $122.9 million and $119.3 million for +2014, 2013 and 2012, respectively. +(s) +Recent Accounting Pronouncements +In May 2014, the FASB amended the FASB Accounting Standards Codification and created a new Topic ASC 606. This amendment +prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The +amendment supersedes the revenue recognition requirements in Topic 605, “ Revenue Recognition ”, and most industry-specific guidance throughout the Industry Topics of the Codification. For annual and interim reporting periods the +mandatory adoption date of ASC 606 is January 1, 2017, and there will be two methods of adoption allowed, either a full retrospective adoption or a modified retrospective adoption. The Company is currently evaluating the impact of ASC 606, but +at the current time does not know what impact the new standard will have on revenue recognized and other accounting decisions in future periods, if any, nor what method of adoption will be selected if the impact is material. +In August 2014, the FASB amended the FASB Accounting Standards Codification and amended Subtopic 205-40, “ Presentation +of Financial Statements — Going Concern.” This amendment prescribes that an entity should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to +continue as a going concern within one year after the date that the financial statements are issued. The amendments will become effective for the Company’s annual and interim reporting periods beginning January 1, 2017. The Company is +evaluating the impact on its consolidated financial statements, however, the Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +(2) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2014 and 2013 is summarized as follows (in thousands): +2014 +2013 +Land +$ +61,163 +$ +59,113 +Buildings and improvements +177,348 +176,987 +Furniture, fixtures and equipment +217,271 +195,629 +Leasehold improvements +197,467 +174,663 +Total property, plant and equipment +653,249 +606,392 +Less accumulated depreciation and amortization +280,066 +244,637 +Property, plant and equipment, net +$ +373,183 +$ +361,755 +59 +Table of Contents +(3) +ACCRUED EXPENSES +Accrued expenses at December 31, 2014 and 2013 are summarized as follows (in thousands): +2014 +2013 +Accrued inventory purchases +$ +22,553 +$ +15,514 +Accrued payroll and taxes +27,152 +24,610 +Accrued expenses +$ +49,705 +$ +40,124 +(4) +LINE OF CREDIT AND SHORT-TERM BORROWINGS +On June 30, 2009, the Company entered into a $250.0 million secured credit agreement, (the “Credit +Agreement”) with a syndicate of banks, of which six currently remain as participants. On November 5, 2009, March 4, 2010, May 3, 2011, and September 30, 2013, the company entered into four successive amendments to +the Credit Agreement (collectively, the “Amended Credit Agreement”). The Amended Credit Agreement matures in June 2015. The Amended Credit Agreement permits the Company and certain of its subsidiaries to borrow up to $250.0 million based +upon a borrowing base of eligible accounts receivable and inventory, which amount can be increased to $300.0 million at its request and upon satisfaction of certain conditions including obtaining the commitment of existing or prospective lenders +willing to provide the incremental amount. Borrowings bear interest at the Company’s election based on LIBOR or a Base Rate (defined as the greatest of the base LIBOR plus 1.00%, the Federal Funds Rate plus 0.5% or one of the lenders’ +prime rate), in each case, plus an applicable margin based on the average daily principal balance of revolving loans under the credit agreement (0.50%, 0.75% or 1.00% for Base Rate loans and 1.50%, 1.75% or 2.00% for LIBOR loans). The company pays a +monthly unused line of credit fee of 0.25% or 0.375% per annum, which varies based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Amended Credit +Agreement further provides for a limit on the issuance of letters of credit to a maximum of $50.0 million. The Amended Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including a +fixed charge coverage ratio that applies when excess availability is less than $40.0 million. In addition, the Amended Credit Agreement places limits on additional indebtedness that the Company is permitted to incur as well as other restrictions on +certain transactions. The Company paid syndication and commitment fees of $6.7 million on this facility, which are being amortized to interest expense over the six-year life of the facility. As of December 31, 2014, there is $0.1 million +outstanding under this facility, which is classified as short-term borrowings in the consolidated balance sheet. The remaining balance in short-term borrowings, as of December 31, 2014, is related to the Company’s joint venture in India. +(5) +LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2014 and 2013 is as follows (in thousands): +2014 +2013 +Note payable to bank, due in monthly installments of $346.6 (includes principal and interest), variable rate interest at 3.92% per +annum, secured by property, balloon payment of $77,060 due October 2015 +$ +77,900 +$ +78,908 +Note payable to bank, due in monthly installments of $531.4 (includes principal and interest), fixed rate interest at 3.54% per +annum, secured by property, balloon payment of $12,635 due December 2015 +19,159 +23,573 +Note payable to bank, due in monthly installments of $483.9 (includes principal and interest), fixed rate interest at 3.19% per +annum, secured by property, balloon payment of $11,670 due June 2016 +17,940 +24,265 +Note payable to TCF Equipment Finance, Inc., due in monthly installments of $30.5 (includes principal and interest), fixed rate +interest at 5.24% per annum, maturity date of July 2019 +1,489 +1,770 +Subtotal +116,488 +128,516 +Less current installments +101,407 +12,028 +Total long-term borrowings, excluding current installments +$ +15,081 +$ +116,488 +60 +Table of Contents +The aggregate maturities of long-term borrowings at December 31, 2014 are as +follows: +2015 +101,407 +2016 +14,198 +2017 +328 +2018 +345 +2019 +210 +Thereafter +— +$ +116,488 +The Company’s long-term debt obligations contain both financial and non-financial +covenants, including cross-default provisions. The Company is in compliance with its non-financial covenants, including any cross default provisions, and financial covenants of its long-term borrowings as of December 31, 2014. +On April 30, 2010, the Company entered into a construction loan agreement (the “Loan Agreement”), by and among +HF Logistics-SKX T1, LLC, a wholly-owned subsidiary of the JV (“HF-T1”), Bank of America, N.A. and Raymond James Bank, FSB. Borrowings made pursuant to the Loan Agreement were up to a maximum limit of $55.0 million (the “Loan”), +which were used to construct the domestic distribution facility in Rancho Belago, California. Borrowings bore interest based on LIBOR, and the Loan Agreement’s original maturity date was April 30, 2012, which was extended to +November 30, 2012. On November 16, 2012, HF-T1 executed a modification to the Loan Agreement (the “Modification”), which increased the borrowings under the Loan to $80.0 million and extended the maturity date of the Loan to +October 31, 2015. The $80.0 million was used to (i) repay $54.7 million in outstanding borrowings under the original Loan, (ii) repay a loan of $18.3 million including accrued interest from HF to the JV, (iii) repay a loan to the +JV of $2.5 million including accrued interest from Skechers RB, LLC, a wholly-owned subsidiary of the Company (iv) pay a deferred management fee of $1.9 million to HF, and (iv) pay distributions of $0.9 million to each of HF and Skechers +RB, LLC, with (v) $0.8 million used for loan fees and other closing costs. Under the Modification, OneWest Bank, FSB is an additional lender that funded in part the increase to the Loan, and the interest rate on the Loan is the daily British +Bankers Association LIBOR rate plus a margin of 3.75%, which is no longer subject to a minimum rate. The Loan Agreement and the Modification are subject to customary covenants and events of default. As of December 31, 2014, there was $77.9 +million outstanding under the Loan Agreement and the Modification, which is included in current installments of long-term borrowings. As of December 31, 2013, there was $78.9 million outstanding under the Loan Agreement and the Modification, +which was included in long-term borrowings. The Company paid commitment fees of $0.6 million on the Loan, which are being amortized to interest expense over the life of the Loan. +On December 29, 2010, the Company entered into a master loan and security agreement (the “Master Agreement”), +by and between us and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan Documents”), by and among us, Banc of America Leasing & Capital, LLC, and Bank of +Utah, as agent (“Agent”). The Company used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in the Rancho Belago distribution facility. Borrowings made pursuant to the Master Agreement may +be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 million and each for a term of 60 months. The Note entered into on the same date as the Master +Agreement represents a borrowing of approximately $39.3 million. Interest will accrue at a fixed rate of 3.54% per annum. On June 30, 2011, the Company entered into another Note agreement for approximately $36.3 million. Interest will +accrue at a fixed rate of 3.19% per annum. As of December 31, 2014, the Company had $37.1 million outstanding on the Notes, of which $23.2 is included in current installments of long-term borrowings and $13.9 million is included in +long-term borrowings. As of December 31, 2013, there was $47.8 million outstanding on the Notes, which was included in long-term borrowings. The Company paid commitment fees of $0.8 million on this loan, which are being amortized to interest +expense over the five-year life of the Notes. +61 +Table of Contents +(6) +INCOME TAXES +The provisions for income tax expense (benefit) were as follows (in thousands): +2014 +2013 +2012 +Federal: +Current +$ +7,677 +$ +632 +$ +(67 +) +Deferred +23,659 +11,537 +(6,381 +) +Total federal +31,336 +12,169 +(6,448 +) +State: +Current +2,060 +519 +1,796 +Deferred +529 +119 +(307 +) +Total state +2,589 +638 +1,489 +Foreign: +Current +5,399 +8,228 +5,325 +Deferred +(140 +) +312 +(405 +) +Total foreign +5,259 +8,540 +4,920 +Total income taxes (benefit) +$ +39,184 +$ +21,347 +$ +(39 +) +The Company’s provision for income tax expense (benefit) and effective income tax rate +are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally significantly lower +than in the U.S., ranging from 0% to 34%. The Company’s provision for income tax expense (benefit) was calculated using the applicable statutory rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) in each +jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +The Company’s earnings (loss) before income taxes and income tax expense (benefit) for 2014, 2013 and 2012 are as follows +(in thousands): +Years Ended December 31, +2014 +2013 +2012 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +United States +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +$ +(27,379 +) +$ +(5,867 +) +Canada +6,241 +1,572 +4,091 +1,187 +2,564 +545 +Chile +629 +138 +9,622 +1,920 +5,971 +1,043 +Peoples Republic of China (“China”) +15,201 +1,179 +6,148 +1,646 +1,278 +319 +Jersey (1) +77,555 +— +25,348 +— +25,162 +— +Non-benefited loss operations (2) +(13,021 +) +— +(15,841 +) +— +(13,492 +) +— +Other jurisdictions (3) +21,997 +3,795 +14,142 +3,787 +16,369 +3,921 +Earnings before income taxes +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +$ +10,473 +$ +(39 +) +Effective tax rate (4) +20.5 +% +26.0 +% +(0.4 +)% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of +offsetting valuation allowances: Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5%, of 2014 consolidated earnings (loss) before +taxes: UK, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +62 +Table of Contents +For 2014, the effective tax rate was lower than the U.S. federal and state +combined statutory rate of approximately 39% primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2014, as reflected in the table above, +earnings (loss) before income taxes in the U.S. was earnings of $82.8 million, with income tax expense of $32.5 million, an average rate of 39.3%, while earnings (loss) before income taxes in non-U.S. jurisdictions was earnings of $108.6 million, +with aggregate income tax expense of $6.7 million, an average rate of 6.2%. Combined, this results in consolidated earnings before income taxes for the period of $191.4 million, and consolidated income tax expense for the period of $39.2 million, +resulting in an effective tax rate of 20.5%. +For 2014, of the Company’s $108.6 million in earnings before income tax +earned outside the U.S., $77.6 million was earned in Jersey, which does not impose a tax on corporate earnings. In addition, there were foreign losses of $13.0 million for which no tax benefit was recognized during the year ended December 31, +2014 because of the provision of offsetting valuation allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of 2014 consolidated earnings (loss) before +taxes. +Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such +earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As +of December 31, 2014, the Company had approximately $466.7 million in cash and cash equivalents, of which $193.2 million, or 41.4%, was held outside the U.S. Of the $193.2 million held by the Company’s non-U.S. subsidiaries, approximately +$42.8 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s financial statements as of December 31, +2014. The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months and the Company does not expect to repatriate any +of the funds presently designated as indefinitely reinvested outside the U.S. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds designated as indefinitely reinvested outside the U.S., the amount +repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2014 and 2013, U.S. income taxes have not been provided on cumulative total earnings of $318.2 million and $226.0 +million, respectively. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as +follows (in thousands): +2014 +2013 +2012 +Expected income tax expense +$ +66,981 +$ +28,775 +$ +3,666 +State income tax, net of federal benefit +1,032 +255 +1,406 +Rate differential on foreign income +(27,364 +) +(11,897 +) +(8,752 +) +Change in unrecognized tax benefits +(2,717 +) +740 +(149 +) +Non-deductible expenses +288 +(150 +) +194 +Prior year R&D credit claims +— +(493 +) +— +Other +3,333 +(1,187 +) +79 +Change in valuation allowance +(2,369 +) +5,304 +3,517 +Total provision (benefit) for income taxes +$ +39,184 +$ +21,347 +$ +(39 +) +Effective tax rate +20.5 +% +26.0 +% +(0.4 +)% +63 +Table of Contents +The tax effects of temporary differences that give rise to significant portions +of deferred tax assets and deferred tax liabilities at December 31, 2014 and 2013 are presented below (in thousands): +DEFERRED TAX ASSETS: +2014 +2013 +Deferred tax assets – current: +Inventory adjustments +$ +4,942 +$ +5,075 +Accrued expenses +15,103 +17,084 +Allowances for bad debts and chargebacks +6,407 +6,179 +Total current assets +26,452 +28,338 +Deferred tax assets – long term: +Loss carryforwards +23,247 +43,711 +Business credit carryforward +4,042 +9,763 +Share-based compensation +2,282 +279 +Valuation allowance +(17,534 +) +(19,903 +) +Total long term assets +12,037 +33,850 +Total deferred tax assets +38,489 +62,188 +Deferred tax liabilities – current: +Prepaid expenses +7,588 +6,223 +Deferred tax liabilities – long term: +Depreciation on property, plant and equipment +22,050 +24,703 +Total deferred tax liabilities +29,638 +30,926 +Net deferred tax assets +$ +8,851 +$ +31,262 +The Company believes it is more likely than not that the results of future operations will +generate sufficient taxable income to realize the net deferred tax assets. +Unused U.S. Federal tax credits and net +operating losses carried forward from 2012 and prior tax years were used to reduce the Company’s 2014 and 2013 federal tax liability. There were no Federal carry-forward amounts remaining as of December 31, 2014. Federal tax credits and +net operating loss carry-forward amounts remaining as of December 31, 2013 were $7.8 million and $47.7 million, respectively. As of December 31, 2014 and 2013, no valuation allowance against the related deferred tax asset has been set up +for these loss and tax credit carry-forwards as the carry-forwards were fully utilized in reducing taxable income in 2013 and 2014. +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2014 were $7.2 million and +$65.6 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2013 were $6.0 million and $109.2 million, respectively. These tax credit and net operating loss carry-forward amounts +don’t begin to expire until 2028 and 2021, respectively. As of December 31, 2014 and 2013, no valuation allowance against the related deferred tax asset has been set up for these loss and credit carry-forwards as it is believed the +carry-forwards will be fully utilized in reducing future taxable income. +As of December 31, 2014 and 2013, the +Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $56.9 million and $55.9 million, respectively. Some of these net operating losses expire beginning in 2015; however others can +be carried forward indefinitely. As of December 31, 2014 and 2013, valuation allowances of $15.9 million and $16.5 million, respectively, had been set up against the related deferred tax assets for those loss carry-forwards that are not more +likely than not to be fully utilized in reducing future taxable income. +64 +Table of Contents +The balance of unrecognized tax benefits included in net prepaid expenses and +long-term liabilities in the consolidated balance sheets decreased by $2.9 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2014 +2013 +Beginning balance +$ +10,816 +$ +10,221 +Additions for current year tax positions +773 +696 +Additions for prior year tax positions +— +164 +Reductions for prior year tax positions +(2,227 +) +(5 +) +Settlement of uncertain tax positions +— +— +Reductions related to lapse of statute of limitations +(1,426 +) +(260 +) +Ending balance +$ +7,936 +$ +10,816 +If recognized, $7.1 million of unrecognized tax benefits would be recorded as a reduction in +income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a +component of income tax expense (benefit) and totaled ($0.2) million for the year ended December 31, 2014, $0.1 million for the year ended December 31, 2013, and $0.2 million for the year ended December 31, 2012. Accrued interest and +penalties were $1.7 million and $1.8 million as of December 31, 2014 and 2013, respectively. +The amount of income +taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances +existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which +may impact the Company’s effective tax rate. +As of December 31, 2014, the Company’s tax filings are +generally subject to examination in the U.S. and several Asian and European tax jurisdictions for years ending on or after December 31, 2007. During the year, the Company reduced the balance of 2014 and prior year unrecognized tax benefits by +$1.4 million as a result of expiring statutes. +The Company is currently under examination by the IRS for tax years 2007 +through 2011. The Company is also under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2014, there was no reduction in the balance of 2014 and prior year unrecognized tax benefits due to +any settlement of an examination. It is reasonably possible that certain federal, state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2014 and prior year unrecognized tax benefits by $4.1 +million. +(7) +COMMITMENTS AND CONTINGENCIES +(a) +Leases +The Company leases facilities under operating lease agreements expiring through November 2031. The Company pays taxes, +maintenance and insurance in addition to the lease obligations. The Company also leases certain equipment and automobiles under operating lease agreements expiring at various dates through September 2018. Rent expense for the years ended +December 31, 2014, 2013 and 2012 approximated $107.0 million, $94.0 million and $88.7 million, respectively. +Minimum +lease payments, which take into account escalation clauses, are recognized on a straight-line basis over the minimum lease term. Subsequent adjustments to the lease payments due to changes in an existing index, usually the consumer price index, are +typically included in the calculation of the minimum lease payments when the adjustment is known. Reimbursements for leasehold improvements are recorded as liabilities and are amortized over the lease term. Lease concessions, usually a free rent +period, are considered in the calculation of the minimum lease payments for the minimum lease term. +65 +Table of Contents +Future minimum lease payments under noncancellable leases at December 31, +2014 are as follows (in thousands): +OPERATING +LEASES +Year ending December 31: +2015 +$ +142,695 +2016 +135,195 +2017 +120,204 +2018 +110,608 +2019 +99,389 +Thereafter +461,356 +$ +1,069,447 +(b) +Litigation +The Company recognizes legal expense in connection with loss contingencies as incurred. +In accordance with accounting principles generally accepted in the U.S., the Company records a liability in its consolidated +financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and +timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate +claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2014, nor is it +possible to estimate what litigation-related costs will be in the future. +(c) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain +of its international manufacturers. These arrangements currently bear interest at rates between 0% and 0.5% for 30- to 60- day financing. The amounts outstanding under these arrangements at December 31, 2014 and 2013 were $171.4 million and +$69.1 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $5.1 million in 2014, $3.9 million in 2013, and $3.8 +million in 2012. The Company has open purchase commitments with its foreign manufacturers at December 31, 2014 of $558.7 million, which are not included in the accompanying consolidated balance sheets. +(8) +NONCONTROLLING INTERESTS +The following VIE’s are consolidated into the Company’s consolidated financial statements and the +carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics-SKX, LLC +December 31, 2014 +December 31, 2013 +Current assets +$ +6,812 +$ +3,076 +Noncurrent assets +118,837 +129,796 +Total assets +$ +125,649 +$ +132,872 +Current liabilities +$ +78,668 +$ +1,835 +Noncurrent liabilities +1,194 +79,389 +Total liabilities +$ +79,862 +$ +81,224 +66 +Table of Contents +Distribution joint ventures (1) +December 31, 2014 +December 31, 2013 +Current assets +$ +94,819 +$ +49,835 +Noncurrent assets +10,322 +9,209 +Total assets +$ +105,141 +$ +59,044 +Current liabilities +$ +38,470 +$ +15,687 +Noncurrent liabilities +66 +32 +Total liabilities +$ +38,536 +$ +15,719 +(1) +Distribution joint ventures include Skechers China Limited, Skechers Southeast Asia Limited, Skechers Thailand Limited, Skechers South Asia Private +Limited, and Skechers Retail India Private Limited. +Noncontrolling interest earnings was $13.4 million, +$6.1 million and $1.0 million for the years ended December 31, 2014, 2013 and 2012, respectively, which represents the share of net earnings or loss that is attributable to the Company’s joint venture partners. HF Logistics-SKX, LLC made +cash capital distributions of $3.7 million and $3.2 million during the years ended December 31, 2014 and 2013, respectively. Skechers China Limited made capital distributions of $0.4 million during the year ended December 31, 2014. The +distribution joint venture partners made cash capital contributions of $0.5 million, $3.6 million and $3.5 million during the year ended December 31, 2014, 2013 and 2012, respectively. +(9) +STOCK COMPENSATION +(a) +Equity Incentive Plans +In January 1998, the Company’s Board of Directors adopted the Amended and Restated 1998 Stock Option, Deferred Stock and +Restricted Stock Plan for the grant of incentive stock options (“ISOs”), non-qualified stock options and deferred and restricted stock (the “Equity Incentive Plan”). In June 2001, the stockholders approved an amendment to the +plan to increase the number of shares of Class A Common Stock authorized for issuance under the plan to 8,215,154. In May 2003, stockholders approved an amendment to the plan to increase the number of shares of Class A Common Stock +authorized for issuance under the plan to 11,215,154. Stock option awards are generally granted with an exercise price per share equal to the market price of a share of Class A Common Stock on the date of grant. Stock option awards generally +become exercisable over a three-year graded vesting period and expire ten years from the date of grant. +On April 16, +2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007. The Company’s Board of Directors +terminated the Equity Incentive Plan as of May 24, 2007, with no granting of awards being permitted thereafter, although any awards then outstanding under the Equity Incentive Plan remain in force according to the terms of such terminated plan +and the applicable award agreements. A total of 7,500,000 shares of Class A Common Stock are reserved for issuance under the 2007 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of +equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2007 Plan is administered by the Compensation Committee of the Company’s Board of Directors. +(b) +Valuation Assumptions +There were no stock options granted under the Equity Incentive Plan or the 2007 Plan during 2014, 2013 or 2012. There were no +options exercised during 2014. The total intrinsic value of options exercised during 2013 and 2012 was $0.9 million and $1.9 million, respectively. +67 +Table of Contents +(c) +Stock-Based Payment Awards +Stock options granted pursuant to the 1998 Stock Option, Deferred Stock and Restricted Stock Plan and the 2007 Incentive Award +Plan (the “Equity Incentive Plans”) were as follows: +SHARES +WEIGHTED AVERAGE +OPTION EXERCISE +PRICE +Outstanding at December 31, 2011 +206,400 +$ +7.62 +Granted +— +— +Exercised +(149,489 +) +7.03 +Cancelled +(4,215 +) +6.95 +Outstanding at December 31, 2012 +52,696 +9.34 +Granted +— +— +Exercised +(37,696 +) +8.83 +Cancelled +— +— +Outstanding at December 31, 2013 +15,000 +10.60 +Granted +— +— +Exercised +— +— +Cancelled +(15,000 +) +10.60 +Outstanding at December 31, 2014 +0 +$ +0 +There was no unrecognized compensation cost related to stock option shares as of +December 31, 2014 and 2013, respectively. +A summary of the status and changes of nonvested shares related to the +Equity Incentive Plans as of and for the period ended December 31, 2014 is presented below: +SHARES +WEIGHTED AVERAGE +GRANT-DATE FAIR +VALUE +Nonvested at December 31, 2011 +740,493 +$ +19.02 +Granted +281,000 +17.58 +Vested/Released +(704,160 +) +18.58 +Cancelled +(33,000 +) +27.60 +Nonvested at December 31, 2012 +284,333 +17.69 +Granted +67,500 +27.70 +Vested/Released +(75,667 +) +18.03 +Cancelled +— +— +Nonvested at December 31, 2013 +276,166 +20.05 +Granted +1,092,500 +47.02 +Vested/Released +(97,333 +) +19.98 +Cancelled +(7,500 +) +18.75 +Nonvested at December 31, 2014 +1,263,833 +$ +43.38 +As of December 31, 2014, a total of 3,716,381 shares remain available for grant as equity +awards under the 2007 Plan. +The Company recognized compensation expense of $8.7 million, $2.4 million and $11.5 million +and related income tax benefits (expense) of $1.4 million, $0.5 million, and $0.5 million for grants under its stock-based compensation plans in the consolidated statements of operations for the years ended December 31, 2014, 2013, and 2012, +respectively. There was $48.7 million and $5.0 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2014 and 2013, respectively. That cost is expected to be recognized over a weighted average period of +3.0 years and 2.7 years, respectively. The total fair value of shares vested during the period ended December 31, 2014 and 2013 was $1.9 million and $1.4 million, respectively. +(d) +Stock Purchase Plans +On April 16, 2007, the Company’s Board of Directors adopted the 2008 Employee Stock Purchase Plan (the “2008 +ESPP”), and the Company’s stockholders approved the 2008 ESPP on May 24, 2007. The 2008 ESPP became effective on January 1, 2008, and the Company’s Board of Directors terminated the 1998 ESPP as of such date, with no +additional granting of rights being permitted under +68 +Table of Contents +the 1998 ESPP. The 2008 ESPP provides that a total of 3,000,000 shares of Class A Common Stock are reserved for issuance under the plan. The number of shares that may be made available for +sale is subject to automatic increases on the first day of each fiscal year during the term of the 2008 ESPP as provided in the plan. The 2008 ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the +Internal Revenue Code of 1986, as amended. The terms of the 2008 ESPP permit eligible employees to purchase Class A Common Stock at six-month intervals through payroll deductions, which may not exceed 15% of an employee’s compensation. The +price of Class A Common Stock purchased under the 2008 ESPP is 85% of the lower of the fair market value of the Class A Common Stock at the beginning of each six-month offering period or on the applicable purchase date. Employees may end +their participation in an offering at any time during the offering period. The 2008 ESPP is administered by the Company’s Board of Directors. +During 2014, 2013 and 2012, 102,153 shares, 149,257 shares and 186,199 shares were issued under the 2008 ESPP for which the +Company received approximately $3.4 million, $2.6 million and $2.4 million, respectively. +(10) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 100,000,000 shares of Class A Common Stock, par +value $.001 per share, 60,000,000 shares of Class B Common Stock, par value $.001 per share, and 10,000,000 shares of preferred stock, $.001 par value per share. +The Company has two classes of issued and outstanding common stock, Class A Common Stock +and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property and the +right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while +holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A +Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon any transfer to any person or entity which is not a permitted +transferee. +During 2014, 2013 and 2012, certain Class B stockholders converted 399,776 shares, 404,396 shares and 22,880 +shares, respectively, of Class B Common Stock to Class A Common Stock. +(11) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates the majority of its sales in the United States; however, several of its products are +sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general +economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their +obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $166.9 million and $138.4 million before allowances for bad debts and sales returns, and +chargebacks at December 31, 2014 and 2013, respectively. Foreign accounts receivable, which generally are collateralized by letters of credit, amounted to $126.2 million and $103.5 million before allowance for bad debts, sales returns, and +chargebacks at December 31, 2014 and 2013, respectively. International net sales amounted to $819.3 million, $558.1 million and $496.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. The Company’s credit +losses charged to expense for the years ended December 31, 2014, 2013 and 2012 were $11.8 million, $2.6 million and $1.5 million, respectively. In addition, the Company’s recorded sales return and allowance expense (recoveries) for the +years ended December 31, 2014, 2013 and 2012 were $2.3 million, $0.2 million and $(0.4) million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and +equipment, and other assets. Net assets held outside the United States were $548.9 million and $413.2 million at December 31, 2014 and 2013, respectively. +During 2014, 2013 and 2012, no customer accounted for 10.0% or more of net sales. No customer accounted for more than 10% of +net trade receivables at December 31, 2014 or December 31, 2013. During 2014, 2013 and 2012, net sales to the five largest customers were approximately 15.7%, 18.1% and 18.1%, respectively. +69 +Table of Contents +The Company’s top five manufacturers produced the following for the years +ended December 31, 2014, 2013 and 2012, respectively: +Percentage of total production +Years Ended December 31, +2014 +2013 +2012 +Manufacturer #1 +37.5 +% +37.8 +% +33.5 +% +Manufacturer #2 +6.1 +% +7.1 +% +9.2 +% +Manufacturer #3 +5.7 +% +6.1 +% +6.7 +% +Manufacturer #4 +4.9 +% +4.8 +% +6.6 +% +Manufacturer #5 +4.7 +% +4.1 +% +5.6 +% +58.9 +% +59.9 +% +61.6 +% +The majority of the Company’s products are produced in China. The Company’s +operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the +transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce these risks by diversifying manufacturing among various factories. To date, these business risks have +not had a material adverse impact on the Company’s operations. +(12) +EMPLOYEE BENEFIT PLANS +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have +completed six months of service. Employees may contribute up to 15.0% of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company did not make a contribution to the plan for the years +ended December 31, 2014, 2013 and 2012, respectively. +In May 2013, the Company established the Skechers U.S.A., Inc. +Deferred Compensation Plan (the “Plan”), which allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to +participating employees, which will be determined by the Company’s Compensation Committee. The Company did not make a contribution to the plan for the year ended December 31, 2014 or 2013. The value of the deferred compensation is +recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred +liabilities are presented in the Company’s condensed consolidated balance sheets. +(13) +SEGMENT INFORMATION +The Company has four reportable segments – domestic wholesale sales, international wholesale sales, +retail sales, and e-commerce sales. The Company evaluates segment performance based primarily on net sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the +Company’s segments. Net sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, retail, and the e-commerce segment on a combined basis were as follows (in thousands): +2014 +2013 +2012 +Net sales +Domestic wholesale +$ +997,994 +$ +802,163 +$ +652,651 +International wholesale +689,195 +478,799 +432,163 +Retail +663,528 +538,186 +453,600 +E-commerce +26,844 +27,213 +21,907 +Total +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +70 +Table of Contents +2014 +2013 +2012 +Gross profit +Domestic wholesale +$ +367,980 +$ +288,818 +$ +242,931 +International wholesale +292,722 +198,853 +166,454 +Retail +398,613 +319,036 +264,010 +E-commerce +12,590 +12,085 +9,931 +Total +$ +1,071,905 +$ +818,792 +$ +683,326 +2014 +2013 +Identifiable assets +Domestic wholesale +$ +979,582 +$ +865,071 +International wholesale +510,063 +374,738 +Retail +185,041 +168,532 +E-commerce +232 +229 +Total +$ +1,674,918 +$ +1,408,570 +2014 +2013 +2012 +Additions to property, plant and equipment +Domestic wholesale +$ +9,655 +$ +9,652 +$ +33,488 +International wholesale +18,899 +4,828 +2,939 +Retail +28,351 +26,814 +16,025 +Total +$ +56,905 +$ +41,294 +$ +52,452 +Geographic Information +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2014 +2013 +2012 +Net Sales (1) +United States +$ +1,558,226 +$ +1,288,302 +$ +1,064,298 +Canada +85,139 +63,665 +49,460 +Other international (2) +734,196 +494,394 +446,563 +Total +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +2014 +2013 +Property, plant and equipment +United States +$ +332,383 +$ +337,727 +Canada +7,203 +5,079 +Other international (2) +33,597 +18,949 +Total +$ +373,183 +$ +361,755 +(1) +The Company has subsidiaries in Canada, the United Kingdom, Germany, France, Spain, Portugal, Italy, the Netherlands, Japan, Brazil and Chile that +generate net sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in India, China, Hong Kong, Malaysia, Singapore and Thailand that generate net sales from those countries. The Company +also has a subsidiary in Switzerland that generates net sales from that country in addition to net sales to distributors located in numerous non-European countries. Net sales are attributable to geographic regions based on the location of the +Company subsidiary. +(2) +Other international consists of Switzerland, the United Kingdom, Germany, Austria, France, Spain, Portugal, Italy, the Netherlands, China, Hong +Kong, Malaysia, Singapore, Thailand, Brazil, Chile, Vietnam, India and Japan. +71 +Table of Contents +(14) +RELATED PARTY TRANSACTIONS +The Company paid approximately $160,000, $178,000, and $162,000 during 2014, 2013 and 2012, respectively, to +the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events including the Company’s holiday party at the Shade Hotel, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, +owns a 12% beneficial ownership interest in MIOC, and four other officers, directors and senior vice presidents of the Company own in aggregate an additional 5% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or +payable with MIOC or the Shade Hotel at December 31, 2014. +On July 29, 2010, the Company formed the Skechers +Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of and is not otherwise affiliated with the Company, and the Company does not have a +financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer and Chief Financial Officer, are also officers +and directors of the Foundation. During the year ended December 31, 2014, the Company did not make any contributions to the Foundation. During the years ended December 31, 2013 and 2012, the Company contributed $1.1 million and $1.0 +million, respectively, to the Foundation to use for various charitable causes. +The Company had receivables from officers +and employees of $0.6 million and $0.4 million at December 31, 2014 and 2013, respectively. These amounts primarily relate to travel advances and incidental personal purchases on Company-issued credit cards. These receivables are short-term and +are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant shareholders of the Company. +(15) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2014, to assess the need for potential +recognition or disclosure in this filing. Based upon this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. +(16) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +Summarized unaudited financial data are as follows (in thousands): +2014 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +546,518 +$ +587,051 +$ +674,270 +$ +569,722 +Gross profit +240,403 +269,375 +304,498 +257,629 +Net earnings attributable to Skechers U.S.A., Inc. +30,965 +34,802 +51,123 +21,921 +Net earnings per share: +Basic +$ +0.61 +$ +0.69 +$ +1.01 +$ +0.43 +Diluted +0.61 +0.68 +1.00 +0.43 +2013 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +451,621 +$ +428,247 +$ +515,756 +$ +450,737 +Gross profit +192,732 +194,894 +230,521 +200,645 +Net earnings attributable to Skechers U.S.A., Inc. +6,680 +7,094 +26,849 +14,165 +Net earnings per share: +Basic +$ +0.13 +$ +0.14 +$ +0.53 +$ +0.28 +Diluted +0.13 +0.14 +0.53 +0.28 +72 +Table of Contents +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on +Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange +Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a +company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required +disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and +operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of +such time. +MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term +is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have +a material effect on our financial statements. +We conducted an evaluation of the effectiveness of our +internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the +framework in Internal Control — Integrated Framework (2013), our management has concluded that as of December 31, 2014, our internal control over financial reporting is effective. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this +annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2014, which is set forth below. +INHERENT LIMITATIONS ON EFFECTIVENESS OF CONTROLS +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls +and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control +system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in +all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent +limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the controls. The design of any system of controls is based in part +73 +Table of Contents +on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. +Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or +procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely +to materially affect, our internal controls over financial reporting during the fourth quarter of 2014. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +74 +Table of Contents +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers +U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations +of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal +control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial +reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board +(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an +understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that +(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as +necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors +of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of +any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries maintained, in all material respects, effective internal control over financial +reporting as of December 31, 2014, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public +Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of earnings, comprehensive income, equity, +cash flows, and schedule for each of the three years in the period ended December 31, 2014, and our report dated February 27, 2015 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 27, 2015 +75 +Table of Contents +ITEM 9B. +OTHER INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information +required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is +hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be +filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be +filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this +Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page +48 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II — Valuation and Qualifying Accounts” on page 77 of this annual report on Form 10-K. +3. +Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. +76 +Table of Contents +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years +Ended December 31, 2014, 2013, and 2012 +DESCRIPTION +BALANCE AT +BEGINNING OF +PERIOD +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF PERIOD +Year-ended December 31, 2012: +Allowance for chargebacks +$ +2,340 +$ +1,357 +$ +(896 +) +$ +2,801 +Allowance for doubtful accounts +10,331 +186 +(3,350 +) +7,167 +Reserve for sales returns and allowances +7,752 +(431 +) +(367 +) +6,954 +Reserve for shrinkage +300 +1,300 +(1,300 +) +300 +Reserve for obsolescence +11,959 +931 +(4,041 +) +8,849 +Year-ended December 31, 2013: +Allowance for chargebacks +$ +2,801 +$ +1,514 +$ +(1,825 +) +$ +2,490 +Allowance for doubtful accounts +7,167 +1,105 +(2,292 +) +5,980 +Reserve for sales returns and allowances +6,954 +249 +253 +7,456 +Reserve for shrinkage +300 +1,166 +(1,200 +) +266 +Reserve for obsolescence +8,849 +1,333 +(6,697 +) +3,485 +Year-ended December 31, 2014: +Allowance for chargebacks +$ +2,490 +$ +5,530 +$ +(1,469 +) +$ +6,551 +Allowance for doubtful accounts +5,980 +6,284 +(6,823 +) +5,441 +Reserve for sales returns and allowances +7,456 +2,339 +(780 +) +9,015 +Reserve for shrinkage +266 +1,292 +(1,220 +) +338 +Reserve for obsolescence +3,485 +5,656 +(6,140 +) +3,001 +See accompanying report of independent registered public accounting firm +77 +Table of Contents +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Registration +Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) +filed with the Securities and Exchange Commission on July 29, 1998). +3.2 (a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December +31, 2005). +3.2 (b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed with the +Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, +as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +10.1 ** +Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s +Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +10.1 (a)** +Amendment No. 1 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 4.4 of the +Registrant’s Registration Statement on Form S-8 (File No. 333-71114), filed with the Securities and Exchange Commission on October 5, 2001). +10.1 (b)** +Amendment No. 2 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 4.5 of the +Registrant’s Registration Statement on Form S-8 (File No. 333-135049), filed with the Securities and Exchange Commission on June 15, 2006). +10.1 (c)** +Amendment No. 3 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 10.1 of the +Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 23, 2007). +10.2 ** +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities +and Exchange Commission on May 1, 2006). +10.3 ** +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission +on May 24, 2007). +10.4 ** +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K for the +year ended December 31, 2007). +10.5 ** +2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange +Commission on May 24, 2007). +10.5 (a)** +Amendment No. 1 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended +June 30, 2010). +10.6 ** +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 +of the Registrant’s Form 10-K for the year ended December 31, 1999). +78 +Table of Contents +10.6 (a)** +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant +(incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +10.7 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit +number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.8 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the +Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.9 + +Credit Agreement dated June 30, 2009, by and among the Registrant, certain of its subsidiaries that are also borrowers under the Agreement, and certain lenders +including Wells Fargo Foothill, LLC, as co-lead arranger and administrative agent, Bank of America, N.A., as syndication agent, and Banc of America Securities LLC, as the other co-lead arranger (incorporated by reference to exhibit number 10.1 of +the Registrant’s Form 10-Q/A filed with the Securities and Exchange Commission on November 16, 2010). +10.9 (a) +Amendment Number One to Credit Agreement dated November 5, 2009, by and among the Registrant, certain of its subsidiaries that are also borrowers under the +Agreement, and certain lenders including Wells Fargo Foothill, LLC, as co-lead arranger and administrative agent, Bank of America, N.A., as syndication agent, and Banc of America Securities LLC, as the other co-lead arranger (incorporated by +reference to exhibit number 10.2 of the Registrant’s Form 10-Q/A filed with the Securities and Exchange Commission on November 16, 2010). +10.9 (b) +Amendment Number Two to Credit Agreement dated March 4, 2010, by and among the Registrant, certain of its subsidiaries that are also borrowers under the +Agreement, and certain lenders including Wells Fargo Capital Finance, LLC (formerly known as Wells Fargo Foothill, LLC), as co-lead arranger and administrative agent, Bank of America, N.A., as syndication agent, and Banc of America Securities LLC, +as the other co-lead arranger (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010). +10.9 (c)+ +Amendment Number Three to Credit Agreement dated May 3, 2011, by and among the Registrant, certain of its subsidiaries that are also borrowers under the +Agreement, and certain lenders including Wells Fargo Capital Finance, LLC (formerly known as Wells Fargo Foothill, LLC), as co-lead arranger and administrative agent, Bank of America, N.A., as syndication agent, and Banc of America Securities LLC, +as the other co-lead arranger (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2011). +10.9 (d) +Amendment Number Four to Credit Agreement dated September 30, 2013, by and among the Registrant, certain of its subsidiaries that are also borrowers under the +Agreement, and certain lenders including Wells Fargo Capital Finance, LLC (formerly known as Wells Fargo Foothill, LLC), as co-lead arranger and administrative agent, Bank of America, N.A., as syndication agent, and Banc of America Securities LLC, +as the other co-lead arranger (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2013). +10.10 +Schedule 1.1 of Defined Terms to the Credit Agreement dated June 30, 2009, by and among the Registrant, certain of its subsidiaries that are also borrowers +under the Agreement, and certain lenders including Wells Fargo Foothill, LLC, Bank of America, N.A., and Banc of America Securities LLC (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and +Exchange Commission on July 7, 2009). +10.11 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned +subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the +Registrant’s Form 10-K for the year ended December 31, 2011). +79 +Table of Contents +10.12 +Construction Loan Agreement dated as of April 30, 2010, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture +entered into between HF Logistics I, LLC and a wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and Raymond James Bank FSB, as a lender (incorporated by reference to exhibit number 10.12 of +the Registrant’s Form 10-K for the year ended December 31, 2011). +10.12 (a) +Modification to Construction Loan Agreement And Other Loan Documents dated November 16, 2012, by and among HF Logistics-SKX T1, LLC, which is a wholly owned +subsidiary of a joint venture entered into between HF Logistics I, LLC and a wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, Raymond James Bank, N.A., as a lender, and OneWest Bank, FSB, as +a lender (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on November 21, 2012). +10.13 +Master Loan and Security Agreement, dated December 29, 2010, by and between the Registrant and Banc of America Leasing & Capital, LLC (incorporated by +reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on January 4, 2011). +10.14 +Equipment Security Note, dated December 29, 2010, by and among the Registrant, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent +(incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on January 4, 2011). +10.15 +Equipment Security Note, dated June 30, 2011, by and among the Registrant, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (incorporated +by reference to exhibit number 10.3 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 1, 2011). +10.16 +Lease Agreement, dated February 8, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park +Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.29 of the Registrant’s Form 10-K for the year ended December 31, 2002). +10.17 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California +(incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 27, 2007). +10.17 (a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, +California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010). +10.17 (b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, +California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.17 (c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, +California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.17 (d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho +Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.18 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege +Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2010). +10.19 +Addendum to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park +Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2010). +80 +Table of Contents +10.20 +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities +and Exchange Commission on May 3, 2013). +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). +31.2 +Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). +32.1 *** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.LAB +Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. ++ +Confidential treatment has been granted by the SEC and/or a renewal is being requested from the SEC to the previously granted confidential +treatment with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +** +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of +Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act. +81 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly +caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 27th day of February 2015. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been +signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert +Greenberg +Chairman of the Board and Chief Executive Officer +February 27, 2015 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael +Greenberg +President and Director +February 27, 2015 +Michael Greenberg +/s/ David +Weinberg +Executive Vice President, Chief Operating Officer, +February 27, 2015 +David Weinberg +Chief Financial Officer and Director +(Principal Financial and Accounting Officer) +/s/ Jeffrey +Greenberg +Director +February 27, 2015 +Jeffrey Greenberg +/s/ Geyer +Kosinski +Director +February 27, 2015 +Geyer Kosinski +/s/ Morton D. +Erlich +Director +February 27, 2015 +Morton D. Erlich +/s/ Richard +Siskind +Director +February 27, 2015 +Richard Siskind +/s/ Thomas +Walsh +Director +February 27, 2015 +Thomas Walsh +/s/ Rick +Rappaport +Director +February 27, 2015 +Rick Rappaport +82 \ No newline at end of file diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/filing_metadata.csv b/raw/filings/0001065837/2014/0001193125-15-068511/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b5e7eb850e9ace097e3071654bc392a9b99f9d0f --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2015-02-27,2014-12-31,2015-02-27T18:13:40.000Z,0001193125-15-068511,d846076d10k.htm,10-K,8431643,1,0,https://www.sec.gov/Archives/edgar/data/1065837/000119312515068511/d846076d10k.htm,https://www.sec.gov/Archives/edgar/data/1065837/000119312515068511/,2014,2014,1 diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/item1.txt b/raw/filings/0001065837/2014/0001193125-15-068511/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..5f69226c55c84900b8e17826291943177f224bae --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/item1.txt @@ -0,0 +1,701 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated +in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as +“we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our Internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current +reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of +1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You +can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and +women under the Skechers GO brand name. Our footwear reflects a combination of style, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, +boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2015, we owned and operated 119 concept stores, 146 factory outlet +stores and 98 warehouse outlet stores in the United States, and 51 concept stores, 33 factory outlet stores, and three warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our +recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of fashionable footwear that satisfies their active, casual, dress casual and athletic +footwear needs. Our core consumers are style-conscious men and women attracted to our youthful brand image and fashion-forward designs, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and +core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed +our brands through comprehensive marketing campaigns for men, women and children. During 2014, our Skechers brand was supported by print, television and outdoor campaigns for men and women; animated kids’ television campaigns featuring our own +action heroes and characters; marathons and other events for our Skechers Performance Division; donation events surrounding our BOBS from Skechers charitable footwear program; and print, television, online and outdoor campaigns featuring our +Skechers Performance and Skechers lifestyle endorsees. These endorsees included television personality multi-platinum recording artist Demi Lovato, baseball legend Pete Rose, Brooke Burke-Charvet, Hall of Fame quarterbacks Joe Montana and Joe +Namath, Dallas Mavericks owner Mark Cuban, Dodgers baseball legend Tommy Lasorda, Olympians Kara Goucher and Meb Keflezighi, and legendary drummer and recording artist Ringo Starr. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and +grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s Skechers-branded product lines benefit from the Skechers reputation for contemporary and progressive +styling, quality, comfort and affordability. Our Performance lines benefit from our marketing, product development and manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately +by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide +array of Skechers-branded product lines for men, women, and children. Within these product lines, we also have numerous categories, many of which have developed into well-known names. Most of these categories are marketed and packaged with unique +shoe boxes, hangtags and in-store support. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Table of Contents +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Casuals, (ii) Dress Casuals, +(iii) Relaxed Fit from Skechers, (iv) Casual Fusion, and (v) seasonal sandals and boots. This category is generally sold through mid-tier retailers, department stores and some footwear specialty shops. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the +Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design — some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and +brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress +details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casual line for women is comprised of trend-influenced stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or +trim, and water-resistant materials. +• +Relaxed Fit from Skechers is a line of trend-right casuals with a wider toe box for men and women who want all-day comfort without compromising +style. Characteristics of the product line include comfortable outsoles, Skechers Memory Foam insoles and quality leather uppers. We market and package Relaxed Fit from Skechers styles in a unique shoe box that is distinct from other categories in +the Skechers USA line of footwear. +• +Our Casual Fusion line is comprised of low-profile, sport-influenced Euro casuals targeted to trend-conscious young men and women. The outsoles are +primarily rubber and adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles for our Casuals, Dress Casuals and +Casual Fusion lines, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials and faux fur and Sherpa +linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and +women includes: (i) Skechers Memory Foam styles, (ii) lightweight performance-inspired athletics, (iii) classic athletic-inspired styles and (iv) sport sandals and boots. Our Skechers Sport category is distinguished by its +technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Skechers Sport is typically sold through specialty shoe stores, department stores and athletic footwear retailers. +• +Skechers Memory Foam styles are designed with a high-volume memory foam insole that will contour to your foot and provide greater comfort. The +lightweight and ultra-soft looks also feature a flexible outsole and soft uppers, some of which feature bio-engineered mesh, soft knit fabrics, and stretchable woven materials. This category features bright, multi-colored and solid basic-colored +uppers. +• +Our lightweight performance-inspired athletics are designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, +weight, materials, design and construction of the outsoles. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features leather and trubuck uppers in both bright and classic athletic colors. +• +Classic athletic-inspired styles are core proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these +shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and boots are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our +sneakers with the addition of new technologies geared toward making a comfortable sport sandal. Sport sandals and boots are designed as seasonal footwear for the consumer who already wears our Skechers Sport sneakers. +3 +Table of Contents +Skechers Active and Skechers Sport Active. A natural companion to +Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-up, Mary Janes, sandals and +open back styles, is available in a multitude of colors as well as solid white or black, in fabrics, leathers and meshes, and with various closures – traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line +includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Memory Foam. Skechers Active and Skechers Sport Active shoes are typically available through specialty casual shoe stores and department stores. +BOBS from Skechers. The BOBS from Skechers line has grown into a year-round product offering with +the addition of vulcanized looks and an “at Home” line. Primarily marketed to young women, the BOBS collection also includes footwear for kids, and men to a smaller degree. BOBS are available at department stores, specialty shoe stores and +online retailers. +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede, and patterned +fabrics. Many styles now include Skechers Memory Foam. +• +BOBS vulcanized looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line +features both classic retro looks and fresh colors and materials for a relevant style. Many styles now include Skechers Memory Foam. +• +The BOBS at Home collection for women is designed with our flexible rubber Keepsakes outsole, and features faux fur linings for the ultimate dorm +or winter shoe. The uppers are primarily designed with tweeds, knits or suede. +• +The BOBS for Kids line is inspired by the successful women’s styles, designed with bright and patterned fabrics and embellished uppers for +girls. +• +BOBS for men features basic slip-on and lace-up canvas styles as well as vulcanized designs. Some styles include Skechers Memory Foam. +Skechers donates new shoes to children in need when consumers purchase BOBS. By the end of 2014, we had +donated over 10 million pairs primarily to SolesforSouls and Fashion Delivers, our charity donation partners, who in turn donate the shoes to various reputable charity organizations in the United States and around the world. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a +specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Design Team, the footwear utilizes the latest advancements in materials and innovative design, including an ultra-lightweight Resalyte +compound for the midsole and GOimpulse sensors for responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. The footwear is +available at athletic footwear retailers, department stores and specialty running stores. +• +Skechers GOrun. Skechers GOrun 4 and Skechers GOrun 3 are the latest in a collection of lightweight, flexible running shoes that +features a midfoot strike design for efficient running. Skechers GOrun Ride 4 and Skechers GOrun Ride 3 feature similar designs as its GOrun counterpart with enhanced cushioning for elevated comfort and support. Skechers GOrun Ultra offers +maximum cushioning with the most support making it perfect for distance or recovery runs. Skechers GOmeb Speed 3 is the high-performance racing shoe worn by elite marathon runner Meb. These flagship lines as well as other Skechers GOrun products are +marketed to serious runners and recreational runners alike. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual +slip-on. The product line features a lightweight and flexible design to promote natural foot movement when walking. Skechers GOwalk 3 incorporates more advanced performance technologies including a high-rebound GOga Mat insole, adaptive GO Pillars +on the outsole and Memory Form Fit for a custom-fit experience. Skechers GOwalk 2 incorporates more performance technologies with a unique V-Stride outsole designed specifically to promote a natural walking stride. Skechers on-the-GO footwear fuses +iconic designs and premium materials with Skechers Performance technologies for comfort and style. +4 +Table of Contents +• +Skechers GObionic. Designed for trail running, Skechers GObionic is engineered with 18 fully articulated bio-responsive zones that +offer flexibility, feel and ground conformity. A proprietary Resagrip outsole increases the durability to handle wear-and-tear from tougher terrain. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum +stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOgolf. Skechers GOgolf is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral +position that is low to the ground to promote a solid foundation while playing golf. A Resagrip outsole helps with traction control and a soft Resamax cushioned insole delivers comfort. +Skechers Kids +The +Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes and sneakers, (ii) Skechers Lightweight Sport, (iii) Skechers GOrun and Skechers GOwalk, +(iv) S-Lights, Hot Lights by Skechers and Luminators by Skechers, (v) Skechers Cali for Girls, (vi) Airators by Skechers, (vii) Skechers Super Z-Strap, (viii) Elastika by Skechers, (ix) Bella Ballerina by Skechers, +(x) Twinkle Toes by Skechers, (xi) Air-Mazing by Skechers, and (xii) Foamies by Skechers. +• +The Skechers Kids line includes embellishments or adornments such as fresh colors and fabrics from our Skechers adult shoes. Some of these styles +are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. +• +Skechers Lightweight Sport styles with Skechers Memory Foam are sneakers designed with many of the same meshes, knits and weaves as the adult +Skechers Sport styles in bright colors and patterns. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Skechers GOrun and Skechers GOwalk for boys and girls are casual adaptations of our popular Skechers Performance styles for the kids’ market, +designed in bright and bold colors for daily play. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +• +S-Lights, Hot Lights by Skechers and Luminators by Skechers are lighted sneakers and sandals for boys and girls. The S-Lights combine patterns of +lights on the outsoles and sides of the shoes while Hot Lights feature lights on the front of the toe to simulate headlights as well as on other areas of the shoes. Luminators by Skechers feature glowing green lights and a marketing campaign with +the Luminators character. +• +Skechers Cali for Girls is a line of sandals inspired by our women’s line of the same name with bright colors, textiles and adornments. +• +Airators by Skechers is a line of boys’ sneakers with a foot-cooling system designed to pump air from the heel through to the toes. The +product line is marketed with the character, Kewl Breeze. +• +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z” shaped closure system. The product line is marketed with +the character, Z-Strap. +• +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +• +Bella Ballerina by Skechers is a line of girls’ shoes with a disc that spins on the outsole, allowing girls to twirl like a ballerina. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also +include lights. The product line is marketed with the character, Twinkle Toes. +• +Air-Mazing by Skechers is a lightweight line of colorful sneakers designed for older boys. The product line is marketed with the character, +Air-Mazing Kid, who performs air tricks in his sneakers. +5 +Table of Contents +• +Foamies by Skechers is a colorful line of lightweight, flexible boys’ and girls’ sneakers constructed with Skechers Memory Foam that can +easily be washed in a washing machine. +Skechers Kids, Skechers Kids Memory Foam, Skechers GO for kids, +and Skechers Cali for Girls are comprised primarily of shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and +schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions +from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and +packaged separately with a distinct shoe box. Skechers Kids shoes are available at department stores and specialty and athletic retailers. +Skechers +Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and +athletic shoes, many of which may also include Skechers Memory Foam. The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and +slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature +breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of +high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, +hikers, athletics, casuals and clogs are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing +method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, as well as marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate new and exciting footwear in all of our product lines with contemporary and +progressive styles and comfort-enhancing performance features. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be fashionable and marketable to the 12- to 24-year-old consumer, while substantially all of our lines +appeal to the broader range of 5- to 50-year olds, with an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical +fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear +markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting +current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers from various sources, including the review and analysis of modern music, television, cinema, clothing, and other trend-setting media; +traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay +abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our +brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our +products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s +and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the +heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate +these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications +are created and forwarded to our manufacturers for a design prototype. The design prototypes are then sent back to our design teams. Our major retail customers +6 +Table of Contents +may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more +collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product +design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 — The Company and +Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and +Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of +managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A +of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we +believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2014, five of our contract +manufacturers accounted for approximately 58.9% of total purchases. One manufacturer accounted for 37.5%, and another accounted for 6.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with +the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open +purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us +additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers; however, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is +substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be +discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and +allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and +inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ +orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee +the key aspects of production from initial prototype manufacture through initial production runs to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through an +approximately 230-person staff working from our offices in China. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time and ensure timely delivery of +finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production +process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality +and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality +control personnel located in China perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various +stages of production and final products prior to shipment. Our employees are on site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on site during significant production runs or we +will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +7 +Table of Contents +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, +build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. The +focus of our marketing plan is print and television advertising, which is supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store support. In addition, we utilize celebrity endorsers +in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, +methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes +for our lifestyle lines, and technology with runners and athletes for our performance lines. Our ads are designed to provide merchandise flexibility and to facilitate the Skechers brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with +celebrities whom we believe will reach new markets. Our Skechers lifestyle endorsees Demi Lovato, Brooke Burke-Charvet, Mark Cuban, Joe Montana, Joe Namath, Pete Rose and Tommy Lasorda all appeared in advertising campaigns in 2014. Additionally, we +signed Mariano Riviera and Ringo Starr, who are set to appear in campaigns in 2015. Our Skechers Performance Division endorsees are elite runner and Olympic medalist Meb and elite runner Kara Goucher, who both appeared in marketing campaigns during +2014. Competing in Skechers GO speed footwear, Meb won the Boston Marathon in 2014. To launch our Skechers GO golf line, we signed leading golfer Matt Kuchar, who has and will continue to appear in marketing campaigns in 2015. From time to time, we +may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear regularly in popular fashion, lifestyle and pop culture publications, including +Runner’s World, Shape, Seventeen, Men’s Fitness, Women’s Fitness, Women’s Health, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar +with our brands. In 2014, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes. We also have many commercials for our performance lines that feature elite +athletes and for our lifestyle lines that feature retired athletes, musicians, and actors. We have found these to be a cost-effective way to advertise on key national and cable programming during high selling seasons. In 2014, many of our television +commercials were translated into multiple languages and aired in Brazil, Canada, the United Kingdom, France, the Benelux Region, Germany, Spain, Italy, Chile, Japan, Austria, Switzerland, China and Mexico, among other countries. +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from +work, we continued our outdoor campaign that included mall and telephone kiosks, billboards, and transportation systems in the Americas, Asia, the Middle East and across Europe. In addition, we advertised on perimeter boards at soccer matches in +several European countries. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Trend-Influenced Marketing/Public Relations. Our public relations objectives are to secure product placement in +key fashion and lifestyle magazines and television shows, place our footwear on the feet of trend-setting celebrities and their children, and gain positive and accurate press about our brands, our Company and our products. We have amassed an array +of prominent product placements in magazines including OK!, Us Weekly, Runner’s World and Competitor , and have been featured on leading business shows with interviews of our executives providing exposure of our brand to +consumers who might not be familiar with our products. In addition, our brands have been associated with cutting edge events and various celebrities. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings, and +relaying the latest news, we have built communities on Facebook, Twitter, and Instagram in the United States and in many countries around the world. The social platforms are divided into Skechers and Skechers Performance sites as well as a BOBS page +to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. +8 +Table of Contents +Promotions and Events. By applying creative sales techniques via a +broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers’ retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store +specials, charity events, product tie-ins and giveaways, and collaborations with national retailers and radio stations. In 2014, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with +Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2014, the Skechers Performance Division became the footwear and apparel sponsor for the Houston Marathon. Our products were made available to +consumers directly or through key accounts at many of these events. In addition, we partnered with many key accounts for BOBS donation events in cities throughout the United States, Puerto Rico and Spain, building both our relationships with these +accounts, as well as with the community as we donated footwear to children in need. +Visual Merchandising. +Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, +graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image as well as draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to +ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our +merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To better showcase our diverse products to footwear buyers in the United States and Europe and to +distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at WSA’s The Shoe Show, FFANY, ASR, MAGIC and Outdoor Retailer in the United States; GDS, MICAM, ISPO, Mess Around and +Who’s Next in Europe; and Couromoda and Francal in Brazil. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual +rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Internet. We promote and sell our brands through our domestic website, www.skechers.com , as well as our +foreign e-commerce sites, which enables fans and customers to shop, browse, find store locations, socially interact, post a shoe review, photo, video, or question and immerse themselves in our brands. Our website is a venue for dialog and feedback +from customers about our products which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have four reportable segments — domestic wholesale sales, international wholesale sales, retail sales and e-commerce +sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in +more than 160 countries and territories via our global network of distributors in addition to our subsidiaries in Asia, Europe, Canada and South America. Skechers owns and operates retail stores both domestically and internationally through three +integrated retail formats — concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. Twenty-three distributors and 15 licensees have opened 374 +distributor-owned or -licensed Skechers retail stores and 118 licensee-owned Skechers retail stores, respectively, in over 60 countries as of December 31, 2014. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: +department stores, specialty stores, athletic specialty shoe stores and independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of +wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each +of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing retail locations and new locations of each customer. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated +by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are +9 +Table of Contents +knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national +sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal customer base through exceptional customer service. We believe that our close +relationships with these accounts help us to maximize their retail sell-throughs. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise +personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts as well as to ensure that appropriate inventory levels are carried at each store. Such +information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale +customers and attract potential new wholesale customers. +Retail Stores. We pursue our retail store strategy +through our three integrated retail formats: the concept store, the factory outlet store and the warehouse outlet store. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a +broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2014, we upgraded the technologies in many of our stores, which provides visibility to our merchandise in other +stores and at our distribution center in order to better serve our customers with an omnichannel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess +potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, +we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 15, 2015, we owned and operated 119 concept stores, 146 +factory outlet stores and 98 warehouse outlet stores in the United States, and 51 concept stores, 33 factory outlet stores, and three warehouse outlet stores internationally. During 2015, we plan to open 50 to 60 new stores. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in +metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer +carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations +are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, Union Square and 34th Street in New York, +Powell Street in San Francisco, Hollywood and Highland in Hollywood, Santa Monica’s Third Street Promenade, Ala Moana Center in Hawaii and Las Vegas’ Fashion Show Mall. International locations include Westfield London and Westfield +Stratford in London, Buchanan Street in Glasgow, Toronto’s Eaton Centre, Vancouver’s Pacific Centre, and Kalverstraat Street in Amsterdam. The stores are typically designed to create a distinctive Skechers look and feel, and enhance +customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback +derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns +and allowances. +The typical Skechers concept store is approximately 2,500 square feet, although in certain +markets we have opened concept stores as large as 7,800 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, South +America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If +we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name +has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +10 +Table of Contents +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the +United States. In addition, we have 33 international factory outlet stores – seven each in England and Canada, four in Spain, three each in Chile and Japan, two each in Germany and Italy, and one each in Austria, the Netherlands, Portugal, +Wales and Scotland. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the +Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,400 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail +price points. +• +Warehouse Outlet Stores +Our free-standing warehouse outlet stores, which are primarily located throughout the United States, enable us +to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 5,000 to +24,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek +to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and joint venture stores are as follows: +December 31, 2013 +December 31, 2014 +Number of Store +Locations +Opened during 2014 +Closed during 2014 +Number of Store +Locations +Domestic stores +Concept +123 +2 +(5 +) +120 +Factory Outlet +130 +17 +(1 +) +146 +Warehouse Outlet +68 +29 +(1 +) +96 +Domestic stores total +321 +48 +(7 +) +362 +International stores +Concept +43 +9 +(1 +) +51 +Factory Outlet +26 +7 +— +33 +Warehouse Outlet +— +3 +— +3 +International stores total +69 +19 +(1 +) +87 +Joint venture stores +China Concept +18 +9 +(3 +) +24 +China Factory Outlet +17 +7 +(3 +) +21 +Hong Kong Concept +20 +3 +— +23 +South East Asia Concept +19 +— +— +19 +Joint venture stores total +74 +19 +(6 +) +87 +Joint venture shop-in-shops +China +135 +80 +— +215 +Hong Kong +12 +— +(1 +) +11 +South East Asia +72 +15 +(6 +) +81 +Joint venture shop-in-shops total +219 +95 +(7 +) +307 +Total domestic, international and joint venture stores and shop-in-shops +683 +181 +(21 +) +843 +11 +Table of Contents +International Wholesale. Our products are sold in more than 160 +countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores in Canada, France, Germany, Spain, Portugal, +Italy, Switzerland, Austria, Malaysia, Thailand, Singapore, Hong Kong, China, Japan, India, the Benelux Region, the United Kingdom, Brazil and Chile through our subsidiaries and joint ventures; (ii) sales to foreign distributors who distribute +our footwear to department stores and specialty retail stores in countries and territories across Eastern Europe, Asia, Central America, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from +licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that +international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which +we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently distribute product in most of Western Europe through the following subsidiaries: Skechers USA +Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and +showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; and Skechers USA Italia S.r.l., with its offices +and showrooms in Milan, Italy. Skechers-owned retail stores in Europe include 12 concept stores and 20 factory outlet stores located in 10 countries. +To accommodate our European subsidiaries’ operations, we operate an approximately 490,000 square-foot +distribution center in Liege, Belgium. During 2014, we completed the initial phase of automation upgrades of our European Distribution Center equipment, allowing us to more efficiently receive and ship product to our subsidiaries and retail stores +throughout Europe. Also in 2014, we agreed to lease an additional 290,000 square foot adjoining facility which we expect to occupy by the end of 2015. This additional space will consolidate off-site storage facilities into a single on-site location +that will further increase efficiencies and offer storage capacity of up to four million pairs of shoes. +Canada +Merchandising and marketing of our product in Canada is managed by our wholly-owned subsidiary, Skechers USA +Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. In 2014, we transitioned three licensed stores to +company-owned locations. We have 12 concept stores, seven factory outlet stores, and three warehouse outlet stores. +Brazil +Merchandising and marketing of our product in Brazil is managed by our wholly-owned subsidiary, Skechers Do +Brasil Calcados LTDA, with its offices located in Sao Paulo, Brazil. Product sold in Brazil is primarily shipped directly from our contract manufacturers’ factories in Vietnam and occasionally from China. +Chile +Our wholly-owned subsidiary, Comercializadora Skechers Chile Limitada, with its offices and showrooms located +in Santiago, Chile supports our 29 retail stores and wholesale accounts in Chile. Product sold in Chile is primarily shipped directly from our contract manufacturers’ factories in China and occasionally from Vietnam. +12 +Table of Contents +Japan +Merchandising and marketing of our product in Japan is managed by our wholly-owned subsidiary, Skechers Japan +GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have one concept store in Osaka and three factory outlet stores, one each in +Osaka, Narita and Toki. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that +generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Shanghai, Beijing, Guangzhou, +Xiamen, Hong Kong, Macau, and other cities. These joint ventures are included in our consolidated financial statements. +Malaysia and +Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that generate net sales +in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Singapore, Kuala Lumpur, Penang and other cities. +These joint ventures are included in our consolidated financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and a 49% interest in Skechers Retail India +Private Limited, which are both joint ventures, that generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key +locations in Mumbai, New Delhi, and Pune. These joint ventures are included in our consolidated financial statements. +13 +Table of Contents +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is +distributed through an extensive network of more than 30 distributors who sell our products to department, athletic and specialty stores in more than 160 countries around the world. As of December 31, 2014, we also had agreements with 23 of +these distributors and 15 licensees regarding 374 distributor-owned or -licensed Skechers retail stores and 118 licensee-owned Skechers retail stores, respectively, that are open in over 60 countries. Our distributors and licensees own and operate +the following retail stores: +December 31, 2013 +December 31, 2014 +Number of Store +Locations +Opened during 2014 +Closed during 2014 +Number of Store +Locations +Distributor and licensee stores +North America Concept +36 +12 +(4 +) +44 +North America Factory Outlet +8 +5 +(2 +) +11 +Central America Concept +8 +2 +— +10 +Central America Factory Outlet +1 +— +— +1 +South America Concept +39 +2 +(15 +) +26 +South America Factory Outlet +1 +— +— +1 +Africa Concept +15 +11 +— +26 +Asia Concept +169 +50 +(5 +) +214 +Asia Factory Outlet +16 +4 +(2 +) +18 +Australia/New Zealand Concept +11 +10 +— +21 +Australia/New Zealand Factory Outlet +11 +1 +(1 +) +11 +Europe Concept +33 +28 +(1 +) +60 +Europe Factory Outlet +3 +2 +(1 +) +4 +Middle East Concept +36 +11 +(4 +) +43 +Middle East Factory Outlet +1 +1 +— +2 +Total distributor and licensee stores +388 +139 +(35 +) +492 +Distributor and licensee shop-in-shops +International shop-in-shops +2,258 +— +(366 +) +1,892 +Total Distributor and licensee stores and shop-in-shops +2,646 +139 +(401 +) +2,384 +Distributors and licensees are responsible for their respective stores’ operations, have +ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and +materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to +foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +Electronic Commerce. Our domestic website, www.skechers.com , as well as our foreign e-commerce sites, are +virtual storefronts that promote the Skechers brands. Our websites are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our +footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience. These websites are an additional efficient and effective retail distribution channel, and has improved our customer service. +14 +Table of Contents +For disclosure of financial information about geographic areas and segment +information for our four reportable segments – domestic wholesale sales, international wholesale sales, retail sales and e-commerce sales — see Note 13 — Segment Information in the consolidated financial statements included in this +annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and +enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with +licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with +reputable non-footwear brands to design and market their footwear. +As of January 31, 2015, we had 25 active domestic +and international licensing agreements in which we are the licensor. These include Skechers branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear and watches, Skechers Performance sport apparel, socks and wearable +technology, BOBS from Skechers apparel, and Twinkle Toes apparel, dolls, toys, and fashion accessories. We have international licensing agreements for the design and distribution of men’s and women’s apparel in Chile, Israel, the +Philippines, the United Kingdom, and South Korea; bags, backpacks and luggage in Mexico; and watches in the Philippines. +DISTRIBUTION FACILITIES AND +OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our +products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximately 490,000 square-foot +European Distribution Center (“EDC”) located in Liege, Belgium, (iii) our company operated distribution centers or third-party distribution centers in South America and Asia or (vi) directly from third-party manufacturers to our +other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to +customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, +and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system, or EDI system, to which some of our larger customers are linked. This system allows these customers to automatically +place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, +2014, our backlog was $988.7 million, compared to $616.1 million as of December 31, 2013. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to the weakened +U.S. economy and shifting footwear trends. For a variety of reasons, including changes in the economy, customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards +tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both +registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 124 foreign countries. We also have design patents and pending design and +utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally where necessary to protect valuable +intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in the marketing of our products. We vigorously protect our trademarks against infringement, including +through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, +copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we +15 +Table of Contents +believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our +intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, +violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if +proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention to and legal costs +associated with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have +been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, +as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful or the costs associated with protecting our rights in +certain jurisdictions may be prohibitive. From time to time we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to +establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as violating trademarks and intellectual +property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the +Skechers brand, result in the shift of consumer preferences away from our products and generally have a material adverse effect on our business, financial condition and results of operations. +COMPETITION +The footwear +industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as +with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor +Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., +adidas AG, Reebok International Ltd., Puma AG, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the +markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including Payless Holdings, and +with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other +considerations. These and other competitors pose challenges to our market share in our major domestic markets and may make it more difficult to establish our products in Europe, Asia and other international regions. We also compete with numerous +manufacturers, importers and distributors of footwear for the limited shelf space available for the display of such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market +entrants. Many of our competitors are larger, have been in existence for a longer period of time, have achieved greater recognition for their brand names, have captured greater market share and/or have substantially greater financial, distribution, +marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial +condition and results of operations. +EMPLOYEES +As of January 31, 2015, we employed 7,772 persons, 2,944 of whom were employed on a full-time basis and 4,828 of whom were +employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +16 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/item13.txt b/raw/filings/0001065837/2014/0001193125-15-068511/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..3587f06e46f3b452632658ab53fef298fb8441f4 --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be +filed pursuant to Regulation 14A within 120 days after the end of our 2014 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/item9a.txt b/raw/filings/0001065837/2014/0001193125-15-068511/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..358df4854df61bc1826c5ba6aa471c4393d1cd13 --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/item9a.txt @@ -0,0 +1,74 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on +Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange +Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a +company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required +disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and +operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of +such time. +MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term +is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally +accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have +a material effect on our financial statements. +We conducted an evaluation of the effectiveness of our +internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the +framework in Internal Control — Integrated Framework (2013), our management has concluded that as of December 31, 2014, our internal control over financial reporting is effective. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this +annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2014, which is set forth below. +INHERENT LIMITATIONS ON EFFECTIVENESS OF CONTROLS +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls +and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control +system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in +all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent +limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more +people, or by management override of the controls. The design of any system of controls is based in part +73 +Table of Contents +on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. +Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or +procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely +to materially affect, our internal controls over financial reporting during the fourth quarter of 2014. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +74 +Table of Contents +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers +U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations +of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal +control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial +reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board +(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an +understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of +financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that +(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as +necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors +of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of +any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries maintained, in all material respects, effective internal control over financial +reporting as of December 31, 2014, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public +Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of earnings, comprehensive income, equity, +cash flows, and schedule for each of the three years in the period ended December 31, 2014, and our report dated February 27, 2015 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 27, 2015 +75 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/rp_note.txt b/raw/filings/0001065837/2014/0001193125-15-068511/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2014/0001193125-15-068511/rpt_disclosure.txt b/raw/filings/0001065837/2014/0001193125-15-068511/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..02e21da56fff32c7b1df407ca71af8371e18dfe9 --- /dev/null +++ b/raw/filings/0001065837/2014/0001193125-15-068511/rpt_disclosure.txt @@ -0,0 +1,35 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and +executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in our Code of Business Conduct and Ethics), (ii) past and proposed +transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ +expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person +Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any +indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct +or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is any (a) person who is or was (since the beginning of the last fiscal year +for which we have filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) greater than five percent beneficial owner of our +Class A or Class B Common Stock or (c) immediate family member of either of the foregoing. +Certain categories of +transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with +Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction shall be considered and, if the Committee determines it to be +appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally +available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member shall participate in any discussion or approval of a transaction with +a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall +review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2014. Each of these transactions was +reviewed, and approved or ratified by the Audit Committee, pursuant to the policies and procedures discussed herein. +Related Person +Transactions +Michael Greenberg owns a 12% beneficial ownership interest in Manhattan Inn Operating Company, LLC +(“MIOC”), the primary business of which is to own and operate the Shade Hotel in Manhattan Beach, California. David Weinberg, who is our Chief Operating Officer, Chief Financial Officer, Executive Vice President and a member of our Board +of Directors, and Michael Greenberg’s brothers Jeffrey Greenberg, who is a director of Skechers, and Jason Greenberg and Joshua Greenberg, all of whom are senior vice presidents of Skechers, own in aggregate a 17% beneficial ownership interest +in MIOC. During 2014, we paid approximately $160,000 to the Shade Hotel for lodging, food and events that were held there including our annual holiday party. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of +Skechers, and they earned total compensation of $548,593, $3,371,164 (which includes the fair value of an award +36 +of 40,000 shares of restricted stock), $2,904,783 (which includes the fair value of an award of 40,000 shares of restricted stock) and $285,778, respectively, in 2014. Jeffrey Greenberg was also +a member of our Board of Directors in 2014, but did not earn any additional compensation for services provided as a director. +Andrew Weinberg, who is the son of David Weinberg, is a non-executive employee of Skechers, and he earned total compensation of +$1,017,014 (which includes an award of 12,000 shares of restricted stock) in 2014. +37 \ No newline at end of file diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/filing.txt b/raw/filings/0001065837/2015/0001564590-16-013515/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..952e32869b0ce06032871d7edee0c74bc6c5ac3b --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/filing.txt @@ -0,0 +1,3685 @@ +10-K +1 +skx-10k_20151231.htm +10-K +skx-10k_20151231.htm +c +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2015 +OR +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-4376145 +(State or Other Jurisdiction of +Incorporation or Organization) +(I.R.S. Employer +Identification No.) +228 Manhattan Beach Blvd., Manhattan Beach, California +90266 +(Address of Principal Executive Offices) +(Zip Code) +Registrant’s telephone number, including area code: (310) 318-3100 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Class A Common Stock, $0.001 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: +None +(Title of Class ) +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +x +Accelerated filer +o +Non-accelerated filer +o +Smaller reporting company +o +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x +As of June 30, 2015, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the Registrant was approximately $4.56 billion based upon the closing price of $36.60 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2016: 130,675,283. +The number of shares of Class B Common Stock outstanding as of February 15, 2016: 25,652,991. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2016 Annual Meeting of the Stockholders of the Registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended december 31, 2015 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +15 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +22 +ITEM 2. +PROPERTIES +22 +ITEM 3. +LEGAL PROCEEDINGS +23 +ITEM 4. +MINE SAFETY DISCLOSURES +25 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +26 +ITEM 6. +SELECTED FINANCIAL DATA +28 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +29 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +43 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +45 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +71 +ITEM 9A. +CONTROLS AND PROCEDURES +71 +ITEM 9B. +OTHER INFORMATION +74 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +74 +ITEM 11. +EXECUTIVE COMPENSATION +74 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +74 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +74 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +74 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +74 +This annual report includes our trademarks, including Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Hot Lights ® , Twinkle Toes ® , each of which is our property. This report contains additional trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected 2016 results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +· +international economic, political and market conditions including the uncertainty of the China markets and of sustained recovery in our European markets; +· +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +· +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +· +our ability to sustain, manage and forecast our costs and proper inventory levels; +· +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +· +our ability to continue to manufacture and ship our products that are sourced in China, which could be adversely affected by various economic, political or trade conditions, or a natural disaster in China; +· +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; +· +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers GO brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2016, we owned and operated 119 concept stores, 155 factory outlet stores and 117 warehouse outlet stores in the United States, and 82 concept stores, 41 factory outlet stores, and five warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our youthful brand image and fashion-forward designs, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2015, our Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television campaigns featuring our own action heroes and characters; marathons and other events for our Skechers Performance Division; donation events surrounding our BOBS from Skechers charitable footwear program; and print, television, online and outdoor campaigns featuring our Skechers Performance and Skechers lifestyle endorsees. These endorsees included globally known recording artists Demi Lovato and Ringo Starr; sports legends Sugar Ray Leonard, Pete Rose, Joe Montana, Joe Namath and Mariano Rivera; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb Keflezighi and Kara Goucher; and professional golfers Matt Kuchar, Belen Mozo, Billy Andrade and Colin Montgomerie. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s Skechers-branded product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development and manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded product lines for men, women and children. Within these product lines, we also have numerous categories, many of which have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Relaxed Fit from Skechers, (ii) Dress Casuals/Modern Comfort, (iii) Casuals, (iv) Casual Fusion, and (v) seasonal sandals and boots. This category is generally sold through mid-tier retailers, department stores and some footwear specialty shops. +· +Relaxed Fit from Skechers is a line of trend-right casuals with a wider toe box for men and women who want all-day comfort without compromising style. Characteristics of the product line include comfortable outsoles, Skechers Memory Foam insoles and quality leather uppers. We market and package Relaxed Fit from Skechers styles in a unique shoe box that is distinct from other categories in the Skechers USA line of footwear. +· +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casual line—also referred to as the Modern Comfort collection—for women is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +· +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +· +Our Casual Fusion line is comprised of low-profile, sport-influenced casuals targeted to trend-conscious young men and women. The outsoles are primarily rubber and adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +· +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles for our Dress Casuals, Casuals and Casual Fusion lines, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles and (iii) sport sandals and boots. Many Skechers Sport styles are enhanced with comfort features such as high-volume Skechers Memory Foam insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Skechers Sport is typically sold through specialty shoe stores, department stores and athletic footwear retailers. In addition to the standard Skechers Sport lines, a collection of licensed Star Wars ™ Skechers footwear for men features characters and designs inspired by the popular film saga. This collection was packaged in a unique box separate from the Skechers Sport collection. +· +Our lightweight sport athletic-inspired product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, materials, design and construction of the outsoles. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features leather and trubuck uppers in both bright and classic athletic colors. +· +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +· +Our sport sandals and boots are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making a comfortable sport sandal. Sport sandals and boots are designed as seasonal footwear for the consumer who already wears our Skechers Sport sneakers. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Memory Foam. Skechers Active and Skechers Sport Active shoes are typically available through specialty casual shoe stores and department stores. +3 +BOBS from Skechers. The BOBS from Skechers line has grown into a year-round product offering with the addition of vulcanized looks and an “At Home” line. Primarily designed for women, the BOBS collection is also available for girls. BOBS are available at department stores, specialty shoe stores and online retailers. +· +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. Many styles now include Skechers Memory Foam. +· +BOBS vulcanized looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. Many styles now include Skechers Memory Foam. +· +The BOBS at Home collection for women is designed with our flexible rubber Keepsakes outsole, and features faux fur linings for the ultimate dorm or winter shoe. The uppers are primarily designed with tweeds, knits or suede. +When consumers purchase BOBS, Skechers donates funds to help save dogs’ and cats’ lives, and new shoes for children in need. In 2015, Skechers announced that up to three million dollars will be donated to help support Best Friends Animal Society ® , an organization focused on stopping the euthanizing of nearly four million pets annually in shelters across America. For children, more than 13 million pairs of new shoes have been donated primarily to charity partners SolesforSouls and Fashion Delivers since the program’s launch. The organizations donate the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. The Mark Nason Collection includes a wide range of on-trend casual, dress and active styles for style-conscious men: Mark Nason Skechers, a low-profile collection of casuals for everyday wear; Mark Nason Los Angeles Collection, casual sneakers for the active male; and the Mark Nason Dress Collection, dress shoes crafted with high-quality leathers and exquisite detailing. Many styles feature Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. The offering is available at Skechers retail stores and www.skechers.com . +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Design Team, the footwear utilizes the latest advancements in materials and innovative design, including an ultra-lightweight Resalyte compound for the midsole and GOimpulse sensors for responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. The footwear is available at athletic footwear retailers, department stores and specialty running stores. +· +Skechers GOrun. Skechers GOrun 4 and Skechers GOrun 3 are the latest in a collection of lightweight, flexible running shoes that features a midfoot strike design for efficient running. Skechers GOrun Ride 4 and Skechers GOrun Ride 3 feature similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Ultra offers maximum cushioning with the most support, making it perfect for distance or recovery runs. Skechers GOmeb Speed 3 is the high-performance racing shoe worn by elite marathon runner Meb. These flagship lines as well as other Skechers GOrun products are marketed to serious runners and recreational runners alike. +· +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on. The product line features a lightweight and flexible design to promote natural foot movement when walking. Skechers GOwalk 2 offers a unique V-Stride outsole and the latest Skechers GOwalk 3 collection incorporates more advanced performance technologies including a high-rebound Goga Mat insole, adaptive GO Pillars on the outsole and Memory Form Fit for a custom-fit experience. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +· +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +· +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A Resagrip outsole helps with traction control and a soft Resamax cushioned insole delivers comfort. Skechers GO GOLF Pro, the official shoe of PGA golfer Matt Kuchar, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes and sneakers, (ii) Skechers Lightweight Sport, (iii) Skech-Air by Skechers, (iv) Twinkle Toes and Twinkle Wishes by Skechers, (v) Skechers Cali for Girls, (vi) Airators by Skechers, (vii) Skechers Super Z-Strap, (viii) Elastika by Skechers, (ix) Skechers GOrun and Skechers GOwalk, (x) S-Lights, Hot Lights by Skechers and Luminators by Skechers, (xi) Mega Flex, (xii) Air-Mazing by Skechers, (xiii) Foamies by Skechers and (xiv) Game Kicks. +· +The Skechers Kids line includes embellishments or adornments such as fresh colors and fabrics from our Skechers adult shoes. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. +· +Skechers Lightweight Sport styles with Skechers Memory Foam are sneakers designed with many of the same meshes, knits and weaves as the adult Skechers Sport styles in bright colors and patterns. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +· +Skech-Air by Skechers for boys and girls are athletic sneakers with a unique visible air-cushioned outsole and a gel-infused memory foam insole. +· +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character, Twinkle Toes. Twinkle Wishes adds a magical light and sound feature that is activated when the toes are tapped together. +· +Skechers Cali for Girls is a line of sandals inspired by our women’s line of the same name with bright colors, textiles and adornments. +· +Airators by Skechers is a line of boys’ sneakers with a foot-cooling system designed to pump air from the heel through to the toes. The product line is marketed with the character, Kewl Breeze. +· +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system. The product line is marketed with the character, Z-Strap. +· +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +· +Skechers GOrun and Skechers GOwalk for boys and girls are casual adaptations of our popular Skechers Performance styles for the kids’ market, designed in bright and bold colors for daily play. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +· +S-Lights, Hot Lights by Skechers and Luminators by Skechers are lighted sneakers and sandals for boys and girls. The S-Lights combine patterns of lights on the outsoles and sides of the shoes while Hot Lights feature lights on the front of the toe to simulate headlights as well as on other areas of the shoes. Luminators by Skechers feature glowing green lights and a marketing campaign with the Luminators character. +· +Mega Flex is a line of athletic sneakers for boys based on a robot character. Styles include fun embellishments like heel springs or an articulated bladed outsole in the Mega Blades collection. +· +Air-Mazing by Skechers is a lightweight line of colorful sneakers designed for older boys. The product line is marketed with the character, Air-Mazing Kid, who performs air tricks in his sneakers. +· +Foamies by Skechers is a colorful line of lightweight, flexible boys’ and girls’ sneakers constructed with Skechers Memory Foam that can easily be washed in a washing machine. +· +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. +Skechers Kids lines are comprised primarily of shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. Skechers Kids shoes are available at department stores and specialty and athletic retailers. In addition to the standard Skechers Kids’ lines, a collection of licensed Star Wars ™ Skechers footwear for boys features characters and designs inspired by the popular film saga. This collection was packaged in a unique box separate from the Skechers Kids collection. +5 +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam. The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative on-trend and classic footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be fashionable and marketable to the 12- to 24-year-old consumer, while substantially all of our lines appeal to the broader range of 5- to 50-year olds, with an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1-The Company and Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +6 +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while co ntrolling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2015, five of our contract manufacturers accounted for approximately 56.5% of total purch ases. One manufacturer accounted for 31.5%, and another accounted for 9.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0.3% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department, and in Asia through an approximately 320-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes for our lifestyle lines, and technology with runners and athletes for our performance lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. Our Skechers lifestyle endorsees include Demi Lovato, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Joe Namath, and Pete Rose. We also signed Ringo Starr, Sugar Ray Leonard and Mariano Riviera, all of +7 +whom appeared in campaigns in 2015. Our Skechers Performance Division endorsees are elite runner and Olympic medalist Meb and elite runner Kara Goucher, who both appeared in marketing campaigns during 2015. To support our Skechers GO GOLF line, we launched a campaign with professional golfer Matt Kuchar, and signed Belen Mozo, Billy Andrade and Colin Montgomerie to appear in campaigns in 2016. Additionally, we signed pop superstar Meghan Trainor to a global agreement in 2015, with her campaign laun ching in 2016. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear regularly in popular fashion, lifestyle and pop culture publications, including Runner's World, Shape, Seventeen, Men's Fitness, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2015, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also have many commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature retired athletes, musicians and actors. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2015, many of our television commercials were translated into multiple languages and aired in Brazil, Canada, the United Kingdom, France, Mexico, Germany, Spain, Italy, Chile, Japan, Austria, Switzerland, the Philippines and across the Middle East, among other countries and regions. +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, we continued our outdoor campaign that included mall and telephone kiosks, billboards, and transportation systems in the Americas, Asia, the Middle East and across Europe. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in several European countries, Canada and Mexico. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting celebrities and their children. We have been featured on leading business shows with interviews of our executives discussing the Company’s business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites, and seeded our footwear to celebrities and influencers who have appeared in magazines, online sites and social media pages in our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and countries around the world where are product is sold. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2015, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance-branded booths to allow runners the ability to try on and often buy our products. In 2015, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, and became the title sponsor of The Skechers Performance Los Angeles Marathon, which saw the first Skechers-branded event in 2016. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with many key accounts for BOBS donation events in cities throughout the United States, Puerto Rico and Spain, building both our relationships with these accounts, as well as with the community as we donated footwear to children in need. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate +8 +with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these effort s help stimulate impulse sales and repeat purchases. +Trade Shows. To better showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, Platform, The Licensing Show and Outdoor Retailer in the United States; GDS, MICAM, and ISPO in Europe; and many other international shows. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Internet. We promote and sell our brands through our domestic website, www.skechers.com , as well as our foreign e-commerce sites in Chile, Germany and the United Kingdom, among other countries. This enables consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. Our website is a venue for dialog and feedback from customers about our products which enhances the Skechers brand experience while driving sales through all our retail channels. In addition, in 2015 we launched the Skechers shopping mobile app. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 160 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, twenty distributors and 16 licensees have opened and operate 413 distributor-owned or -licensed Skechers retail stores and 250 licensee-owned Skechers retail stores, respectively, in over 60 countries as of December 31, 2015. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores and independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal customer base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-throughs. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: the concept store, the factory outlet store and the warehouse outlet store. Our domestic website, www.skechers.com , as well as our foreign e-commerce sites, are virtual storefronts that promote the Skechers brands. Our websites are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience. These websites are an +9 +additional efficient and effective retail distribution channel, which has improved our customer service. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess potent ial impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the u seful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 15, 2016, we owned and operated 119 concept stores, 155 factory outlet stores and 1 17 warehouse outlet stores in the United States, and 82 concept stores, 41 factory outlet stores, and five warehouse outlet stores internationally. During 2015, we took over the operations of 15 international concept stores and two international outlet sto res from our distributor in Panama. During 2016, we plan to open 55 to 65 new stores. +· +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square (with a second location opened in 2015), 5 th Avenue, Union Square, Roosevelt Field Mall, and 34th Street in New York, Powell Street in San Francisco, Hollywood and Highland in Hollywood, Santa Monica’s Third Street Promenade, Ala Moana Center in Hawaii and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mall. International locations include Westfield London and Westfield Stratford in London, Buchanan Street in Glasgow, Princes Street in Edinburgh, Toronto’s Eaton Centre, Vancouver’s Pacific Centre, the Shinsaibashi shopping district of Osaka and Kalverstraat Street in Amsterdam. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,400 square feet, although in certain markets we have opened concept stores as large as 7,800 square feet or as small as 1,500 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +· +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 41 international factory outlet stores – nine in England, eight in Canada, four each in Chile and Spain, three in Japan, two each in Austria, Germany and Italy, and one each in Colombia, the Netherlands, Panama, Poland, Portugal, Scotland and Wales. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,000 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +· +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,400 to 30,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers +10 +brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we wan t to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store +Locations +Opened during +Closed during +Number of Store +Locations +December 31, 2014 +2015 +2015 +December 31, 2015 +Domestic stores +Concept +120 +5 +(6 +) +119 +Factory Outlet +145 +11 +(1 +) +155 +Warehouse Outlet +97 +19 +— +116 +Domestic stores total +362 +35 +(7 +) +390 +International stores +Concept +51 +31 +(1 +) +81 +Factory Outlet +33 +8 +— +41 +Warehouse Outlet +3 +2 +— +5 +International stores total +87 +41 +(1 +) +127 +Joint venture stores +China Concept +24 +10 +(2 +) +32 +China Factory Outlet +18 +5 +(3 +) +20 +Hong Kong Concept +24 +5 +— +29 +Hong Kong Outlet +— +— +— +— +South East Asia Concept +18 +4 +(1 +) +21 +South East Asia Outlet +— +— +— +— +India Concept +18 +12 +(1 +) +29 +India Outlet +2 +— +(1 +) +1 +Joint venture stores total +104 +36 +(8 +) +132 +Total domestic, international and joint +venture stores +553 +112 +(16 +) +649 +International Wholesale. Our products are sold in more than 160 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia, as well as through our subsidiaries in Central America, Europe, Japan, North America and South America; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +· +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. Skechers-owned retail stores in Europe include 15 concept stores and 24 factory outlet stores located in 12 countries. +11 +To acco mmodate our European subsidiaries’ operations, we operate an approximately 780,000 square-foot distribution center in Liege, Belgium. During 2015, we completed the third phase of automation upgrades of our European Distribution Center equipment, allowing u s to more efficiently receive and ship product to our subsidiaries and retail stores throughout Europe. In 2016, we plan to complete the fourth expansion phase, bringing our European facility to one million square-feet. The additional space that we added i n 2015 will consolidate off-site storage facilities into a single on-site location that will further increase efficiencies and offer storage capacity of up to four million pairs of shoes. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have 15 concept stores, eight factory outlet stores, and five warehouse outlet stores. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. Our retail stores are in key locations in Osaka, Tokyo, and other cities. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Shanghai, Beijing, Guangzhou, Hong Kong, Macau and other cities. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Singapore, Kuala Lumpur, Petaling Jaya and other cities. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and a 49% interest in Skechers Retail India Private Limited, which are both joint ventures, that generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Bangalore, Mumbai, New Delhi and other cities. These joint ventures are consolidated in our financial statements. +12 +· +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 25 distributors who sell our products to department, athletic and specialty stores in more than 75 countries around the world. As of December 31, 2015, we also had agreements with 19 of these distributors and 17 licensees regarding 413 distributor-owned or -licensed Skechers retail stores and 250 licensee-owned Skechers retail stores, respectively, that are open in over 65 countries. Our distributors and licensees own and operate the following retail stores: +Number of Store +Locations +Opened during +Closed during +Number of Store +Locations +December 31, 2014 +2015 +2015 +December 31, 2015 +Distributor and licensee stores +North America Concept +46 +7 +— +53 +North America Factory Outlet +12 +2 +— +14 +Central America Concept +8 +2 +(7 +) +3 +Central America Factory Outlet +1 +1 +(2 +) +— +South America Concept +26 +7 +(13 +) +20 +South America Factory Outlet +1 +— +(1 +) +— +Africa Concept +26 +5 +— +31 +Asia Concept +193 +98 +(22 +) +269 +Asia Factory Outlet +18 +55 +(2 +) +71 +Australia/New Zealand Concept +20 +10 +— +30 +Australia/New Zealand Factory Outlet +11 +— +— +11 +Europe Concept +63 +36 +(5 +) +94 +Europe Factory Outlet +4 +1 +— +5 +Middle East Concept +43 +17 +(1 +) +59 +Middle East Factory Outlet +2 +1 +— +3 +Total distributor and licensee stores +474 +242 +(53 +) +663 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 17 – Segment Information in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 15, 2016, we had 25 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear, fitness, yoga and running accessories, work accessories and watches, Skechers Sport apparel, BOBS from Skechers apparel, and Twinkle Toes dolls, toys backpacks, lunchboxes, do-it-yourself fashion kits and fashion accessories. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in Chile, Israel, the Philippines, the United Kingdom and South Korea; socks in France; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 780,000 square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central American, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, 2015 our backlog was $1.08 billion, compared to $988.7 million as of December 31, 2014. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to the weakened U.S. economy and shifting footwear trends. For a variety of reasons, including changes in the economy, customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 128 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition and results of operations. +14 +COMPETITION +The footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in our major domestic markets, and may make it more difficult to establish our products in Europe, Asia and other international regions. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Many of our competitors are larger, have been in existence for a longer period of time, have achieved greater recognition for their brand names, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +EMPLOYEES +As of January 31, 2016, we employed approximately 9,200 persons, of whom approximately 3,600 were employed on a full-time basis and approximately 5,600 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition and results of operations could be materially and adversely affected. +15 +Our Future S uccess Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +· +substantial investment in product innovation, design and development; +· +commitment to product quality; and +· +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition and results of operations could be materially and adversely affected. +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results and financial condition. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our net sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this +16 +risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale sales during 2015 or 2014. However, this may change in the future, and fluctuations in sales of any style representing a significant portion of our future net sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state continues to negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of net sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. There could be a number of follow-on effects from the credit crisis on our business, including insolvency of certain of our key distributors, which could impair our distribution channels, or our significant customers, including our distributors, may experience diminished liquidity or an inability to obtain credit to finance purchases of our product. Our customers may also experience weak demand for our products or other difficulties in their businesses. If conditions in the global financial markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations and financial condition. +We Depend Upon A Relatively Small Group Of Customers For A Large Portion Of Our Sales. +During 2015, 2014 and 2013, our net sales to our five largest customers accounted for approximately 14.6%, 15.7% and 18.1% of total net sales, respectively. No customer accounted for more than 10.0% of our net sales during 2015, 2014 and 2013. As of December 31, 2015, one customer accounted for 10.6% of trade receivables. No other customer accounted for more than 10.0% of trade receivables at December 31, 2015 and 2014. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest sales generally occurring in our second and third quarters for the back-to-school selling season. Back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers could negatively impact our net sales and results of operations for our second or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future net sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +17 +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is hi ghly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factor s, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analy sts and investors could cause a decrease in the trading price of our Class A Common Stock. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China, Which Could Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our net sales during the year ended December 31, 2015 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations or financial condition. +In particular, because most of our products are manufactured in China, the possibility of adverse changes in trade or political relations with China, political instability in China, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China, or the outbreak of a pandemic disease in China could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. +The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions may be imposed on the importation of our products in the future. Such actions could result in increases in the cost of our products generally and might adversely affect the sales and profitability of Skechers and the imported footwear industry as a whole. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During 2015 and 2014, the top five manufacturers of our products produced approximately 56.5% and 58.9% of our total purchases, respectively. One manufacturer accounted for 31.5% and 37.5% of total purchases during 2015 and 2014, respectively. Another manufacturer accounted for 9.1% and +18 +6.1% of our total purchases during 2015 and 2014, respectively. We do not have long-term contracts with manufacturers, and we compete with other footwear companies for production facilities. We could experience difficulties with the se manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet production deadlines, or increased manufacturing costs. This could result in our customers canceling orders, r efusing to accept deliveries, or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business. +If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards, or higher lead times for delivery. If we are unable to provide products consistent with our standards, or the manufacture of our footwear is delayed or becomes more expensive, our business would be harmed. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our reputation in the United States, or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +The Toning Footwear Category Has Come Under Public And Regulatory Scrutiny That May Have A Material Negative Impact On Our Business And Results Of Operations. +Since 2010, the toning footwear product category, including our Shape-ups products, has come under significant public scrutiny, such as highly publicized negative professional opinions, negative publicity and media attention, personal injury lawsuits and attorneys publicly marketing their services to consumers allegedly injured by toning products, including Shape-ups. In addition, we have been responding to inquiries by state, federal, and foreign governmental and quasi-governmental regulators regarding the claims, advertising, and safety of our toning products, and are engaged as defendants in civil lawsuits that involve similar claims. This public and regulatory scrutiny has included the questioning of our advertising, promotional claims, and the overall safety of these products, as well as allegations of personal injuries. We believe that Shape-ups and our other toning products are safe, but the negative publicity from this public and regulatory scrutiny appears to have had a negative impact on sales of toning footwear generally and our Shape-ups products in particular. We are not able to predict whether such negative publicity, regulatory review and related litigation will continue or what the continued effect will be on the sales of our Shape-up products, our business, and our results of operations beyond that included in this annual report. Further details regarding these legal and regulatory matters are discussed in greater detail under “Legal Proceedings” in Part I, Item 3 of this annual report. +It Is Difficult To Predict The Effect Of Regulatory Inquiries About Advertising And Promotional Claims Related To Our Toning Shoe Products. +The toning footwear market is dominated by a handful of competitors who design, market and advertise their products to promote fitness benefits associated with wearing the footwear. Advertising that promotes fitness benefits associated with the toning footwear market has come under review from state, federal, and foreign governmental and quasi-governmental regulators. As discussed in greater detail under “Legal Proceedings” in Part I, Item 3 of this annual report, we announced on May 16, 2012 that we had settled all domestic legal proceedings relating to advertising claims made in connection with the marketing of our toning shoe products. Under the terms of the global settlement—without admitting any fault or liability, with no findings being made that our company had violated any law, and with no fines or penalties being imposed—we made payments in the aggregate amount of $50 +19 +million to settle all domestic advertising class action lawsuits and related claims brought by the FTC and the SAGs. On November 8, 2012, we were served with a Grand Jury Subpoena (“Subpoena”) that was issued by a grand jury of the United States District Court for the Northern District of Ohio, in Cleveland, Oh io for documents and information relating to past advertising claims for our toning footwear, including Shape-ups and Resistance Runners. The Subpoena, which seeks documents and information related to outside studies conducted on our toning footwear, appea rs related to the FTC’s inquiry into our claims and advertising for Shape-ups and our other toning shoe products. In December 2015, the Assistant United States Attorney informed us that the grand jury had concluded its review of this matter and that no leg al action would be taken against our company, any of our employees or any other individuals. Although the grand jury’s inquiry was concluded without having a material adverse impact on our results of operations or financial position, it is still too early to predict if there will be any additional government inquiries either in the United States or abroad and whether the final resolution of these matters could have a material adverse impact on our advertising, promotional claims, business, results of opera tions and financial position. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, some or a substantial number of new stores could be opened in regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced net sales volumes in existing stores in those markets. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer, Chief Financial Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations And Financial Condition. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability our company may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business, consolidated financial statements and financial condition. +For a discussion of risks related to regulatory inquiries, see the risks discussed on page 19 under “ It Is Difficult To Predict The Effect Of Regulatory Inquiries About Advertising And Promotional Claims Related To Our Toning Shoe Products.” +20 +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Hot Lights ® , Twinkle Toes ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the United States, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +We utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, and others, including credit card information and personal identification information. A security breach may expose us to a risk of loss or misuse of this information, litigation and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks. Attacks may be targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could have an adverse effect on our business, financial condition and reputation. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2015, a substantial portion of our operations are located in California, including 87 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our net sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wild fire affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +21 +Two Principal Stockholders Are Able Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2015, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 45.0% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 15.7% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 38.7% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2015, Mr. Greenberg beneficially owned 30.2% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 41.2% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 25.9% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs, or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to significantly influence or substantially control, respectively, actions requiring stockholder approval may result in our company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchaser view the superior voting rights of our Class B common shares to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in Manhattan Beach, California, which consist of an aggregate of approximately 145,000 square feet. We own and lease portions of our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The lease for this facility expires in 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is consolidated in our financial statements. +Our European Distribution Center occupies approximately 780,000 square feet in Liege, Belgium under four operating leases, with base rent of approximately $4.1 million per year. Each lease provides for an original term of 15 years, commencing on January 1, 2016 (except for one lease that is not expected to commence until April 1, 2016), subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring between March 2016 and May 2032. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the +22 +relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $63.3 million for the year ended December 31, 2015. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates between March 2016 and November 2027. Total base rent for the leased properties aggregated approximately $46.4 million for the year ended December 31, 2015. +ITEM 3. +LEGAL PROCEEDINGS +Our claims and advertising for our toning products including for our Shape-ups are subject to the requirements of, and routinely come under review by regulators including the U.S. Federal Trade Commission (“FTC”), states’ Attorneys General and government and quasi-government regulators in foreign countries. We have responded to requests for information regarding our claims and advertising from regulatory and quasi-regulatory agencies in several countries and fully cooperated with such requests. While we believe that our claims and advertising with respect to our core toning products are supported by scientific tests, expert opinions and other relevant data, and while we have been successful in defending our claims and advertising in several different countries, we have discontinued using certain test results and we periodically review and update our claims and advertising. The regulatory inquiries may conclude in a variety of outcomes, including the closing of the inquiry with no further regulatory action, settlement of any issues through changes in its claims and advertising, settlement of any issues through payment to the regulatory entity, or litigation. +As we disclosed in previous periodic SEC filings, the FTC and Attorneys General for 44 states and the District of Columbia (“SAGs”) had been reviewing the claims and advertising for Shape-ups and our other toning shoe products. We also disclosed that we had been named as a defendant in multiple consumer class actions challenging our claims and advertising for our toning shoe products, including Shape-ups. On May 16, 2012, we announced that we had settled all domestic legal proceedings relating to advertising claims made in connection with the marketing of our toning shoe products. Under the terms of the global settlement—without admitting any fault or liability, with no findings being made that our company had violated any law, and with no fines or penalties being imposed—we made payments in the aggregate amount of $50 million to settle and finally resolve the domestic advertising class action lawsuits and related claims brought by the FTC and the SAGs. The FTC Stipulated Final Judgment was approved by the United States District Court for the Northern District of Ohio on July 12, 2012. Consent judgments in the 45 SAG actions were approved and entered by courts in those jurisdictions. On May 13, 2013, the United States District Court for the Western District of Kentucky entered an order finally approving the nationwide consumer class action settlement, and the time for any appeals from that final approval order has expired. +On November 8, 2012, we were served with a Grand Jury Subpoena (“Subpoena”) for documents and information relating to our past advertising claims for our toning footwear, including Shape-ups and Resistance Runners. The Subpoena was issued by a Grand Jury of the United States District Court for the Northern District of Ohio, in Cleveland, Ohio. The Subpoena sought documents and information related to outside studies conducted on our toning footwear and appeared to grow out of the FTC’s inquiry into our claims and advertising for Shape-ups and our other toning shoe products, which we settled with the FTC, SAGs and consumer class as part of a global settlement, as set forth above. In December 2015, after reviewing materials provided in response to the Subpoena, the Assistant United States Attorney informed us that the Grand Jury had concluded its review of this matter and that no legal action would be taken against our company, any of our employees or any other individuals. +The toning footwear category, including our Shape-ups products, has also been the subject of some media attention arising from a number of consumer complaints and lawsuits alleging injury while wearing Shape-ups. We believe our products are safe and are defending ourselves from these media stories and injury lawsuits. It is too early to predict the outcome of any case or inquiry, whether there will be future personal injury cases filed, whether adverse results in any single case or in the aggregate would have a material adverse impact on our results of operations, financial position, or result in a material loss in excess of a recorded accrual and whether insurance coverage will be adequate to cover any losses. +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups are defective and unreasonably dangerous, negligently designed and/or manufactured, and do not conform to representations made by our company, and that we failed to provide adequate warnings of alleged risks associated with Shape-ups. In total, we are named as a defendant in 1,141 currently pending cases (some on behalf of multiple plaintiffs) filed in various courts that assert further varying injuries but employ similar legal theories and assert similar claims to the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are some variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. +23 +On December 19, 2011, the Judicial Panel on Multidistrict Lit igation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2 011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding and 414 additional individuals have submitted claims by plaintiff fact sheets. Skechers has resolved 481 personal injury claims in the MDL proceedings, comp rised of 90 that were filed as formal actions and 391 that were submitted by plaintiff fact sheets. Skechers has also settled 1,332 claims in principle—1,101 filed cases and 231 claims submitted by plaintiff fact sheets—either directly or pursuant to a glo bal settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 42 cases in the MDL proceeding have been dismissed either voluntarily or on motions by Skechers and 38 unfiled claims submitted by plain tiff fact sheet have been abandoned. Between the consummated settlements and cases subject to the settlement program, all but two personal injury cases pending in the MDL have been or are expected to soon be resolved. On August 6, 2015, the Court entered a n order staying all deadlines, including trial, pending further order of the Court. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition by our company to coordinate all personal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coordinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. Thirty-five actions brought on behalf of a total of 476 plaintiffs, have been settled and dismissed. We have also settled in principle an additional 31 actions brought on behalf of 405 plaintiffs pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). One single-plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff lawsuits have been dismissed entirely, either voluntarily or on motion by us. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by us. Thus, taking into account both consummated settlements and cases subject to the settlement program, only five lawsuits on behalf of a total of ten plaintiffs are expected to remain in the LASC Coordinated Cases. Discovery is continuing in those five remaining cases. No trial dates have been set. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. Ten of those actions have been resolved and dismissed. One of the remaining actions that includes the claims of 65 plaintiffs has been settled in principle pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). The last remaining action in a state court other than California was recently filed in Missouri on January 4, 2016 on behalf of a single plaintiff. We have not yet been served in that action. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. The global settlement program involves complex monetary and non-monetary terms that are in the final stages of being documented. If the group settlements are not finalized and the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for business purposes in order to end the distraction of litigation, and we continue to believe we have meritorious defenses and intend to defend any remaining cases vigorously. In addition, even if the global settlement is finalized, it is too early to predict whether there will be future personal injury cases filed which are not covered by the settlement, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be available and/or adequate to cover any losses. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against our company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued +24 +products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle T oes and BOBS Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in eith er or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +Deckers Outdoor Corporation v. Skechers U.S.A., Inc. — On November 20, 2014, Deckers filed an action against our company in the United States District Court for the Central District of California, Case 2:14-cv-08988-SJO-FFM, alleging trademark infringement, patent infringement, trade dress infringement, and unfair competition arising out of our alleged use of certain names and design elements. The complaint seeks, among other things, injunctive relief, an accounting of profits, compensatory damages, statutory, treble and punitive damages, costs and attorneys’ fees. We have finalized a settlement involving both monetary and non-monetary terms, which will not have a material adverse impact on our operations or financial position. +Brian Nicklaus v. Skechers USA, Inc. et al. — On July 27, 2015, a former employee named Brian Nicklaus filed an action against our company in the Superior Court of California, County of Los Angeles, Case No. BC589344, alleging age discrimination, wrongful termination, and retaliation, among other causes of actions, and seeking compensatory damages, punitive and exemplary damages and attorneys’ fees. Skechers believes it has meritorious defenses, vehemently denies the allegations and intends to defend this case vigorously. Notwithstanding, it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. +adidas America, Inc., et. al v. Skechers USA, Inc. — On September 14, 2015, adidas filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:15-cv-1741, alleging that three Skechers shoe styles (Skechers Onix, Skechers Relaxed Fit Cross Court TR, and Skechers Relaxed Fit – Supernova Style) infringe adidas’ trademarks and/or trade dress rights. adidas asserts claims under federal and state law for trademark and trade dress infringement, unfair competition, trademark and trade dress dilution, unfair and deceptive trade practices, and breach of a settlement agreement entered into between the parties in 1995. adidas seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble, enhanced and punitive damages), and attorneys’ fees. On September 14, 2015, adidas filed a motion for preliminary injunction in which it sought to preliminarily restrain us from manufacturing, distributing, advertising, selling, or offering for sale any footwear (a) that is confusingly similar to adidas’ STAN SMITH Trade Dress, (b) bearing stripes in a manner that is confusingly similar to adidas’ Three-Stripe Mark, or (c) under adidas’ SUPERNOVA Mark. We opposed adidas’ motion. A hearing on adidas’ motion was held on December 15, 2015. On February 12, 2016, the Court issued a preliminary injunction prohibiting us from selling two styles from our vast footwear collection and from using the word “Supernova” in connection with a third style. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc., v. Skechers USA, Inc . — On January 4, 2016, Nike filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +In addition to the matters included in its reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MI NE SAFETY DISCLOSURES +Not applicable. +25 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” The following table sets forth, for the periods indicated, the high and low sales prices of our Class A Common Stock. +LOW +HIGH +YEAR ENDED DECEMBER 31, 2015 +First Quarter +$ +18.41 +$ +24.75 +Second Quarter +23.33 +38.26 +Third Quarter +36.53 +54.53 +Fourth Quarter +24.56 +49.28 +YEAR ENDED DECEMBER 31, 2014 +First Quarter +$ +8.82 +$ +12.26 +Second Quarter +11.05 +15.84 +Third Quarter +14.82 +21.56 +Fourth Quarter +15.92 +20.78 +HOLDERS +As of February 15, 2016, there were 105 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 29 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Earnings have been and will be retained for the foreseeable future in the operations of our business. We have not declared or paid any cash dividends on our Class A Common Stock and do not anticipate paying any cash dividends in the foreseeable future. Our current policy is to retain all of our earnings to finance the growth and development of our business. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report. +26 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our company’s Class A Common Stock from December 31, 2010 to December 31, 2015, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2010 in each of our company’s Class A Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our company’s Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN +(in dollars) +12/10 +12/11 +12/12 +12/13 +12/14 +12/15 +Skechers U.S.A., Inc. +100.00 +60.60 +92.50 +165.65 +276.25 +453.15 +Russell 2000 +100.00 +95.82 +111.49 +154.78 +162.35 +155.18 +Peer Group +100.00 +109.30 +123.96 +188.65 +189.57 +240.54 +27 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2015 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +(In thousands, except net earnings (loss) per share) +YEARS ENDED DECEMBER 31, +STATEMENT OF OPERATIONS DATA: +2015 +2014 +2013 +2012 +2011 +Net sales +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +$ +1,606,016 +Gross profit +1,424,008 +1,071,905 +818,792 +683,326 +623,748 +Earnings (loss) from operations +350,824 +209,071 +93,609 +22,319 +(133,793 +) +Earnings (loss) before income taxes (benefit) +333,497 +191,380 +82,215 +10,473 +(131,047 +) +Net earnings (loss) attributable to Skechers +U.S.A., Inc. +231,912 +138,811 +54,788 +9,512 +(67,484 +) +Net earnings (loss) per share:(1) +Basic +1.52 +0.91 +0.36 +0.06 +(0.46 +) +Diluted +1.50 +0.91 +0.36 +0.06 +(0.46 +) +Weighted average shares:(1) +Basic +152,847 +151,839 +151,090 +148,485 +145,473 +Diluted +154,200 +153,079 +151,690 +149,826 +145,473 +AS OF DECEMBER 31, +BALANCE SHEET DATA: +2015 +2014 +2013 +2012 +2011 +Working capital +$ +993,454 +$ +779,277 +$ +704,506 +$ +647,771 +$ +578,885 +Total assets +2,047,408 +1,674,918 +1,408,570 +1,340,220 +1,281,888 +Long-term borrowings, excluding current +installments +68,942 +15,081 +116,488 +128,517 +76,531 +Skechers U.S.A., Inc. equity +1,327,556 +1,075,249 +930,322 +875,969 +852,561 +(1) +Basic earnings per share represents net earnings (loss) divided by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share, in addition to the weighted average determined for basic earnings (loss) per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. All share and per share information has been retroactively adjusted for the three-for-one stock split that was effective on October 16, 2015. +28 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +GENERAL +We design, market and sell contemporary footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own retail stores, distributor and licensee-owned international retail stores and our e-commerce websites. Our objective is to continue to profitably grow our domestic operations while leveraging our brand name to expand internationally. +Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and retail sales, which includes our e-commerce sales. We evaluate segment performance based primarily on net sales and gross margins. See detailed segment information in Note 17 – Segment Information in our consolidated financial statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our net sales for 2015 increased $769.8 million, or 32.4%, to $3.147 billion, compared to net sales of $2.378 billion in 2014. The increase in net sales was broad based across our domestic wholesale, international wholesale and retail segments, with the largest increases across our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions during 2015. Net earnings attributable to Skechers U.S.A., Inc. were $231.9 million for 2015, an increase of $93.1 million, or 67.1%, compared to net earnings of $138.8 million in 2014. Diluted earnings per share for 2015 was $1.50, which reflected a 65.9% increase from the $0.91 diluted earnings per share reported in the prior year. The increase in net earnings attributable to Skechers U.S.A., Inc. for 2015 was primarily the result of increased sales in our domestic wholesale, international wholesale and retail segments following the introduction of new products with increased margins in our domestic wholesale and domestic retail segments. Our working capital was $993.5 million at December 31, 2015, which was an increase of $214.2 million from working capital of $779.3 million at December 31, 2014. Our cash and cash equivalents increased $41.3 million to $508.0 million at December 31, 2015 from $466.7 million at December 31, 2014. This increase in cash of $41.3 million was primarily the result of our increased net earnings and increased payables, which were partially offset by increased inventories and increased accounts receivables. +2015 OVERVIEW +In 2015, we focused on product development, building a strong team of global brand ambassadors, domestic and international growth, development of our global infrastructure, and balance sheet and expense management. +New product design and delivery . Our success depends on our ability to design and deliver comfortable, stylish, affordable product to consumers across a broad range of demographics. In 2015, we focused on innovation and comfort across all of our core and existing styles, added fresh looks to our product lines, and developed new product lines that included lifestyle and performance footwear. This included the addition of Skech-Air for men, women and kids, Skechers Modern Comfort, Skechers GOwalk Flex, and Game Kicks and Twinkle Wishes for kids. +Grow our domestic business. In 2015, our focus was on maintaining our core Skechers business in our domestic wholesale accounts, while finding new opportunities to add shelf space and expand into new locations with new Skechers categories. We became the second largest footwear brand in the United States, as well as the number one walking brand and number one work brand. We also focused on expanding our domestic retail distribution channel by opening 35 additional company-owned domestic stores, including our second store in Times Square. +Further develop our international businesses. During 2015, we continued to focus on improving our international operations by increasing our customer base within our existing subsidiary business and increasing our product offering to accounts within each country. As part of our ongoing efforts to maximize our growth in key markets, we expanded our direct distribution base with the transition of the business of several distributors to a wholly-owned Central Eastern European subsidiary that encompasses 14 countries, including Hungary, the Czech Republic, Croatia and Serbia. We also transitioned our distributor’s business in Panama to a wholly-owned subsidiary in Latin America that will oversee 30 countries in the region, including the key markets of Peru, Colombia, Costa Rica and Panama. With strong growth across numerous international markets, we also focused in on some key growth countries, including China, who achieved triple-digit sales growth in 2015. In our international retail distribution channel, we expanded by opening 41 additional company-owned international stores, which included taking over the operations of 15 international concept stores and two international outlet stores from our distributor in Panama. Additionally, we expanded our franchise retail base with more Skechers branded stores in countries where we directly handle the distribution of our product. +29 +Develop our global infrastructure. In 2015, we completed the second and third phases of the automation upgrade and expansion of our European Distribution Center, increasing our capacity to 780,000 square feet, and completed an additional equipment upgrade in our Rancho Belago distribution c enter, further increasing our efficiencies. We continue to upgrade our distribution facilities to increase our capacity and efficiency and to better manage our growth worldwide. +Balance sheet and expense management. During 2015, we continued to focus on managing our inventory levels and bringing our marketing expenses and general and administrative expenses in line with expected sales. +OUTLOOK FOR 2016 +During 2016, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. The global footwear market is competitive; however, because our products are marketed at affordable prices, we believe that our styles resonate with consumers worldwide, which translates into a brand that is in demand globally. With a growing team of brand ambassadors—including legends Sugar Ray Leonard and Ringo Starr for men; pop superstars Demi Lovato and Meghan Trainor for young women; and elite athletes Meb, Kara Goucher and Matt Kuchar for our Skechers Performance division, we believe our appeal is broad and demand for our product will continue. We will continue to broaden the targeted demographic profile of our consumer base, increase our shelf space and open 55 to 65 company-owned retail locations, predominantly in the United States, without detracting from existing business. In addition, we will complete the last phase of expansion at our European Distribution Center by the end of the second quarter of 2016, which will increase the capacity to one million square feet, which will continue to increase our product distribution efficiencies and support expected future growth. +DEFINITIONS +Comparable sales +As part of our discussion of our results of operations, we disclose comparable store sales, which exclude the impact of e-commerce sales. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +Cost of sales or Gross margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative expenses +General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for our Rancho Belago, European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. +30 +YEAR ENDED DECEMBER 31, 2015 COMPARED TO THE YEAR ENDED DECEMBER 31, 2014 +Net sales +Net sales for 2015 were $3.147 billion, which was an increase of $769.8 million, or 32.4%, compared to net sales of $2.378 billion for 2014. The increase in net sales was broad-based and attributable to higher sales in our domestic wholesale segment, international wholesale segment and our retail segment primarily due to the introduction of new styles and lines of footwear. +Our domestic wholesale net sales increased $221.8 million, or 22.2%, to $1.220 billion for 2015 compared to $998.0 million for 2014. The increase in our domestic wholesale segment’s net sales resulted from a 15.3% unit sales volume increase to 51.8 million pairs in 2015 from 44.9 million pairs in 2014. This increase was attributable to strong sales and significant growth in several key divisions including our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions during 2015. The average selling price per pair within the domestic wholesale segment also increased 6.0%, to $23.53 per pair for 2015 from $22.20 for 2014, which was primarily the result of increased selling prices for our Women’s GO, Women’s Active and Men’s Sport divisions. +Our international wholesale segment net sales increased $405.2 million, or 58.8%, to $1.094 billion for 2015 compared to sales of $689.2 million for 2014. Our international wholesale sales consist of direct sales by our foreign subsidiaries – those sales we make to department stores and specialty retailers – and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries increased $271.0 million, or 54.5%, to $768.2 million for 2015 compared to sales of $497.2 million for 2014. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Hong Kong. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $134.2 million, or 69.9%, to $326.2 million for 2015, compared to sales of $192.0 million for 2014. This was primarily attributable to increased sales to our distributors in Australia and New Zealand, South Korea, Turkey and the United Arab Emirates (“UAE”). +Our retail segment sales increased $142.8 million to $833.1 million for the year ended December 31, 2015, a 20.7% increase over sales of $690.4 million for 2014. The increase in retail sales was primarily attributable to increased comparable sales of 10.5%, which included increased sales within our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions and a net increase of 28 domestic and 40 international stores compared to 2014. For the year ended December 31, 2015, our domestic retail sales increased 17.2% compared to 2014, which was attributable to positive comparable domestic store sales of 10.0% and increased domestic store count, and our international retail store sales increased 35.8% compared to 2014, which was attributable to increased international store count and positive comparable international store sales of 12.5%. +We believe that we have established our presence in most major domestic retail markets. We had 391 domestic stores and 128 international retail stores as of February 15, 2016, and we currently plan to open approximately 55 to 65 stores in 2016. During 2015, we opened five new domestic concept stores, 11 domestic factory outlet stores, 19 domestic warehouse outlet stores, 16 international concept stores, six international factory outlet stores and two international warehouse outlet stores, which included taking over the operations of 15 international concept stores and two international outlet stores from our distributor in Panama. During 2015, we closed six domestic concept stores, one domestic outlet store and one international concept store. We periodically review all of our stores for impairment. During 2015 and 2014, we did not record an impairment charge. Further, we carefully review our under-performing stores and may consider the non-renewal of leases upon completion of the current term of the applicable lease. +Gross profit +Gross profit for 2015 increased $352.1 million to $1.424 billion from $1.072 billion for 2014. Gross profit as a percentage of net sales, or gross margin, increased slightly to 45.2% in 2015 from 45.1% for 2014. Our domestic wholesale segment gross profit increased $103.1 million, or 28.0%, to $471.1 million for 2015 from $368.0 million for 2014, which was attributable to increased sales volumes and selling prices. Domestic wholesale margins increased to 38.6% for 2015 from 36.9% for 2014. The increase in domestic wholesale margins was primarily attributable to higher margins in our Women’s GO, Women’s Active, Women’s Sport and Men’s USA lines. +Gross profit for our international wholesale segment increased $162.0 million, or 55.3%, to $454.7 million for 2015 compared to $292.7 million for 2014. Gross margins for the international wholesale segment were 41.5% for 2015 compared to 42.5% for 2014. Gross margins for our international direct subsidiary sales were 47.2% for 2015 as compared to 48.6% for 2014. The decrease in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to foreign currency fluctuations. Gross margins for our international distributor sales were 28.1% for 2015 as compared to 26.5% for 2014. +31 +Gross profit for our retail segment increa sed $87.0 million, or 21.2%, to $498.2 million for 2015 as compared to $411.2 million for 2014. Gross margins for all stores were 59.8% for 2015 compared to 59.6% for 2014. Gross margins for our domestic stores were 61.5% for 2015 as compared to 60.1% for 2014. Gross margins for our international stores were 53.4% for 2015 as compared to 57.2% for 2014. The increases in domestic and overall retail margins were primarily attributable to increased domestic sales of our newer products at higher margins. +Selling expenses +Selling expenses increased by $54.6 million, or 30.1%, to $235.6 million for 2015 from $181.0 million for 2014. As a percentage of net sales, selling expenses were 7.5% and 7.6% for 2015 and 2014, respectively. The increase in selling expenses was primarily the result of increased sales commissions of $7.7 million due to increased revenues and $43.8 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.4% in 2015 from 5.3% in 2014. +General and administrative expenses +General and administrative expenses increased by $158.4 million, or 22.9%, to $849.3 million for 2015 from $690.9 million for 2014. As a percentage of sales, general and administrative expenses were 27.0% and 29.1% for 2015 and 2014, respectively. The increase in general and administrative expenses was primarily attributable to $68.0 million related to supporting our growing international operations, increased store operating costs of $42.7 million primarily attributable to an additional 68 stores, which includes 17 stores that were transitioned from our distributor in Panama to our wholly-owned subsidiary, increased salaries and wages of $22.9 million, including incentive compensation, and $17.9 million in professional fees. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $35.4 million, due to increased shipments, to $170.2 million from $134.8 million for 2015 and 2014, respectively. +Other income (expense) +Interest income was $0.7 million for 2015 compared to $0.8 million for 2014. Interest expense for 2015 decreased $1.8 million to $10.7 million compared to $12.5 million in 2014. The decrease was primarily due to decreased interest expense of $1.3 million attributable to reduced interest paid on loans for our domestic distribution center and domestic distribution center equipment. Loss on foreign currency transactions for 2015 increased $1.2 million to $6.6 million compared to $5.4 million in 2014. This increased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2015 decreased $0.2 million to a loss of $0.7 million as compared to a loss of $0.9 million in 2014. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34% . Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes . +32 +Our earnings (loss) before income taxes and income tax expense for 2015, 2014 and 2013 are as follows (in thousands): +Years Ended December 31, +2015 +2014 +2013 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States +$ +136,726 +$ +52,173 +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +Canada +4,228 +1,024 +6,241 +1,572 +4,091 +1,187 +Chile +2,983 +572 +629 +138 +9,622 +1,920 +Peoples Republic of China (“China”) +49,027 +11,084 +15,201 +1,179 +6,148 +1,646 +Jersey (1) +123,721 +— +77,555 +— +25,348 +— +Non-benefited loss operations (2) +(16,719 +) +164 +(13,021 +) +— +(15,841 +) +— +Other jurisdictions (3) +33,531 +7,433 +21,997 +3,795 +14,142 +3,787 +Earnings before income taxes +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +Effective tax rate (4) +21.7 +% +20.5 +% +26.0 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Panama, Poland, Romania, Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of 2015 consolidated earnings (loss) before taxes: Hungary, Serbia, Bosnia and Herzegovina, Montenegro, Macedonia, Albania, Kosovo, Vietnam, Panama, Peru, Colombia, Costa Rica, the United Kingdom, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2015, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2015, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $136.7 million, with income tax expense of $52.2 million, which is an average rate of 38.2%. Earnings (loss) before income taxes in non-U.S. jurisdictions were $196.8 million, with an aggregate income tax expense of $20.3 million, which is an average rate of 10.3%. Combined, this results in consolidated earnings before income taxes for the period of $333.5 million, and consolidated income tax expense for the period of $72.5 million, resulting in an effective tax rate of 21.7%. We estimate our annual effective tax rate for 2016 to be between 20% and 25%. The estimated effective tax rate for 2016 is subject to management’s ongoing review and revision, if necessary. For 2015, of our $196.8 million in earnings before income tax earned outside the U.S., $123.7 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $46.2 million, or 59.5%, to $123.7 million for 2015, from $77.6 million for 2014. This increase was primarily attributable to us experiencing an increase of $433.7 million in net sales in the “Other international” geographic area for 2015 (see Note 17), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2014 to 2015 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $16.7 million for which no tax benefit was recognized during the year ended December 31, 2015 because of the provision of offsetting valuation allowances, but in which $0.2 million in nonrefundable withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of our 2015 consolidated earnings (loss) before taxes. Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2015, we had approximately $508.0 million in cash and cash equivalents, of which $218.7 million, or 43.1%, was held outside the U.S. Of the $218.7 million held by our non-U.S. subsidiaries, approximately $33.4 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our financial statements as of December 31, 2015. We believe our cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect that we will need to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2015 and 2014, U.S. income taxes have not been provided on cumulative total earnings of approximately $482.7 million and $318.2 million, respectively. +33 +Non-controlling interest in net income and loss of consolidated subsidiaries +Non-controlling interest for 2015 increased $15.7 million to $29.1 million as compared to $13.4 million for 2014 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +YEAR ENDED DECEMBER 31, 2014 COMPARED TO THE YEAR ENDED DECEMBER 31, 2013 +Net sales +Net sales for 2014 were $2.378 billion, which was an increase of $531.2 million, or 28.8%, compared to net sales of $1.846 billion for 2013. The increase in net sales was broad-based and attributable to higher sales in our domestic wholesale segment, international wholesale segment and our retail segment which was primarily due to the introduction of new styles and lines of footwear. +Our domestic wholesale net sales increased $195.8 million, or 24.4%, to $998.0 million for 2014 compared to $802.2 million for 2013. The increase in our domestic wholesale segment’s net sales resulted from a 19.1% unit sales volume increase to 44.9 million pairs in 2014 from 37.7 million pairs in 2013. This increase was attributable to strong sales and significant growth in several key divisions including our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions, which was partially offset by reduced sales of our BOB’s products during 2014. The average selling price per pair within the domestic wholesale segment also increased 4.4%, to $22.20 per pair for 2014 from $21.26 for 2013, which was primarily the result of increased selling prices for our Women’s Sport, Women’s Active and Men’s USA divisions. +Our international wholesale segment net sales increased $210.4 million, or 43.9%, to $689.2 million for 2014 compared to sales of $478.8 million for 2013. Direct sales by our foreign subsidiaries increased $143.0 million, or 40.4%, to $497.1 million for 2014 compared to sales of $354.1 million for 2013. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany, and Canada and our joint ventures in China and Hong Kong. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $67.3 million, or 54.1%, to $192.0 million for 2014, compared to sales of $124.7 million for 2013. This was primarily attributable to increased sales to our distributors in Australia and New Zealand, South Korea, Taiwan, and the United Arab Emirates (“UAE”). +Our retail segment sales increased $125.3 million to $663.5 million for the year ended December 31, 2014, a 23.3% increase over sales of $538.2 million for 2013. The increase in retail sales was primarily attributable to increased comparable sales of 10.6%, which included increased sales of our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions and a net increase of 41 domestic and 18 international stores compared to 2013. For the year ended December 31, 2014, our domestic retail sales increased 16.2% compared to 2013, which was attributable to positive comparable domestic store sales of 8.9% and increased domestic store count, and our international retail store sales increased 64.2% compared to 2013, which was attributable to increased international store count and positive comparable international store sales of 20.8%. During 2014, we opened two new domestic concept stores, 17 domestic factory outlet stores, 29 domestic warehouse outlet stores, nine international concept stores, seven international factory outlet stores and three international warehouse outlet stores. +We believe that we have established our presence in most major domestic retail markets. We had 363 domestic stores and 84 international retail stores as of February 15, 2015. We opened 48 domestic retail stores and 19 international retail stores in 2014, while closing seven underperforming domestic stores and one international concept store. We opened 31 domestic retail stores and 16 international retail stores in 2013, while closing 10 underperforming domestic stores and one international store. We periodically review all of our stores for impairment. During 2014 and 2013, we did not record an impairment charge. +Our e-commerce net sales decreased $0.3 million to $26.9 million for 2014, a 1.3% decrease compared to sales of $27.2 million for 2013. Our e-commerce sales made up approximately 1.1% and 1.5% of our consolidated net sales for 2014 and 2013, respectively. +Gross profit +Gross profit for 2014 increased $253.1 million to $1.072 billion from $818.8 million for 2013. Gross profit as a percentage of net sales, or gross margin, increased to 45.1% in 2014 from 44.4% for 2013. Our domestic wholesale segment gross profit increased $79.2 million, or 27.4%, to $368.0 million for 2014 from $288.8 million for 2013 attributable to increased sales volume. Domestic wholesale margins increased to 36.9% for 2014 from 36.0% for 2013. The increase in domestic wholesale margins was primarily attributable to higher margins in our Men’s USA and Women’s Sport lines. +Gross profit for our international wholesale segment increased $93.8 million, or 47.2%, to $292.7 million for 2014 compared to $198.9 million for 2013. Gross margins were 42.5% for 2014 compared to 41.5% for 2013. The increase in gross margins for our +34 +international wholesale segment was primarily attributable to increased sales by our subsidiaries, which historically have achieved higher gross margins attributable t o direct sales to customers than our international wholesale sales through our foreign distributors. Gross margins for our international direct subsidiary sales were 48.6% for 2014 as compared to 47.3% for 2013 primarily attributable to increased sales of our newer products. Gross margins for our international distributor sales were 26.5% for 2014 as compared to 25.1% for 2013. +Gross profit for our retail segment increased $79.6 million, or 24.9%, to $398.6 million for 2014 as compared to $319.0 million for 2013. Gross margins for all stores were 60.1% for 2014 compared to 59.3% for 2013. Gross margins for our domestic stores were 60.8% for 2014 as compared to 59.6% for 2013. Gross margins for our international stores were 57.2% for 2014 and 2013. The increases in domestic and overall retail margins were primarily attributable to increased sales of our newer products at higher margins. +Selling expenses +Selling expenses increased by $27.5 million, or 17.9%, to $181.0 million for 2014 from $153.5 million for 2013, although selling expenses decreased as a percentage of net sales to 7.6% for 2014 from 8.3% for 2013 attributable to increased net sales. The increase in selling expenses was primarily the result of higher advertising expenses, which also decreased as a percentage of net sales to 5.3% in 2014 from 5.6% in 2013 attributable to increased net sales. +General and administrative expenses +General and administrative expenses increased by $111.5 million, or 19.2%, to $690.9 million for 2014 from $579.4 million for 2013. As a percentage of sales, general, administrative and legal expenses were 29.1% and 31.4% for 2014 and 2013, respectively. The increase in general, administrative and legal expenses was primarily attributable to $41.6 million related to supporting our growing international operations, increased store operating costs of $31.6 million primarily attributable to an additional 59 stores in comparison to the prior year, increased salaries and wages of $19.9 million, which includes incentive compensation, $7.5 million from bad debt write-offs and increased warehouse and distribution costs of $11.9 million. In addition, the expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products totaled $134.8 million and $122.9 million for 2014 and 2013, respectively. +Other income (expense) +Interest income was $0.8 million for each of 2014 and 2013. Interest expense for 2014 increased $0.6 million to $12.5 million compared to $11.9 million in 2013. The increase was primarily attributable to increased interest expense of $1.3 million attributable to interest incurred on purchases from our foreign manufacturers that increased compared to the prior year, which was offset by reduced interest paid on loans for our domestic distribution center equipment. Loss on foreign currency transactions for 2014 increased $4.6 million to $5.4 million compared to $0.8 million in 2013. This increased foreign currency exchange loss was primarily attributable to higher short-term intercompany investments balances in our foreign subsidiaries and a stronger U.S. dollar. Gain on disposal of assets for 2014 decreased $1.3 million to a loss of $0.9 million as compared to a gain of $0.4 million in 2013. +Income taxes +Our provision for income tax expense (benefit) and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34% . Our provision for income tax expense (benefit) was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense (benefit) by earnings (loss) before income taxes . +35 +Our earnings (loss) before income taxes and income tax expense (benefit) for 2014, 2013 and 2012 are as follows (in thousands): +Years Ended December 31, +2014 +2013 +2012 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +United States +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +$ +(27,379 +) +$ +(5,867 +) +Canada +6,241 +1,572 +4,091 +1,187 +2,564 +545 +Chile +629 +138 +9,622 +1,920 +5,971 +1,043 +Peoples Republic of China (“China”) +15,201 +1,179 +6,148 +1,646 +1,278 +319 +Jersey (1) +77,555 +— +25,348 +— +25,162 +— +Non-benefited loss operations (2) +(13,021 +) +— +(15,841 +) +— +(13,492 +) +— +Other jurisdictions (3) +21,997 +3,795 +14,142 +3,787 +16,369 +3,921 +Earnings before income taxes +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +$ +10,473 +$ +(39 +) +Effective tax rate (4) +20.5 +% +26.0 +% +(0.4 +)% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5%, of 2014 consolidated earnings (loss) before taxes: UK, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes . +For 2014, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39% primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2014, as reflected in the table above, earnings (loss) before income taxes in the U.S. was earnings of $82.8 million, with income tax expense of $32.5 million, an average rate of 39.3%, while earnings (loss) before income taxes in non-U.S. jurisdictions was earnings of $108.6 million, with aggregate income tax expense of $6.7 million, an average rate of 6.2%. Combined, this results in consolidated earnings before income taxes for the period of $191.4 million, and consolidated income tax expense for the period of $39.2 million, resulting in an effective tax rate of 20.5%. We estimate our annual effective tax rate for 2015 to be between 20 percent and 25 percent. The estimated effective tax rate for 2015 is subject to management’s ongoing review and revision, if necessary. +For 2014, of our $108.6 million in earnings before income tax earned outside the U.S., $77.6 million was earned in Jersey, which does not impose a tax on corporate earnings. In addition, there were foreign losses of $13.0 million for which no tax benefit was recognized during the year ended December 31, 2014 because of the provision of offsetting valuation allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of our 2014 consolidated earnings (loss) before taxes. +Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2014, we had approximately $466.7 million in cash and cash equivalents, of which $193.2 million, or 41.4%, was held outside the U.S. Of the $193.2 million held by our non-U.S. subsidiaries, approximately $42.8 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our financial statements as of December 31, 2014. We believe our cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect that we will need to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2014 and 2013, U.S. income taxes have not been provided on cumulative total earnings of approximately $318.2 million and $226.0 million, respectively. +36 +Non-controlling interest in net income and loss of consolidated subsidiaries +Non-controlling interest for 2014 increased $7.3 million to and expense of $13.4 million, as compared expense of $6.1 million for 2013. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +LIQUIDITY AND CAPITAL RESOURCES +Cash Flows +Our working capital at December 31, 2015 was $993.5 million, an increase of $214.2 million from working capital of $779.3 million at December 31, 2014. Our cash and cash equivalents at December 31, 2015 was $508.0 million, compared to $466.7 million at December 31, 2014. This increase in cash and cash equivalents of $41.3 million, after consideration of the effect of exchange rates, was the result of our net earnings of $261.0 million, increased payables of $130.1 million, and increased accrued expenses of $50.4 million, which was partially offset by increased inventories of $176.1 million, capital expenditures of $118.1 million, and increased receivables of $100.0 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $232.2 million for 2015 and $163.9 million for 2014. On a comparative year-to-year basis, the $68.3 million increase in cash flows from operating activities in 2015 from cash used in operating activities in 2014 primarily resulted from an increase in net earnings of $108.9 million, an increase in accounts payable balances of $31.4 million primarily attributable to increased unpaid balances to our contract manufacturers due to increased purchases at the end of the year when compared to the same period in the prior year, a decrease in prepaid expenses of $29.7 million, and an increase in accrued expenses of $34.9 million. The increases were partially offset by a $75.9 million increase in inventories to support increased worldwide backlogs and, $29.3 million increase in accounts receivable, and a $27.3 million increase in deferred income taxes as of December 31, 2015 as compared to December 31, 2014. +Investing Activities +Net cash used in investing activities was $126.5 million for 2015, as compared to $56.9 million in 2014. The increase in cash used in investing activities in 2015 as compared to 2014 was the result of increased capital expenditures of $61.2 million. Capital expenditures for 2015 were approximately $118.1 million, which primarily consisted of $42.2 million for new store openings and remodels, $6.2 million for the automation upgrades for our European Distribution Center equipment, $11.2 million in domestic warehouse equipment upgrades, $17.4 million for new office space for our China joint venture, and $15.0 million related to property purchases for potential future corporate development. This was compared to capital expenditures of $56.9 million in the prior year, which primarily consisted of development costs for our Rancho Belago distribution center and automation upgrades for our European Distribution Center. We expect our ongoing capital expenditures for 2016 to be between $50.0 million and $55.0 million, which includes opening 55 to 65 retail stores, store remodels, a property purchase for potential future corporate development and investments in information technology. In addition, we are currently in the process of completing equipment upgrades for our European Distribution Center and estimate the remaining cost of these equipment upgrades to be approximately $10.0 million. We expect these upgrades to be substantially complete during the second quarter of 2016. We believe our current cash, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. +Financing Activities +Net cash used in financing activities was $58.2 million during 2015, compared to $9.0 million during 2014. The increase in cash used by financing activities was primarily attributable to the maturity and payoff of our first domestic equipment note, and a $39.1 million distribution to HF Logistics-SKX, LLC (the “JV”) which were offset by increased excess tax benefits from share-based compensation. +Sources of Liquidity +On December 29, 2010, we entered into a master loan and security agreement (the “Master Agreement”), by and between us and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan Documents”), by and among us, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (“Agent”). We used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in our Rancho Belago distribution center. Borrowings made pursuant to the Master Agreement may be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 million, and each for a term of 60 months. The Note entered +37 +into on the same date as the Master Agreement represented a borrowing of approximately $39.3 million (the “First Note”). Interest accrued at a fixed rate of 3.54% per annum on the First Note. We made the final payment on the First Note on December 29, 2015. On June 30, 2 011, we entered into another Note for approximately $36.3 million (“the Second Note”). Interest accrues at a fixed rate of 3.19% per annum on the Second Note. As of December 31, 2015, $13.9 million was outstanding on the Second Note, which is included in c urrent installments of long-term borrowings. We paid commitment fees of $0.8 million on the Notes, which are being amortized to interest expense over the five-year life of the Notes. +On June 30, 2015, we entered into a $250.0 million loan and security agreement, subject to increase by up to $100 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits us and certain of our subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at our election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. We pay a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. We paid closing and arrangement fees of $1.1 million on this facility, which are being amortized to interest expense over the five-year life of the facility. As of December 31, 2015, there was $0.1 million outstanding under this credit facility, which is classified as short-term borrowings in our consolidated balance sheets. +On April 30, 2010, the JV, through HF Logistics-SKX T1, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the JV ("HF-T1"), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the Project on the Property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. +On August 11, 2015, the JV through HF-T1 entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF agreed that we would make an additional capital contribution of $38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any +38 +amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been include d in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent unde r our credit agreement dated June 30, 2015. We were in compliance with all debt covenant provisions related to the Amended Loan Agreement as of the date of this annual report. We had $69.5 million outstanding under the Amended Loan Agreement, which is incl uded in long-term borrowings as of December 31, 2015. +As of December 31, 2015, outstanding short-term and long-term borrowings were $84.6 million, of which $13.9 million relates to a note payable for warehouse equipment in our domestic distribution center which is secured by the equipment and $70.7 million relates to loans for our domestic distribution center. We were in compliance with all debt covenants under the Amended Loan Agreement, the Loan Documents and the Credit Agreement as of the date of this annual report. +We believe that anticipated cash flows from operations, available borrowings under our credit agreement, existing cash balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least through March 31, 2017. Our future capital requirements will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of our footwear, the success of our international operations, costs associated with upgrading the equipment in our European Distribution Center, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, any potential acquisitions of other brands or companies, and the number and timing of new store openings. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition and results of operations. In addition, if additional capital is raised through the sale of additional equity or convertible securities, dilution to our stockholders could occur. +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2015 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +59 +$ +59 +$ +— +$ +— +$ +— +Long-term borrowings (1) +97,518 +18,721 +9,084 +69,713 +— +Operating lease obligations (2) +1,077,769 +154,512 +268,447 +217,948 +436,862 +Purchase obligations (3) +738,196 +738,196 +— +— +— +EDC equipment +10,000 +10,000 +— +— +— +Minimum payments related to other arrangements +19,435 +8,612 +10,823 +— +— +Total (4) +$ +1,942,977 +$ +930,100 +$ +288,354 +$ +287,661 +$ +436,862 +(1) +Amounts include anticipated interest payments based on interest rates currently in effect. +(2) +Operating lease obligations consists primarily of real property leases for our retail stores, corporate offices, European and other international distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $120.4 million, (ii) outstanding letters of credit of $4.0 million and (iii) open purchase commitments with our foreign manufacturers for $613.8 million. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(4) +Our consolidated balance sheet, as of December 31, 2015, included $6.1 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. +39 +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make difficult, subjective and complex estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. +We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves, and valuation of deferred income taxes. +Revenue Recognition . We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. Domestically, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For our international wholesale customers in the European community, product is shipped FOB shipping point direct from our distribution center in Liege, Belgium. For our distributor sales, the goods are generally delivered directly from the independent factories to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. We recognize revenue from retail sales at the point of sale. Sales and value added taxes collected from retail customers are excluded from reported revenues. While customers do not have the right to return goods, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. +Royalty income is earned from our licensing arrangements. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. Typically, at each quarter-end, we receive correspondence from our licensees indicating actual sales for the period, which is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. When a customer’s account becomes significantly past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. +We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. +40 +The likelihood of a material loss on an uncollectible account would be mainly dependent on dete rioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our histo rical loss rate as a percentage of sales. Gross trade accounts receivable were $368.2 million and $293.1 million, and the allowance for bad debts, returns, sales allowances and customer chargebacks were $24.3 million and $21.0 million, at December 31, 2015 and 2014, respectively. Our credit losses charged to expense for the years ended December 31, 2015, 2014 and 2013 were $5.3 million, $11.8 million and $2.6 million, respectively. In addition, we recorded sales return and allowance expense for the years ended December 31, 2015, 2014 and 2013 of $2.2 million, $2.3 million and $0.2 million, respectively. +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. Our gross inventory value was $623.9 million and $457.1 million, and our inventory reserve was $3.7 million and $3.3 million, at December 31, 2015 and 2014, respectively. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances: +· +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets; +· +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +· +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +· +overall financial performance such as negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; +· +other relevant entity-specific events such as changes in management, key personnel, strategy, customers, contemplation of bankruptcy, or litigation; +· +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and +· +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. In addition, we prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. For the years ended December 31, 2015, 2014 and 2013, respectively we did not record an impairment charge. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated balance sheets. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As +41 +additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. As of December 31, 2015, we had net deferred tax assets of $31.8 million reduced by a valuation allowance of $18.1 million against loss carry-forwards not expected to be utilized by certain foreign subsidiaries. +INFLATION +We do not believe that the relatively moderate rates of inflation experienced in the United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2015 and 2014, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases” (Topic 842) , (“ASU 2016-02”). The new standard requires lessees to recognize most leases on the balance sheet. This will increase lessees reported assets and liabilities. ASU 2016-02 is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2018. ASU 2016-02 mandates a modified retrospective transition method for all entities. We are currently evaluating the impact of ASU 2016-02 on our consolidated financial statements, however, we do not know what impact the new standard will have on our financial condition or results of operations. +In November 2015, the FASB issued ASU 2015‑17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17), which amends the guidance requiring companies to separate deferred income tax liabilities and assets into current and non-current amounts in a classified statement of financial position. This accounting guidance simplifies the presentation of deferred income taxes, such that deferred tax liabilities and assets be classified as non-current in a classified statement of financial position. ASU 2015-17 will be effective for our annual and interim reporting periods beginning after December 15, 2016, and interim periods within those annual periods. Entities may adopt the guidance prospectively or retrospectively. We are currently evaluating the impact of ASU 2015-17. However, we do not expect that the adoption of this standard will have a material impact on our consolidated financial statements. +In September 2015, the FASB issued ASU 2015‑16, “ Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments ” (“ASU 2015-16”). ASU 2015-16 eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. ASU 2015-16 will be effective for our annual and interim reporting periods beginning January 1, 2018, although early adoption is permitted. We do not expect that the adoption of this standard will have a material impact on our consolidated financial statements. +In July 2015, the FASB issued ASU 2015-11, “ Inventory (Topic 330): Simplifying the Measurement of Inventory ” (“ASU 2015-11”). ASU 2015-11 requires that inventory within the scope of this standard be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in this update do not apply to inventory that is measured using the last-in, first-out ( “ LIFO ” ) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured +42 +using first-in, first-out ( “ FIFO ” ) or average cost. ASU 2015-11 will be effective for our annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. We do not expect that the adoption of this sta ndard will have a material impact on our consolidated financial statements. +In April 2015, the FASB issued ASU 2015-03, “ Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs ” (“ASU 2015-03”). This guidance requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance simplifies presentation of debt issuance costs, but does not address presentation or subsequent measurement of debt issue costs related to line-of-credit arrangements. In August 2015, the FASB issued ASU 2015-15, “ Interest-Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, ” which indicates the Securities and Exchange Commission staff would not object to an entity deferring and presenting debt issuance costs related to line-of-credit arrangements as an asset, and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-03 will be effective for our annual and interim reporting periods beginning January 1, 2016, and should be applied on a retrospective basis, although early adoption is permitted. The adoption of ASU 2015-03 will not have any impact on our results of operations, but will result in debt issuance costs being presented as a direct reduction from the carrying amount of debt liabilities that are not line-of-credit arrangements. We do not expect that the adoption of this standard will have a material impact on our consolidated financial statements. +In February 2015, the FASB issued ASU 2015-02, “ Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 amends the consolidation guidance for VIEs and general partners' investments in limited partnerships, and modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities. The amendment will be effective for our annual and interim reporting periods beginning January 1, 2016, with early adoption permitted. We will begin evaluating the impact of ASU 2015-02 based on this guidance upon adoption. We do not expect that the adoption of this standard will have a material impact on our consolidated financial statements. +In August 2014, the FASB amended the FASB Accounting Standards Codification, and amended Subtopic 205-40, “ Presentation of Financial Statements – Going Concern. ” This amendment prescribes that an entity should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will become effective for our annual and interim reporting periods beginning January 1, 2017. We will begin evaluating going concern disclosures based on this guidance upon adoption. We do not expect that the adoption of this standard will have a material impact on our consolidated financial statements. +In May 2014, the FASB issued ASU 2014-09, which amended the FASB Accounting Standards Codification (“ASC”) and created a new Topic ASC 606, “ Revenue from Contracts with Customers” (“ASC 606”) . This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in Topic 605, “ Revenue Recognition ,” and most industry-specific guidance throughout the Industry Topics of the Codification. For annual and interim reporting periods, the mandatory adoption date of ASC 606 is January 1, 2018, and there will be two methods of adoption allowed, either a full retrospective adoption or a modified retrospective adoption. We are currently evaluating the impact of ASC 606, but at the current time, we do not know what impact the new standard will have on revenue recognized and other accounting decisions in future periods if any, nor what method of adoption will be selected if the impact is material. +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations. Interest rates charged on our long-term debt are based on either the prime rate of interest or the LIBOR, and changes in either of these rates of interest could have an effect on the interest charged on our outstanding balances. At December 31, 2015 we had $0.1 million and $69.5 million of outstanding short-term and long-term borrowings, respectively subject to changes in interest rates. On August 12, 2015, we entered into a variable-to-fixed rate swap in connection with the refinancing of our domestic distribution center loan which effectively modifies our exposure to interest rate risk by converting $69.5 million floating rate debt to a fixed rate debt for the next seven years. Therefore, we do not expect that any changes in interest rates will have a material impact on our financial condition or results of operations. +43 +Foreign exchange rate fluctuations . We face market risk to the e xtent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiary’s revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commi tments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not currently engage in hedging activities with respect to such exchange rate risks. A 200 basis point reduction in the exchange rates used to ca lculate foreign currency translations at December 31, 2015 would have reduced the values of our net investments by approximately $15.5 million. +44 +ITEM 8. +FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +46 +CONSOLIDATED BALANCE SHEETS +47 +CONSOLIDATED STATEMENTS OF EARNINGS +48 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +49 +CONSOLIDATED STATEMENTS OF EQUITY +50 +CONSOLIDATED STATEMENTS OF CASH FLOWS +51 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +52 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +75 +45 +Report of Independent Regist ered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2015 and 2014 and the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2015. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Skechers U.S.A., Inc. and subsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. +Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Skechers U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 26, 2016 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 26, 2016 +46 +SKECHERS U.S.A., INC. AND SUBSIDIA RIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +December 31, +2015 +2014 +ASSETS +Current Assets: +Cash and cash equivalents +$ +507,991 +$ +466,685 +Trade accounts receivable, less allowances of $24,260 in 2015 and $21,007 in 2014 +343,930 +272,103 +Other receivables +18,661 +16,510 +Total receivables +362,591 +288,613 +Inventories +620,247 +453,837 +Prepaid expenses and other current assets +57,363 +57,015 +Deferred tax assets +22,275 +18,864 +Total current assets +1,570,467 +1,285,014 +Property, plant and equipment, net +435,907 +373,183 +Other assets +41,034 +16,721 +Total non-current assets +476,941 +389,904 +TOTAL ASSETS +$ +2,047,408 +$ +1,674,918 +LIABILITIES AND EQUITY +Current Liabilities: +Current installments of long-term borrowings +$ +15,653 +$ +101,407 +Short-term borrowings +59 +1,810 +Accounts payable +473,983 +352,815 +Accrued expenses +87,318 +49,705 +Total current liabilities +577,013 +505,737 +Long-term borrowings, excluding current installments +68,942 +15,081 +Other long-term liabilities +25,719 +19,993 +Total non-current liabilities +94,661 +35,074 +Total liabilities +671,674 +540,811 +Commitments and contingencies +Stockholders’ equity: +Preferred Stock, $0.001 par value; 10,000 shares authorized; none issued +and outstanding +— +— +Class A Common Stock, $0.001 par value; 500,000 shares authorized; +127,324 and 120,862 shares issued and outstanding at December 31, 2015 +and 2014, respectively +127 +120 +Class B Convertible Common Stock, $0.001 par value; 75,000 shares +authorized; 26,278 and 31,410 shares issued and outstanding at +December 31, 2015 and 2014, respectively +26 +31 +Additional paid-in capital +386,156 +355,535 +Accumulated other comprehensive loss +(26,305 +) +(16,077 +) +Retained earnings +967,552 +735,640 +Skechers U.S.A., Inc. equity +1,327,556 +1,075,249 +Noncontrolling interests +48,178 +58,858 +Total stockholders' equity +1,375,734 +1,134,107 +TOTAL LIABILITIES AND EQUITY +$ +2,047,408 +$ +1,674,918 +See accompanying notes to consolidated financial statements. +47 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Year Ended December 31, +2015 +2014 +2013 +Net sales +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +Cost of sales +1,723,315 +1,305,656 +1,027,569 +Gross profit +1,424,008 +1,071,905 +818,792 +Royalty income +11,745 +9,107 +7,734 +1,435,753 +1,081,012 +826,526 +Operating expenses: +Selling +235,586 +181,018 +153,491 +General and administrative +849,343 +690,923 +579,426 +1,084,929 +871,941 +732,917 +Earnings from operations +350,824 +209,071 +93,609 +Other income (expense): +Interest income +722 +837 +841 +Interest expense +(10,728 +) +(12,466 +) +(11,890 +) +Other, net +(7,321 +) +(6,062 +) +(345 +) +Total other expense +(17,327 +) +(17,691 +) +(11,394 +) +Earnings before income tax expense +333,497 +191,380 +82,215 +Income tax expense +72,450 +39,184 +21,347 +Net earnings +261,047 +152,196 +60,868 +Less: Net earnings attributable to non-controlling interests +29,135 +13,385 +6,080 +Net earnings attributable to Skechers U.S.A., Inc. +$ +231,912 +$ +138,811 +$ +54,788 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +1.52 +$ +0.91 +$ +0.36 +Diluted +$ +1.50 +$ +0.91 +$ +0.36 +Weighted average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +152,847 +151,839 +151,090 +Diluted +154,200 +153,079 +151,690 +See accompanying notes to consolidated financial statements. +48 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2015 +2014 +2013 +Net earnings +$ +261,047 +$ +152,196 +$ +60,868 +Other comprehensive income, net of tax: +Loss on foreign currency translation adjustment +(13,167 +) +(7,954 +) +(6,363 +) +Comprehensive income +247,880 +144,242 +54,505 +Less: Comprehensive income attributable to noncontrolling interests +26,196 +12,807 +6,018 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +221,684 +$ +131,435 +$ +48,487 +See accompanying notes to consolidated financial statements. +49 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +NON +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +CONTROLLING +STOCKHOLDERS' +STOCK +STOCK +STOCK +STOCK +CAPITAL +LOSS +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at December 31, 2012 +117,062 +33,823 +$ +118 +$ +33 +$ +336,177 +$ +(2,400 +) +$ +542,041 +$ +875,969 +$ +43,120 +$ +919,089 +Net earnings +— +— +— +— +— +— +54,788 +54,788 +6,080 +60,868 +Foreign currency translation adjustment +— +— +— +— +— +(6,301 +) +— +(6,301 +) +(62 +) +(6,363 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +3,635 +3,635 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(3,175 +) +(3,175 +) +Stock compensation expense +— +— +— +— +2,388 +— +— +2,388 +— +2,388 +Proceeds from issuance of common stock under the +employee stock purchase plan +448 +— +— +— +2,614 +— +— +2,614 +— +2,614 +Shares issued under the Incentive Award Plan +341 +— +1 +— +332 +— +— +333 +— +333 +Tax benefit of stock options exercised +— +— +— +— +531 +— +— +531 +— +531 +Conversion of Class B Common Stock into Class A +Common Stock +1,213 +(1,213 +) +1 +(1 +) +— +— +— +— +— +— +Balance at December 31, 2013 +119,064 +32,610 +$ +120 +$ +32 +$ +342,042 +$ +(8,701 +) +$ +596,829 +$ +930,322 +$ +49,598 +$ +979,920 +Net earnings +— +— +— +— +— +— +138,811 +138,811 +13,385 +152,196 +Foreign currency translation adjustment +— +— +— +— +— +(7,376 +) +— +(7,376 +) +(578 +) +(7,954 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +503 +503 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(4,050 +) +(4,050 +) +Stock compensation expense +— +— +— +— +8,684 +— +— +8,684 +— +8,684 +Proceeds from issuance of common stock under the +employee stock purchase plan +306 +— +— +— +3,363 +— +— +3,363 +— +3,363 +Shares issued under the Incentive Award Plan +292 +— +— +— +— +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +1,446 +— +— +1,446 +— +1,446 +Conversion of Class B Common Stock into Class A +Common Stock +1,200 +(1,200 +) +— +(1 +) +— +— +— +(1 +) +— +(1 +) +Balance at December 31, 2014 +120,862 +31,410 +$ +120 +$ +31 +$ +355,535 +$ +(16,077 +) +$ +735,640 +$ +1,075,249 +$ +58,858 +$ +1,134,107 +Net earnings +— +— +— +— +— +— +231,912 +231,912 +29,135 +261,047 +Foreign currency translation adjustment +— +— +— +— +— +(10,228 +) +— +(10,228 +) +(2,939 +) +(13,167 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +2,272 +2,272 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(39,148 +) +(39,148 +) +Stock compensation expense +— +— +— +— +18,296 +— +— +18,296 +— +18,296 +Proceeds from issuance of common stock under the +employee stock purchase plan +224 +— +1 +— +4,317 +— +— +4,318 +— +4,318 +Shares issued under the Incentive Award Plan +1,106 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +8,009 +— +— +8,009 +— +8,009 +Conversion of Class B Common Stock into Class A +Common Stock +5,132 +(5,132 +) +5 +(5 +) +— +— +— +— +— +— +Balance at December 31, 2015 +127,324 +26,278 +$ +127 +$ +26 +$ +386,156 +$ +(26,305 +) +$ +967,552 +$ +1,327,556 +$ +48,178 +$ +1,375,734 +See accompanying notes to consolidated financial statements +50 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2015 +2014 +2013 +Cash flows from operating activities: +Net earnings +$ +261,047 +$ +152,196 +$ +60,868 +Adjustments to reconcile net earnings to net cash provided by operating +activities: +Depreciation and amortization of property, plant and equipment +52,433 +47,557 +42,397 +Amortization of deferred financing costs +687 +1,201 +1,201 +Amortization of intangible assets +527 +747 +912 +Provision for bad debts and returns +7,520 +14,153 +2,868 +Non-cash share-based compensation +18,296 +8,684 +2,388 +Deferred income taxes +(4,844 +) +22,411 +11,583 +Other +656 +837 +(447 +) +(Increase) decrease in assets: +Receivables +(100,032 +) +(70,695 +) +(21,279 +) +Inventories +(176,062 +) +(100,162 +) +(22,589 +) +Prepaid expenses and other current assets +(2,082 +) +(31,788 +) +1,205 +Other assets +(6,423 +) +4,548 +(3,239 +) +Increase in liabilities: +Accounts payable +130,075 +98,686 +17,596 +Accrued expenses and other long-term liabilities +50,416 +15,507 +5,714 +Net cash provided by operating activities +232,214 +163,882 +99,178 +Cash flows from investing activities: +Capital expenditures +(118,144 +) +(56,905 +) +(41,294 +) +Intangible asset additions +(55 +) +— +(87 +) +Purchases of investments +(8,428 +) +— +— +Proceeds from sales of investments +144 +— +— +Net cash used in investing activities +(126,483 +) +(56,905 +) +(41,381 +) +Cash flows from financing activities: +Net proceeds from the issuances of common stock through employee +stock purchase plan +4,318 +3,363 +2,947 +Payments on long-term debt +(32,656 +) +(12,028 +) +(11,667 +) +Proceeds from long-term debt +762 +— +— +Proceeds (payments) on short-term borrowings +(1,733 +) +1,723 +(2,382 +) +Excess tax benefits from share-based compensation +8,009 +1,446 +531 +Contribution from non-controlling interests of consolidated entity +2,272 +503 +3,635 +Distributions to non-controlling interests of consolidated entity +(39,148 +) +(4,050 +) +(3,175 +) +Net cash used in financing activities +(58,176 +) +(9,043 +) +(10,111 +) +Net increase in cash and cash equivalents +47,555 +97,934 +47,686 +Effect of exchange rates on cash and cash equivalents +(6,249 +) +(3,260 +) +(1,501 +) +Cash and cash equivalents at beginning of the period +466,685 +372,011 +325,826 +Cash and cash equivalents at end of the period +$ +507,991 +$ +466,685 +$ +372,011 +Supplemental disclosures of cash flow information: +Cash paid during the period for: +Interest +$ +9,891 +$ +10,822 +$ +10,624 +Income taxes +63,479 +29,499 +5,480 +See accompanying notes to consolidated financial statements. +51 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2015, 2014 and 2013 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company operates 390 domestic and 127 international retail stores and an e-commerce business as of December 31, 2015. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. +On August 21, 2015, the Company’s Board of Directors approved a three-for-one stock split, effected in the form of a stock dividend, of both the Company’s Class A and Class B common stock. The stock split was made on October 16, 2015 to stockholders of record at the close of business on October 2, 2015. All share numbers and per-share amounts presented in the consolidated financial statements reflect the three-for-one stock split. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves and valuation of deferred income taxes. Actual results could differ from those estimates. +(c) +Revenue Recognition +The Company recognizes revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Wholesale sales, which include amounts billed for shipping and handling costs, are recognized net of allowances for estimated returns, sales allowances, discounts, and chargebacks. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are recorded when related revenue is recorded. Related costs paid to third-party shipping companies are recorded as cost of sales. The Company recognizes revenue from retail and e-commerce sales at the point of sale. Sales and value-added taxes collected from retail customers are excluded from reported revenues. +Royalty income is earned from licensing arrangements. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned. In addition, the Company receives royalty payments based on actual sales of the licensed products. Typically, at each quarter-end the Company receives correspondence from licensees indicating the actual sales for the period, which is used to calculate and record the related royalties based on the terms of the agreement. +(d) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic wholesale, international wholesale, and retail, which includes e-commerce sales. Information regarding these segments is summarized in Note 17 – Segment Information. +(e) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Asia or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) 810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has determined that it is the primary beneficiary for these VIE’s because the Company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity, or the right to receive benefits from the entity that could potentially be significant to the variable interest +52 +entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated financial statements, even though the Company may not hold a majority equity interest. There have been no changes during 2015 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The assets of these joint ventures are res tricted in that they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Company does not have a variable interest in any unconsoli dated VIEs. +(f) +Fair Value of Financial Instruments +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, investments, accounts receivable, accounts payable and accrued expenses, approximate fair value due to the relatively short maturity of such instruments. +The carrying amount of the Company’s long-term borrowings are considered Level 2 liabilities, which approximates fair value, based upon current rates and terms available to the Company for similar debt. +As of August 12, 2015, the Company entered into an interest rate swap agreement concurrent with refinancing its domestic distribution center construction loan (see Note 6, Derivative Instruments). The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with accounting principles generally accepted in the United States of America (“U.S. GAAP”), credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The majority of the inputs used to value the interest rate swap were within Level 2 of the fair value hierarchy. As of December 31, 2015, the interest rate swap was a Level 2 derivative and was classified as other long-term liabilities in the Company’s consolidated balance sheets. +(g) +Cash and Cash Equivalents +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +(h) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectability, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the account. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high-risk, the Company provides a reserve based upon its historical loss rate as a percentage of sales. +(i) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market (net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories, and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +53 +(j) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method, which based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, +whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company reviews both quantitative and qualitative factors to assess whether a triggering event occurred. The Company prepares a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of 24 months are then reviewed in detail to determine whether impairment exists. Recoverability of assets or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. The Company did not record impairment charges during the years ended December 31, 2015, 2014 or 2013. +(k) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry-forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +(l) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Translation adjustments for subsidiaries where the functional currency is its local currency are included in other comprehensive income. Foreign currency transaction gains (losses) resulting from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +(m) +Comprehensive Income +Comprehensive income is presented in the consolidated statements of comprehensive income. Comprehensive income consists of net earnings, foreign currency translation adjustments, and income attributable to non-controlling interests. +(n) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run, or over the life of the endorsement contract. Advertising expense for the years ended December 31, 2015, 2014 and 2013 was approximately $188.1 million, $141.7 million and $118.5 million, respectively. Prepaid advertising costs were $11.2 million and $13.0 million at December 31, 2015 and 2014, respectively. Prepaid amounts outstanding at December 31, 2015 and 2014, represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but had not run, as of December 31, 2015 and 2014, respectively. +(o) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses, when incurred. Product design and development costs aggregated approximately $11.2 million, $10.3 million, and $9.2 million during the years ended December 31, 2015, 2014 and 2013, respectively. +54 +(p) +Warehouse and Distribution Costs +The Company’s distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $170.2 million, $134.8 million and $122.9 million for 2015, 2014 and 2013, respectively. +(q) +Recent Accounting Pronouncements +In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) , (“ASU 2016-02”). The new standard requires lessees to recognize most leases on the balance sheet. This will increase lessees reported assets and liabilities. ASU 2016-02 is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2018. ASU 2016-02 mandates a modified retrospective transition method for all entities. The Company is currently evaluating the impact of ASU 2016-02 on its consolidated financial statements, however, the Company does not know what impact the new standard will have on its financial condition or results of operations. +In November 2015, the FASB issued ASU 2015‑17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17), which amends the guidance requiring companies to separate deferred income tax liabilities and assets into current and non-current amounts in a classified statement of financial position. This accounting guidance simplifies the presentation of deferred income taxes, such that deferred tax liabilities and assets be classified as non-current in a classified statement of financial position. ASU 2015-17 will be effective for the Company’s annual and interim reporting periods beginning after December 15, 2016, and interim periods within those annual periods. Entities may adopt the guidance prospectively or retrospectively. The Company is currently evaluating the impact of ASU 2015-17, however, the Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In September 2015, the FASB issued ASU 2015-16, “ Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments ” (“ASU 2015-16”). ASU 2015-16 eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. ASU 2015-16 will be effective for the Company’s annual and interim reporting periods beginning January 1, 2018, although early adoption is permitted. The Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In July 2015, the FASB issued ASU 2015-11, “ Inventory (Topic 330): Simplifying the Measurement of Inventory ” (“ASU 2015-11”). ASU 2015-11 requires that inventory within the scope of this standard be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in this update do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. ASU 2015-11 will be effective for the Company’s annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. The Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In April 2015, the FASB issued ASU 2015-03, “ Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs ” (“ASU 2015-03”). This guidance requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance simplifies presentation of debt issuance costs, but does not address presentation or subsequent measurement of debt issue costs related to line of credit arrangements. In August 2015, the FASB issued ASU 2015-15 “Interest-Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” which indicates the Securities and Exchange Commission staff would not object to an entity deferring and presenting debt issuance costs related to line-of-credit arrangements as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-03 will be effective for the Company’s annual and interim reporting periods beginning January 1, 2016, and should be applied on a retrospective basis, although early adoption is permitted. The adoption of ASU 2015-03 will not have any impact on the Company’s results of operations, but will result in debt issuance costs being presented as a direct reduction from the carrying amount of debt liabilities that are not line-of-credit arrangements. The Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In February 2015, the FASB issued ASU 2015-02, “ Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 amends the consolidation guidance for variable interest entities (“VIEs”) and general partners’ investments in limited partnerships, and modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities. The amendment will be effective for the Company’s annual and interim reporting periods beginning January 1, 2016, with early adoption +55 +permitted. The Company will begin evaluating the impact of ASU 2015-02 based on this guidance upon adoption. The Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In August 2014, the FASB issued ASU 2014-15, which amended the FASB Accounting Standards Codification and amended Subtopic 205-40, “ Presentation of Financial Statements – Going Concern .” This amendment prescribes that an entity should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will become effective for the Company’s annual and interim reporting periods beginning January 1, 2017. The Company will begin evaluating going concern disclosures based on this guidance upon adoption. The Company does not expect that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. +In May 2014, the FASB issued ASU 2014-09, which amended the FASB Accounting Standards Codification (“ASC”) and created a new Topic ASC 606, “ Revenue from Contracts with Customers ” (“ASC 606”). This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in Topic 605, “ Revenue Recognition ,” and most industry-specific guidance throughout the Industry Topics of the Codification. For annual and interim reporting periods the mandatory adoption date of ASC 606 is January 1, 2018, and there will be two methods of adoption allowed, either a full retrospective adoption or a modified retrospective adoption. The Company is currently evaluating the impact of ASC 606, but at the current time does not know what impact the new standard will have on revenue recognized and other accounting decisions in future periods, if any, nor what method of adoption will be selected if the impact is material. +(2) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2015 and 2014 is summarized as follows (in thousands): +2015 +2014 +Land +$ +76,163 +$ +61,163 +Buildings and improvements +200,607 +177,348 +Furniture, fixtures and equipment +248,684 +217,271 +Leasehold improvements +236,842 +197,467 +Total property, plant and equipment +762,296 +653,249 +Less accumulated depreciation and amortization +326,389 +280,066 +Property, plant and equipment, net +$ +435,907 +$ +373,183 +(3) +ACCRUED EXPENSES +Accrued expenses at December 31, 2015 and 2014 are summarized as follows (in thousands): +2015 +2014 +Accrued inventory purchases +$ +53,607 +$ +22,553 +Accrued payroll and taxes +33,711 +27,152 +Accrued expenses +$ +87,318 +$ +49,705 +(4) +LINE OF CREDIT AND SHORT-TERM BORROWINGS +On June 30, 2015, the Company entered into a $250.0 million loan and security agreement, subject to increase by up to $100 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits the Company and certain of its subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at the Company’s election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. The Company pays a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, +56 +which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $ 100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the C ompany and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make cert ain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Comm itments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. The Company paid closing and arrangement fees of $ 1.1 million on this facility, whic h are being amortized to interest expense over the five -year life of the facility. As of December 31, 2015 and December 31, 2014 , there was $ 0.1 million outstanding under the Company’s credit facilities, classified as short-term borrowings in the Company’s consolidated balance sheets. The remaining balance in short-term borrowings, as of December 31, 2014, is related to the Company’s joint venture in India. +(5) +LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2015 and 2014 is as follows (in thousands): +2015 +2014 +Note payable to banks, due in monthly installments of $261.4 +(includes principal and interest), variable-rate interest at +2.42% per annum, secured by property, balloon payment of +$62,843 due August 2020 +$ +69,515 +$ +77,900 +Note payable to banks, due in monthly installments of $531.4 +(includes principal and interest), fixed-rate interest at 3.54% +per annum, secured by property, balloon payment of $12,635 +paid in December 2015 +— +17,940 +Note payable to banks, due in monthly installments of $483.9 +(includes principal and interest), fixed-rate interest at 3.19% +per annum, secured by property, balloon payment of $11,670 +due June 2016 +13,886 +19,159 +Note payable to TCF Equipment Finance, Inc., due in monthly +installments of $30.5, (includes principal and interest) fixed- +rate interest at 5.24% per annum, maturity date of July 2019 +1,194 +1,489 +Subtotal +84,595 +116,488 +Less current installments +15,653 +101,407 +Total long-term borrowings +$ +68,942 +$ +15,081 +The aggregate maturities of long-term borrowings at December 31, 2015 are as follows (in thousands): +2016 +15,653 +2017 +1,783 +2018 +1,801 +2019 +1,666 +2020 +63,692 +$ +84,595 +The Company’s long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. The Company is in compliance with its non-financial covenants, including any cross default provisions, and financial covenants of its long-term borrowings as of December 31, 2015. +On April 30, 2010, HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the project on certain property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. +57 +On August 11, 2015, the JV, through HF-T1, entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) an d Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. As of the date of the Amended Loan Agreement, the outstanding principal ba lance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF Logistics (“HF”) agreed that the Company would make an additional capital contribution of $38.7 million to the J V, through HF -T1, to make a payment on the Original Loan based on the Company’s 50% eq uity interest in the JV. The payment equaled the Company’s 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed th at the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV, through HF-T1, to (i) refinance all amounts owed on the Original Loan a fter taking into account the payment described above, (ii) pay $0.9 million in a ccrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fe e and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transaction s that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursu ant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in the Company’s consolid ated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Credit Agree ment dated June 30, 2015 (see Note 6, Derivative Instruments). +On December 29, 2010, the Company entered into a master loan and security agreement (the “Master Agreement”), by and between the Company and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan Documents”), by and among the Company, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (“Agent”). The Company used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in the Rancho Belago distribution facility. Borrowings made pursuant to the Master Agreement may be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 million and each for a term of 60 months. The First Note entered into on the same date as the Master Agreement represents a borrowing of approximately $39.3 million (“the First Note”). Interest accrued at a fixed rate of 3.54% per annum on the First Note. The Company made the final payment on the First Note on December 29, 2015. On June 30, 2011, the Company entered into another Note agreement for approximately $36.3 million (“the Second Note”). Interest accrues at a fixed rate of 3.19% per annum on the Second Note. As of December 31, 2015, the Company had $13.9 million outstanding on the Second Note, which is included in current installments of long-term borrowings. As of December 31, 2014, there was $37.1 million outstanding on the Notes, of which $23.2 was included in current installments of long-term borrowings and $13.9 million was included in long-term borrowings. The Company paid commitment fees of $0.8 million on the Notes, which are being amortized to interest expense over the five-year life of the Notes. +(6) +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company used an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. On August 12, 2015, in connection with refinancing its domestic distribution center loan, described in Note 5 above, the Company entered into a variable-to-fixed interest rate swap agreement with Bank of America, N.A., to hedge the cash flows on the Company’s $70.0 million variable rate debt. As of December 31, 2015, the swap agreement has an aggregate notional amount of $69.5 million and a maturity date of August 12, 2022, subject to early termination commencing on August 1, 2020 at the option of HF Logistics-SKX T1, LLC (“HF-T1”), a wholly-owned subsidiary of the Company’s joint venture HF Logistics-SKX, LLC (the “JV”), Under the terms of the swap agreement, the Company will pay a weighted-average fixed rate of 2.08% on the $69.5 million notional amount and receive payments from the counterparty based on the 30-day LIBOR rate. The rate swap agreement utilized by the Company effectively modifies its exposure to interest rate risk by converting the Company’s floating-rate debt to a fixed-rate of 4.08% for the next seven years, thus reducing the impact of interest-rate changes on future interest expense. +By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major +58 +financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2015, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +(7) +COMMITMENTS AND CONTINGENCIES +(a) +Leases +The Company leases facilities under operating lease agreements expiring through May 2032. The Company pays taxes, maintenance and insurance in addition to the lease obligations. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of gross sales in excess of a base annual rent. The Company also leases certain equipment and automobiles under operating lease agreements expiring at various dates through January 2019. Rent expense for the years ended December 31, 2015, 2014 and 2013 approximated $137.8 million, $107.0 million and $94.0 million, respectively. +Minimum lease payments, which take into account escalation clauses, are recognized on a straight-line basis over the minimum lease term. Reimbursements for leasehold improvements are recorded as liabilities and are amortized over the lease term. Lease concessions, usually a free rent period, are considered in the calculation of the minimum lease payments for the minimum lease term. +Future minimum lease payments under noncancellable leases at December 31, 2015 are as follows (in thousands): +OPERATING +LEASES +Year ending December 31: +2016 +$ +154,512 +2017 +141,136 +2018 +127,311 +2019 +110,379 +2020 +107,569 +Thereafter +436,862 +$ +1,077,769 +(b) +Litigation +The Company recognizes legal expense in connection with loss contingencies as incurred. +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups are defective and unreasonably dangerous, negligently designed and/or manufactured, and do not conform to representations made by the Company, and that the Company failed to provide adequate warnings of alleged risks associated with Shape-ups. In total, the Company is named as a defendant in 1,141 currently pending cases (some on behalf of multiple plaintiffs) filed in various courts that assert further varying injuries but employ similar legal theories and assert similar claims to the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are some variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding and 414 additional individuals have submitted claims by plaintiff fact sheets. The Company has resolved 481 personal injury claims in the MDL proceedings, comprised of 90 that were filed as formal actions and 391 that were submitted by plaintiff fact sheets. The Company has also settled 1,332 claims in principle—1,101 filed cases and 231 claims submitted by plaintiff fact sheets— either directly or pursuant to a global settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 42 cases in the MDL proceeding have been dismissed either voluntarily or on motions by the Company and 38 unfiled claims submitted by plaintiff fact sheet have been abandoned. Between the consummated settlements and cases subject to the settlement program, all but two personal injury cases pending in the MDL have been or are expected to soon be resolved. On August 6, 2015, the Court entered an order staying all deadlines, including trial, pending further order of the Court. +59 +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition by the Company to coordinate all personal injury actions filed in Califo rnia that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coordinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. Thirty-five actions brought on behalf of a total of 476 plaintiffs, have been settled and dismissed. The Company has also settled in principle an additional 31 actions b rought on behalf of 405 plaintiffs pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). One single plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff l awsuits have been dismissed entirely either voluntarily or on motion by the Company. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by the Company. Thus, taking into account both consummated settlements an d cases subject to the settlement program, only five lawsuits on behalf of a total of ten plaintiffs are expected to remain in the LASC Coordinated Cases. Discover is continuing in those five remaining cases. No trial dates have been set. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. Ten of those actions have been resolved and dismissed. One of the remaining actions that includes the claims of 65 plaintiffs, has been settled in principle pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). The last remaining action in a state court other than California was recently filed in Missouri on January 4, 2016 on behalf of a single plaintiff. The Company has not yet been served in that action. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. The global settlement program involves complex monetary and non-monetary terms that are in the final stages of being documented. If the group settlements are not finalized and the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for business purposes in order to end the distraction of litigation, and the Company continues to believe it has meritorious defenses and intend to defend any remaining cases vigorously. In addition, even if the global settlement is finalized, it is too early to predict whether there will be future personal injury cases filed which are not covered by the settlement, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be available and/or adequate to cover any losses. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against the Company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of the Company’s alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including the Company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, The Company responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and BOBS Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on the Company’s operations or financial position, the Company believes it has meritorious defenses and intend to defend these legal matters vigorously. +The Company has reserved $4.0 million for costs and potential exposure related to the settlement of the foregoing personal injury lawsuits. Although the Company’s reserve of $4.0 million appropriately reflects the current estimated range of loss, it is not possible to predict the final outcome of the related proceedings or any other pending legal proceedings and, consequently, the final exposure and costs associated with pending legal proceedings could have a further material adverse impact on the Company’s result of operations or financial position. +60 +In accordance with U.S. GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2015, nor is it possible to estimate what litigation-related costs will be in the future. +(c) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.3% and 0.5% for 30- to 60-day financing. The amounts outstanding under these arrangements at December 31, 2015 and 2014 were $120.4 million and $171.4 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $5.4 million in 2015, $5.1 million in 2014, and $3.9 million in 2013. The Company has open purchase commitments with its foreign manufacturers at December 31, 2015 of $613.8 million, which are not included in the accompanying 2015 consolidated balance sheets. +(8) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $.001 per share, 75 million shares of Class B Common Stock, par value $.001 per share, and 10 million shares of preferred stock, $.001 par value per share. +During 2015, 2014 and 2013, certain Class B stockholders converted 5,131,296 shares, 1,199,328 shares and 1,213,188 shares, respectively, of Class B Common Stock to Class A Common Stock. +(9) +NONCONTROLLING INTERESTS +The following VIE’s are consolidated into the Company’s consolidated financial statements and the carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics-SKX, LLC +December 31, 2015 +December 31, 2014 +Current assets +$ +2,111 +$ +6,812 +Noncurrent assets +113,928 +118,837 +Total assets +$ +116,039 +$ +125,649 +Current liabilities +$ +2,461 +$ +78,668 +Noncurrent liabilities +69,951 +1,194 +Total liabilities +$ +72,412 +$ +79,862 +Distribution joint ventures (1) +December 31, 2015 +December 31, 2014 +Current assets +$ +154,060 +$ +94,819 +Noncurrent assets +34,782 +10,322 +Total assets +$ +188,842 +$ +105,141 +Current liabilities +$ +68,198 +$ +38,470 +Noncurrent liabilities +62 +66 +Total liabilities +$ +68,260 +$ +38,536 +(1) +Distribution joint ventures include Skechers China Limited, Skechers Southeast Asia Limited, Skechers Thailand Limited, Skechers Retail India Private Limited, and Skechers South Asia Private Limited. +Noncontrolling interest earnings were $29.1 million, $13.4 million and $6.1 million for the years ended December 31, 2015, 2014 and 2013, respectively, which represents the share of net earnings or loss that is attributable to the Company’s joint venture partners. HF Logistics-SKX, LLC made cash capital distributions of $38.6 million, $3.7 million, and $3.2 million during the years ended December 31, 2015, 2014, and 2013 respectively. Skechers China Limited made capital distributions of $0.5 million and $0.4 +61 +million during the years ended December 31, 2015 and 2014. The distributi on joint venture partners made cash capital contributions of $2.3 million, $0.5 million and $3.6 million during the years ended December 31, 2015, 2014 and 2013, respectively. +(10) +EARNINGS PER SHARE +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential dilutive common shares using the treasury stock method. +The Company has two classes of issued and outstanding common stock; Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted net earnings per share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating earnings per share (in thousands): +Basic earnings per share +2015 +2014 +2013 +Net earnings attributable to Skechers U.S.A., Inc. +$ +231,912 +$ +138,811 +$ +54,788 +Weighted average common shares outstanding +152,847 +151,839 +151,090 +Basic earnings per share attributable to Skechers U.S.A., Inc. +$ +1.52 +$ +0.91 +$ +0.36 +Diluted earnings per share +2015 +2014 +2013 +Net earnings attributable to Skechers U.S.A., Inc. +$ +231,912 +$ +138,811 +$ +54,788 +Weighted average common shares outstanding +152,847 +151,839 +151,090 +Dilutive effect of nonvested shares +1,353 +1,240 +600 +Weighted average common shares outstanding +154,200 +153,079 +151,690 +Diluted earnings per share attributable to Skechers U.S.A., +Inc. +$ +1.50 +$ +0.91 +$ +0.36 +There were no shares excluded from the computation of diluted earnings per share for the years ended December 31, 2015, 2014 or 2013. +(11) +STOCK COMPENSATION +(a) +Incentive Award Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007. Also on May 24, 2007, the Company’s Board of Directors terminated the Company’s previous 1998 Stock Option, Deferred Stock and Restricted Stock Plan, with no further granting of awards being permitted thereafter. A total of 22,500,000 shares of Class A Common Stock are reserved for issuance under the 2007 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2007 Plan is administered by the Compensation Committee of the Company’s Board of Directors. +62 +A summary of the status and changes of nonvested shares related to the 2007 Plan as of and for the period ended December 31, 2015 is presented below: +SHARES +WEIGHTED-AVERAGE +GRANT-DATE FAIR VALUE +Nonvested at December 31, 2012 +852,999 +$ +5.90 +Granted +202,500 +9.23 +Vested/Released +(227,001 +) +6.01 +Nonvested at December 31, 2013 +828,498 +6.68 +Granted +3,277,500 +15.67 +Vested/Released +(291,999 +) +6.66 +Cancelled +(22,500 +) +6.25 +Nonvested at December 31, 2014 +3,791,499 +14.46 +Granted +40,500 +29.83 +Vested/Released +(1,106,499 +) +11.81 +Nonvested at December 31, 2015 +2,725,500 +15.77 +As of December 31, 2015, a total of 11,108,643 shares remain available for grant as equity awards under the 2007 Plan. +The Company recognized in the consolidated statements of earnings compensation expense of $18.3 million, $8.7 million and $2.4 million and related excess income tax benefits of $8.0 million, $1.4 million, and $0.5 million in the consolidated balance sheets for grants under its stock-based compensation plans for the years ended December 31, 2015, 2014, and 2013, respectively. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. There was $33.0 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2015, which is expected to be recognized over a weighted average period of 1.9 years. The total fair value of shares vested during the period ended December 31, 2015 and 2014 was $13.1 million and $1.9 million, respectively. +(b) +Stock Purchase Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2008 Employee Stock Purchase Plan (the “2008 ESPP”), and the Company’s stockholders approved the 2008 ESPP on May 24, 2007. The 2008 ESPP became effective on January 1, 2008, and the Company’s Board of Directors terminated the 1998 ESPP as of such date, with no additional granting of rights being permitted under the 1998 ESPP. The 2008 ESPP provides that a total of 9,000,000 shares of Class A Common Stock are reserved for issuance under the plan. The number of shares that may be made available for sale is subject to automatic increases on the first day of each fiscal year during the term of the 2008 ESPP as provided in the plan. The 2008 ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code of 1986, as amended. The terms of the 2008 ESPP permit eligible employees to purchase Class A Common Stock at six-month intervals through payroll deductions, which may not exceed 15% of an employee’s compensation. The price of Class A Common Stock purchased under the 2008 ESPP is 85% of the lower of the fair market value of the Class A Common Stock at the beginning of each six-month offering period or on the applicable purchase date. Employees may end their participation in an offering at any time during the offering period. The 2008 ESPP is administered by the Compensation Committee of the Company’s Board of Directors. +During 2015, 2014 and 2013, 223,892 shares, 306,459 shares and 447,771 shares were issued under the 2008 ESPP for which the Company received approximately $4.3 million, $3.4 million and $2.6 million, respectively. +63 +( 12) +INCOME TAXES +The provisions for income tax expense were as follows (in thousands): +2015 +2014 +2013 +Federal: +Current +$ +45,095 +$ +7,677 +$ +632 +Deferred +2,774 +23,659 +11,537 +Total federal +47,869 +31,336 +12,169 +State: +Current +2,506 +2,060 +519 +Deferred +1,798 +529 +119 +Total state +4,304 +2,589 +638 +Foreign: +Current +21,204 +5,399 +8,228 +Deferred +(927 +) +(140 +) +312 +Total foreign +20,277 +5,259 +8,540 +Total income taxes +$ +72,450 +$ +39,184 +$ +21,347 +The Company’s provision for income tax expense and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. The Company’s provision for income tax expense was calculated using the applicable statutory rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense by earnings before income taxes. +The Company’s earnings (loss) before income taxes and income tax expense for 2015, 2014 and 2013 are as follows (in thousands): +Years Ended December 31, +2015 +2014 +2013 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States +$ +136,725 +$ +52,173 +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +Canada +4,228 +1,024 +6,241 +1,572 +4,091 +1,187 +Chile +2,983 +572 +629 +138 +9,622 +1,920 +Peoples Republic of China (“China”) +49,028 +11,084 +15,201 +1,179 +6,148 +1,646 +Jersey (1) +123,721 +— +77,555 +— +25,348 +— +Non-benefited loss operations (2) +(16,719 +) +164 +(13,021 +) +— +(15,841 +) +— +Other jurisdictions (3) +33,531 +7,433 +21,997 +3,795 +14,142 +3,787 +Earnings before income taxes +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +Effective tax rate (4) +21.7 +% +20.5 +% +26.0 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Panama, Poland, Romania, Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of 2015 consolidated earnings (loss) before taxes: Hungary, Serbia, Bosnia, Herzegovina, Montenegro, Macedonia, Albania, Kosovo, Vietnam, Panama, Peru, Colombia, Costa Rica, UK, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +For 2015, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39% primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2015, as reflected in the table above, earnings (loss) before income taxes in the U.S. were earnings of $136.7 million, with income tax expense of $52.2 million, which is an average rate of 38.2%. Earnings (loss) before income taxes in non-U.S. jurisdictions were earnings of $196.8 million, with aggregate income tax expense of $20.3 million, which is an average rate +64 +of 10.3%. Combined, this results in consolidated earnings before income taxes for the period of $333.5 million, and consolidated i ncome tax expense for the period of $72.5 million, resulting in an effective tax rate of 21.7%. For 2015, of the Company’s $196.8 million in earnings before income tax earned outside the U.S., $123.7 million was earned in Jersey, which does not impose a ta x on corporate earnings. In Jersey, earnings before income taxes increased by $46.1 million, or 59%, to $123.7 million for 2015 from $77.6 million for 2014. This increase was primarily attributable to the Company experiencing an increase of $433.7 million in net sales in the “Other international” geographic area for 2015 (see Note 17 – Segment Information), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary a greements. Increases in net sales in the “Other international” geographic area from 2014 to 2015 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $16.7 million for whic h no tax benefit was recognized during the year ended December 31, 2015 because of the provision of offsetting valuation allowances, but in which $0.2 million in nonrefundable withholding taxes were paid. Individually, none of the other foreign jurisdictio ns included in “Other jurisdictions” in the table above had more than 5% of our 2015 consolidated earnings (loss) before taxes. Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2015, the Company had approximately $508.0 million in cash and cash equivalents, of which $218.7 million, or 43.1%, was held outside the U.S. Of the $218.7 million held by the Company’s non-U.S. subsidiaries, approximately $33.4 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s financial statements as of December 31, 2015. The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months and the Company does not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. Because of the need for cash for operating capital and continued overseas expansion, the Company also does not foresee the need for any of its foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2015 and 2014, U.S. income taxes have not been provided on cumulative total earnings of $482.7 million and $318.2 million, respectively. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows (in thousands): +2015 +2014 +2013 +Expected income tax expense +$ +116,724 +$ +66,981 +$ +28,775 +State income tax, net of federal benefit +2,011 +1,032 +255 +Rate differential on foreign income +(44,541 +) +(27,364 +) +(11,897 +) +Change in unrecognized tax benefits +(2,233 +) +(2,717 +) +740 +Non-deductible expenses +(350 +) +288 +(150 +) +Prior year R&D credit claims +— +— +(493 +) +Other +285 +3,333 +(1,187 +) +Change in valuation allowance +554 +(2,369 +) +5,304 +Total provision for income taxes +$ +72,450 +$ +39,184 +$ +21,347 +Effective tax rate +21.7 +% +20.5 +% +26.0 +% +65 +The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2015 and 2014 are presented below (in thousands): +2015 +2014 +Deferred tax assets: +Inventory adjustments +$ +6,249 +$ +4,942 +Accrued expenses +17,619 +15,103 +Allowances for bad debts and chargebacks +6,972 +6,407 +Loss carryforwards +23,073 +23,247 +Business credit carryforward +5,214 +4,042 +Share-based compensation +3,628 +2,282 +Valuation allowance +(18,088 +) +(17,534 +) +Total deferred tax assets +44,667 +38,489 +Deferred tax liabilities: +Prepaid expenses +8,566 +7,588 +Depreciation on property, plant and equipment +22,406 +22,050 +Total deferred tax liabilities +30,972 +29,638 +Net deferred tax assets +$ +13,695 +$ +8,851 +The Company believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2015 were $8.8 million and $33.3 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2014 were $7.2 million and $65.6 million, respectively. These tax credit and net operating loss carry-forward amounts don’t begin to expire until 2028 and 2021, respectively. As of December 31, 2015 and 2014, no valuation allowance against the related deferred tax asset has been set up for these loss and credit carry-forwards as it is believed the carry-forwards will be fully utilized in reducing future taxable income. +As of December 31, 2015 and 2014, the Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $66.8 million and $56.9 million, respectively. Some of these net operating losses expire beginning in 2016; however others can be carried forward indefinitely. As of December 31, 2015 and 2014, valuation allowances of $16.5 million and $15.9 million, respectively, had been set up against the related deferred tax assets for those loss carry-forwards that are not more likely than not to be fully utilized in reducing future taxable income. +The balance of unrecognized tax benefits, included in prepaid expenses in the consolidated balance sheets, decreased by $1.8 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2015 +2014 +Beginning balance +$ +7,936 +$ +10,816 +Additions for current year tax positions +888 +773 +Reductions for prior year tax positions +(1,099 +) +(2,227 +) +Reductions related to lapse of statute of limitations +(1,582 +) +(1,426 +) +Ending balance +$ +6,143 +$ +7,936 +If recognized, $6.1 million of unrecognized tax benefits would be recorded as a reduction in income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax expense (benefit) and totaled $(0.6) million for the year ended December 31, 2015, $(0.2) million for the year ended December 31, 2014, and $0.1 million for the year ended December 31, 2013. Accrued interest and penalties were $1.5 million and $1.7 million as of December 31, 2015 and 2014, respectively. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +66 +As of December 31, 2015, the Company’s tax filings are generally subject to examination in the U.S. and several Asian and European t ax jurisdictions for years ending on or after December 31, 2010. During the year, the Company reduced the balance of 2015 and prior year unrecognized tax benefits by $1.6 million as a result of expiring statutes. +The Company is currently under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2015, there was no reduction in the balance of 2015 and prior year unrecognized tax benefits due to any settlement of an examination. It is reasonably possible that certain state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2015 and prior year unrecognized tax benefits by $1.5 million. +(13) +EMPLOYEE BENEFIT PLAN +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have completed six months of service. Employees may contribute up to 15.0% of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company did not make a contribution to the plan for the years ended December 31, 2015, 2014 and 2013, respectively. +In May 2013, the Company established the Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”), which allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees, which will be determined by the Company’s Compensation Committee. The Company did not make a contribution to the plan for the year ended December 31, 2015 or 2014. The value of the deferred compensation is recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred liabilities are presented in the Company’s consolidated balance sheets. +(14) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates a significant portion of its sales in the United States; however, several of its products are sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $180.2 million and $166.9 million before allowances for bad debts and sales returns, and chargebacks at December 31, 2015 and 2014, respectively. Foreign accounts receivable, which are generally collateralized by letters of credit, amounted to $188.0 million and $126.2 million before allowance for bad debts, sales returns, and chargebacks at December 31, 2015 and 2014, respectively. International net sales amounted to $1.271 billion, $819.3 million and $558.1 million for the years ended December 31, 2015, 2014 and 2013, respectively. The Company’s credit losses charged to expense for the years ended December 31, 2015, 2014 and 2013 were $5.3 million, $11.8 million and $2.6 million, respectively. In addition, the Company’s recorded sales return and allowance expense for the years ended December 31, 2015, 2014 and 2013 were $2.2 million, $2.3 million and $0.2 million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the United States were $773.5 million and $548.9 million at December 31, 2015 and 2014, respectively. +During 2015, 2014 and 2013, no customer accounted for 10.0% or more of net sales. As of December 31, 2015, one customer accounted for 10.6% of gross trade receivables. No other customer accounted for more than 10% of net trade receivables at December 31, 2015 or 2014. During 2015, 2014 and 2013, net sales to the five largest customers were approximately 14.6%, 15.7% and 18.1%, respectively. +67 +The Company’s top five manufacturers produced the following for the years ended December 31, 2015, 2014 and 2013, respectively: +Percentage of Total Production +Years Ended December 31, +2015 +2014 +2013 +Manufacturer #1 +31.5 +% +37.5 +% +37.8 +% +Manufacturer #2 +9.1 +% +6.1 +% +7.1 +% +Manufacturer #3 +7.3 +% +5.7 +% +6.1 +% +Manufacturer #4 +5.0 +% +4.9 +% +4.8 +% +Manufacturer #5 +3.6 +% +4.7 +% +4.1 +% +56.5 +% +58.9 +% +59.9 +% +The majority of the Company’s products are produced in China. The Company’s operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce these risks by diversifying manufacturing among various factories. To date, these business risks have not had a material adverse impact on the Company’s operations. +(15) +RELATED PARTY TRANSACTIONS +The Company paid approximately $180,000, $160,000, and $178,000 during 2015, 2014 and 2013, respectively, to the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events, including the Company’s holiday party at the Shade Hotel, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, owns a 12% beneficial ownership interest in MIOC, and four other officers, directors and senior vice presidents of the Company own in aggregate an additional 5% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable with MIOC or the Shade Hotel at December 31, 2015 and 2014. +On July 29, 2010, the Company formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with the Company, and the Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer and Chief Financial Officer, are also officers and directors of the Foundation. During the years ended December 31, 2015 and 2014, the Company did not make any contributions to the Foundation. +The Company had receivables from officers and employees of $1.3 million and $0.6 million at December 31, 2015 and 2014, respectively. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans, These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant shareholders of the Company. +(16) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2015, to assess the need for potential recognition or disclosure in this filing. Based on this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. +68 +( 17 ) +SEGMENT INFORMATION +The Company has three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. The Company evaluates segment performance based primarily on net sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the Company’s segments. Net sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, and retail segments on a combined basis were as follows (in thousands): +2015 +2014 +2013 +Net sales +Domestic wholesale +$ +1,219,779 +$ +997,994 +$ +802,163 +International wholesale +1,094,395 +689,195 +478,799 +Retail +833,149 +690,372 +565,399 +Total +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +2015 +2014 +2013 +Gross profit +Domestic wholesale +$ +471,104 +$ +367,980 +$ +288,818 +International wholesale +454,665 +292,722 +198,853 +Retail +498,239 +411,203 +331,121 +Total +$ +1,424,008 +$ +1,071,905 +$ +818,792 +2015 +2014 +Identifiable assets +Domestic wholesale +$ +1,094,084 +$ +979,582 +International wholesale +713,424 +510,063 +Retail +239,900 +185,273 +Total +$ +2,047,408 +$ +1,674,918 +2015 +2014 +2013 +Additions to property, plant and equipment +Domestic wholesale +$ +38,080 +$ +9,655 +$ +9,652 +International wholesale +37,909 +18,899 +4,828 +Retail +42,155 +28,351 +26,814 +Total +$ +118,144 +$ +56,905 +$ +41,294 +69 +Geographic Information +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2015 +2014 +2013 +Net Sales (1) +United States +$ +1,876,201 +$ +1,558,226 +$ +1,288,302 +Canada +103,268 +85,139 +63,665 +Other international (2) +1,167,854 +734,196 +494,394 +Total +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +2015 +2014 +Property, plant and equipment, net +United States +$ +356,704 +$ +332,383 +Canada +8,447 +7,203 +Other international (2) +70,756 +33,597 +Total +$ +435,907 +$ +373,183 +(1) +The Company has subsidiaries in Asia, Central America, Europe, North America, and South America that generate net sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in Asia that generate net sales from those countries. The Company also has a subsidiary in Switzerland that generates net sales from that country in addition to net sales to distributors located in numerous non-European countries. External net sales are attributable to geographic regions based on the location of each of the Company’s subsidiaries. A subsidiary may earn revenue from external net sales and external royalties, or from inter-subsidiary net sales, royalties, fees and commissions provided in accordance with certain inter-subsidiary agreements. The resulting earnings of each subsidiary in its respective country are recognized under each respective country’s tax code. Inter-subsidiary revenues and expenses subsequently are eliminated in the Company’s consolidated financial statements and are not included as part of the external net sales reported in different geographic areas. +(2) +Other international consists of Asia, Central America, Europe, North America, and South America. +(18) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +Summarized unaudited financial data are as follows (in thousands): +2015 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +767,997 +$ +800,464 +$ +856,179 +$ +722,683 +Gross profit +332,540 +374,608 +387,006 +329,854 +Net earnings attributable to Skechers U.S.A., Inc. +56,080 +79,782 +66,602 +29,448 +Net earnings per share: +Basic +0.37 +0.52 +0.44 +0.19 +Diluted +0.37 +0.52 +0.43 +0.19 +2014 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +546,518 +$ +587,051 +$ +674,270 +$ +569,722 +Gross profit +240,403 +269,375 +304,498 +257,629 +Net earnings attributable to Skechers U.S.A., Inc. +30,965 +34,802 +51,123 +21,921 +Net earnings per share: +Basic +0.20 +0.23 +0.34 +0.14 +Diluted +0.20 +0.23 +0.33 +0.14 +70 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOU NTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that as of December 31, 2015, our internal control over financial reporting is effective. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2015, which is set forth below. +71 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2015. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +72 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of earnings, comprehensive income, equity, cash flows, and schedule for each of the three years in the period ended December 31, 2015, and our report dated February 26, 2016 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 26, 2016 +73 +ITEM 9B. +OTHE R INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. +ITEM 14. +PRIN CIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 45 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 75 of this annual report on Form 10-K. +3. +Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. +74 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years Ended December 31, 2015, 2014, and 2013 +DESCRIPTION +BALANCE AT +BEGINNING OF +PERIOD +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF PERIOD +Year-ended December 31, 2013 +Allowance for chargebacks +$ +2,801 +$ +1,514 +$ +(1,825 +) +$ +2,490 +Allowance for doubtful accounts +7,167 +1,105 +(2,292 +) +5,980 +Reserve for sales returns and allowances +6,954 +249 +253 +7,456 +Reserve for shrinkage +300 +1,166 +(1,200 +) +266 +Reserve for obsolescence +8,849 +1,333 +(6,697 +) +3,485 +Year-ended December 31, 2014 +Allowance for chargebacks +$ +2,490 +$ +5,530 +$ +(1,469 +) +$ +6,551 +Allowance for doubtful accounts +5,980 +6,284 +(6,823 +) +5,441 +Reserve for sales returns and allowances +7,456 +2,339 +(780 +) +9,015 +Reserve for shrinkage +266 +1,292 +(1,220 +) +338 +Reserve for obsolescence +3,485 +5,656 +(6,140 +) +3,001 +Year-ended December 31, 2015 +Allowance for chargebacks +$ +6,551 +$ +3,703 +$ +(3,189 +) +$ +7,065 +Allowance for doubtful accounts +5,441 +1,538 +(1,026 +) +5,953 +Reserve for sales returns and allowances +9,015 +2,279 +(52 +) +11,242 +Reserve for shrinkage +338 +2,014 +(1,945 +) +407 +Reserve for obsolescence +3,001 +10,321 +(10,041 +) +3,281 +See accompanying report of independent registered public accounting firm +75 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +10.1** +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2013). +10.2** +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2006). +10.3** +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.4** +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K for the year ended December 31, 2007). +10.5** +2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.5(a)** +Amendment No. 1 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2010). +10.5(b)** +Amendment No. 2 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 3.3 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +10.6** +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.6(a)** +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +10.7 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.8 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.9** +Employment Agreement, executed August 7, 2015, effective as of January 1, 2015, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +76 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.10 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 7, 2015). +10.11 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.11(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.12 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.13 +Master Loan and Security Agreement, dated December 29, 2010, by and between the Registrant and Banc of America Leasing & Capital, LLC (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on January 4, 2011). +10.14 +Equipment Security Note, dated December 29, 2010, by and among the Registrant, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on January 4, 2011). +10.15 +Equipment Security Note, dated June 30, 2011, by and among the Registrant, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 1, 2011). +10.16 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 27, 2007). +10.16(a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010) . +10.16(b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.17 +Lease Agreement, dated August 12, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.29 of the Registrant’s Form 10-K for the year ended December 31, 2002). +10.17(a) +Addendum to Lease Agreement, dated January 19, 2006, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium. +77 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.17(b) +Addendum 2 to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on May 27, 2008). +10.17(c) +Addendum 3 to Agreement dated June 11, 2013 and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium. +10.17(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium. +10.18 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 27, 2008). +10.18(a) +Addendum 1 to Lease Agreement, dated March 10, 2009, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium. +10.18(b) +Addendum 2 to Lease Agreement dated December 22, 2009 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium. +10.18(c) +Addendum 3 to Agreement dated June 11, 2013 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium. +10.18(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium. +10.19 +Lease Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center III in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2015). +10.19(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Centers I, II and III in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.20 +Lease Agreement dated July 10, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.20(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +78 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). +31.2 +Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.LAB +Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +** +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act. +79 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 26th day of February 2016. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 26, 2016 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 26, 2016 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 26, 2016 +David Weinberg +Chief Financial Officer and Director +(Principal Financial and Accounting Officer) +/s/ Jeffrey Greenberg +Director +February 26, 2016 +Jeffrey Greenberg +/s/ Geyer Kosinski +Director +February 26, 2016 +Geyer Kosinski +/s/ Morton D. Erlich +Director +February 26, 2016 +Morton D. Erlich +/s/ Richard Siskind +Director +February 26, 2016 +Richard Siskind +/s/ Thomas Walsh +Director +February 26, 2016 +Thomas Walsh +/s/ Rick Rappaport +Director +February 26, 2016 +Rick Rappaport +80 \ No newline at end of file diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/filing_metadata.csv b/raw/filings/0001065837/2015/0001564590-16-013515/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b2e196eacf040aff732edb2765da043645efa026 --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2016-02-26,2015-12-31,2016-02-26T18:45:06.000Z,0001564590-16-013515,skx-10k_20151231.htm,10-K,12557945,1,0,https://www.sec.gov/Archives/edgar/data/1065837/000156459016013515/skx-10k_20151231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459016013515/,2015,2015,1 diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/item1.txt b/raw/filings/0001065837/2015/0001564590-16-013515/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..9e619d6a2d9ec240081beb9061bcbf1b2ef706ef --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/item1.txt @@ -0,0 +1,398 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers GO brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2016, we owned and operated 119 concept stores, 155 factory outlet stores and 117 warehouse outlet stores in the United States, and 82 concept stores, 41 factory outlet stores, and five warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our youthful brand image and fashion-forward designs, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2015, our Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television campaigns featuring our own action heroes and characters; marathons and other events for our Skechers Performance Division; donation events surrounding our BOBS from Skechers charitable footwear program; and print, television, online and outdoor campaigns featuring our Skechers Performance and Skechers lifestyle endorsees. These endorsees included globally known recording artists Demi Lovato and Ringo Starr; sports legends Sugar Ray Leonard, Pete Rose, Joe Montana, Joe Namath and Mariano Rivera; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb Keflezighi and Kara Goucher; and professional golfers Matt Kuchar, Belen Mozo, Billy Andrade and Colin Montgomerie. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s Skechers-branded product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development and manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded product lines for men, women and children. Within these product lines, we also have numerous categories, many of which have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Relaxed Fit from Skechers, (ii) Dress Casuals/Modern Comfort, (iii) Casuals, (iv) Casual Fusion, and (v) seasonal sandals and boots. This category is generally sold through mid-tier retailers, department stores and some footwear specialty shops. +· +Relaxed Fit from Skechers is a line of trend-right casuals with a wider toe box for men and women who want all-day comfort without compromising style. Characteristics of the product line include comfortable outsoles, Skechers Memory Foam insoles and quality leather uppers. We market and package Relaxed Fit from Skechers styles in a unique shoe box that is distinct from other categories in the Skechers USA line of footwear. +· +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casual line—also referred to as the Modern Comfort collection—for women is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +· +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +· +Our Casual Fusion line is comprised of low-profile, sport-influenced casuals targeted to trend-conscious young men and women. The outsoles are primarily rubber and adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +· +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles for our Dress Casuals, Casuals and Casual Fusion lines, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles and (iii) sport sandals and boots. Many Skechers Sport styles are enhanced with comfort features such as high-volume Skechers Memory Foam insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Skechers Sport is typically sold through specialty shoe stores, department stores and athletic footwear retailers. In addition to the standard Skechers Sport lines, a collection of licensed Star Wars ™ Skechers footwear for men features characters and designs inspired by the popular film saga. This collection was packaged in a unique box separate from the Skechers Sport collection. +· +Our lightweight sport athletic-inspired product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, materials, design and construction of the outsoles. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features leather and trubuck uppers in both bright and classic athletic colors. +· +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +· +Our sport sandals and boots are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making a comfortable sport sandal. Sport sandals and boots are designed as seasonal footwear for the consumer who already wears our Skechers Sport sneakers. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Memory Foam. Skechers Active and Skechers Sport Active shoes are typically available through specialty casual shoe stores and department stores. +3 +BOBS from Skechers. The BOBS from Skechers line has grown into a year-round product offering with the addition of vulcanized looks and an “At Home” line. Primarily designed for women, the BOBS collection is also available for girls. BOBS are available at department stores, specialty shoe stores and online retailers. +· +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. Many styles now include Skechers Memory Foam. +· +BOBS vulcanized looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. Many styles now include Skechers Memory Foam. +· +The BOBS at Home collection for women is designed with our flexible rubber Keepsakes outsole, and features faux fur linings for the ultimate dorm or winter shoe. The uppers are primarily designed with tweeds, knits or suede. +When consumers purchase BOBS, Skechers donates funds to help save dogs’ and cats’ lives, and new shoes for children in need. In 2015, Skechers announced that up to three million dollars will be donated to help support Best Friends Animal Society ® , an organization focused on stopping the euthanizing of nearly four million pets annually in shelters across America. For children, more than 13 million pairs of new shoes have been donated primarily to charity partners SolesforSouls and Fashion Delivers since the program’s launch. The organizations donate the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. The Mark Nason Collection includes a wide range of on-trend casual, dress and active styles for style-conscious men: Mark Nason Skechers, a low-profile collection of casuals for everyday wear; Mark Nason Los Angeles Collection, casual sneakers for the active male; and the Mark Nason Dress Collection, dress shoes crafted with high-quality leathers and exquisite detailing. Many styles feature Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. The offering is available at Skechers retail stores and www.skechers.com . +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Design Team, the footwear utilizes the latest advancements in materials and innovative design, including an ultra-lightweight Resalyte compound for the midsole and GOimpulse sensors for responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. The footwear is available at athletic footwear retailers, department stores and specialty running stores. +· +Skechers GOrun. Skechers GOrun 4 and Skechers GOrun 3 are the latest in a collection of lightweight, flexible running shoes that features a midfoot strike design for efficient running. Skechers GOrun Ride 4 and Skechers GOrun Ride 3 feature similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Ultra offers maximum cushioning with the most support, making it perfect for distance or recovery runs. Skechers GOmeb Speed 3 is the high-performance racing shoe worn by elite marathon runner Meb. These flagship lines as well as other Skechers GOrun products are marketed to serious runners and recreational runners alike. +· +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on. The product line features a lightweight and flexible design to promote natural foot movement when walking. Skechers GOwalk 2 offers a unique V-Stride outsole and the latest Skechers GOwalk 3 collection incorporates more advanced performance technologies including a high-rebound Goga Mat insole, adaptive GO Pillars on the outsole and Memory Form Fit for a custom-fit experience. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +· +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +· +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A Resagrip outsole helps with traction control and a soft Resamax cushioned insole delivers comfort. Skechers GO GOLF Pro, the official shoe of PGA golfer Matt Kuchar, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes and sneakers, (ii) Skechers Lightweight Sport, (iii) Skech-Air by Skechers, (iv) Twinkle Toes and Twinkle Wishes by Skechers, (v) Skechers Cali for Girls, (vi) Airators by Skechers, (vii) Skechers Super Z-Strap, (viii) Elastika by Skechers, (ix) Skechers GOrun and Skechers GOwalk, (x) S-Lights, Hot Lights by Skechers and Luminators by Skechers, (xi) Mega Flex, (xii) Air-Mazing by Skechers, (xiii) Foamies by Skechers and (xiv) Game Kicks. +· +The Skechers Kids line includes embellishments or adornments such as fresh colors and fabrics from our Skechers adult shoes. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. +· +Skechers Lightweight Sport styles with Skechers Memory Foam are sneakers designed with many of the same meshes, knits and weaves as the adult Skechers Sport styles in bright colors and patterns. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +· +Skech-Air by Skechers for boys and girls are athletic sneakers with a unique visible air-cushioned outsole and a gel-infused memory foam insole. +· +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character, Twinkle Toes. Twinkle Wishes adds a magical light and sound feature that is activated when the toes are tapped together. +· +Skechers Cali for Girls is a line of sandals inspired by our women’s line of the same name with bright colors, textiles and adornments. +· +Airators by Skechers is a line of boys’ sneakers with a foot-cooling system designed to pump air from the heel through to the toes. The product line is marketed with the character, Kewl Breeze. +· +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system. The product line is marketed with the character, Z-Strap. +· +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +· +Skechers GOrun and Skechers GOwalk for boys and girls are casual adaptations of our popular Skechers Performance styles for the kids’ market, designed in bright and bold colors for daily play. The collection is designed to appeal both to younger kids as well as tweens transitioning to adult shoes. +· +S-Lights, Hot Lights by Skechers and Luminators by Skechers are lighted sneakers and sandals for boys and girls. The S-Lights combine patterns of lights on the outsoles and sides of the shoes while Hot Lights feature lights on the front of the toe to simulate headlights as well as on other areas of the shoes. Luminators by Skechers feature glowing green lights and a marketing campaign with the Luminators character. +· +Mega Flex is a line of athletic sneakers for boys based on a robot character. Styles include fun embellishments like heel springs or an articulated bladed outsole in the Mega Blades collection. +· +Air-Mazing by Skechers is a lightweight line of colorful sneakers designed for older boys. The product line is marketed with the character, Air-Mazing Kid, who performs air tricks in his sneakers. +· +Foamies by Skechers is a colorful line of lightweight, flexible boys’ and girls’ sneakers constructed with Skechers Memory Foam that can easily be washed in a washing machine. +· +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. +Skechers Kids lines are comprised primarily of shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. Skechers Kids shoes are available at department stores and specialty and athletic retailers. In addition to the standard Skechers Kids’ lines, a collection of licensed Star Wars ™ Skechers footwear for boys features characters and designs inspired by the popular film saga. This collection was packaged in a unique box separate from the Skechers Kids collection. +5 +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam. The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative on-trend and classic footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be fashionable and marketable to the 12- to 24-year-old consumer, while substantially all of our lines appeal to the broader range of 5- to 50-year olds, with an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1-The Company and Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +6 +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while co ntrolling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2015, five of our contract manufacturers accounted for approximately 56.5% of total purch ases. One manufacturer accounted for 31.5%, and another accounted for 9.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0.3% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department, and in Asia through an approximately 320-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes for our lifestyle lines, and technology with runners and athletes for our performance lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. Our Skechers lifestyle endorsees include Demi Lovato, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Joe Namath, and Pete Rose. We also signed Ringo Starr, Sugar Ray Leonard and Mariano Riviera, all of +7 +whom appeared in campaigns in 2015. Our Skechers Performance Division endorsees are elite runner and Olympic medalist Meb and elite runner Kara Goucher, who both appeared in marketing campaigns during 2015. To support our Skechers GO GOLF line, we launched a campaign with professional golfer Matt Kuchar, and signed Belen Mozo, Billy Andrade and Colin Montgomerie to appear in campaigns in 2016. Additionally, we signed pop superstar Meghan Trainor to a global agreement in 2015, with her campaign laun ching in 2016. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear regularly in popular fashion, lifestyle and pop culture publications, including Runner's World, Shape, Seventeen, Men's Fitness, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2015, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also have many commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature retired athletes, musicians and actors. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2015, many of our television commercials were translated into multiple languages and aired in Brazil, Canada, the United Kingdom, France, Mexico, Germany, Spain, Italy, Chile, Japan, Austria, Switzerland, the Philippines and across the Middle East, among other countries and regions. +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, we continued our outdoor campaign that included mall and telephone kiosks, billboards, and transportation systems in the Americas, Asia, the Middle East and across Europe. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in several European countries, Canada and Mexico. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting celebrities and their children. We have been featured on leading business shows with interviews of our executives discussing the Company’s business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites, and seeded our footwear to celebrities and influencers who have appeared in magazines, online sites and social media pages in our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and countries around the world where are product is sold. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2015, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance-branded booths to allow runners the ability to try on and often buy our products. In 2015, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, and became the title sponsor of The Skechers Performance Los Angeles Marathon, which saw the first Skechers-branded event in 2016. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with many key accounts for BOBS donation events in cities throughout the United States, Puerto Rico and Spain, building both our relationships with these accounts, as well as with the community as we donated footwear to children in need. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate +8 +with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these effort s help stimulate impulse sales and repeat purchases. +Trade Shows. To better showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, Platform, The Licensing Show and Outdoor Retailer in the United States; GDS, MICAM, and ISPO in Europe; and many other international shows. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Internet. We promote and sell our brands through our domestic website, www.skechers.com , as well as our foreign e-commerce sites in Chile, Germany and the United Kingdom, among other countries. This enables consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. Our website is a venue for dialog and feedback from customers about our products which enhances the Skechers brand experience while driving sales through all our retail channels. In addition, in 2015 we launched the Skechers shopping mobile app. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 160 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, twenty distributors and 16 licensees have opened and operate 413 distributor-owned or -licensed Skechers retail stores and 250 licensee-owned Skechers retail stores, respectively, in over 60 countries as of December 31, 2015. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores and independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal customer base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-throughs. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: the concept store, the factory outlet store and the warehouse outlet store. Our domestic website, www.skechers.com , as well as our foreign e-commerce sites, are virtual storefronts that promote the Skechers brands. Our websites are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience. These websites are an +9 +additional efficient and effective retail distribution channel, which has improved our customer service. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess potent ial impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the u seful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 15, 2016, we owned and operated 119 concept stores, 155 factory outlet stores and 1 17 warehouse outlet stores in the United States, and 82 concept stores, 41 factory outlet stores, and five warehouse outlet stores internationally. During 2015, we took over the operations of 15 international concept stores and two international outlet sto res from our distributor in Panama. During 2016, we plan to open 55 to 65 new stores. +· +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square (with a second location opened in 2015), 5 th Avenue, Union Square, Roosevelt Field Mall, and 34th Street in New York, Powell Street in San Francisco, Hollywood and Highland in Hollywood, Santa Monica’s Third Street Promenade, Ala Moana Center in Hawaii and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mall. International locations include Westfield London and Westfield Stratford in London, Buchanan Street in Glasgow, Princes Street in Edinburgh, Toronto’s Eaton Centre, Vancouver’s Pacific Centre, the Shinsaibashi shopping district of Osaka and Kalverstraat Street in Amsterdam. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,400 square feet, although in certain markets we have opened concept stores as large as 7,800 square feet or as small as 1,500 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +· +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 41 international factory outlet stores – nine in England, eight in Canada, four each in Chile and Spain, three in Japan, two each in Austria, Germany and Italy, and one each in Colombia, the Netherlands, Panama, Poland, Portugal, Scotland and Wales. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,000 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +· +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,400 to 30,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers +10 +brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we wan t to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store +Locations +Opened during +Closed during +Number of Store +Locations +December 31, 2014 +2015 +2015 +December 31, 2015 +Domestic stores +Concept +120 +5 +(6 +) +119 +Factory Outlet +145 +11 +(1 +) +155 +Warehouse Outlet +97 +19 +— +116 +Domestic stores total +362 +35 +(7 +) +390 +International stores +Concept +51 +31 +(1 +) +81 +Factory Outlet +33 +8 +— +41 +Warehouse Outlet +3 +2 +— +5 +International stores total +87 +41 +(1 +) +127 +Joint venture stores +China Concept +24 +10 +(2 +) +32 +China Factory Outlet +18 +5 +(3 +) +20 +Hong Kong Concept +24 +5 +— +29 +Hong Kong Outlet +— +— +— +— +South East Asia Concept +18 +4 +(1 +) +21 +South East Asia Outlet +— +— +— +— +India Concept +18 +12 +(1 +) +29 +India Outlet +2 +— +(1 +) +1 +Joint venture stores total +104 +36 +(8 +) +132 +Total domestic, international and joint +venture stores +553 +112 +(16 +) +649 +International Wholesale. Our products are sold in more than 160 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia, as well as through our subsidiaries in Central America, Europe, Japan, North America and South America; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +· +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. Skechers-owned retail stores in Europe include 15 concept stores and 24 factory outlet stores located in 12 countries. +11 +To acco mmodate our European subsidiaries’ operations, we operate an approximately 780,000 square-foot distribution center in Liege, Belgium. During 2015, we completed the third phase of automation upgrades of our European Distribution Center equipment, allowing u s to more efficiently receive and ship product to our subsidiaries and retail stores throughout Europe. In 2016, we plan to complete the fourth expansion phase, bringing our European facility to one million square-feet. The additional space that we added i n 2015 will consolidate off-site storage facilities into a single on-site location that will further increase efficiencies and offer storage capacity of up to four million pairs of shoes. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have 15 concept stores, eight factory outlet stores, and five warehouse outlet stores. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. Our retail stores are in key locations in Osaka, Tokyo, and other cities. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Shanghai, Beijing, Guangzhou, Hong Kong, Macau and other cities. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Singapore, Kuala Lumpur, Petaling Jaya and other cities. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and a 49% interest in Skechers Retail India Private Limited, which are both joint ventures, that generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. Our retail stores are in key locations in Bangalore, Mumbai, New Delhi and other cities. These joint ventures are consolidated in our financial statements. +12 +· +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 25 distributors who sell our products to department, athletic and specialty stores in more than 75 countries around the world. As of December 31, 2015, we also had agreements with 19 of these distributors and 17 licensees regarding 413 distributor-owned or -licensed Skechers retail stores and 250 licensee-owned Skechers retail stores, respectively, that are open in over 65 countries. Our distributors and licensees own and operate the following retail stores: +Number of Store +Locations +Opened during +Closed during +Number of Store +Locations +December 31, 2014 +2015 +2015 +December 31, 2015 +Distributor and licensee stores +North America Concept +46 +7 +— +53 +North America Factory Outlet +12 +2 +— +14 +Central America Concept +8 +2 +(7 +) +3 +Central America Factory Outlet +1 +1 +(2 +) +— +South America Concept +26 +7 +(13 +) +20 +South America Factory Outlet +1 +— +(1 +) +— +Africa Concept +26 +5 +— +31 +Asia Concept +193 +98 +(22 +) +269 +Asia Factory Outlet +18 +55 +(2 +) +71 +Australia/New Zealand Concept +20 +10 +— +30 +Australia/New Zealand Factory Outlet +11 +— +— +11 +Europe Concept +63 +36 +(5 +) +94 +Europe Factory Outlet +4 +1 +— +5 +Middle East Concept +43 +17 +(1 +) +59 +Middle East Factory Outlet +2 +1 +— +3 +Total distributor and licensee stores +474 +242 +(53 +) +663 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 17 – Segment Information in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 15, 2016, we had 25 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear, fitness, yoga and running accessories, work accessories and watches, Skechers Sport apparel, BOBS from Skechers apparel, and Twinkle Toes dolls, toys backpacks, lunchboxes, do-it-yourself fashion kits and fashion accessories. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in Chile, Israel, the Philippines, the United Kingdom and South Korea; socks in France; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 780,000 square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central American, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, 2015 our backlog was $1.08 billion, compared to $988.7 million as of December 31, 2014. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to the weakened U.S. economy and shifting footwear trends. For a variety of reasons, including changes in the economy, customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 128 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition and results of operations. +14 +COMPETITION +The footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in our major domestic markets, and may make it more difficult to establish our products in Europe, Asia and other international regions. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Many of our competitors are larger, have been in existence for a longer period of time, have achieved greater recognition for their brand names, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +EMPLOYEES +As of January 31, 2016, we employed approximately 9,200 persons, of whom approximately 3,600 were employed on a full-time basis and approximately 5,600 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. \ No newline at end of file diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/item13.txt b/raw/filings/0001065837/2015/0001564590-16-013515/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..651e52c50ee86d86bc57d27f923d52714bbb466a --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2015 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/item9a.txt b/raw/filings/0001065837/2015/0001564590-16-013515/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e15bc28d49b31f26f8a586ce3a69458f3778e91b --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/item9a.txt @@ -0,0 +1,35 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that as of December 31, 2015, our internal control over financial reporting is effective. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2015, which is set forth below. +71 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2015. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +72 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of earnings, comprehensive income, equity, cash flows, and schedule for each of the three years in the period ended December 31, 2015, and our report dated February 26, 2016 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +February 26, 2016 +73 \ No newline at end of file diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/rp_note.txt b/raw/filings/0001065837/2015/0001564590-16-013515/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2015/0001564590-16-013515/rpt_disclosure.txt b/raw/filings/0001065837/2015/0001564590-16-013515/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e8c970237eed4c76581b72a564dfaa313b877a50 --- /dev/null +++ b/raw/filings/0001065837/2015/0001564590-16-013515/rpt_disclosure.txt @@ -0,0 +1,35 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the +Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our +38 +policies relating to the avoidance of conflicts of interest (which is discussed in our Code of Business Conduct and Ethics), (ii) past and proposed transactions between our company, on the +one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the +use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was +adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which +(i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result +of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is any (a) person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy +statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) greater than five percent beneficial owner of our Class A or Class B Common Stock or +(c) immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as +transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the +Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction shall be considered and, if the Committee determines it to be appropriate, ratified at the +Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated +third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member shall participate in any discussion or approval of a transaction with a Related Person pursuant to +which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing +relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The +following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2015. Each of these transactions was reviewed, and approved or ratified by the Audit +Committee, pursuant to the policies and procedures discussed herein. +Related Person Transactions +Michael Greenberg owns a 12% beneficial ownership interest in Manhattan Inn Operating Company, LLC (“MIOC”), the primary +business of which is to own and operate the Shade Hotel in Manhattan Beach, California. David Weinberg, who is our Chief Operating Officer, Chief Financial Officer, Executive Vice President and a member of our Board of Directors, and Michael +Greenberg’s brothers Jeffrey Greenberg, who is a director of Skechers, and Jason Greenberg and Joshua Greenberg, all of whom are senior vice presidents of Skechers, own in aggregate a 17% beneficial ownership interest in MIOC. During 2015, we +paid approximately $180,000 to the Shade Hotel for lodging, food and events that were held there including our annual holiday party. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of +Skechers, and they earned total compensation of $512,049, $1,888,856, $1,441,849 and $283,773, respectively, in 2015. Jeffrey Greenberg was also a member of our Board of Directors in 2015, but did not earn any additional compensation for services +provided as a director. +Andrew Weinberg, who is the son of David Weinberg, is a non-executive employee of Skechers, and he +earned total compensation of $352,070 in 2015. +39 \ No newline at end of file diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/filing.txt b/raw/filings/0001065837/2016/0001564590-17-003040/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..af4ddef951d1cf99ba359630244e3441457e6fee --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/filing.txt @@ -0,0 +1,3679 @@ +10-K +1 +skx-10k_20161231.htm +SKX-10K-20161231 +skx-10k_20161231.htm +c +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +OR +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-4376145 +(State or Other Jurisdiction of +Incorporation or Organization) +(I.R.S. Employer +Identification No.) +228 Manhattan Beach Blvd., Manhattan Beach, California +90266 +(Address of Principal Executive Offices) +(Zip Code) +Registrant’s telephone number, including area code: (310) 318-3100 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Class A Common Stock, $0.001 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: +None +(Title of Class ) +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2016, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the Registrant was approximately $4.0 billion based upon the closing price of $29.72 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2017: 133,771,430. +The number of shares of Class B Common Stock outstanding as of February 15, 2017: 24,545,188. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2017 Annual Meeting of the Stockholders of the Registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended december 31, 2016 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +15 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +23 +ITEM 2. +PROPERTIES +23 +ITEM 3. +LEGAL PROCEEDINGS +23 +ITEM 4. +MINE SAFETY DISCLOSURES +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +27 +ITEM 6. +SELECTED FINANCIAL DATA +29 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +30 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +43 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +44 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +71 +ITEM 9A. +CONTROLS AND PROCEDURES +71 +ITEM 9B. +OTHER INFORMATION +74 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +74 +ITEM 11. +EXECUTIVE COMPENSATION +74 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +74 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +74 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +74 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +74 +ITEM 16. +FORM 10-K SUMMARY +74 +This annual report includes our trademarks including Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , You by Skechers™, ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skecher Street™ , D’Lites®, Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Energy Lights™, Hot Lights ® and Twinkle Toes ® , each of which is our property. This report contains additional trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected 2017 results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +• +global economic, political and market conditions including the difficult consumer retail market in the United States and the uncertainty of the European and Asian markets; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers GO brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 1, 2017, we owned and operated 117 concept stores, 163 factory outlet stores and 134 warehouse outlet stores in the United States, and 101 concept stores, 51 factory outlet stores, and 5 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2016, our Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television campaigns featuring our own action heroes and characters; marathons and other events for Skechers Performance and BOBS from Skechers divisions; and print, television, online and outdoor campaigns featuring our brand ambassadors and endorsees. These endorsees included globally-known recording artists Demi Lovato, Ringo Starr and Meghan Trainor; sports legends Sugar Ray Leonard, Pete Rose, Joe Montana, and Ozzie Smith; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb, Kara Goucher, and Matt Kuchar; and professional golfers Belen Mozo, Billy Andrade and Colin Montgomerie. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded product lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Fusion, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Fusion line is comprised of low-profile, sport-influenced casuals targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies. Select styles include knit uppers, the Skechers Burst midsole and the Skech-Air outsole. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skechers Originals. This fashionable sport line is known for its retro profiles and includes cool sneakers with bold colors, prints and metallics, which all contribute to the collection’s throwback vibe. Select Skechers Originals styles are designed with a hidden heel for an added boost in height. This line is intended to appeal to juniors. +3 +BOBS from Skechers. At the core of t he BOBS from Skechers line is its vast coll ection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home . Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents is donated to Best Friends to help save the lives of dogs and cats in America’s shelters. Skechers has committed to donating at least $3.0 million dollars to Best Friends Animal Society for the promotion. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 14 million pairs of new kids’ shoes have been donated, including one million pairs in 2016. The charitable shoes are primarily donated to charity partner K.I.D.S./Fashion, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by 1970’s rock and roll, the Mark Nason Collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. Categories in the Mark Nason Collection include Mark Nason Skechers, a low-profile collection of casuals for everyday wear; Mark Nason Los Angeles, casual sneakers for the active male; and Mark Nason Dress, dress shoes crafted with high-quality leathers and exquisite detailing. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Sport adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes and Twinkle Wishes by Skechers, (iv) Skechers Super Z-Strap, (v) Elastika by Skechers, (vi) Lighted footwear, (vii) Mega Flex, and (viii) Game Kicks. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character, Twinkle Toes. Twinkle Wishes by Skechers adds a magical light and sound feature that is activated when the toes are tapped together. +• +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system. The product line is marketed with the character, Z-Strap. +• +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +• +Skechers’ lighted collection for boys and girls includes the categories of S-Lights, Hot Lights by Skechers and Energy Lights by Skechers. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Hot Lights feature lights on the front of the toe to simulate headlights as well as lights on other areas of the shoes. Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features seven colors and four light sequences. +• +Mega Flex is a line of athletic sneakers for boys based on a robot character. Styles include fun embellishments like heel springs or an articulated bladed outsole in the Mega Blades collection. +• +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. Some styles include a remote control operating system. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2016, five of our contract manufacturers accounted for approximately 51.0% of total purchases. One manufacturer accounted for 22.9%, and another accounted for 10.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued +6 +after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail store s, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an i nternal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by pl acing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 359-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes for our lifestyle lines, and technology with runners and athletes for our performance lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2016, our Skechers lifestyle endorsees included Demi Lovato, Meghan Trainor, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Sugar Ray Leonard, Ozzie Smith, and Ringo Starr. Our Skechers Performance Division 2016 endorsees included elite runner and Olympic medalist Meb and elite runner Kara Goucher, and professional golfers Matt Kuchar (who also medaled at the 2016 Olympics), Belen Mozo, Brooke Henderson, Billy Andrade and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. In 2016, these ambassadors included Korean pop groups for numerous countries in Asia and local celebrities and athletes in Europe. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications, including Runner's World, Seventeen, Men's Fitness, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +7 +Our television commercials are produced both in-house and through produ cers that we have utilized in the past who are familiar with our brands. In 2016, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action co mmercials that appeal to older kids and tweens. We also have many commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature musicians , actors and retired athletes . We have found these to be cost-effective w ays to advertise on key national and cable programming during high-selling seasons. In 2016, many of our television commercials were translated into multiple languages and aired in numerous markets around the world . +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in several European countries, Canada and Mexico. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting celebrities and their families. We have been featured on leading business shows with interviews of our executives discussing the Company’s business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and in countries around the world where our product is sold. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2016, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance-branded booths to allow runners the ability to try on and often buy our products. In 2016, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of The Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts for BOBS footwear donation events in cities throughout the United States, Puerto Rico and Canada, building both our relationships with these accounts, as well as with the community as we donated footwear to children in need. As part of our BOBS for Dogs charity program we partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +8 +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, Platform, The Licensing Show and Outdoor Retailer in the United States; GDS, MICAM, and ISPO in Europe; and many other international shows. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Digital. In 2016, we launched marketing campaigns on YouTube, developed a performance branded website for the Skechers Performance Los Angeles Marathon, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Chile, Germany, the United Kingdom, and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 15 distributors and 45 licensees have opened and operate 490 distributor-owned or -licensed Skechers retail stores and 739 licensee-owned Skechers retail stores, respectively, in over 80 countries as of December 31, 2016. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate +9 +revenues or otherwise be used by us. As of February 1, 2017, we owned and operated 117 concept stores, 163 factor y outlet stores and 134 warehouse outlet stores in the United States, and 101 concept stores, 51 factory outlet stores, and 5 warehouse outlet stores internationally. During 201 6 , we took over the operations of 3 international concept stores and 11 interna tional outlet stores from our distributor in South Korea . During 2017, we plan to open 70 to 9 0 new stores. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, United Kingdom, Germany and Chile. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square (with a second location opened in 2015), 5 th Avenue, Union Square, Westfield World Trade Center, and 34th Street, in New York; Powell Street in San Francisco: Hollywood and Highland in Hollywood; Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mall. International locations include Westfield London and Westfield Stratford in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,400 square feet, although in certain markets we have opened concept stores as large as 7,800 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 51 international factory outlet stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,400 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 31,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2015 +Opened during 2016 +Closed during 2016 +Number of Store Locations December 31, 2016 +Domestic stores +Concept +119 +4 +(6 +) +117 +Factory Outlet +155 +8 +— +163 +Warehouse Outlet +116 +18 +(1 +) +133 +Domestic stores total +390 +30 +(7 +) +413 +International stores +Concept +81 +21 +(1 +) +101 +Factory Outlet +41 +10 +— +51 +Warehouse Outlet +5 +— +— +5 +International stores total +127 +31 +(1 +) +157 +Joint venture stores +China Concept +59 +12 +(3 +) +68 +China Factory Outlet +20 +15 +(7 +) +28 +Hong Kong Concept +29 +9 +(1 +) +37 +Hong Kong Outlet +— +3 +— +3 +India Concept +29 +6 +(1 +) +34 +India Outlet +1 +3 +(3 +) +1 +Israel Concept +— +6 +— +6 +South Korea Concept +— +3 +— +3 +South Korea Outlet +— +11 +— +11 +South East Asia Concept +21 +2 +(4 +) +19 +South East Asia Outlet +— +2 +— +2 +Joint venture stores total +159 +72 +(19 +) +212 +Total domestic, international and joint +venture stores +676 +133 +(27 +) +782 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. +11 +To accommodate our European subsidiaries’ operations, we operate a distribution center in Liege, Belgium. During 2015, we completed the third phase of automation upgrades of our European Distribution Center equipment, allowing us to more efficiently receive and ship product to our subsidiaries and retail stores throughout Europe. In 2016, we complete d the four th and fifth expansion phase s , bringing our European facility to approximately 1.3 million square-feet. The additional space that we added will consolidate off-site storage facilities into a single on-site location that will further increase efficiencies a nd offer storage capacity of up to four million pairs of shoes. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +12 +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores in more than 170 countries around the world. As of December 31, 2016, we also had agreements with 15 of these distributors and 45 licensees regarding 490 distributor-owned or -licensed Skechers retail stores and 739 licensee-owned Skechers retail stores, respectively, that are open in over 80 countries. Our distributors and licensees own and operate the following retail stores: +Number of Store Locations December 31, 2015 +Opened during 2016 +Closed during 2016 +Number of Store Locations December 31, 2016 +Distributor and licensee stores +Africa Concept +31 +8 +(2 +) +37 +Asia Concept +355 +269 +(23 +) +601 +Asia Factory Outlet +71 +99 +(13 +) +157 +Australasia Concept +30 +18 +— +48 +Australasia Outlet +11 +2 +— +13 +Central America Concept +3 +2 +— +5 +Europe Concept +94 +48 +— +142 +Europe Factory Outlet +5 +3 +— +8 +Middle East Concept +59 +65 +(6 +) +118 +Middle East Factory Outlet +3 +1 +— +4 +North America Concept +53 +5 +— +58 +North America Factory Outlet +14 +2 +— +16 +South America Concept +20 +4 +(2 +) +22 +Total distributor and licensee stores +749 +526 +(46 +) +1,229 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 17 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2017, we had 27 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear, fitness, yoga and running accessories, work accessories and watches; Skechers Sport apparel; BOBS from Skechers apparel; and Twinkle Toes dolls, toys backpacks, lunchboxes, do-it-yourself fashion kits and fashion accessories. We have international licensing agreements for the design +13 +and distribution of men’s, women’s and kids’ apparel in Chile, Israel, the Philippines, the United Kingdom and South K orea; socks in France; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, 2016 our backlog was $1.37 billion, compared to $1.25 billion as of December 31, 2015. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to a difficult U.S. consumer retail market combined with constantly shifting global footwear trends. For a variety of reasons, including changes in the global economy, worldwide customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 128 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to +14 +block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a thir d party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our prod ucts, and generally have a material adverse effect on our business, financial condition and results of operations. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +EMPLOYEES +As of January 31, 2017, we employed approximately 9,800 persons, of whom approximately 4,000 were employed on a full-time basis and approximately 5,800 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition and results of operations could be materially and adversely affected. +15 +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Product s. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition and results of operations could be materially and adversely affected. +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results and financial condition. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our net sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this +16 +risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale sales during 2016 or 201 5. However, this may change in the future, and fluctuations in sales of any style representing a significant portion of our future net sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state continues to negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of net sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations and financial condition. +We Depend Upon A Relatively Small Group Of Customers For A Large Portion Of Our Sales. +During 2016, 2015 and 2014, our net sales to our five largest customers accounted for approximately 11.3%, 14.6% and 15.7% of total net sales, respectively. No customer accounted for more than 10.0% of our net sales during 2016, 2015 and 2014. No customer accounted for more than 10.0% of trade receivables at December 31, 2016 and 2014. As of December 31, 2015, one customer accounted for 10.6% of trade receivables. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory and personnel. We have also made substantial operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to e-commerce and mobile channels, and our ability to effectively develop our e-commerce and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations and financial position. +17 +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders in the past, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest domestic sales generally occurring in our second and third quarters for the back-to-school selling season. Domestically, back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers could negatively impact our net sales and results of operations for our second or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future net sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for our company, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars in which the cost of those products will vary depending on the foreign currency rates and will impact the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency rates. Although we typically work to mitigate this negative foreign currency transaction impact through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations and financial position. +An Increase In Our Effective Tax Rate Could Have A Material Adverse Effect On Our Results Of Operations And Financial Position. +A significant amount of our foreign earnings are generated in low or zero tax jurisdictions. As a result, our income tax expense has historically been lower than the tax computed at the U.S. statutory income tax rate because we do not provide for U.S. taxes on earnings that we consider to be permanently reinvested in foreign operations. Our future effective tax rates could be unfavorably affected by a number of factors, including but not limited to, changes in the tax rates or the tax rules and regulations, or in the interpretation thereof, in the jurisdictions in which we do business; decreases in the amount of earnings in countries with low statutory tax rates; increases in the amount of earnings in countries with high statutory tax rates; or if we repatriate foreign earnings (or if U.S. tax laws change to tax foreign earnings) for which no provision for U.S. taxes has previously been made. An increase in our effective tax rate could have a material adverse effect on our business, results of operations and financial position. +18 +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam , Which Could Affect Our Ability To Sell Or Manufacture Our Products In Internati onal Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our net sales during the year ended December 31, 2016 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations or financial condition. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether there may be unfavorable changes in tax laws in the United States or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During 2016 and 2015, the top five manufacturers of our products produced approximately 51.0% and 56.5% of our total purchases, respectively. One manufacturer accounted for 22.9% and 31.5% of total purchases during 2016 and 2015, respectively. Another manufacturer accounted for 10.1% and 9.1% of our total purchases during 2016 and 2015, respectively. We do not have long-term contracts with manufacturers, and we compete with other footwear companies for production facilities. We could experience difficulties with these manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet production deadlines, or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries, or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business. +19 +If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternativ e manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards, or higher lead times for delivery. If we are unable to provide products consistent with our standards, or the manufacture of our footwear is delayed or becomes more expensive, our business would be harmed. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistic and distribution systems include computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all of our products are distributed from a few key locations. Therefore, our operations could be interrupted by earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the adverse effects that could be caused by significant disruptions affecting our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of products to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our reputation in the United States, or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, some or a substantial number of new stores could be opened in regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced net sales volumes in existing stores in those markets. +20 +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer, Chief Financial Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations And Financial Condition. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability our company may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business, consolidated financial statements and financial condition. +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers D’Lites ® , Skechers Sport ® , Skechers USA ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , You by Skechers™, ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skecher Street™, D’Lites®, Skechers Air-Cooled Memory Foam ™ and Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Energy Lights™, S-Lights ® and Twinkle Toes ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the United States, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +21 +Breaches Or Compromises Of Our Information Security Systems, Information Technol ogy Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +We utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, and others, including credit card information and personal identification information. A security breach may expose us to a risk of loss or misuse of this information, litigation and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks. Attacks may be targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could have an adverse effect on our business, financial condition and reputation. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2016, a substantial portion of our operations are located in California, including 93 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our net sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wild fire affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Two Principal Stockholders Are Able Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2016, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 75.2% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 11.0% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 34.3% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2016, Mr. Greenberg beneficially owned 48.9% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 56.8% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 22.2% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Mr. Greenberg is able to substantially control, and Mr. Schwartzberg is able to exert significant influence over, all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs, or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to significantly influence or substantially control, respectively, actions requiring stockholder approval may result in our company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchaser view the superior voting rights of our Class B common shares to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock +22 +and Class B Common Stock, t he classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Manhattan Beach, California, which consist of an aggregate of approximately 181,000 square feet. We own and lease portions of our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The lease for this facility expires in 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is consolidated in our financial statements. +Our European Distribution Center occupies approximately 1.3 million square feet in Liege, Belgium under five operating leases, with base rents of approximately $5.1 million per year. These leases provide for original terms of 10-15 years, commencing between January 2016 and June 2016, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring between March 2017 and January 2033. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $77.6 million for the year ended December 31, 2016. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates between March 2017 and November 2027. Total base rent for the leased properties aggregated approximately $65.1 million for the year ended December 31, 2016. +ITEM 3. +LEGAL PROCEEDINGS +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups are defective and unreasonably dangerous, negligently designed and/or manufactured, and do not conform to representations made by our company, and that we failed to provide adequate warnings of alleged risks associated with Shape-ups. In total, we are named as a defendant in 50 currently pending cases (some on behalf of multiple plaintiffs) filed in various courts that assert further varying injuries but employ similar legal theories and assert similar claims to the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are some variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. +23 +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-0 2308-TBR. Since 2011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding. Skechers has resolved 1,743 personal injury claims in the MDL proceedings, comprised of 1,141 that were filed as formal actions and 602 th at were submitted by plaintiff fact sheets. Skechers has also settled 34 claims in principle— 17 filed cases and 17 claims submitted by plaintiff fact sheets—either directly or pursuant to a global settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 42 cases in the MDL proceeding have been dismissed either voluntarily or on motions by Skechers and 38 unfiled claims submitted by plaintiff fact sheet have been abandoned. Between the consummated se ttlements and cases subject to the settlement program, all but 35 personal injury cases pending in the MDL have been or are expected to be resolved. On August 6, 2015, the Court entered an order staying all deadlines, including trial, pending further order of the Court. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition by our company to coordinate all personal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coordinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. Fifty-three actions brought on behalf of a total of 620 plaintiffs have been settled and dismissed. Eleven actions have been partially dismissed, with the claims of 221 plaintiffs being fully resolved. We have also settled in principle the claims of 26 plaintiffs from 4 actions pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). One single-plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff lawsuits have been dismissed entirely, either voluntarily or on motion by us. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by us. Thus, taking into account both consummated settlements and cases subject to the settlement program, only 14 lawsuits on behalf of a total of 24 plaintiffs are expected to remain in the LASC Coordinated Cases. Discovery is continuing in those fourteen remaining cases. No trial dates have been set. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. Eleven of those actions have been resolved and dismissed. The last remaining action in a state court other than California was filed in Missouri on January 4, 2016 on behalf of a single plaintiff. The complaint was served on November 14, 2016. We have answered the complaint and denied all material allegations asserted therein. The parties are now engaged in discovery. No trial date has been set. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. A master settlement agreement was executed as of March 24, 2016 and the parties are in the process of completing individual settlements. To the extent that the settlements with individual claimants are not finalized or otherwise consummated such that the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for business purposes in order to end the distraction of litigation, and we continue to believe we have meritorious defenses and intend to defend any remaining cases vigorously. In addition, it is too early to predict whether there will be future personal injury cases filed which are not covered by the global settlement program, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be available and/or adequate to cover any losses. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against our company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the +24 +ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and BOBS Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued a ruling affirming that Skechers Twinkle Toe’s and Bob’s canvas shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bob’s canvas shoes do not infringe. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +adidas America, Inc., et. al v. Skechers USA, Inc. — On September 14, 2015, adidas filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:15-cv-1741, alleging that three Skechers shoe styles (Skechers Onix, Skechers Relaxed Fit Cross Court TR, and Skechers Relaxed Fit – Supernova Style) infringe adidas’ trademarks and/or trade dress rights. adidas asserts claims under federal and state law for trademark and trade dress infringement, unfair competition, trademark and trade dress dilution, unfair and deceptive trade practices, and breach of a settlement agreement entered into between the parties in 1995. adidas seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble, enhanced and punitive damages), and attorneys’ fees. On September 14, 2015, adidas filed a motion for preliminary injunction in which it sought to preliminarily restrain us from manufacturing, distributing, advertising, selling, or offering for sale any footwear (a) that is confusingly similar to adidas’ STAN SMITH Trade Dress, (b) bearing stripes in a manner that is confusingly similar to adidas’ Three-Stripe Mark, or (c) under adidas’ SUPERNOVA Mark. We opposed adidas’ motion. A hearing on adidas’ motion was held on December 15, 2015. On February 12, 2016, the Court issued a preliminary injunction prohibiting us from selling two styles from our vast footwear collection and from using the word “Supernova” in connection with a third style. We have appealed the Court’s order granting the injunction to the United States Court of Appeals for the Ninth Circuit. Trial is set to begin on August 8, 2017. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc., v. Skechers USA, Inc . — On January 4, 2016, Nike filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. In April and May, 2016, we filed petitions with the United States Patent and Trademark Office’s Patent Trial and Appeal Board for inter partes review of all eight design patents, seeking to invalidate those patents. In September and November, 2016, the Patent Trial and Appeal Board denied each of our petitions. On January 6, 2017, we filed several additional petitions for inter partes review with the Patent Trial and Appeal Board, seeking to invalidate seven of the eight designs patents that Nike is asserting. Those petitions are currently pending. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +adidas America, Inc. and adidas AG v. Skechers USA, Inc. – On July 11, 2016, adidas filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-01400-AC, alleging that certain of our children’s styles (Boys’ Mega Blade 2.0 and 2.5) infringe two of adidas’ patents. The complaint seeks, among other things, injunctive relief and damages (including treble damages). On July 28, 2016, adidas filed a motion for a preliminary injunction, asking the Court to preliminarily restrain Skechers from importing, manufacturing, distributing, advertising, selling, or offering for sale any of the accused styles. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Karey Teng v. Skechers USA, Inc. et al. — On August 1, 2016, a former employee named Karey Teng filed an action against our company in the Superior Court of California, County of Los Angeles, Case No. YC071483, alleging harassment, national original and racial discrimination, failure to investigate and prevent harassment, retaliation, wrongful termination and constructive discharge, intentional and negligent infliction of emotional distress, among other causes of actions, and seeking special, general and consequential damages, punitive and exemplary damages, and attorneys’ fees. This matter has been settled and the settlement did not have a material adverse impact on our operations or financial position. +In addition to the matters included in its reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the +25 +outcome of litigation is inherently uncertain and assessments and decisions on defense and settleme nt can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these leg al matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” The following table sets forth, for the periods indicated, the high and low sales prices of our Class A Common Stock. +LOW +HIGH +Year Ended December 31, 2016 +First Quarter +$ +25.47 +$ +34.27 +Second Quarter +25.89 +34.20 +Third Quarter +20.90 +32.71 +Fourth Quarter +18.81 +27.76 +Year Ended December 31, 2015 +First Quarter +$ +18.41 +$ +24.75 +Second Quarter +23.33 +38.26 +Third Quarter +36.53 +54.53 +Fourth Quarter +24.56 +49.28 +HOLDERS +As of February 15, 2017, there were 100 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 26 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Earnings have been and will be retained for the foreseeable future in the operations of our business. We have not declared or paid any cash dividends on our Class A Common Stock and do not anticipate paying any cash dividends in the foreseeable future. Our current policy is to retain all of our earnings to finance the growth and development of our business. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report. +27 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our company’s Class A Common Stock from December 31, 2011 to December 31, 2016, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2011 in each of our company’s Class A Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our company’s Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +12/11 +12/12 +12/13 +12/14 +12/15 +12/16 +Skechers U.S.A., Inc. +100.00 +152.64 +273.35 +455.86 +747.77 +608.42 +Russell 2000 +100.00 +116.35 +161.52 +169.43 +161.95 +196.45 +Peer Group +100.00 +113.42 +172.60 +173.44 +220.08 +218.01 +28 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2016 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +(In thousands, except net earnings per share) +YEARS ENDED DECEMBER 31, +STATEMENT OF EARNINGS DATA: +2016 +2015 +2014 +2013 +2012 +Net sales +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +$ +1,560,321 +Gross profit +1,634,596 +1,424,008 +1,071,905 +818,792 +683,326 +Earnings from operations +370,518 +350,824 +209,071 +93,609 +22,319 +Earnings before income taxes +359,484 +333,497 +191,380 +82,215 +10,473 +Net earnings attributable to Skechers U.S.A., Inc. +243,493 +231,912 +138,811 +54,788 +9,512 +Net earnings per share: (1) +Basic +1.58 +1.52 +0.91 +0.36 +0.06 +Diluted +1.57 +1.50 +0.91 +0.36 +0.06 +Weighted average shares: (1) +Basic +154,169 +152,847 +151,839 +151,090 +148,485 +Diluted +155,084 +154,200 +153,079 +151,690 +149,826 +AS OF DECEMBER 31, +BALANCE SHEET DATA: +2016 +2015 +2014 +2013 +2012 +Working capital +$ +1,206,036 +$ +971,179 +$ +779,277 +$ +704,506 +$ +647,771 +Total assets +2,393,670 +2,039,878 +1,674,918 +1,408,570 +1,340,220 +Long-term borrowings, excluding current installments +67,159 +68,942 +15,081 +116,488 +128,517 +Skechers U.S.A., Inc. equity +1,603,633 +1,327,556 +1,075,249 +930,322 +875,969 +(1) +Basic earnings per share represents net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. All share and per share information has been retroactively adjusted for the three-for-one stock split that was effective on October 16, 2015. +29 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +GENERAL +We design, market and sell contemporary footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own retail stores, distributor and licensee-owned international retail stores and our e-commerce websites. Our objective is to continue to profitably grow our domestic operations while leveraging our brand name to expand internationally. +Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and retail sales, which includes our e-commerce sales. We evaluate segment performance based primarily on net sales and gross margins. See detailed segment information in Note 17 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our net sales for 2016 increased $416.0 million, or 13.2%, to $3.56 billion, compared to net sales of $3.15 billion in 2015. The increase in net sales was primarily from our international wholesale and retail segments offset by decreases in our domestic wholesale segment. The largest increases came in our Women’s and Men’s GO, Men’s and Women’s Sport, and Work divisions during 2016. Net earnings attributable to Skechers U.S.A., Inc. were $243.5 million for 2016, an increase of $11.6 million, or 5.0%, compared to net earnings of $231.9 million in 2015. Diluted earnings per share for 2016 were $1.57, which reflected a 4.7% increase from the $1.50 diluted earnings per share reported in the prior year. The increase in net earnings attributable to Skechers U.S.A., Inc. for 2016 was primarily the result of increased sales and margins in our international wholesale segment and increased sales in our retail segment. Our working capital was $1.2 billion at December 31, 2016, which was an increase of $0.2 million from working capital of $971.2 million at December 31, 2015. Our cash and cash equivalents increased $210.5 million to $718.5 million at December 31, 2016 from $508.0 million at December 31, 2015. This increase in cash and cash equivalents of $210.5 million was primarily the result of our increased net earnings and increased payables, which were partially offset by increased inventories and increased capital investments. +2016 OVERVIEW +In 2016, we focused on product development, maintaining our position in our domestic wholesale accounts, growing our international market share, opening retail stores in key locations worldwide, developing our global infrastructure, and balance sheet and expense management. +New product design and delivery . Our success depends on our ability to design and deliver comfortable, stylish, affordable products to consumers across a broad range of demographics. In 2016, we focused on innovation and comfort across all of our core and existing styles, added fresh looks to our product lines, and developed new product lines that included lifestyle and performance footwear. This included updates to our running and walking lines, an updated collection of D’lites®, and a broader offering of lighted footwear. +Maintain our domestic business. In 2016, our focus was on maintaining our core Skechers business in our domestic wholesale accounts, by delivering the right product to accounts at the right time, while finding new opportunities to add shelf space and expand into new locations with new Skechers categories. In 2016, we remained the number two sport footwear brand in the United States, and the number one walking brand, work brand, and dress/comfort casual brand. +Further develop our international businesses. During 2016, we continued to focus on improving our international sales by increasing our product offering to accounts within each country, delivering the right product to accounts at the right time, and increasing our shelf space and our customer base. As part of our ongoing efforts to maximize our growth in key markets, we expanded our direct distribution by transitioning our international distributors in Israel and South Korea to joint ventures. +Expand Skechers global retail base. Believing that Skechers retail stores are effective brand building tools, we continued to focus on opening Skechers stores around the world—both company-owned and third-party owned through our distributors, franchisees or joint venture partners. In 2016, we opened 30 additional company-owned domestic stores and 31 additional company-owned international stores. In addition, we transitioned the operations of three international concept stores and 11 international outlet stores from our distributor in South Korea. Additionally, we continued to expand our franchise retail base with more Skechers branded stores in countries where we directly handle the distribution of our product. +30 +Develop our global infrastructure. In 2016, we completed the fourth and fifth phase of automation upgrades and expansion of our European Distribut ion Center increasing our capacity to approximately 1.3 million square feet. +Balance sheet and expense management. During 2016, we continued to focus on managing our inventory levels and bringing our marketing expenses and general and administrative expenses in line with expected sales. +OUTLOOK FOR 2017 +During 2017, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. This includes the planned launch of the lifestyle and wellness line You by Skechers™ and the youthful lifestyle line Skecher Street™. The global footwear market is competitive; however, because our products are marketed at affordable prices, we believe that our styles resonate with consumers worldwide, which translates into a brand that is in demand globally. With a growing team of brand ambassadors—including sports icons Joe Montana, Sugar Ray Leonard and Howie Long for men; pop superstar Meghan Trainor for women; actors and personalities Rob Lowe, Brooke Burke-Charvet, and Kelly Brooke for men and women; elite athletes Meb and Kara Goucher; and professional golfers Matt Kuchar, Belen Mozo, Brooke Henderson, Billy Andrade and Colin Montgomerie. We believe our appeal is broad and demand for our product will continue. We will continue to broaden the targeted demographic profile of our consumer base, increase our shelf space and plan to open 70 to 90 company-owned retail locations, predominantly in the United States. +DEFINITIONS +Comparable sales +As part of our discussion of our results of operations, we disclose comparable store sales, which exclude the impact of e-commerce sales. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +Cost of sales or Gross margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative expenses +General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for our Rancho Belago, European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. +31 +YEAR ENDED DECEMBER 31, 2016 COMPARED TO THE YEAR ENDED DECEMBER 31, 2015 +Net sales +Net sales for 2016 were $3.56 billion, which was an increase of $416.0 million, or 13.2%, compared to net sales of $3.15 billion for 2015. The increase in net sales was primarily from our international wholesale and retail segments offset by a decrease in our domestic wholesale segment. +Our domestic wholesale net sales decreased $20.0 million, or 1.6%, to $1.20 billion for 2016 compared to $1.22 billion for 2015. The decrease in our domestic wholesale segment’s net sales was primarily the result of average selling price per pair decreasing 2.7%, to $22.89 per pair for 2016 from $23.53 for 2015, which was partially offset by a 1.1% unit sales volume increase to 52.4 million pairs in 2016 from 51.8 million pairs in 2015. This net sales decrease was also attributable to lower sales in our Women’s and Men’s Go, Women’s Active and Men’s USA divisions which was partially offset by increases in our Men’s and Women’s Sport and Work divisions during 2016. The average selling price per pair decrease within the domestic wholesale segment was primarily the result of decreased selling prices for our Women’s GO and Women’s Active divisions. +Our international wholesale segment net sales increased $296.8 million, or 27.1%, to $1.39 billion for 2016 compared to sales of $1.09 billion for 2015. Our international wholesale sales consist of direct sales by our foreign subsidiaries – those sales we make to department stores and specialty retailers – and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries increased $319.8 million, or 41.6%, to $1.09 billion for 2016 compared to sales of $768.2 million for 2015. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Hong Kong. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales decreased $23.0 million, or 7.0%, to $303.2 million for 2016, compared to sales of $326.2 million for 2015. This was primarily attributable to decreased sales to our distributors in Australia and New Zealand, Turkey, the United Arab Emirates (“UAE”) and South Korea, which was transitioned from a distributor to a joint-venture in 2016. +Our retail segment sales increased $139.1 million to $972.2 million for the year ended December 31, 2016, a 16.7% increase over sales of $833.1 million for 2015. The increase in retail sales was primarily attributable to increased comparable sales of 4.1%, which included increased sales within our Men’s and Women’s Go, Men’s and Women’s Sport, and Work divisions and a net increase of 23 domestic and 30 international stores compared to 2015. For the year ended December 31, 2016, our domestic retail sales, which includes e-commerce, increased 9.7% compared to 2015, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 2.2% and, and our international retail store sales increased 42.6% compared to 2015, which was attributable to increased international store count and positive comparable international store sales of 11.8%. +We believe that we have established our presence in most major domestic retail markets. We had 414 domestic stores and 157 international retail stores as of February 15, 2017, and we currently plan to open approximately 70 to 90 stores in 2017. During 2016, we opened four new domestic concept stores, eight domestic factory outlet stores, 18 domestic warehouse outlet stores, 21 international concept stores, and 10 international factory outlet stores. We also took over the operations of three international concept stores and 11 international outlet stores from our distributor in South Korea. During 2016, we closed six domestic concept stores, one domestic warehouse store and one international concept store. We periodically review all of our stores for impairment. During 2016 and 2015, we did not record an impairment charge. Further, we carefully review our under-performing stores and may consider the non-renewal of leases upon completion of the current term of the applicable lease. +Gross profit +Gross profit for 2016 increased $210.6 million to $1.63 billion from $1.42 billion for 2015. Gross profit, as a percentage of net sales, or gross margin, increased slightly to 45.9% in 2016 from 45.2% for 2015. Our domestic wholesale segment gross profit decreased $17.0 million, or 3.6%, to $454.1 million for 2016 from $471.1 million for 2015, which was attributable to decreased sales volumes and selling prices. Domestic wholesale margins decreased to 37.8% for 2016 from 38.6% for 2015. The decrease in domestic wholesale margins was primarily attributable to lower margins in our Women’s GO and Women’s Active lines. +Gross profit for our international wholesale segment increased $161.4 million, or 35.5%, to $616.1 million for 2016 compared to $454.7 million for 2015. Gross margins for the international wholesale segment were 44.3% for 2016 compared to 41.5% for 2015. Gross margins for our international direct subsidiary sales were 49.3% for 2016 as compared to 47.2% for 2015. The increase in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to sales of products with higher average selling prices. Gross margins for our international distributor sales decreased to 26.2% for 2016 as compared to 28.1% for 2015 primarily from sales of products with lower average selling prices. +32 +Gross profit for our retail segment increased $ 66.2 million, or 13.3 %, to $ 564.4 million for 2016 as compared to $ 498.2 million for 2015 . Gross margins for all stores were 58.1 % for 2016 compared to 59.8 % for 2015 . Gross margins for our domestic stores were 60.1 % for 2016 as compared to 61.5 % for 2015 . Gross margins for our international stores were 52.3 % for 2016 as compared to 53.4 % for 2015 . The decrease in our retail margins were primarily attributable to lower margins in our Women’s GO, Women’s Active and Women’s USA products. +Selling expenses +Selling expenses increased by $21.5 million, or 9.1%, to $257.1 million for 2016 from $235.6 million for 2015. As a percentage of net sales, selling expenses were 7.2% and 7.5% for 2016 and 2015, respectively. The increase in selling expenses was primarily the result of $26.3 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.5% in 2016 from 5.4% in 2015. +General and administrative expenses +General and administrative expenses increased by $171.5 million, or 20.2%, to $1.02 billion for 2016 from $849.3 million for 2015. As a percentage of sales, general and administrative expenses were 28.6% and 27.0% for 2016 and 2015, respectively. The increase in general and administrative expenses was primarily attributable to $81.9 million related to supporting our growing international operations in China, Japan, South Korea and Latin America, increased store operating costs of $70.5 million primarily attributable to an additional 53 stores and increased domestic wholesale general and administrative expenses of $19.1 million primarily due to increased headcount in the United States to support our brand worldwide. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $20.0 million, due to increased shipments, to $187.3 million from $167.3 million for 2016 and 2015, respectively. +Other income (expense) +Interest income was $1.2 million for 2016 compared to $0.7 million for 2015. Interest expense for 2016 decreased $4.4 million to $6.3 million compared to $10.7 million in 2015. The decrease was primarily due to decreased interest expense of $3.0 million primarily attributable to our domestic distribution center equipment loans being paid in December 2015 and June 2016. Loss on foreign currency transactions for 2016 decreased $1.6 million to $5.0 million compared to $6.6 million in 2015. This decreased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2016 increased $0.4 million to a loss of $1.1 million as compared to a loss of $0.7 million in 2015. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34% . Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes . +33 +Our earnings (lo ss) before income taxes and income tax expense for 2016 , 2015 and 201 4 are as follows (in thousands): +Years Ended December 31, +2016 +2015 +2014 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +$ +82,778 +$ +32,500 +Peoples Republic of China (“China”) +72,584 +11,720 +49,027 +11,084 +15,201 +1,179 +Jersey (1) +146,880 +— +123,721 +— +77,555 +— +Non-benefited loss operations (2) +(16,189 +) +12 +(16,719 +) +164 +(13,021 +) +— +Other jurisdictions (3) +50,620 +17,739 +40,742 +9,029 +28,867 +5,505 +Earnings before income taxes +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +Effective tax rate (4) +20.6 +% +21.7 +% +20.5 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Panama, Poland, Romania, and South Korea. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom, +(4) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2016, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2016, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $105.6 million, with income tax expense of $44.7 million, which is an average rate of 42.3%. Earnings (loss) before income taxes in non-U.S. jurisdictions were $253.9 million, with an aggregate income tax expense of $29.5 million, which is an average rate of 11.6%. Combined, this results in consolidated earnings before income taxes for the period of $359.5 million, and consolidated income tax expense for the period of $74.1 million, resulting in an effective tax rate of 20.6%. We estimate our annual effective tax rate for 2017 to be between 19% and 24%. The estimated effective tax rate for 2017 is subject to management’s ongoing review and revision, if necessary. For 2016, of our $253.9 million in earnings before income tax earned outside the U.S., $146.9 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $23.2 million, or 18.7%, from $123.7 million in 2015 to $146.9 million in 2016. This increase was primarily attributable to us experiencing an increase of $344.9 million in net sales in the “Other international” geographic area for 2016 (see Note 17 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2015 to 2016 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $16.2 million for which no tax benefit was recognized during the year ended December 31, 2016 because of the provision of offsetting valuation allowances, but in which $12 thousand in nonrefundable withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2016, we had approximately $718.5 million in cash and cash equivalents, of which $368.4 million, or 51.3%, was held outside the U.S. Of the $368.4 million held by our non-U.S. subsidiaries, approximately $33.4 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2016. We believe our cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect that we will need to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2016 and 2015, U.S. income taxes have not been provided on cumulative total earnings of approximately $699.6 million and $482.7 million, respectively. +34 +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2016 increased $12.8 million to $41.9 million as compared to $29.1 million for 2015 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +YEAR ENDED DECEMBER 31, 2015 COMPARED TO THE YEAR ENDED DECEMBER 31, 2014 +Net sales +Net sales for 2015 were $3.15 billion, which was an increase of $769.8 million, or 32.4%, compared to net sales of $2.38 billion for 2014. The increase in net sales was broad-based and attributable to higher sales in our domestic wholesale segment, international wholesale segment and our retail segment primarily due to the introduction of new styles and lines of footwear. +Our domestic wholesale net sales increased $221.8 million, or 22.2%, to $1.220 billion for 2015 compared to $998.0 million for 2014. The increase in our domestic wholesale segment’s net sales resulted from a 15.3% unit sales volume increase to 51.8 million pairs in 2015 from 44.9 million pairs in 2014. This increase was attributable to strong sales and significant growth in several key divisions including our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions during 2015. The average selling price per pair within the domestic wholesale segment also increased 6.0%, to $23.53 per pair for 2015 from $22.20 for 2014, which was primarily the result of increased selling prices for our Women’s GO, Women’s Active and Men’s Sport divisions. +Our international wholesale segment net sales increased $405.2 million, or 58.8%, to $1.094 billion for 2015 compared to sales of $689.2 million for 2014. Our international wholesale sales consist of direct sales by our foreign subsidiaries – those sales we make to department stores and specialty retailers – and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries increased $271.0 million, or 54.5%, to $768.2 million for 2015 compared to sales of $497.2 million for 2014. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Hong Kong. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $134.2 million, or 69.9%, to $326.2 million for 2015, compared to sales of $192.0 million for 2014. This was primarily attributable to increased sales to our distributors in Australia and New Zealand, South Korea, Turkey and the United Arab Emirates (“UAE”). +Our retail segment sales increased $142.7 million to $833.1 million for the year ended December 31, 2015, a 20.7% increase over sales of $690.4 million for 2014. The increase in retail sales was primarily attributable to increased comparable sales of 10.5%, which included increased sales within our Women’s Go, Women’s Active, Men’s and Women’s Sport, and Men’s USA divisions and a net increase of 28 domestic and 40 international stores compared to 2014. For the year ended December 31, 2015, our domestic retail sales increased 17.2% compared to 2014, which was attributable to positive comparable domestic store sales of 10.0% and increased domestic store count, and our international retail store sales increased 35.8% compared to 2014, which was attributable to increased international store count and positive comparable international store sales of 12.5%. +We believe that we have established our presence in most major domestic retail markets. We had 391 domestic stores and 128 international retail stores as of February 15, 2016. During 2015, we opened five new domestic concept stores, 11 domestic factory outlet stores, 19 domestic warehouse outlet stores, 16 international concept stores, six international factory outlet stores and two international warehouse outlet stores, which included taking over the operations of 15 international concept stores and two international outlet stores from our distributor in Panama. During 2015, we closed six domestic concept stores, one domestic outlet store and one international concept store. We periodically review all of our stores for impairment. During 2015 and 2014, we did not record an impairment charge. +Gross profit +Gross profit for 2015 increased $352.1 million to $1.424 billion from $1.072 billion for 2014. Gross profit as a percentage of net sales, or gross margin, increased slightly to 45.2% in 2015 from 45.1% for 2014. Our domestic wholesale segment gross profit increased $103.1 million, or 28.0%, to $471.1 million for 2015 from $368.0 million for 2014, which was attributable to increased sales volumes and selling prices. Domestic wholesale margins increased to 38.6% for 2015 from 36.9% for 2014. The increase in domestic wholesale margins was primarily attributable to higher margins in our Women’s GO, Women’s Active, Women’s Sport and Men’s USA lines. +35 +Gross profit for our international wholesale segment increased $162.0 million, o r 55.3%, to $454.7 million for 2015 compared to $292.7 million for 2014. Gross margins for the international wholesale segment were 41.5% for 2015 compared to 42.5% for 2014. Gross margins for our international direct subsidiary sales were 47.2% for 2015 a s compared to 48.6% for 2014. The decrease in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to foreign currency fluctuations. Gross margins for our international distributor sale s were 28.1% for 2015 as compared to 26.5% for 2014. +Gross profit for our retail segment increased $87.0 million, or 21.2%, to $498.2 million for 2015 as compared to $411.2 million for 2014. Gross margins for all stores were 59.8% for 2015 compared to 59.6% for 2014. Gross margins for our domestic stores were 61.5% for 2015 as compared to 60.1% for 2014. Gross margins for our international stores were 53.4% for 2015 as compared to 57.2% for 2014. The increases in domestic and overall retail margins were primarily attributable to increased domestic sales of our newer products at higher margins. +Selling expenses +Selling expenses increased by $54.6 million, or 30.1%, to $235.6 million for 2015 from $181.0 million for 2014. As a percentage of net sales, selling expenses were 7.5% and 7.6% for 2015 and 2014, respectively. The increase in selling expenses was primarily the result of increased sales commissions of $7.7 million due to increased revenues and $43.8 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.4% in 2015 from 5.3% in 2014. +General and administrative expenses +General and administrative expenses increased by $158.4 million, or 22.9%, to $849.3 million for 2015 from $690.9 million for 2014. As a percentage of sales, general and administrative expenses were 27.0% and 29.1% for 2015 and 2014, respectively. The increase in general and administrative expenses was primarily attributable to $68.0 million related to supporting our growing international operations, increased store operating costs of $42.7 million primarily attributable to an additional 68 stores, which includes 17 stores that were transitioned from our distributor in Panama to our wholly-owned subsidiary, increased salaries and wages of $22.9 million, including incentive compensation, and $17.9 million in professional fees. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $32.5 million, due to increased shipments, to $167.3 million from $134.8 million for 2015 and 2014, respectively. +Other income (expense) +Interest income was $0.7 million for 2015 compared to $0.8 million for 2014. Interest expense for 2015 decreased $1.8 million to $10.7 million compared to $12.5 million in 2014. The decrease was primarily due to decreased interest expense of $1.3 million attributable to reduced interest paid on loans for our domestic distribution center and domestic distribution center equipment. Loss on foreign currency transactions for 2015 increased $1.2 million to $6.6 million compared to $5.4 million in 2014. This increased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2015 decreased $0.2 million to a loss of $0.7 million as compared to a loss of $0.9 million in 2014. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34% . Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes . +36 +Our earnings (loss) before income taxes and income tax expense for 2015, 2014 and 2013 are as follows (in thousands): +Years Ended December 31, +2015 +2014 +2013 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States +$ +136,726 +$ +52,173 +$ +82,778 +$ +32,500 +$ +38,705 +$ +12,807 +Canada +4,228 +1,024 +6,241 +1,572 +4,091 +1,187 +Chile +2,983 +572 +629 +138 +9,622 +1,920 +Peoples Republic of China (“China”) +49,027 +11,084 +15,201 +1,179 +6,148 +1,646 +Jersey (1) +123,721 +— +77,555 +— +25,348 +— +Non-benefited loss operations (2) +(16,719 +) +164 +(13,021 +) +— +(15,841 +) +— +Other jurisdictions (3) +33,531 +7,433 +21,997 +3,795 +14,142 +3,787 +Earnings before income taxes +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +$ +82,215 +$ +21,347 +Effective tax rate (4) +21.7 +% +20.5 +% +26.0 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Panama, Poland, Romania, Japan, Brazil and India. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of 2015 consolidated earnings (loss) before taxes: Hungary, Serbia, Bosnia and Herzegovina, Montenegro, Macedonia, Albania, Kosovo, Vietnam, Panama, Peru, Colombia, Costa Rica, the United Kingdom, Germany, France, Spain, Belgium, Italy, Netherlands, Switzerland, Malaysia, Thailand, Singapore, Hong Kong, Portugal and Austria. +(4) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2015, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2015, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $136.7 million, with income tax expense of $52.2 million, which is an average rate of 38.2%. Earnings (loss) before income taxes in non-U.S. jurisdictions were $196.8 million, with an aggregate income tax expense of $20.3 million, which is an average rate of 10.3%. Combined, this results in consolidated earnings before income taxes for the period of $333.5 million, and consolidated income tax expense for the period of $72.5 million, resulting in an effective tax rate of 21.7%. For 2015, of our $196.8 million in earnings before income tax earned outside the U.S., $123.7 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $46.1 million, or 59.5%, to $123.7 million for 2015, from $77.6 million for 2014. This increase was primarily attributable to us experiencing an increase of $433.7 million in net sales in the “Other international” geographic area for 2015 (see Note 17 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2014 to 2015 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $16.7 million for which no tax benefit was recognized during the year ended December 31, 2015 because of the provision of offsetting valuation allowances, but in which $0.2 million in nonrefundable withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had more than 5% of our 2015 consolidated earnings (loss) before taxes. Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2015, we had approximately $508.0 million in cash and cash equivalents, of which $218.7 million, or 43.1%, was held outside the U.S. Of the $218.7 million held by our non-U.S. subsidiaries, approximately $33.4 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our financial statements as of December 31, 2015. As of December 31, 2015 and 2014, U.S. income taxes have not been provided on cumulative total earnings of approximately $482.7 million and $318.2 million, respectively. +Non-controlling interest in net income and loss of consolidated subsidiaries +Non-controlling interest for 2015 increased $15.7 million to $29.1 million as compared to $13.4 million for 2014 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +37 +LIQUIDITY AND CAPITAL RESOURCES +Cash Flows +Our working capital at December 31, 2016 was $1.21 billion, an increase of $234.9 million from working capital of $971.2 million at December 31, 2015. Our cash and cash equivalents at December 31, 2016 was $718.5 million, compared to $508.0 million at December 31, 2015. This increase in cash and cash equivalents of $210.5 million, after consideration of the effect of exchange rates, was the result of our net earnings of $285.4 million, increased payables of $38.2 million, contributions from non-controlling interests of $14.0 million, and increased proceeds on short-term borrowings of $6.1 million, which was partially offset by capital expenditures of $119.5 million, increased inventories of $58.2 million and increased prepaid expenses and other current assets of $15.3 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $361.6 million for 2016 and $232.2 million for 2015. On a comparative year-to-year basis, the $129.4 million increase in cash flows from operating activities in 2016 from cash used in operating activities in 2015 primarily resulted from a smaller increase in inventories of $117.9 million, a smaller increase in accounts receivable balances of $89.7 million, and decreased distributions to non-controlling interests of $21.4 million. The increases were partially offset by a $91.8 million smaller increase in accounts payable, a smaller increase of $41.1 million in accrued expenses and other long-term liabilities as of December 31, 2016 when compared to December 31, 2015. +Investing Activities +Net cash used in investing activities was $145.6 million for 2016, as compared to $126.5 million in 2015. The increase in cash used in investing activities in 2016 as compared to 2015 was due to the acquisition of our South Korea distributor for $22.5 million and an increase in capital expenditures of $1.3 million partially offset by a decrease in investments purchased of $4.6 million. Capital expenditures for 2016 were approximately $119.5 million, which primarily consisted of $37.3 million for new store openings and remodels, $17.5 million for the automation upgrades for our European Distribution Center equipment, $17.5 million for the improvement of our international corporate offices and showrooms, and $7.0 million related to property purchases for potential future corporate development. This was compared to capital expenditures of $118.1 million in the prior year, which primarily consisted of $42.2 million for new store openings and remodels, $6.2 million for the automation upgrades for our European Distribution Center equipment, $11.2 million in domestic warehouse equipment upgrades, $17.4 million for new office space for our China joint venture, and $15.0 million related to property purchases for potential future corporate development. We expect our ongoing capital expenditures for 2017 to be between $75.0 million and $80.0 million, which include opening 70 to 90 retail stores, store remodels, $25.0 million for infrastructure primarily in our China joint venture, corporate office and information technology upgrades. We believe our current cash, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. +Financing Activities +Net cash used in financing activities was $3.5 million during 2016, compared to net cash used of $58.2 million during 2015. The increase in cash provided by financing activities was primarily attributable to the decrease in distributions to non-controlling interests, reduced payments required on our long-term debt, and increased contributions from non-controlling interests. +Sources of Liquidity +On December 29, 2010, we entered into a Master Loan and Security agreement (the “Master Agreement”), by and between us and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan Documents”), by and among us, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (“Agent”). We used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in our Rancho Belago distribution center. Borrowings made pursuant to the Master Agreement may be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 million, and each for a term of 60 months. The Note entered into on the same date as the Master Agreement represented a borrowing of approximately $39.3 million (the “First Note”). Interest accrued at a fixed rate of 3.54% per annum on the First Note. We made the final payment on the First Note on December 29, 2015. On June 30, 2011, we entered into another Note for approximately $36.3 million (“the Second Note”). Interest accrued at a fixed rate of 3.19% per annum on the Second Note. We made the final payment on the Second Note on June 29, 2016. +On June 30, 2015, we entered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, +38 +National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agr eement permits us and certain of our subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidat ion value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at our election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. We pay a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants t hat will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividen ds and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability d rops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. We paid closing and arrangement fees of $1.1 mill ion on this facility, which are being amortized to interest expense over the five-year life of the facility. As of December 31, 201 6 , there was $0.1 million outstanding under this credit facility, which is classified as short-term borrowings in our consoli dated balance sheets. +On April 30, 2010, the JV, through HF Logistics-SKX T1, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the JV ("HF-T1"), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the Project on the Property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV through HF-T1 entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF agreed that we would make an additional capital contribution of $38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under our credit agreement dated June 30, 2015. We had $68.1 million outstanding under the Amended Loan Agreement, which is included in long-term borrowings as of December 31, 2016. +As of December 31, 2016, outstanding short-term and long-term borrowings were $75.0 million, of which $68.9 million relates to loans for our domestic distribution center. We were in compliance with all debt covenants under the Amended Loan Agreement and the Credit Agreement as of the date of this annual report. +39 +We believe that anticipated cash flows from operations, available borrowings under our credit agre ement, existing cash balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least through March 31, 201 8 . Our future capital requirement s will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market accepta nce of our footwear, the success of our international operations, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, any potential a cquisitions of other brands or companies, and the number and timing of new store openings. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition and results of operations. In addition, if additional capital is raise d through the sale of additional equity or convertible securities, dilution to our stockholders could occur. +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2016 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +6,086 +$ +6,086 +$ +— +$ +— +$ +— +Long-term borrowings (1) +78,796 +4,571 +8,812 +65,413 +— +Operating lease obligations (2) +1,369,895 +191,345 +336,723 +284,539 +557,288 +Purchase obligations (3) +1,113,315 +1,113,315 +— +— +— +Minimum payments related to other arrangements +16,578 +9,667 +6,661 +250 +— +Total (4) +$ +2,584,670 +$ +1,324,984 +$ +352,196 +$ +350,202 +$ +557,288 +(1) +Amounts include anticipated interest payments based on interest rates currently in effect. +(2) +Operating lease obligations consists primarily of real property leases for our retail stores, corporate offices, European and other international distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $260.7 million, (ii) outstanding letters of credit of $2.0 million and (iii) open purchase commitments with our foreign manufacturers for $850.6 million. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(4) +Our consolidated balance sheet, as of December 31, 2016, included $6.6 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. +40 +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves, and valuation of deferred income taxes. +Revenue Recognition . We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. Domestically, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For our international wholesale customers in the European community, product is shipped FOB shipping point direct from our distribution center in Liege, Belgium. For our distributor sales, the goods are generally delivered directly from the independent factories to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. We recognize revenue from retail sales at the point of sale. Sales and value added taxes collected from retail customers are excluded from reported revenues. While customers do not have the right to return goods, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. +Royalty income is earned from our licensing arrangements. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. Typically, at each quarter-end, we receive correspondence from our licensees indicating actual sales for the period, which is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. When a customer’s account becomes significantly past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. +We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. Gross trade accounts receivable were $368.5 million and $368.2 million, and the allowance for bad debts, returns, sales allowances and customer chargebacks were $41.6 million and $24.3 million, at December 31, 2016 and 2015, respectively. Our credit losses charged to expense for the years ended December 31, 2016, 2015 and 2014 were $12.7 million, $5.3 million, and $11.8 million, respectively. In addition, we recorded sales return and allowance expense for the years ended December 31, 2016, 2015 and 2014 of $18.1 million, $2.3 million, and $2.3 million, respectively. +41 +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inve ntory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our exp ectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably o r unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. Our gross inventory value was $7 12.0 million and $623.9 million, and our inventory reserve was $11.5 million and $3.7 million, at December 31, 2016 and 20 15 , respectively. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances: +• +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets; +• +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +• +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +• +overall financial performance such as negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; +• +other relevant entity-specific events such as changes in management, key personnel, strategy, customers, contemplation of bankruptcy, or litigation; +• +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and +• +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. In addition, we prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. For the years ended December 31, 2016, 2015 and 2014, respectively we did not record an impairment charge. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. As of December 31, 2016, we had net deferred tax assets of $45.2 million reduced by a valuation allowance of $19.5 million primarily related to loss carry-forwards not expected to be utilized by certain foreign subsidiaries. +42 +INFLATION +We do not believe that the rates of inflation experienced in the United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2016 and 2015, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — The Company and Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2016, we have $6.1 million and $68.1 million of outstanding short-term and long-term borrowings, respectively, subject to changes in interest rates. A 200 basis point increase in interest rates would have increased interest expense by less than $0.1 million for the year ended December 31, 2016. We do not expect any changes in interest rates to have a material impact on our financial condition or results of operations during the remainder of 2017. The interest rate charged on our domestic secured line of credit facility is based on the prime rate of interest and our domestic distribution center loan is based on the one month LIBOR. Changes in the prime rate of interest or the LIBOR interest rate will have an effect on the interest charged on outstanding balances. As of December 31, 2016, there was $0.1 million outstanding under this credit facility and $ 68.1 million outstanding on our domestic distribution center loan. +We have entered into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on our long-term debt. We will not enter into derivative transactions for speculative purposes. We had one derivative instrument in place as of December 31, 2016 to hedge the cash flows on our $68.1 million variable rate debt on our domestic distribution center. This instrument was a variable to fixed derivative with a notional amount of $68.1 million at December 31, 2016. Our average receive rate was one month LIBOR and the average pay rate was 2.08%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest expense. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not engage in hedging activities with respect to such exchange rate risks. +Assets and liabilities outside the United States are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, the Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. Accordingly, we do not hedge these net investments. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation loss of $0.3 million and $10.2 million for the years ended December 31, 2016 and 2015, respectively, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2016 would have reduced the values of our net investments by approximately $21.2 million. +43 +ITEM 8. +FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +45 +CONSOLIDATED BALANCE SHEETS +46 +CONSOLIDATED STATEMENTS OF EARNINGS +47 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +48 +CONSOLIDATED STATEMENTS OF EQUITY +49 +CONSOLIDATED STATEMENTS OF CASH FLOWS +50 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +51 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +75 +44 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, California +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries (“Company”) as of December 31, 2016 and 2015 and the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2016. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Skechers U.S.A., Inc. and subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. +Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. +As discussed in note 12 to the consolidation financial statements, the Company changed its method of presentation of deferred tax assets and liabilities in 2016 due to the adoption of Financial Accounting Standards Board Accounting Standards Update 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This change was applied retrospectively to all periods presented and resulted in the reclassification of approximately $22.3 million of deferred tax assets from current assets to noncurrent assets within the Company’s consolidated balance sheet as of December 31, 2015. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Skechers U.S.A., Inc. and subsidiaries internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 1, 2017 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +March 1, 2017 +45 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +December 31, +2016 +2015 +ASSETS +Current assets: +Cash and cash equivalents +$ +718,536 +$ +507,991 +Trade accounts receivable, less allowances of $41,647 in 2016 and $24,260 in 2015 +326,844 +343,930 +Other receivables +19,191 +18,661 +Total receivables +346,035 +362,591 +Inventories +700,515 +620,247 +Prepaid expenses and other current assets +62,680 +57,363 +Total current assets +1,827,766 +1,548,192 +Property, plant and equipment, net +494,473 +435,907 +Deferred tax assets +26,043 +17,825 +Other assets, net +45,388 +37,954 +Total non-current assets +565,904 +491,686 +TOTAL ASSETS +$ +2,393,670 +$ +2,039,878 +LIABILITIES AND EQUITY +Current liabilities: +Current installments of long-term borrowings +$ +1,783 +$ +15,653 +Short-term borrowings +6,086 +59 +Accounts payable +520,437 +473,983 +Accrued expenses +93,424 +87,318 +Total current liabilities +621,730 +577,013 +Long-term borrowings, excluding current installments +67,159 +68,942 +Deferred tax liabilities +412 +8,507 +Other long-term liabilities +18,855 +9,682 +Total non-current liabilities +86,426 +87,131 +Total liabilities +708,156 +664,144 +Commitments and contingencies +Stockholders’ equity: +Preferred stock, $0.001 par value; 10,000 shares authorized; none issued +and outstanding +— +— +Class A common stock, $0.001 par value; 500,000 shares authorized; +130,386 and 127,324 shares issued and outstanding at December 31, 2016 +and December 31, 2015, respectively +130 +127 +Class B convertible common stock, $0.001 par value; 75,000 shares +authorized; 24,545 and 26,278 shares issued and outstanding at +December 31, 2016 and December 31, 2015, respectively +24 +26 +Additional paid-in capital +419,038 +386,156 +Accumulated other comprehensive loss +(26,604 +) +(26,305 +) +Retained earnings +1,211,045 +967,552 +Skechers U.S.A., Inc. equity +1,603,633 +1,327,556 +Noncontrolling interests +81,881 +48,178 +Total stockholders' equity +1,685,514 +1,375,734 +TOTAL LIABILITIES AND EQUITY +$ +2,393,670 +$ +2,039,878 +See accompanying notes to consolidated financial statements. +46 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Year Ended December 31, +2016 +2015 +2014 +Net sales +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +Cost of sales +1,928,715 +1,723,315 +1,305,656 +Gross profit +1,634,596 +1,424,008 +1,071,905 +Royalty income +13,885 +11,745 +9,107 +1,648,481 +1,435,753 +1,081,012 +Operating expenses: +Selling +257,129 +235,586 +181,018 +General and administrative +1,020,834 +849,343 +690,923 +1,277,963 +1,084,929 +871,941 +Earnings from operations +370,518 +350,824 +209,071 +Other income (expense): +Interest income +1,186 +722 +837 +Interest expense +(6,270 +) +(10,728 +) +(12,466 +) +Other, net +(5,950 +) +(7,321 +) +(6,062 +) +Total other expense +(11,034 +) +(17,327 +) +(17,691 +) +Earnings before income tax expense +359,484 +333,497 +191,380 +Income tax expense +74,125 +72,450 +39,184 +Net earnings +285,359 +261,047 +152,196 +Less: Net earnings attributable to non-controlling interests +41,866 +29,135 +13,385 +Net earnings attributable to Skechers U.S.A., Inc. +$ +243,493 +$ +231,912 +$ +138,811 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +1.58 +$ +1.52 +$ +0.91 +Diluted +$ +1.57 +$ +1.50 +$ +0.91 +Weighted average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +154,169 +152,847 +151,839 +Diluted +155,084 +154,200 +153,079 +See accompanying notes to consolidated financial statements. +47 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2016 +2015 +2014 +Net earnings +$ +285,359 +$ +261,047 +$ +152,196 +Other comprehensive income: +Loss on foreign currency translation adjustment +(4,698 +) +(13,167 +) +(7,954 +) +Comprehensive income +280,661 +247,880 +144,242 +Less: Comprehensive income attributable to noncontrolling interests +37,467 +26,196 +12,807 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +243,194 +$ +221,684 +$ +131,435 +See accompanying notes to consolidated financial statements. +48 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +NON +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +CONTROLLING +STOCKHOLDERS' +STOCK +STOCK +STOCK +STOCK +CAPITAL +LOSS +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at January 1, 2014 +119,064 +32,610 +$ +120 +$ +32 +$ +342,042 +$ +(8,701 +) +$ +596,829 +$ +930,322 +$ +49,598 +$ +979,920 +Net earnings +— +— +— +— +— +— +138,811 +138,811 +13,385 +152,196 +Foreign currency translation adjustment +— +— +— +— +— +(7,376 +) +— +(7,376 +) +(578 +) +(7,954 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +503 +503 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(4,050 +) +(4,050 +) +Stock compensation expense +— +— +— +— +8,684 +— +— +8,684 +— +8,684 +Proceeds from issuance of common stock under the +employee stock purchase plan +306 +— +— +— +3,363 +— +— +3,363 +— +3,363 +Shares issued under the Incentive Award Plan +292 +— +— +— +— +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +1,446 +— +— +1,446 +— +1,446 +Conversion of Class B Common Stock into Class A +Common Stock +1,200 +(1,200 +) +— +(1 +) +— +— +— +(1 +) +— +(1 +) +Balance at December 31, 2014 +120,862 +31,410 +$ +120 +$ +31 +$ +355,535 +$ +(16,077 +) +$ +735,640 +$ +1,075,249 +$ +58,858 +$ +1,134,107 +Net earnings +— +— +— +— +— +— +231,912 +231,912 +29,135 +261,047 +Foreign currency translation adjustment +— +— +— +— +— +(10,228 +) +— +(10,228 +) +(2,939 +) +(13,167 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +2,272 +2,272 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(39,148 +) +(39,148 +) +Stock compensation expense +— +— +— +— +18,296 +— +— +18,296 +— +18,296 +Proceeds from issuance of common stock under the +employee stock purchase plan +224 +— +1 +— +4,317 +— +— +4,318 +— +4,318 +Shares issued under the Incentive Award Plan +1,106 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +8,009 +— +— +8,009 +— +8,009 +Conversion of Class B Common Stock into Class A +Common Stock +5,132 +(5,132 +) +5 +(5 +) +— +— +— +— +— +— +Balance at December 31, 2015 +127,324 +26,278 +$ +127 +$ +26 +$ +386,156 +$ +(26,305 +) +$ +967,552 +$ +1,327,556 +$ +48,178 +$ +1,375,734 +Net earnings +— +— +— +— +— +— +243,493 +243,493 +41,866 +285,359 +Foreign currency translation adjustment +— +— +— +— +— +(299 +) +— +(299 +) +(4,399 +) +(4,698 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +13,980 +13,980 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(17,744 +) +(17,744 +) +Stock compensation expense +— +— +— +— +23,081 +— +— +23,081 +— +23,081 +Proceeds from issuance of common stock under the +employee stock purchase plan +221 +— +— +— +5,120 +— +— +5,120 +— +5,120 +Shares issued under the Incentive Award Plan +1,108 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +4,682 +— +— +4,682 +— +4,682 +Conversion of Class B Common Stock into Class A +Common Stock +1,733 +(1,733 +) +2 +(2 +) +— +— +— +— +— +— +Balance at December 31, 2016 +130,386 +24,545 +$ +130 +$ +24 +$ +419,038 +$ +(26,604 +) +$ +1,211,045 +$ +1,603,633 +$ +81,881 +$ +1,685,514 +See accompanying notes to consolidated financial statements +49 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2016 +2015 +2014 +Cash flows from operating activities: +Net earnings +$ +285,359 +$ +261,047 +$ +152,196 +Adjustments to reconcile net earnings to net cash provided by operating activities: +Depreciation and amortization of property, plant and equipment +66,083 +52,433 +47,557 +Amortization of other assets +13,099 +1,214 +1,948 +Provision for bad debts and returns +30,820 +7,520 +14,153 +Non-cash share-based compensation +23,081 +18,296 +8,684 +Deferred income taxes +(11,936 +) +(4,844 +) +22,411 +Loss on non-current assets +413 +656 +837 +Net foreign currency adjustments +(3,949 +) +— +— +(Increase) decrease in assets: +Receivables +(10,350 +) +(100,032 +) +(70,695 +) +Inventories +(58,152 +) +(176,062 +) +(100,162 +) +Prepaid expenses and other current assets +(15,343 +) +(2,082 +) +(31,788 +) +Other assets +(5,056 +) +(6,423 +) +4,548 +Increase in liabilities: +Accounts payable +38,247 +130,075 +98,686 +Accrued expenses and other long-term liabilities +9,306 +50,416 +15,507 +Net cash provided by operating activities +361,622 +232,214 +163,882 +Cash flows from investing activities: +Capital expenditures +(119,471 +) +(118,144 +) +(56,905 +) +Intangible asset additions +— +(55 +) +— +Purchases of investments +(3,810 +) +(8,428 +) +— +Proceeds from sales of investments +170 +144 +— +Acquisition of South Korea distributor +(22,534 +) +— +Net cash used in investing activities +(145,645 +) +(126,483 +) +(56,905 +) +Cash flows from financing activities: +Net proceeds from the issuances of common stock through employee stock purchase plan +5,120 +4,318 +3,363 +Payments on long-term debt +(15,653 +) +(32,656 +) +(12,028 +) +Proceeds from long-term debt +— +762 +— +Proceeds (payments) on short-term borrowings +6,091 +(1,733 +) +1,723 +Excess tax benefits from share-based compensation +4,682 +8,009 +1,446 +Contribution from non-controlling interests of consolidated entity +13,980 +2,272 +503 +Distributions to non-controlling interests of consolidated entity +(17,744 +) +(39,148 +) +(4,050 +) +Net cash used in financing activities +(3,524 +) +(58,176 +) +(9,043 +) +Net increase in cash and cash equivalents +212,453 +47,555 +97,934 +Effect of exchange rates on cash and cash equivalents +(1,908 +) +(6,249 +) +(3,260 +) +Cash and cash equivalents at beginning of the period +507,991 +466,685 +372,011 +Cash and cash equivalents at end of the period +$ +718,536 +$ +507,991 +$ +466,685 +Supplemental disclosures of cash flow information: +Cash paid during the period for: +Interest +$ +5,724 +$ +9,891 +$ +10,822 +Income taxes +65,260 +63,479 +29,499 +See accompanying notes to consolidated financial statements. +50 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2016, 2015 and 2014 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company operates 413 domestic and 157 international retail stores and an e-commerce business as of December 31, 2016. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. +On August 21, 2015, the Company’s Board of Directors approved a three-for-one stock split, effected in the form of a stock dividend, of both the Company’s Class A and Class B common stock. The stock split was made on October 16, 2015 to stockholders of record at the close of business on October 2, 2015. All share numbers and per-share amounts presented in the consolidated financial statements reflect the three-for-one stock split. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +(c) +Revenue Recognition +The Company recognizes revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. Generally, wholesale customers do not have the right to return goods, however, the Company periodically decides to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. The Company recognizes revenue from retail sales at the point of sale. Sales and value added taxes collected from retail customers are excluded from reported revenues. +Royalty income is earned from licensing arrangements. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned. The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. Typically, at each quarter-end, the Company receives correspondence from licensees indicating actual sales for the period, which is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +(d) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic wholesale, international wholesale, and retail, which includes e-commerce sales. Information regarding these segments is summarized in Note 17 – Segment and Geographic Reporting. +(e) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Asia and the Middle East or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) 810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has determined that it is the primary beneficiary for these VIE’s because the Company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity, or the right to receive benefits from the entity that could potentially be significant to the +51 +variable interest entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated fin ancial statements, even though the Company may not hold a majority equity interest. There have been no changes during 2016 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationshi ps quarterly. The assets of these joint ventures are restricted in that they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Co mpany does not have a variable interest in any unconsolidated VIEs. +(f) +Fair Value of Financial Instruments +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, investments, accounts receivable, accounts payable and accrued expenses, approximate fair value due to the relatively short maturity of such instruments. +The carrying amount of the Company’s long-term borrowings are considered Level 2 liabilities, which approximates fair value, based upon current rates and terms available to the Company for similar debt. +As of August 12, 2015, the Company entered into an interest rate swap agreement concurrent with refinancing its domestic distribution center construction loan (see Note 6, Derivative Instruments). The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with U.S. GAAP, credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The majority of the inputs used to value the interest rate swap were within Level 2 of the fair value hierarchy. As of December 31, 2016, the interest rate swap was a Level 2 derivative and was classified as other long-term liabilities in the Company’s consolidated balance sheets. +(g) +Cash and Cash Equivalents +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +(h) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectability, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the account. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high-risk, the Company provides a reserve based upon its historical loss rate as a percentage of sales. +(i) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market (net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories, and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +52 +(j) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method, which based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, +whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company reviews both quantitative and qualitative factors to assess whether a triggering event occurred. The Company prepares a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of 24 months are then reviewed in detail to determine whether impairment exists. Recoverability of assets or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. The Company did not record impairment charges during the years ended December 31, 2016, 2015 or 2014. +(k) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry-forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +(l) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Translation adjustments for subsidiaries where the functional currency is its local currency are included in other comprehensive income. Foreign currency transaction gains (losses) resulting from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +(m) +Comprehensive Income +Comprehensive income is presented in the consolidated statements of comprehensive income. Comprehensive income consists of net earnings, foreign currency translation adjustments, and income attributable to non-controlling interests. +(n) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run, or over the life of the endorsement contract. Advertising expense for the years ended December 31, 2016, 2015 and 2014 was approximately $213.1 million, $188.1 million and $141.7 million, respectively. Prepaid advertising costs were $9.8 million and $11.2 million at December 31, 2016 and 2015, respectively. Prepaid amounts outstanding at December 31, 2016 and 2015 represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run, as of December 31, 2016 and 2015, respectively. +(o) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses, when incurred. Product design and development costs aggregated approximately $13.6 million, $11.2 million, and $10.3 million during the years ended December 31, 2016, 2015 and 2014, respectively. +53 +(p) +Warehouse and Distr ibution Costs +The Company’s distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $187.3 million, $167.3 million and $134.8 million for 2016, 2015 and 2014, respectively. +(q) +Recent Accounting Pronouncements +In October 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. ASU No. 2016-16, “ Accounting for Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory .” The standard requires that the income tax impact of intra-entity sales and transfers of property, except for inventory, be recognized when the transfer occurs. The standard will become effective for the Company’s annual and interim reporting periods beginning January 1, 2018 and will require any deferred taxes not yet recognized on intra-entity transfers to be recorded to retained earnings under a modified retrospective approach. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2016-16; however at the current time the Company does not know what impact the adoption of this ASU will have on its consolidated financial statements, financial condition or results of operations. +In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments,” (“ASU 2016-15”) which eliminates the diversity in practice related to the classification of certain cash receipts and payments. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. The retrospective transition method, requiring adjustment to all comparative periods presented, is required unless it is impracticable for some of the amendments, in which case those amendments would be prospectively adopted as of the earliest date practicable. ASU 2016-15 is effective for the Company’s annual and interim reporting periods beginning January 1, 2018. The Company is currently evaluating the impact of ASU 2016-15; however at the current time the Company does not know what impact the adoption of this ASU will have on its consolidated financial statements, financial condition or results of operations. +In June 2016, the FASB issued ASU No. 2016-13, “ Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ,” (“ASU 2016-13”) which requires measurement and recognition of expected versus incurred credit losses for financial assets held. ASU 2016-13 is effective for the Company’s annual and interim reporting periods beginning January 1, 2020, with early adoption permitted on January 1, 2019. The Company is currently evaluating the impact of ASU 2016-13; however at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements, financial condition or results of operations. +In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). The updated guidance changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Management anticipates increased income statement volatility due to the recognition of all excess tax benefits and deficiencies within the consolidated statements of earnings. Income statement volatility will be driven by the number of shares vesting in any given period, and the change in share price between grant date and vesting. Directionally, increasing share prices from grant date to vesting date will result in lower income tax expense and higher net income. The update to the standard is effective for the Company’s annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. The Company is currently evaluating the impact of ASU 2016-09; however at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements, financial condition or results of operations. +In February 2016, the FASB issued ASU No. 2016-02, “ Leases (Topic 842) ” (“ASU 2016-02”). The new standard requires lessees to recognize most leases on the balance sheet, which will increase lessees’ reported assets and liabilities. ASU 2016-02 is effective for the Company’s annual and interim reporting periods beginning January 1, 2019. ASU 2016-02 mandates a modified retrospective transition method. The Company is currently assessing the impact of the new standard on its consolidated financial statements, but anticipates an increase in assets and liabilities due to the recognition of the required right-of-use asset and corresponding liability for all lease obligations that are currently classified as operating leases, such as real estate leases for corporate headquarters, administrative offices, retail stores, showrooms, and distribution facilities, as well as additional disclosure on all our lease obligations. The income statement recognition of lease expense is not expected to change from the current methodology. +In January 2016, the FASB issued ASU No. 2016-01, “ Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” “ASU 2016-01”). The updated guidance enhances the reporting model for financial instruments, which includes amendments to address aspects of recognition, measurement, presentation and disclosure. The +54 +update to the standard should be applied prospectively and is effective for the Company’s annual and interim reporting periods beginning January 1, 2018. The Company is currently evaluating the impact of ASU 2016-01; howev er at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements, financial condition or results of operations. +In July 2015, the FASB issued ASU No. 2015-11, “ Inventory (Topic 330): Simplifying the Measurement of Inventory ” (“ASU 2015-11”). ASU 2015-11 requires that inventory within the scope of this standard be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in this update do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. ASU 2015-11 will be effective for the Company’s annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. The Company is currently evaluating the impact of this ASU; however the Company does not expect that the adoption of ASU 2015-11 will have a material impact on its consolidated financial statements, financial condition or results of operations. +In May 2014, the FASB issued ASU No. 2014-09 “ Revenue from Contracts with Customers ,” which amended the FASB Accounting Standards Codification (“ASC”) and created a new Topic ASC 606, “ Revenue from Contracts with Customers ” (“ASC 606”). This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in ASC Topic 605, “ Revenue Recognition ,” and most industry-specific guidance throughout the Industry Topics of the Codification. For the Company’s annual and interim reporting periods the mandatory adoption date of ASC 606 is January 1, 2018, and there will be two methods of adoption allowed, either a full retrospective adoption or a modified retrospective adoption. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to the first quarter of 2018. In March 2016, April 2016, May 2016, and December 2016, the FASB issued ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20, respectively, as clarifications to ASU 2014-09. ASU 2016-08 clarifies how to identify the unit of accounting for the principal versus agent evaluation, how to apply the control principle to certain types of arrangements, such as service transactions, and reframed the indicators in the guidance to focus on evidence that an entity is acting as a principal rather than as an agent. ASU 2016-10 clarifies the existing guidance on identifying performance obligations and licensing implementation. ASU 2016-12 adds practical expedients related to the transition for contract modifications and further defines a completed contract, clarifies the objective of the collectability assessment and how revenue is recognized if collectability is not probable, and when non-cash considerations should be measured. ASU 2016-20 corrects or improves guidance in thirteen narrow focus aspects of the guidance. The effective dates for these ASUs are the same as the effective date for ASU No. 2014-09, for the Company’s annual and interim periods beginning January 1, 2018. These ASU’s also require enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows. The Company will adopt the new revenue standards in its first quarter of 2018. The Company has not selected a transition method. The Company is still completing the assessment of the impact of these ASUs on its consolidated financial statements ; however at the current time the Company does not expect that the adoption of these ASUs will have a material impact on its consolidated financial statements, financial condition or results of operations. +(2) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2016 and 2015 is summarized as follows (in thousands): +2016 +2015 +Land +$ +83,163 +$ +76,163 +Buildings and improvements +207,665 +200,607 +Furniture, fixtures and equipment +297,540 +248,684 +Leasehold improvements +289,847 +236,842 +Total property, plant and equipment +878,215 +762,296 +Less accumulated depreciation and amortization +383,742 +326,389 +Property, plant and equipment, net +$ +494,473 +$ +435,907 +55 +(3) +ACCRUED EXPENSES +Accrued expenses at December 31, 2016 and 2015 are summarized as follows (in thousands): +2016 +2015 +Accrued inventory purchases +$ +48,087 +$ +53,607 +Accrued payroll and taxes +45,337 +33,711 +Accrued expenses +$ +93,424 +$ +87,318 +(4) +LINE OF CREDIT AND SHORT-TERM BORROWINGS +On June 30, 2015, the Company entered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits the Company and certain of its subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at the Company’s election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. The Company pays a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. The Company paid closing and arrangement fees of $1.1 million on this facility, which are being amortized to interest expense over the five-year life of the facility. As of December 31, 2016 and December 31, 2015, there was $0.1 million outstanding under the Company’s credit facilities, classified as short-term borrowings in the Company’s consolidated balance sheets. The remaining balance of $6.0 million in short-term borrowings as of December 31, 2016 is related to the Company’s joint venture in India. +(5) +LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2016 and 2015 is as follows (in thousands): +2016 +2015 +Note payable to banks, due in monthly installments of $121.3 +(includes principal and interest), variable-rate interest at +2.77% per annum, secured by property, balloon payment of +$62,843 due August 2020 +$ +68,059 +$ +69,515 +Note payable to banks, due in monthly installments of $483.9 +(includes principal and interest), fixed-rate interest at 3.19% +per annum, secured by property, balloon payment of $11,670 +paid in June 2016 +— +13,886 +Note payable to TCF Equipment Finance, Inc., due in monthly +installments of $30.5, (includes principal and interest) fixed- +rate interest at 5.24% per annum, maturity date of July 2019 +883 +1,194 +Subtotal +68,942 +84,595 +Less current installments +1,783 +15,653 +Total long-term borrowings +$ +67,159 +$ +68,942 +56 +The aggregate maturities of long-term borrowings at December 31, 2016 are as follows (in thousands): +2017 +$ +1,783 +2018 +1,801 +2019 +1,666 +2020 +63,692 +$ +68,942 +The Company’s long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. The Company is in compliance with its non-financial covenants, including any cross default provisions, and financial covenants of its long-term borrowings as of December 31, 2016. +On April 30, 2010, HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the project on certain property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV, through HF-T1, entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF Logistics (“HF”) agreed that the Company would make an additional capital contribution of $38.7 million to the JV, through HF-T1, to make a payment on the Original Loan based on the Company’s 50% equity interest in the JV. The payment equaled the Company’s 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV, through HF-T1, to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in the Company’s consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Credit Agreement dated June 30, 2015 (see Note 6, Derivative Instruments). +On December 29, 2010, the Company entered into a master loan and security agreement (the “Master Agreement”), by and between the Company and Banc of America Leasing & Capital, LLC, and an Equipment Security Note (together with the Master Agreement, the “Loan Documents”), by and among the Company, Banc of America Leasing & Capital, LLC, and Bank of Utah, as agent (“Agent”). The Company used the proceeds to refinance certain equipment already purchased and to purchase new equipment for use in the Rancho Belago distribution facility. Borrowings made pursuant to the Master Agreement may be in the form of one or more equipment security notes (each a “Note,” and, collectively, the “Notes”) up to a maximum limit of $80.0 million and each for a term of 60 months. The First Note entered into on the same date as the Master Agreement represented a borrowing of approximately $39.3 million (“the First Note”). Interest accrued at a fixed rate of 3.54% per annum on the First Note. The Company made the final payment on the First Note on December 29, 2015. On June 30, 2011, the Company entered into another Note agreement for approximately $36.3 million (“the Second Note”). Interest accrued at a fixed rate of 3.19% per annum on the Second Note. The Company made the final payment on the Second Note on June 29, 2016. +57 +(6) +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company used an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. On August 12, 2015, in connection with refinancing its domestic distribution center loan, described in Note 5 above, the Company entered into a variable-to-fixed interest rate swap agreement with Bank of America, N.A., to hedge the cash flows on the Company’s $70.0 million variable rate debt. As of December 31, 2016, the swap agreement has an aggregate notional amount of $68.1 million and a maturity date of August 12, 2022, subject to early termination commencing on August 1, 2020 at the option of HF Logistics-SKX T1, LLC (“HF-T1”), a wholly-owned subsidiary of the Company’s joint venture HF Logistics-SKX, LLC (the “JV”). Under the terms of the swap agreement, the Company will pay a weighted-average fixed rate of 2.08% on the $68.1 million notional amount and receive payments from the counterparty based on the 30-day LIBOR rate. The rate swap agreement utilized by the Company effectively modifies its exposure to interest rate risk by converting the Company’s floating-rate debt to a fixed-rate of 4.08% for the life of the loan thus reducing the impact of interest-rate changes on future interest expense. Pursuant to the terms of the JV, HF Logistics is responsible for any amounts related to the Swap Agreement. +By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2016, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +(7) +COMMITMENTS AND CONTINGENCIES +(a) +Leases +The Company leases facilities under operating lease agreements expiring through January 31, 2033. The Company pays taxes, maintenance and insurance in addition to the lease obligations. Leases may provide for renewal options and rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of gross sales in excess of a base annual rent. The Company also leases certain equipment and automobiles under operating lease agreements expiring at various dates through September 2018. Rent expense for the years ended December 31, 2016, 2015 and 2014 approximated $171.0 million, $137.8 million and $107.0 million, respectively. +Minimum lease payments, which take into account escalation clauses, are recognized on a straight-line basis over the minimum lease term. Reimbursements for leasehold improvements are recorded as liabilities and are amortized as a reduction to rent expense over the lease term. Lease concessions, usually a free rent period, are considered in the calculation of the minimum lease payments for the minimum lease term. +Future minimum lease payments under noncancellable leases at December 31, 2016 are as follows (in thousands): +OPERATING +LEASES +Year ending December 31: +2017 +$ +191,345 +2018 +179,873 +2019 +156,850 +2020 +143,309 +2021 +141,230 +Thereafter +557,288 +$ +1,369,895 +(b) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0% and 0.5% for 30- to 60-day financing. The amounts outstanding under these arrangements at December 31, 2016 and 2015 were $260.7 million and $120.4 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $4.4 million in 2016, $5.4 million in 2015, and $5.1 million in 2014. +58 +The Company has open purchase commitments with its foreign manufacturers at December 31, 2016 of $850. 6 million, which are not included in the accompanying 2016 consolidated balance sheet. +(c) +Litigation +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups are defective and unreasonably dangerous, negligently designed and/or manufactured, and do not conform to representations made by the Company, and that the Company failed to provide adequate warnings of alleged risks associated with Shape-ups. In total, the Company is named as a defendant in 50 currently pending cases (some on behalf of multiple plaintiffs) filed in various courts that assert further varying injuries but employ similar legal theories and assert similar claims to the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are some variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding. The Company has resolved 1,743 personal injury claims in the MDL proceedings, comprised of 1,141 that were filed as formal actions and 602 that were submitted by plaintiff fact sheets. The Company has also settled 34 claims in principle—17 filed cases and 17 claims submitted by plaintiff fact sheets—either directly or pursuant to a global settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 42 cases in the MDL proceeding have been dismissed either voluntarily or on motions by the Company and 38 unfiled claims submitted by plaintiff fact sheet have been abandoned. Between the consummated settlements and cases subject to the settlement program, all but 35 personal injury cases pending in the MDL have been or are expected to be resolved. On August 6, 2015, the Court entered an order staying all deadlines, including trial, pending further order of the Court. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition by the Company to coordinate all personal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coordinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. Fifty-three actions brought on behalf of a total of 620 plaintiffs have been settled and fully dismissed. Eleven actions have been partially dismissed, with the claims of 221 plaintiffs in those actions having been fully resolved and dismissed. The Company has also settled in principle the claims of 26 plaintiffs from 4 actions either directly or pursuant to a global settlement program that has been approved by the plaintiffs’ attorneys (described in greater detail below). One single-plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff lawsuits have been dismissed entirely, either voluntarily or on motion by the Company. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by the Company. Thus, taking into account both consummated settlements and cases subject to the settlement program, only 14 lawsuits on behalf of a total of 24 plaintiffs are expected to remain in the LASC Coordinated Cases. Discovery is continuing in those fourteen remaining cases. No trial dates have been set. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. Eleven of those actions have been resolved and dismissed. The last remaining action in a state court other than California was filed in Missouri on January 4, 2016 on behalf of a single plaintiff. The complaint was served on November 14, 2016. We have answered the complaint and denied all material allegations asserted therein. The parties are now engaged in discovery. No trial date has been set. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. A master settlement agreement was executed as of March 24, 2016 and the parties are in the process of completing individual settlements. To the extent that the settlements with individual claimants are not finalized or otherwise consummated such that the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for +59 +business purposes in order to end the distraction of litigation, and the Company continues to believe it has meritorious defenses and intend s to defend any remaining cases vigorously. In addition, it is too early to predict whether there wil l be future personal injury cases filed which are not covered by the global settlement program, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insuran ce coverage will be available and/o r adequate to cover any losses. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against the Company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of the Company’s alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including the Company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, The Company responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and BOBS Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued a ruling affirming that Skechers Twinkle Toe’s and Bob’s canvas shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bob’s canvas shoes do not infringe. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on the Company’s operations or financial position, the Company believes it has meritorious defenses and intend to defend these legal matters vigorously. +In accordance with U.S. GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2016, nor is it possible to estimate what litigation-related costs will be in the future. +(8) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $.001 per share, 75 million shares of Class B Common Stock, par value $.001 per share, and 10 million shares of preferred stock, $.001 par value per share. +During 2016, 2015 and 2014, certain Class B stockholders converted 1,733,270 shares, 5,131,296 shares and 1,199,328 shares, respectively, of Class B Common Stock to Class A Common Stock (see Note 10 – Earnings Per Share). +(9) +NONCONTROLLING INTERESTS +The following VIEs are consolidated into the Company’s consolidated financial statements and the carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics-SKX, LLC +December 31, 2016 +December 31, 2015 +Current assets +$ +2,006 +$ +2,111 +Non-current assets +108,668 +113,928 +Total assets +$ +110,674 +$ +116,039 +Current liabilities +$ +2,469 +$ +2,461 +Non-current liabilities +68,168 +69,951 +Total liabilities +$ +70,637 +$ +72,412 +60 +Distribution joint ventures (1) +December 31, 2016 +December 31, 2015 +Current assets +$ +289,227 +$ +154,060 +Non-current assets +49,229 +34,782 +Total assets +$ +338,456 +$ +188,842 +Current liabilities +$ +132,518 +$ +68,198 +Non-current liabilities +2,214 +62 +Total liabilities +$ +134,732 +$ +68,260 +(1) Distribution joint ventures include Skechers Limited (Israel), Skechers China Limited, Skechers Korea Limited, Skechers Southeast Asia Limited, Skechers (Thailand) Limited, Skechers Retail India Private Limited, and Skechers South Asia Private Limited. +The following is a summary of net earnings attributable to, distributions to and contributions from non-controlling interests (in thousands): +Year Ended December 31, +2016 +2015 +2014 +Net earnings attributable to non-controlling +interests +$ +41,866 +$ +29,135 +$ +13,385 +Distributions to: +HF Logistics-SKX, LLC +4,091 +38,092 +3,700 +Skechers China Limited +11,922 +450 +350 +Skechers Southeast Asia Limited +1,280 +— +— +Skechers Hong Kong Limited +451 +— +— +Contributions from: +India distribution joint ventures +2,943 +2,273 +504 +Skechers Korea Co., Ltd. +8,273 +— +— +Skechers Footwear Ltd. (Israel) +2,764 +— +— +61 +(10) +EARNINGS PER SHARE +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential dilutive common shares using the treasury stock method. +The Company has two classes of issued and outstanding common stock; Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted net earnings per share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating earnings per share (in thousands): +Basic earnings per share +2016 +2015 +2014 +Net earnings attributable to Skechers U.S.A., Inc. +$ +243,493 +$ +231,912 +$ +138,811 +Weighted average common shares outstanding +154,169 +152,847 +151,839 +Basic earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.58 +$ +1.52 +$ +0.91 +Diluted earnings per share +2016 +2015 +2014 +Net earnings attributable to Skechers U.S.A., Inc. +$ +243,493 +$ +231,912 +$ +138,811 +Weighted average common shares outstanding +154,169 +152,847 +151,839 +Dilutive effect of nonvested shares +915 +1,353 +1,240 +Weighted average common shares outstanding +155,084 +154,200 +153,079 +Diluted earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.57 +$ +1.50 +$ +0.91 +There were 346,912 shares excluded from the computation of diluted earnings per share for the year ended December 31, 2016. There were no shares excluded from the computation of diluted earnings per share for the years ended December 31, 2015 and 2014. +(11) +STOCK COMPENSATION +(a) +Incentive Award Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007. Also on May 24, 2007, the Company’s Board of Directors terminated the Company’s previous 1998 Stock Option, Deferred Stock and Restricted Stock Plan, with no further granting of awards being permitted thereafter. A total of 22,500,000 shares of Class A Common Stock are reserved for issuance under the 2007 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2007 Plan is administered by the Compensation Committee of the Company’s Board of Directors. +62 +A summary of the status and changes of nonvested shares related to the 2007 Plan as of and for the period ended December 31, 2016 is prese nted below: +SHARES +WEIGHTED-AVERAGE +GRANT-DATE FAIR VALUE +Nonvested at January 1, 2014 +828,498 +$ +6.68 +Granted +3,277,500 +15.67 +Vested/Released +(291,999 +) +6.66 +Cancelled +(22,500 +) +6.25 +Nonvested at December 31, 2014 +3,791,499 +14.46 +Granted +40,500 +29.83 +Vested/Released +(1,106,499 +) +11.81 +Nonvested at December 31, 2015 +2,725,500 +15.77 +Granted +1,444,000 +31.69 +Vested/Released +(1,108,336 +) +12.32 +Cancelled +(18,000 +) +17.81 +Nonvested at December 31, 2016 +3,043,164 +24.57 +As of December 31, 2016, a total of 9,682,643 shares remain available for grant as equity awards under the 2007 Plan. +The Company recognized in the consolidated statements of earnings compensation expense of $23.1 million, $18.3 million and $8.7 million and related excess income tax benefits of $4.7 million, $8.0 million, and $1.4 million for grants under its 2007 Plan and 2008 ESPP compensation plans for the years ended December 31, 2016, 2015, and 2014, respectively. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. There was $57.0 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2016, which is expected to be recognized over a weighted average period of 2.2 years. The total fair value of shares vested during the period ended December 31, 2016 and 2015 was $13.7 million and $13.1 million, respectively. +(b) +Stock Purchase Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2008 Employee Stock Purchase Plan (the “2008 ESPP”), and the Company’s stockholders approved the 2008 ESPP on May 24, 2007. The 2008 ESPP became effective on January 1, 2008, and the Company’s Board of Directors terminated the 1998 ESPP as of such date, with no additional granting of rights being permitted under the 1998 ESPP. The 2008 ESPP provides that a total of 9,000,000 shares of Class A Common Stock are reserved for issuance under the plan. The 2008 ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code of 1986, as amended. The terms of the 2008 ESPP permit eligible employees to purchase Class A Common Stock at six-month intervals through payroll deductions, which may not exceed 15% of an employee’s compensation. The price of Class A Common Stock purchased under the 2008 ESPP is 85% of the lower of the fair market value of the Class A Common Stock at the beginning of each six-month offering period or on the applicable purchase date. Employees may end their participation in an offering at any time during the offering period. The 2008 ESPP is administered by the Compensation Committee of the Company’s Board of Directors. +During 2016, 2015 and 2014, 220,844 shares, 223,892 shares and 306,459 shares were issued under the 2008 ESPP for which the Company received approximately $5.1 million, $4.3 million and $3.4 million, respectively. +63 +( 12) +INCOME TAXES +The provisions for income tax expense were as follows (in thousands): +2016 +2015 +2014 +Federal: +Current +$ +45,258 +$ +45,095 +$ +7,677 +Deferred +(3,961 +) +2,774 +23,659 +Total federal +41,297 +47,869 +31,336 +State: +Current +3,406 +2,506 +2,060 +Deferred +(49 +) +1,798 +529 +Total state +3,357 +4,304 +2,589 +Foreign: +Current +31,046 +21,204 +5,399 +Deferred +(1,575 +) +(927 +) +(140 +) +Total foreign +29,471 +20,277 +5,259 +Total income taxes +$ +74,125 +$ +72,450 +$ +39,184 +The Company’s provision for income tax expense and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. The Company’s provision for income tax expense was calculated using the applicable statutory rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense by earnings before income taxes. +The Company’s earnings (loss) before income taxes and income tax expense for 2016, 2015 and 2014 are as follows (in thousands): +Years Ended December 31, +2016 +2015 +2014 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +$ +82,778 +$ +32,500 +Peoples Republic of China (“China”) +72,584 +11,720 +49,027 +11,084 +15,201 +1,179 +Jersey (1) +146,880 +— +123,721 +— +77,555 +— +Non-benefited loss operations (2) +(16,189 +) +12 +(16,719 +) +164 +(13,021 +) +— +Other jurisdictions (3) +50,620 +17,739 +40,742 +9,029 +28,867 +5,505 +Earnings before income taxes +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +Effective tax rate (4) +20.6 +% +21.7 +% +20.5 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Panama, Poland, Romania, and South Korea. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom. +(4) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2016, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2016, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $105.6 million, with income tax expense of $44.7 million, which is an average rate of 42.3%. Earnings (loss) before income taxes in non-U.S. jurisdictions were $253.9 million, with an aggregate income tax expense of $29.5 million, which is an average rate of 11.6%. Combined, this results in consolidated earnings before income taxes for the period of $359.5 million, and consolidated income tax expense for the period of $74.1 million, resulting in an effective tax rate of 20.6%. For 2016, $253.9 million in earnings before +64 +income tax earned outside the U.S., $146.9 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $23.2 million, or 18.7%, to $146.9 million in 2016 from $123.7 million in 2015. This increase was primarily attributable to the Company experiencing an incre ase of $344.9 million in net sales in the “Other international” geographic area for 2016 (see Note 17 – Segment and Geographic Reporting), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions und er the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2015 to 2016 resulted in a disproportionately greater increase in earnings before income taxes i n Jersey. In addition, there were foreign losses of $16.2 million for which no tax benefit was recognized during the year ended December 31, 2016 because of the provision of offsetting valuation allowances, but in which nonrefundable withholding taxes wer e paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of the Company’s consolidated earnings (loss) before taxes in any of the years shown. Unremitted earnings of non -U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2016, the Company had approximately $718.5 million in cash and cash equivalents, of which $368.4 million, or 51.3%, was held outside the U.S. Of the $368.4 million held by the Company’s non-U.S. subsidiaries, approximately $33.4 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s consolidated financial statements as of December 31, 2016. The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months and the Company does not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. Because of the need for cash for operating capital and continued overseas expansion, the Company also does not foresee the need for any of its foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2016 and 2015, U.S. income taxes have not been provided on cumulative total earnings of $699.6 million and $482.7 million, respectively. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows (in thousands): +2016 +2015 +2014 +Expected income tax expense +$ +125,819 +$ +116,724 +$ +66,981 +State income tax, net of federal benefit +2,335 +2,011 +1,032 +Rate differential on foreign income +(58,508 +) +(44,541 +) +(27,364 +) +Change in unrecognized tax benefits +135 +(2,233 +) +(2,717 +) +Non-deductible expenses +2,330 +(350 +) +288 +Other +575 +285 +3,333 +Change in valuation allowance +1,439 +554 +(2,369 +) +Total provision for income taxes +$ +74,125 +$ +72,450 +$ +39,184 +Effective tax rate +20.6 +% +21.7 +% +20.5 +% +The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2016 and 2015 are presented below (in thousands): +2016 +2015 +Deferred tax assets: +Inventory adjustments +$ +6,985 +$ +6,249 +Accrued expenses +29,094 +17,619 +Allowances for bad debts and chargebacks +4,837 +6,972 +Loss carryforwards +20,891 +23,073 +Business credit carryforward +5,031 +5,214 +Share-based compensation +5,993 +3,628 +Valuation allowance +(19,527 +) +(18,088 +) +Total deferred tax assets +53,304 +44,667 +Deferred tax liabilities: +Prepaid expenses +8,422 +8,566 +Depreciation on property, plant and equipment +19,251 +22,406 +Total deferred tax liabilities +27,673 +30,972 +Net deferred tax assets +$ +25,631 +$ +13,695 +65 +The Company believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2016 were $5.0 million and $31.7 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2015 were $8.8 million and $33.3 million, respectively. These tax credit and net operating loss carry-forward amounts don’t begin to expire until 2028 and 2021, respectively. As of December 31, 2016 and 2015, no valuation allowance against the related deferred tax asset have been recorded for these credit and loss and credit carry-forwards as it is believed the carry-forwards will be fully utilized in reducing future taxable income. +As of December 31, 2016 and 2015, the Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $69.4 million and $66.8 million, respectively. Some of these net operating losses expire beginning in 2017; however others can be carried forward indefinitely. As of December 31, 2016 and 2015, valuation allowances of $16.7 million and $16.5 million, respectively, had been recorded against the related deferred tax assets for those loss carry-forwards that are not more likely than not to be fully utilized in reducing future taxable income. +The balance of unrecognized tax benefits, included in prepaid expenses in the consolidated balance sheets, increased by $0.5 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2016 +2015 +Beginning balance +$ +6,143 +$ +7,936 +Additions for current year tax positions +1,069 +888 +Additions for prior year tax positions +138 +— +Reductions for prior year tax positions +— +(1,099 +) +Settlement of uncertain tax positions +(616 +) +— +Reductions related to lapse of statute of limitations +(126 +) +(1,582 +) +Ending balance +$ +6,608 +$ +6,143 +If recognized, $5.5 million of unrecognized tax benefits would be recorded as a reduction in income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax expense and totaled $0.4 million, $0.6 million, and $0.2 million for the years ended December 31, 2016, 2015, and 2014, respectively. Accrued interest and penalties were $1.1 million and $1.5 million as of December 31, 2016 and 2015, respectively. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +As of December 31, 2016, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2012, and in several Asian and European tax jurisdictions for years ending on or after December 31, 2006. During the year, the Company reduced the balance of 2016 and prior year unrecognized tax benefits by $0.1 million as a result of expiring statutes. It is reasonably possible that certain domestic and foreign statutes will expire during the next twelve months which would reduce the balance of 2016 and prior year unrecognized tax benefits by $0.4 million. +The Company is currently under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2016, there was a $0.6 million reduction in the balance of 2016 and prior year unrecognized tax benefits due to settlements of examinations. It is reasonably possible that certain state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2016 and prior year unrecognized tax benefits by $0.9 million. +In November 2015, the FASB issued ASU No. 2015‑17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”), which amends the guidance requiring companies to separate deferred income tax liabilities and assets into current and non-current amounts in a classified balance sheet. This accounting guidance simplifies the presentation of deferred income taxes, such that deferred tax liabilities and assets are classified as non-current in a classified balance sheet. ASU 2015-17 will be effective for annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. In the first quarter of 2016, the Company early adopted ASU 2015-17 on a retrospective basis. For all periods presented, deferred income taxes are reported as “Deferred tax assets” or “Deferred tax liabilities” on the condensed consolidated balance sheets. Prior to adoption, the Company +66 +reported deferred income taxes in either “Deferred tax assets,” “Other assets,” or “Other long-term liabilities” in the consolidated balance sheets, depending on whether the net current deferred income taxes and net non-current deferr ed income taxes were in an asset or liability position. The change in presentation as of December 31, 2015 resulted in a reduction of current deferred tax assets and non-current deferred tax liabilities, and an increase of non-current deferred tax assets. The adoption of ASU 2015-17 did not have a material impact on the Company’s consolidated financial statements, financial condition or results of operations. +(13) +EMPLOYEE BENEFIT PLAN +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have completed six months of service. Employees may contribute up to 15.0% of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company did not make a contribution to the plan for the years ended December 31, 2016, 2015 and 2014, respectively. +In May 2013, the Company established the Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”), which allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees, which will be determined by the Company’s Compensation Committee. The Company did not make a contribution to the plan for the year ended December 31, 2016, 2015 or 2014. The value of the deferred compensation is recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred liabilities are presented in the Company’s consolidated balance sheets. +(14) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates a significant portion of its sales in the United States; however, several of its products are sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $169.4 million and $180.2 million before allowances for bad debts and sales returns, and chargebacks at December 31, 2016 and 2015, respectively. Foreign accounts receivable, which are generally collateralized by letters of credit, amounted to $199.1 million and $188.0 million before allowance for bad debts, sales returns, and chargebacks at December 31, 2016 and 2015, respectively. International net sales amounted to $1.64 billion, $1.27 billion and $819.3 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company’s credit losses charged to expense for the years ended December 31, 2016, 2015 and 2014 were $12.7 million, $5.2 million and $11.8 million, respectively. In addition, the Company’s recorded sales return and allowance expense for the years ended December 31, 2016, 2015 and 2014 were $16.9 million, $2.3 million and $2.3 million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the United States were $1.06 billion and $773.5 million at December 31, 2016 and 2015, respectively. +During 2016, 2015 and 2014, no customer accounted for 10.0% or more of net sales. No customer accounted for more than 10% of net trade receivables at December 31, 2016 or 2014. As of December 31, 2015, one customer accounted for 10.6% of gross trade receivables. During 2016, 2015 and 2014, net sales to the five largest customers were approximately 11.3%, 14.6% and 15.7%, respectively. +The Company’s top five manufacturers produced the following for the years ended December 31, 2016, 2015 and 2014, respectively: +Percentage of Total Production +Years Ended December 31, +2016 +2015 +2014 +Manufacturer #1 +22.9 +% +31.5 +% +37.5 +% +Manufacturer #2 +10.1 +% +9.1 +% +6.1 +% +Manufacturer #3 +8.8 +% +7.3 +% +5.7 +% +Manufacturer #4 +4.9 +% +5.0 +% +4.9 +% +Manufacturer #5 +4.3 +% +3.6 +% +4.7 +% +51.0 +% +56.5 +% +58.9 +% +67 +The majority of the Company’s products are produced in China and Vietnam. The Company’s operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce the se risks by diversifying manufacturing among various factories. To date, these business risks have not had a material adverse impact on the Company’s operations. +(15) +RELATED PARTY TRANSACTIONS +The Company paid approximately $111,000, $180,000, and $160,000 during 2016, 2015 and 2014, respectively, to the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events, including the Company’s holiday party at the Shade Hotel in Manhattan Beach, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, owns a 12% beneficial ownership interest in MIOC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 5% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable with MIOC, the Shade Hotel in Manhattan Beach at December 31, 2016 or 2015. +The Company paid approximately $110,000 during 2016 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, food and events, including the Company’s 2016 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg, President and a director of the Company, owns a 5% beneficial ownership interest in RBHC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 3% beneficial ownership in RBHC. The Company had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2016 or 2015. +On July 29, 2010, the Company formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with the Company, and the Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer and Chief Financial Officer, are also officers and directors of the Foundation. During the year ended December 31, 2016, the Company made contributions of $1.0 million to the Foundation. During the year ended December 31, 2015, and 2014 the Company did not make any contributions to the Foundation. +The Company had receivables from officers and employees of $0.8 million and $1.3 million at December 31, 2016 and 2015, respectively. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant shareholders of the Company. +(16) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2016, to assess the need for potential recognition or disclosure in this filing. Based on this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. +( 17 ) +SEGMENT AND GEOGRAPHIC REPORTING +The Company has three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. Management evaluates segment performance based primarily on net sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the Company’s segments. Net sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, and retail segments on a combined basis were as follows (in thousands): +2016 +2015 +2014 +Net sales +Domestic wholesale +$ +1,199,832 +$ +1,219,779 +$ +997,994 +International wholesale +1,391,235 +1,094,395 +689,195 +Retail +972,244 +833,149 +690,372 +Total +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +68 +2016 +2015 +2014 +Gross profit +Domestic wholesale +$ +454,088 +$ +471,104 +$ +367,980 +International wholesale +616,110 +454,665 +292,722 +Retail +564,398 +498,239 +411,203 +Total +$ +1,634,596 +$ +1,424,008 +$ +1,071,905 +2016 +2015 +Identifiable assets +Domestic wholesale +$ +1,161,719 +$ +1,086,554 +International wholesale +954,874 +713,424 +Retail +277,077 +239,900 +Total +$ +2,393,670 +$ +2,039,878 +2016 +2015 +2014 +Additions to property, plant and equipment +Domestic wholesale +$ +33,677 +$ +38,080 +$ +9,655 +International wholesale +44,286 +37,909 +18,899 +Retail +41,508 +42,155 +28,351 +Total +$ +119,471 +$ +118,144 +$ +56,905 +Geographic Information +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2016 +2015 +2014 +Net Sales (1) +United States +$ +1,920,051 +$ +1,876,201 +$ +1,558,226 +Canada +130,555 +103,268 +85,139 +Other international (2) +1,512,705 +1,167,854 +734,196 +Total +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +2016 +2015 +Property, plant and equipment, net +United States +$ +374,459 +$ +356,704 +Canada +10,410 +8,447 +Other international (2) +109,604 +70,756 +Total +$ +494,473 +$ +435,907 +(1) +The Company has subsidiaries in Asia, Central America, Europe, the Middle East, North America, and South America that generate net sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in Asia that generate net sales from those countries. The Company also has a subsidiary in Switzerland that generates net sales from that country in addition to net sales to distributors located in numerous non-European countries. External net sales are attributable to geographic regions based on the location of each of the Company’s subsidiaries. A subsidiary may earn revenue from external net sales and external royalties, or from inter-subsidiary net sales, royalties, fees and commissions provided in accordance with certain inter-subsidiary agreements. The resulting earnings of each subsidiary in its respective country are recognized under each respective country’s tax code. Inter-subsidiary revenues and expenses subsequently are eliminated in the Company’s consolidated financial statements and are not included as part of the external net sales reported in different geographic areas. +(2) +Other international consists of Asia, Central America, Europe, the Middle East, and South America. +In response to the State Department’s trade restrictions with Sudan and Syria, we do not authorize or permit any distribution or sales of our product in these countries, and we are not aware of any current or past distribution or sales of our product in Sudan or Syria. +69 +(18) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +Summarized unaudited financial data are as follows (in thousands): +2016 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +978,794 +$ +877,810 +$ +942,417 +$ +764,290 +Gross profit +432,152 +416,254 +429,978 +356,212 +Net earnings +109,639 +84,009 +76,542 +15,169 +Net earnings attributable to Skechers U.S.A., Inc. +97,612 +74,107 +65,110 +6,664 +Net earnings per share: +Basic +0.63 +0.48 +0.42 +0.04 +Diluted +0.63 +0.48 +0.42 +0.04 +2015 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +767,997 +$ +800,464 +$ +856,179 +$ +722,683 +Gross profit +332,540 +374,608 +387,006 +329,854 +Net earnings +61,658 +87,065 +73,834 +38,490 +Net earnings attributable to Skechers U.S.A., Inc. +56,080 +79,782 +66,602 +29,448 +Net earnings per share: +Basic +0.37 +0.52 +0.44 +0.19 +Diluted +0.37 +0.52 +0.43 +0.19 +70 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOU NTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2016, which is set forth below. +71 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2016. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +72 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control –Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries’ maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of earnings, comprehensive income, equity, cash flows, and schedule for each of the three years in the period ended December 31, 2016 and our report dated March 1, 2017 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +March 1, 2017 +73 +ITEM 9B. +OTHE R INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 44 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 75 of this annual report on Form 10-K. +3. +Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +74 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years Ended December 31, 2016, 2015, and 2014 +DESCRIPTION +BALANCE AT +BEGINNING OF +PERIOD +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF PERIOD +Year-ended December 31, 2014 +Allowance for chargebacks +$ +2,490 +$ +5,530 +$ +(1,469 +) +$ +6,551 +Allowance for doubtful accounts +5,980 +6,284 +(6,823 +) +5,441 +Reserve for sales returns and allowances +7,456 +2,339 +(780 +) +9,015 +Reserve for shrinkage +266 +1,292 +(1,220 +) +338 +Reserve for obsolescence +3,485 +5,656 +(6,140 +) +3,001 +Year-ended December 31, 2015 +Allowance for chargebacks +$ +6,551 +$ +3,703 +$ +(3,189 +) +$ +7,065 +Allowance for doubtful accounts +5,441 +1,538 +(1,026 +) +5,953 +Reserve for sales returns and allowances +9,015 +2,279 +(52 +) +11,242 +Reserve for shrinkage +338 +2,014 +(1,945 +) +407 +Reserve for obsolescence +3,001 +10,321 +(10,041 +) +3,281 +Year-ended December 31, 2016 +Allowance for chargebacks +$ +7,065 +$ +10,882 +$ +(6,973 +) +$ +10,974 +Allowance for doubtful accounts +5,953 +1,837 +(2,170 +) +5,620 +Reserve for sales returns and allowances +11,242 +18,101 +(4,290 +) +25,053 +Reserve for shrinkage +407 +2,396 +(2,261 +) +542 +Reserve for obsolescence +3,281 +22,867 +(15,220 +) +10,928 +See accompanying report of independent registered public accounting firm +75 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K (File No. 001-14429) filed with the Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +10.1** +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2013). +10.2** +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.2(a)** +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.3** +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K (File No. 001-14429) filed with the Securities and Exchange Commission on May 24, 2007). +10.4** +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 2007). +10.5** +2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K (File No. 001-14429) filed with the Securities and Exchange Commission on May 24, 2007). +10.5(a)** +Amendment No. 1 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended June 30, 2010). +10.5(b)** +Amendment No. 2 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 3.3 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +10.6** +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 1999). +10.6(a)** +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 2005). +10.7 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended June 30, 1999). +10.8 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended June 30, 1999). +10.9** +Employment Agreement, executed August 7, 2015, effective as of January 1, 2015, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +76 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.10 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 7, 2015). +10.11 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 2011). +10.11(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.12 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.13 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K (File No. 001-14429) filed with the Securities and Exchange Commission on September 27, 2007). +10.13(a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended March 31, 2010) . +10.13(b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended September 30, 2010). +10.13(c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended September 30, 2010). +10.13(d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q (File No. 001-14429) for the quarter ended September 30, 2010). +10.14 +Lease Agreement, dated August 12, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.29 of the Registrant’s Form 10-K (File No. 001-14429) for the year ended December 31, 2002). +10.14(a) +Addendum to Lease Agreement, dated January 19, 2006, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.14(b) +Addendum 2 to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K (File No. 001-14429) filed with Securities and Exchange Commission on May 27, 2008). +10.14(c) +Addendum 3 to Agreement dated June 11, 2013 and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +77 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.14(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.15 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K (File No. 001-14429) filed with the Securities and Exchange Commission on May 27, 2008). +10.15(a) +Addendum 1 to Lease Agreement, dated March 10, 2009, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.18(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.15(b) +Addendum 2 to Lease Agreement dated December 22, 2009 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(b) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.15(c) +Addendum 3 to Agreement dated June 11, 2013 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.15(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.16 +Lease Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center III in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2015). +10.16(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Centers I, II and III in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.17 +Lease Agreement dated July 10, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.17(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.18 +Lease Agreement dated July 1, 2016 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and Warehouse and Industrial Properties (W.I.P.) SA, regarding Liegistics Park 34, Avenue du Parc Industriel in Milmort, Belgium. +10.19 +Lease Agreement dated November 17, 2015 by and between the Registrant and Omni Manhattan Towers Limited Partnership, regarding 1240 Rosecrans Avenue, Suites 300 and 400, Manhattan Beach, California. +78 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). +31.2 +Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.LAB +Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +** +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act. +79 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 1st day of March 2017. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +March 1, 2017 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +March 1, 2017 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +March 1, 2017 +David Weinberg +Chief Financial Officer and Director +(Principal Financial and Accounting Officer) +/s/ Jeffrey Greenberg +Director +March 1, 2017 +Jeffrey Greenberg +/s/ Geyer Kosinski +Director +March 1, 2017 +Geyer Kosinski +/s/ Morton D. Erlich +Director +March 1, 2017 +Morton D. Erlich +/s/ Richard Siskind +Director +March 1, 2017 +Richard Siskind +/s/ Thomas Walsh +Director +March 1, 2017 +Thomas Walsh +/s/ Rick Rappaport +Director +March 1, 2017 +Rick Rappaport +80 \ No newline at end of file diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/filing_metadata.csv b/raw/filings/0001065837/2016/0001564590-17-003040/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..7525a808663c21147401fdac08dff6a1df3d5358 --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2017-03-01,2016-12-31,2017-03-01T18:30:00.000Z,0001564590-17-003040,skx-10k_20161231.htm,SKX-10K-20161231,13302437,1,0,https://www.sec.gov/Archives/edgar/data/1065837/000156459017003040/skx-10k_20161231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459017003040/,2016,2016,1 diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/item1.txt b/raw/filings/0001065837/2016/0001564590-17-003040/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..5a540bcb88ecbea764fc5a36c17bb66c1a331917 --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/item1.txt @@ -0,0 +1,383 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers GO brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 1, 2017, we owned and operated 117 concept stores, 163 factory outlet stores and 134 warehouse outlet stores in the United States, and 101 concept stores, 51 factory outlet stores, and 5 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our strong product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2016, our Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television campaigns featuring our own action heroes and characters; marathons and other events for Skechers Performance and BOBS from Skechers divisions; and print, television, online and outdoor campaigns featuring our brand ambassadors and endorsees. These endorsees included globally-known recording artists Demi Lovato, Ringo Starr and Meghan Trainor; sports legends Sugar Ray Leonard, Pete Rose, Joe Montana, and Ozzie Smith; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb, Kara Goucher, and Matt Kuchar; and professional golfers Belen Mozo, Billy Andrade and Colin Montgomerie. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded product lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Fusion, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Fusion line is comprised of low-profile, sport-influenced casuals targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies. Select styles include knit uppers, the Skechers Burst midsole and the Skech-Air outsole. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skechers Originals. This fashionable sport line is known for its retro profiles and includes cool sneakers with bold colors, prints and metallics, which all contribute to the collection’s throwback vibe. Select Skechers Originals styles are designed with a hidden heel for an added boost in height. This line is intended to appeal to juniors. +3 +BOBS from Skechers. At the core of t he BOBS from Skechers line is its vast coll ection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home . Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents is donated to Best Friends to help save the lives of dogs and cats in America’s shelters. Skechers has committed to donating at least $3.0 million dollars to Best Friends Animal Society for the promotion. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 14 million pairs of new kids’ shoes have been donated, including one million pairs in 2016. The charitable shoes are primarily donated to charity partner K.I.D.S./Fashion, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by 1970’s rock and roll, the Mark Nason Collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. Categories in the Mark Nason Collection include Mark Nason Skechers, a low-profile collection of casuals for everyday wear; Mark Nason Los Angeles, casual sneakers for the active male; and Mark Nason Dress, dress shoes crafted with high-quality leathers and exquisite detailing. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition packs with Skechers GOdri all-weather protection or Skechers Nite Owl glow-in-the-dark technology are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Sport adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes and Twinkle Wishes by Skechers, (iv) Skechers Super Z-Strap, (v) Elastika by Skechers, (vi) Lighted footwear, (vii) Mega Flex, and (viii) Game Kicks. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character, Twinkle Toes. Twinkle Wishes by Skechers adds a magical light and sound feature that is activated when the toes are tapped together. +• +Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system. The product line is marketed with the character, Z-Strap. +• +Elastika by Skechers is a line of girls’ sneakers with bungee closures. The product line is marketed with the character, Elastika. +• +Skechers’ lighted collection for boys and girls includes the categories of S-Lights, Hot Lights by Skechers and Energy Lights by Skechers. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Hot Lights feature lights on the front of the toe to simulate headlights as well as lights on other areas of the shoes. Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features seven colors and four light sequences. +• +Mega Flex is a line of athletic sneakers for boys based on a robot character. Styles include fun embellishments like heel springs or an articulated bladed outsole in the Mega Blades collection. +• +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. Some styles include a remote control operating system. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores. By working closely with store personnel, we obtain customer feedback that often influences product design and development. Our design teams can easily and quickly modify and refine a design based on customer input. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the consolidated financial statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2016, five of our contract manufacturers accounted for approximately 51.0% of total purchases. One manufacturer accounted for 22.9%, and another accounted for 10.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued +6 +after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail store s, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an i nternal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by pl acing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 359-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by online, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our lifestyle, performance-inspired and image-driven advertising, we generally seek to build and increase brand awareness by linking the Skechers brand to youthful attitudes for our lifestyle lines, and technology with runners and athletes for our performance lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2016, our Skechers lifestyle endorsees included Demi Lovato, Meghan Trainor, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Sugar Ray Leonard, Ozzie Smith, and Ringo Starr. Our Skechers Performance Division 2016 endorsees included elite runner and Olympic medalist Meb and elite runner Kara Goucher, and professional golfers Matt Kuchar (who also medaled at the 2016 Olympics), Belen Mozo, Brooke Henderson, Billy Andrade and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. In 2016, these ambassadors included Korean pop groups for numerous countries in Asia and local celebrities and athletes in Europe. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications, including Runner's World, Seventeen, Men's Fitness, People, Us Weekly, and OK!, among others. Our advertisements also appear in international magazines around the world. +7 +Our television commercials are produced both in-house and through produ cers that we have utilized in the past who are familiar with our brands. In 2016, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action co mmercials that appeal to older kids and tweens. We also have many commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature musicians , actors and retired athletes . We have found these to be cost-effective w ays to advertise on key national and cable programming during high-selling seasons. In 2016, many of our television commercials were translated into multiple languages and aired in numerous markets around the world . +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in several European countries, Canada and Mexico. We believe these are effective and efficient ways to reach a broad range of consumers and leave a lasting impression for our brands. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting celebrities and their families. We have been featured on leading business shows with interviews of our executives discussing the Company’s business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and in countries around the world where our product is sold. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2016, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance-branded booths to allow runners the ability to try on and often buy our products. In 2016, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of The Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts for BOBS footwear donation events in cities throughout the United States, Puerto Rico and Canada, building both our relationships with these accounts, as well as with the community as we donated footwear to children in need. As part of our BOBS for Dogs charity program we partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +8 +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, Platform, The Licensing Show and Outdoor Retailer in the United States; GDS, MICAM, and ISPO in Europe; and many other international shows. Our dynamic, state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. By investing in innovative displays and individual rooms showcasing each line, our sales force can present a sales plan for each line and buyers are able to truly understand the breadth and depth of our offerings, thereby optimizing commitments and sales at the retail level. +Digital. In 2016, we launched marketing campaigns on YouTube, developed a performance branded website for the Skechers Performance Los Angeles Marathon, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Chile, Germany, the United Kingdom, and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 15 distributors and 45 licensees have opened and operate 490 distributor-owned or -licensed Skechers retail stores and 739 licensee-owned Skechers retail stores, respectively, in over 80 countries as of December 31, 2016. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We periodically review all of our stores for impairment. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate +9 +revenues or otherwise be used by us. As of February 1, 2017, we owned and operated 117 concept stores, 163 factor y outlet stores and 134 warehouse outlet stores in the United States, and 101 concept stores, 51 factory outlet stores, and 5 warehouse outlet stores internationally. During 201 6 , we took over the operations of 3 international concept stores and 11 interna tional outlet stores from our distributor in South Korea . During 2017, we plan to open 70 to 9 0 new stores. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, United Kingdom, Germany and Chile. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square (with a second location opened in 2015), 5 th Avenue, Union Square, Westfield World Trade Center, and 34th Street, in New York; Powell Street in San Francisco: Hollywood and Highland in Hollywood; Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mall. International locations include Westfield London and Westfield Stratford in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,400 square feet, although in certain markets we have opened concept stores as large as 7,800 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 51 international factory outlet stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,400 to 9,000 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 31,000 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2015 +Opened during 2016 +Closed during 2016 +Number of Store Locations December 31, 2016 +Domestic stores +Concept +119 +4 +(6 +) +117 +Factory Outlet +155 +8 +— +163 +Warehouse Outlet +116 +18 +(1 +) +133 +Domestic stores total +390 +30 +(7 +) +413 +International stores +Concept +81 +21 +(1 +) +101 +Factory Outlet +41 +10 +— +51 +Warehouse Outlet +5 +— +— +5 +International stores total +127 +31 +(1 +) +157 +Joint venture stores +China Concept +59 +12 +(3 +) +68 +China Factory Outlet +20 +15 +(7 +) +28 +Hong Kong Concept +29 +9 +(1 +) +37 +Hong Kong Outlet +— +3 +— +3 +India Concept +29 +6 +(1 +) +34 +India Outlet +1 +3 +(3 +) +1 +Israel Concept +— +6 +— +6 +South Korea Concept +— +3 +— +3 +South Korea Outlet +— +11 +— +11 +South East Asia Concept +21 +2 +(4 +) +19 +South East Asia Outlet +— +2 +— +2 +Joint venture stores total +159 +72 +(19 +) +212 +Total domestic, international and joint +venture stores +676 +133 +(27 +) +782 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. +11 +To accommodate our European subsidiaries’ operations, we operate a distribution center in Liege, Belgium. During 2015, we completed the third phase of automation upgrades of our European Distribution Center equipment, allowing us to more efficiently receive and ship product to our subsidiaries and retail stores throughout Europe. In 2016, we complete d the four th and fifth expansion phase s , bringing our European facility to approximately 1.3 million square-feet. The additional space that we added will consolidate off-site storage facilities into a single on-site location that will further increase efficiencies a nd offer storage capacity of up to four million pairs of shoes. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +12 +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores in more than 170 countries around the world. As of December 31, 2016, we also had agreements with 15 of these distributors and 45 licensees regarding 490 distributor-owned or -licensed Skechers retail stores and 739 licensee-owned Skechers retail stores, respectively, that are open in over 80 countries. Our distributors and licensees own and operate the following retail stores: +Number of Store Locations December 31, 2015 +Opened during 2016 +Closed during 2016 +Number of Store Locations December 31, 2016 +Distributor and licensee stores +Africa Concept +31 +8 +(2 +) +37 +Asia Concept +355 +269 +(23 +) +601 +Asia Factory Outlet +71 +99 +(13 +) +157 +Australasia Concept +30 +18 +— +48 +Australasia Outlet +11 +2 +— +13 +Central America Concept +3 +2 +— +5 +Europe Concept +94 +48 +— +142 +Europe Factory Outlet +5 +3 +— +8 +Middle East Concept +59 +65 +(6 +) +118 +Middle East Factory Outlet +3 +1 +— +4 +North America Concept +53 +5 +— +58 +North America Factory Outlet +14 +2 +— +16 +South America Concept +20 +4 +(2 +) +22 +Total distributor and licensee stores +749 +526 +(46 +) +1,229 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening flagship retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 17 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2017, we had 27 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes, belts, wallets and headwear, socks, eyewear, fitness, yoga and running accessories, work accessories and watches; Skechers Sport apparel; BOBS from Skechers apparel; and Twinkle Toes dolls, toys backpacks, lunchboxes, do-it-yourself fashion kits and fashion accessories. We have international licensing agreements for the design +13 +and distribution of men’s, women’s and kids’ apparel in Chile, Israel, the Philippines, the United Kingdom and South K orea; socks in France; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +BACKLOG +As of December 31, 2016 our backlog was $1.37 billion, compared to $1.25 billion as of December 31, 2015. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced in the past, due to a difficult U.S. consumer retail market combined with constantly shifting global footwear trends. For a variety of reasons, including changes in the global economy, worldwide customer demand for our products, the timing of shipments, product mix of customer orders, the amount of in-season orders and a shift towards tighter shipment lead times, our backlog may not be a reliable measure of future sales for any succeeding period. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 128 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to +14 +block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a thir d party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our prod ucts, and generally have a material adverse effect on our business, financial condition and results of operations. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others including, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition and results of operations. +EMPLOYEES +As of January 31, 2017, we employed approximately 9,800 persons, of whom approximately 4,000 were employed on a full-time basis and approximately 5,800 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. \ No newline at end of file diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/item13.txt b/raw/filings/0001065837/2016/0001564590-17-003040/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..25b866e7696d5d9543210778d6cc142ca9cfb7b3 --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2016 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/item9a.txt b/raw/filings/0001065837/2016/0001564590-17-003040/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..9fd687f651ff5e2181ce7ab086b3f8994d330c4b --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/item9a.txt @@ -0,0 +1,35 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2016, which is set forth below. +71 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2016. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +72 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Skechers U.S.A., Inc. +Manhattan Beach, CA +We have audited Skechers U.S.A., Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control –Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Skechers U.S.A., Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Skechers U.S.A., Inc. and subsidiaries’ maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of earnings, comprehensive income, equity, cash flows, and schedule for each of the three years in the period ended December 31, 2016 and our report dated March 1, 2017 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Los Angeles, CA +March 1, 2017 +73 \ No newline at end of file diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/rp_note.txt b/raw/filings/0001065837/2016/0001564590-17-003040/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2016/0001564590-17-003040/rpt_disclosure.txt b/raw/filings/0001065837/2016/0001564590-17-003040/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..a8f867257d9b044eb1c880d516007d3ac255692f --- /dev/null +++ b/raw/filings/0001065837/2016/0001564590-17-003040/rpt_disclosure.txt @@ -0,0 +1,28 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the +Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest +(which is discussed in our Code of Business Conduct and Ethics), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures +as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or +relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar +year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related +Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an +executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed +and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If +advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction shall be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled +meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar +circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member shall participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except +for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to +determine that the transaction with the Related Person remains appropriate. +The following list of transactions with Related +Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2016. Each of these transactions was reviewed, and approved or ratified by the Audit Committee, pursuant to the policies and procedures +discussed herein. +49 +Related Person Transactions +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are +non-executive employees of Skechers, and they earned total compensation of $276,230, $2,860,601, $2,327,619 and $226,245, respectively, in 2016. Jeffrey Greenberg was also a member of our Board of Directors in +2016, but did not earn any additional compensation for services provided as a director. +Andrew Weinberg and Jeffrey Weinberg, +who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $537,615 and $369,675, respectively, in 2016. \ No newline at end of file diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/filing.txt b/raw/filings/0001065837/2017/0001564590-18-004045/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..2594350090235fb9f22eddfe0c2cae22ab3a81a6 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/filing.txt @@ -0,0 +1,3735 @@ +10-K +1 +skx-10k_20171231.htm +10-K +skx-10k_20171231.htm +c +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2017 +OR +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-4376145 +(State or Other Jurisdiction of +Incorporation or Organization) +(I.R.S. Employer +Identification No.) +228 Manhattan Beach Blvd., Manhattan Beach, California +90266 +(Address of Principal Executive Offices) +(Zip Code) +Registrant’s telephone number, including area code: (310) 318-3100 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Class A Common Stock, $0.001 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: +None +(Title of Class ) +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ (Do not check if a smaller reporting company) +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2017, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the Registrant was approximately $3.9 billion based upon the closing price of $29.50 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2018: 135,670,030. +The number of shares of Class B Common Stock outstanding as of February 15, 2018: 24,545,188. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2018 Annual Meeting of the Stockholders of the Registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended DECEMBER 31, 2017 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +15 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +24 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +24 +ITEM 4. +MINE SAFETY DISCLOSURES +27 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +28 +ITEM 6. +SELECTED FINANCIAL DATA +30 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +31 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +45 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +46 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +74 +ITEM 9A. +CONTROLS AND PROCEDURES +74 +ITEM 9B. +OTHER INFORMATION +77 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +77 +ITEM 11. +EXECUTIVE COMPENSATION +77 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +77 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +77 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +77 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +77 +ITEM 16. +FORM 10-K SUMMARY +77 +This annual report includes our trademarks including Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , You by Skechers™, ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skecher Street™ , D’Lites ® , DLT-A™, Skechers Memory Foam™, BOBS ® , Energy Lights ® , and Twinkle Toes ® , each of which is our property. This report contains additional trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected 2018 operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +• +global economic, political and market conditions including the challenging consumer retail market in the United States; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; and +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2018, we owned and operated 117 concept stores, 170 factory outlet stores and 162 warehouse outlet stores in the United States, and 120 concept stores, 67 factory outlet stores, and 9 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2017, the Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television and digital campaigns; marathons and other events for Skechers Performance and BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artists Camila Cabello; sports legends Sugar Ray Leonard, Howie Long, David Ortiz, Tony Romo and Joe Montana; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb, Kara Goucher, and Matt Kuchar; and professional golfers Ashlan Ramsey, Belen Mozo, Brooke Henderson, Billy Andrade and Colin Montgomerie as well as the newly signed Edward Cheserek, who won 17 National Collegiate Athletic Association (“NCAA”) distance titles before graduating from college in 2017. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets running and golf apparel under the Skechers Performance brand. The apparel is primarily available at Skechers ret ail stores, but is also available to domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials, Gen Y’s and young women, Skecher Street™ Los Angeles delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer +3 +embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest tren ds with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. At the core of the BOBS from Skechers line is its vast collection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home. Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents is donated to Best Friends to help save the lives of dogs and cats in America’s shelters. Skechers has committed to donating at least $3.0 million dollars to Best Friends Animal Society during the promotion period. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 15 million pairs of new kids’ shoes have been donated, including one million pairs in 2017. The charitable shoes are primarily donated to charity partner Delivering Good, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason Collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition features such as Skechers Nite Owl glow-in-the-dark technology or special colorways are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +• +YOU by Skechers ™ . The v ersatile YOU by Skechers ™ footwear collection combines lifestyle with wellness in an eclectic assortment of easy-to-wear and comfortable knitted lace-up and slip-on sneakers for women. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, (v) Lighted footwear, (vi) Game Kicks. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; Elastika by Skechers is a line of girls’ sneakers with bungee closures marketed with the character Elastika; and Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories, featuring S-Lights and rechargeable technology with brands like Energy Lights by Skechers footwear. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features a variety of colors and light. +• +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. Some styles include a remote control operating system. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. The new Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allowing our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2017, five of our contract manufacturers accounted for approximately 47.5% of total purchases. One manufacturer accounted for 17.9%, and another accounted for 11.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued +6 +after a lim ited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze h istorical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high s ell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 367-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by digital, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our performance-inspired and image-driven advertising, we generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2017, our Skechers lifestyle endorsees included Camila Cabello, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo. Our Skechers Performance Division 2017 endorsees included elite runner and Olympic medalist Meb, elite runners Kara Goucher and Edward Cheserek, and professional golfers Matt Kuchar, Belen Mozo, Brooke Henderson, Ashlan Ramsey, Billy Andrade and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including Korean pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications in the United States and around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2017, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also have commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature musicians, actors and retired athletes. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2017, many of our television commercials were translated into multiple languages and aired in numerous markets around the world. Further, select markets have created television commercials specific to their market with local celebrities, and many international Skechers teams have translated our television commercials and aired in their markets around the world. +7 +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outd oor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. I n addition, we advertised on perimeter boards at soccer matches and professional sporting events in Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting influencers, celebrities and their families. We have been featured on leading business shows with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers, bloggers and vloggers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers ® , Skechers Performance™, Skecher Street™ and Mark Nason. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2017, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2017, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of The Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM and ISPO in Europe; and many other international shows. Our state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. +Digital. In 2017, we launched marketing campaigns on YouTube, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +8 +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 46 licensees have opened and operate 616 distributor-owned or -licensed Skechers retail stores and 1,047 licensee-owned Skechers retail stores, respectively, in over 170 countries as of December 31, 2017. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2018, we owned and operated 117 concept stores, 170 factory outlet stores and 162 warehouse outlet stores in the United States, and 120 concept stores, 67 factory outlet stores, and 9 warehouse outlet stores internationally. We plan to open 75 to 85 new stores in 2018. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop +9 +open-floor setting, providing the customer with the complete Skechers story. Second, retai l locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, Union Square, Westfield W orld Trade Center, and 34 th Street, in New York; Powell Street in San Francisco: Hollywood and Highland in Hollywood; Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mal l. International locations include Westfield London and Westfield Stratford in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such res ponses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,500 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 67 international factory outlet stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,300 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2016 +Opened during 2017 +Closed during 2017 +Number of Store Locations December 31, 2017 +Domestic stores +Concept +117 +5 +(5 +) +117 +Factory Outlet +163 +7 +— +170 +Warehouse Outlet +133 +29 +— +162 +Domestic stores total +413 +41 +(5 +) +449 +International stores +Concept +101 +19 +— +120 +Factory Outlet +51 +16 +— +67 +Warehouse Outlet +5 +4 +— +9 +International stores total +157 +39 +— +196 +Joint venture stores +China Concept +68 +19 +(32 +) +55 +China Factory Outlet +28 +44 +(2 +) +70 +Hong Kong Concept +37 +3 +(4 +) +36 +Hong Kong Outlet +3 +4 +(3 +) +4 +India Concept +34 +11 +(1 +) +44 +India Outlet +1 +2 +(1 +) +2 +Israel Concept +6 +1 +— +7 +South Korea Concept +3 +3 +— +6 +South Korea Outlet +11 +2 +(2 +) +11 +South East Asia Concept +19 +4 +(1 +) +22 +South East Asia Outlet +2 +3 +— +5 +Joint venture stores total +212 +96 +(46 +) +262 +Total domestic, international and joint +venture stores +782 +176 +(51 +) +907 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +11 +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +12 +• Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2017, we also had agreements with 18 of these distributors and 46 licensees regarding 616 distributor-owned or -licensed Skechers retail stores and 1,047 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations December 31, 2016 +Opened during 2017 +Closed during 2017 +Number of Store Locations December 31, 2017 +Distributor, licensee and franchise stores +Africa Concept +37 +10 +(1 +) +46 +Asia Concept +601 +252 +(99 +) +754 +Asia Factory Outlet +157 +189 +(12 +) +334 +Australasia Concept +48 +12 +— +60 +Australasia Outlet +13 +2 +— +15 +Central America Concept +5 +2 +— +7 +Europe Concept +142 +50 +(18 +) +174 +Europe Factory Outlet +8 +7 +— +15 +Middle East Concept +118 +32 +(2 +) +148 +Middle East Factory Outlet +4 +— +— +4 +North America Concept +58 +6 +— +64 +North America Factory Outlet +16 +1 +— +17 +South America Concept +22 +3 +— +25 +Total distributor, licensee and franchise stores +1,229 +566 +(132 +) +1,663 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 18 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2018, we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes; belts, wallets and watches; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; and bicycles and safety gear. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks, lunchboxes, do-it-yourself fashion kits, sunglasses and hair accessories; and Skechers Work socks. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in the United Kingdom and Indonesia; socks throughout Europe; bags and backpacks in the Philippines, Taiwan, Indonesia, Australia, New Zealand, Europe and the Middle East; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 133 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, +14 +Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in techn ology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others includin g, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displa ying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong bran d recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2018, we employed approximately 11,800 persons, of whom approximately 4,500 were employed on a full-time basis and approximately 7,300 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal +15 +markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our net sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale sales during 2017 or 2016. However, this may change in the future, and fluctuations in sales of any style representing a significant portion of our future net sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state, including the challenging consumer retail market in the United States, continues to negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of net sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +16 +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +We Depend Upon A Relatively Small Group Of Customers For A Large Portion Of Our Sales. +During 2017, 2016 and 2015, our net sales to our five largest customers accounted for approximately 10.5%, 11.3% and 14.6% of total net sales, respectively. No customer accounted for more than 10.0% of our net sales during 2017, 2016 and 2015. No customer accounted for more than 10.0% of trade receivables at December 31, 2017 and 2016. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +We May Experience Losses Because Of The Inability To Collect Accounts Receivable If Our Customers Are Unable To Pay Their Debts To Us When Due. +We rely on our network of domestic and international wholesale customers, comprised of department, athletic and specialty stores and online retailers, to distribute our products. Certain of our wholesale customers may from time to time experience bankruptcy, insolvency, and/or an inability to pay their debts to us as they come due. If our wholesale customers suffer significant financial difficulty, they may be unable to pay their debts to us timely or at all, which could have a material adverse effect on our results of operations. It is possible that wholesale customers may contest their contractual obligations to us under bankruptcy laws or otherwise. Significant customer bankruptcies could further adversely affect our net sales and increase our operating expenses by requiring larger accruals for bad debt expense. In addition, even when our contracts with these customers are not contested, if customers are unable to meet their obligations on a timely basis, it could adversely affect our ability to collect receivables. Further, we may have to negotiate significant discounts and/or extended financing terms with these customers in such a situation. If we are unable to collect upon our accounts receivable as they come due in an efficient and timely manner, our business, financial condition, or results of operations may be materially adversely affected. We also face risk from international customers that file for bankruptcy protection in foreign jurisdictions, as the application of foreign bankruptcy laws may be more difficult to predict. Although we believe that we have sufficient reserves to cover anticipated customer bankruptcies, there can be no assurance that such reserves will be adequate, and if they are not adequate, our business, cash flows, operating results and financial condition would be adversely affected. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory and personnel. We have also made substantial operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to e-commerce and mobile channels, and our ability to effectively develop our e-commerce and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position and cash flows. +17 +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctu ations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders in the past, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest domestic sales generally occurring in our second and third quarters for the back-to-school selling season. Domestically, back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers could negatively impact our net sales and results of operations for our second or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future net sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for our company, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars in which the cost of those products will vary depending on the foreign currency rates and will impact the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency rates. Although we typically work to mitigate this negative foreign currency transaction impact through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +Recent U.S. Tax Legislation May Materially Adversely Affect Our Financial Condition, Results of Operations and Cash Flows. +Recently enacted U.S. tax legislation has significantly changed the U.S. federal income taxation of U.S. corporations, by reducing the U.S. corporate income tax rate, permitting immediate expensing of certain capital expenditures, adopting elements of a territorial tax system, imposing a one-time Transition Tax on all undistributed earnings and profits of certain U.S.-owned foreign corporations, revising the rules governing foreign tax credits, and introducing new anti-base-erosion provisions. Many of these changes are effective immediately, without any transition periods or grandfathering for existing transactions. The legislation is unclear in many respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementing regulations by the U.S. Treasury Department (“Treasury”) and U.S. Internal Revenue Service (“IRS”), any of which could lessen or increase certain adverse impacts of the legislation. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities. +While our analysis and interpretation of this legislation is preliminary and ongoing, based on our current evaluation, we have reflected a $1.9 million write-down of our deferred income tax assets due the reduction of the U.S. corporate income tax rate and incurred an additional $98.0 million tax liability as a result of the Transition Tax. These items have resulted in a total charge against +18 +earnings in the fourth quarter of 2017 in an amount of $99.9 million. This amount may be subject to further adjustment in subsequent periods throughout 2018 in accordance with U.S. Securities and Exchange Commission (“SEC” ) Staff Accounting Bulletin 118 (“ SAB 118”) and subsequent interpretive guidance issued by the SEC or the IRS. Further, there may be other material adverse effects resulting from the legislation that we have not yet identified. +While some of the changes made by the tax legislation may adversely affect the Company in one or more reporting periods and prospectively, other changes may be beneficial on a going forward basis. We continue to work with our tax advisors to determine the full impact that the recent tax legislation as a whole will have on us. We urge our investors to consult with their legal and tax advisors with respect to such legislation. +An Increase In Our Effective Tax Rate Could Have A Material Adverse Effect On Our Results Of Operations And Financial Position. +A significant amount of our foreign earnings are generated in low or zero tax jurisdictions. As a result, our income tax expense has historically been lower than the tax computed at the U.S. statutory income tax rate because we had not previously provided for U.S. taxes on earnings that we considered to be indefinitely reinvested outside the U.S. As discussed above, recent U.S. tax legislation included a one-time Transition Tax on the accumulated earnings of our foreign operations including those that we considered to be indefinitely reinvested outside the U.S. The resulting $98.0 million one-time tax increased our effective tax rate for the year ended December 31, 2017 to 38.8%. Our future effective tax rates could be unfavorably affected by a number of factors, including but not limited to, changes in the tax rates or the tax rules and regulations (including rules and regulations related to recently enacted U.S. tax legislation), or in the interpretation thereof, in the jurisdictions in which we do business; decreases in the amount of earnings in countries with low statutory tax rates; increases in the amount of earnings in countries with high statutory tax rates; or if we need to make significant taxable distributions of foreign earnings for which foreign taxes have not been provided. An increase in our effective tax rate could have a material adverse effect on our business, results of operations, financial position and cash flows. +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether there may be unfavorable changes in tax laws in the United States or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our net sales during the year ended December 31, 2017 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the Communist Party of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic +19 +decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PR C government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or natio nalization of private enterprises. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During 2017 and 2016, the top five manufacturers of our products produced approximately 47.5% and 51.0% of our total purchases, respectively. One manufacturer accounted for 17.9% and 22.9% of total purchases during 2017 and 2016, respectively. Another manufacturer accounted for 11.1% and 10.1% of our total purchases during 2017 and 2016, respectively. We do not have long-term contracts with manufacturers, and we compete with other footwear companies for production facilities. We could experience difficulties with these manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet production deadlines, or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries, or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business. +If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards, or higher lead times for delivery. If we are unable to provide products consistent with our standards, or the manufacture of our footwear is delayed or becomes more expensive, our business would be harmed. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistic and distribution systems include computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all of our products are distributed from a few key locations. Therefore, our operations could be interrupted by earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the adverse effects that could be caused by significant disruptions affecting our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of products to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical +20 +business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our reputation in the United States, or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, some or a substantial number of new stores could be opened in regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced net sales volumes in existing stores in those markets. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability our company may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers D’Lites ® , Skechers Sport ® , Skechers USA ® , Skechers Performance ™ , Skechers GOrun ® , Skechers +21 +GOwalk ® , You by Skechers™, ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skecher Street™, D’Lites®, Skechers Air-Cooled Memory Foam ™ and Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Energy Lights™, S-Lights ® and Twinkle Toes ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against in fringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and tradem ark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the United States, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, in particular, has been the target of many recent cyber-attacks. Although we believe that we take appropriate measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2017, a substantial portion of our operations are located in California, including 103 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our net sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads +22 +beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wild fire affecting California, could significantly disrupt our business including the operation of our only domestic distribut ion center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Two Principal Stockholders Are Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2017, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 75.2% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 10.9% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 34.3% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2017, Mr. Greenberg beneficially owned 35.1% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 42.7% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 22.2% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over, all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to substantially control or significantly influence, respectively, actions requiring stockholder approval, may result in our company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchaser view the superior voting rights of our Class B common shares to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +23 +ITEM 1B. +UNRESOLVE D STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Manhattan Beach, California, which consist of an aggregate of approximately 181,000 square feet. We own and lease portions of our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The lease for this facility expires in November 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is consolidated in our financial statements. +Our European Distribution Center occupies approximately 1.3 million square feet in Liege, Belgium under five operating leases, with base rents of approximately $5.8 million per year. These leases provide for original terms of 10-15 years, commencing between January 2016 and June 2016, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring between March 2018 and January 2033. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $92.9 million for the year ended December 31, 2017. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates between March 2018 and December 2027. Total base rent for the leased properties aggregated approximately $95.1 million for the year ended December 31, 2017. +ITEM 3. +LEGAL PROCEEDINGS +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups were defective and unreasonably dangerous, negligently designed and/or manufactured, and did not conform to representations made by our company, and that we failed to provide adequate warnings of alleged risks associated with Shape-ups. Other product liability lawsuits involving Shape-ups (some on behalf of multiple plaintiffs) subsequently were filed in various courts alleging varying injuries but employing similar legal theories and asserting similar claims to those made in the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are variations in the relief sought, the plaintiffs generally sought compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. As detailed below, our company remains a defendant in only one currently active case. +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding. Skechers has resolved 1,766 personal injury claims in the MDL proceedings, comprised of 1,154 that were filed as formal actions and 612 that were submitted by plaintiff fact sheets. Skechers has also settled another 13 claims in principle—8 filed cases and 5 claims submitted by plaintiff fact sheets—either directly or pursuant to a global settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 72 cases in the MDL proceeding have been dismissed either voluntarily or on motions by Skechers and 40 unfiled claims submitted by plaintiff fact sheet have been abandoned. Between the consummated settlements and cases subject to the settlement program, all but one of the personal injury cases pending in the MDL have been or are expected to be resolved. Fact discovery in that case has been completed and a court-ordered mediation is scheduled in March 2018. No trial date has been set. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the +24 +Judicial Council of California granted a petition by our company to coordinate all pers onal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coo rdinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. +Fifty-seven actions brought on behalf of a total of 647 plaintiffs have been settled and dismissed in the LASC Coordinated Cases. Twelve actions have been partially dismissed, with the claims of 224 plaintiffs in those actions having been fully resolved and dismissed. The claims of one additional plaintiff from these partially settled multi-plaintiff lawsuits has been settled in principle and should be dismissed in the short term. One single-plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff lawsuits have been dismissed entirely, either voluntarily or on motion by us. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by us. +Fourteen cases—two single-plaintiff actions and 12 partially dismissed, multi-plaintiff actions—remain pending in the LASC Coordinated Cases. The two single-plaintiff cases have been settled in principle and should be dismissed in the short term. With respect to the 12 multi-plaintiff actions, the claims of only 17 individual plaintiffs remain. Skechers has moved to dismiss the claims of 16 of those 17 individual plaintiffs for violation of court orders and failure to prosecute their claims, and anticipates bringing a similar motion relating to the last individual plaintiff in the near future. No discovery has been taken in any of those actions and no trial dates have been set. If the two settlements are consummated and the 17 individual plaintiffs’ claims are dismissed for failure to prosecute, then there will be no more claims pending LASC Coordinated Cases. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. All of those actions have been resolved and dismissed. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. A master settlement agreement was executed as of March 24, 2016 and the parties are in the process of completing individual settlements. To the extent that the settlements with individual claimants are not finalized or otherwise consummated such that the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for business purposes in order to end the distraction of litigation, and we continue to believe we have meritorious defenses and intend to defend any remaining cases vigorously. In addition, it is too early to predict whether there will be future personal injury cases filed which are not covered by the global settlement program, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be available and/or adequate to cover any losses. +Converse, Inc. v. Skechers U.S.A., Inc. — On October 14, 2014, Converse filed an action against our company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014-24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and Bobs Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued a ruling affirming that Skechers Twinkle Toes and Bobs canvas shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bobs canvas shoes do not infringe. On June 26, 2017, we filed our responsive brief, and on February 8, 2018 the court heard oral argument. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +25 +adidas America, Inc., et. al v. Skechers USA, Inc. — On September 14, 2015, adidas filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:15-cv-1741, alleging that three Skechers shoe styles (Skechers Onix, Skechers Relaxed Fit Cross Court TR, and Skechers Relaxed Fit – Supernova Style) infringe adidas’ trademarks and/or trade dress rights. adidas asserts claims under federal and state law for trademark and trade dress infringement, unfair competition, trade mark and trade dress dilution, unfair and deceptive trade practices, and breach of a settlement agreement entered into between the parties in 1995. adidas seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble, enhanced and p unitive damages), and attorneys’ fees. On September 14, 2015, adidas filed a motion for preliminary injunction in which it sought to preliminarily restrain us from manufacturing, distributing, advertising, selling, or offering for sale any footwear (a) tha t is confusingly similar to adidas’ STAN SMITH Trade Dress, (b) bearing stripes in a manner that is confusingly similar to adidas’ Three-Stripe Mark, or (c) under adidas’ SUPERNOVA Mark. We opposed adidas’ motion. A hearing on adidas’ motion was held on De cember 15, 2015. On February 12, 2016, the Court issued a preliminary injunction prohibiting us from selling two styles from our vast footwear collection and from using the word “Supernova” in connection with a third style. We have appealed the Court’s or der granting the injunction to the United States Court of Appeals for the Ninth Circuit. Trial has been continued from April 3, 2018 until June 4, 2018. While it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc., v. Skechers USA, Inc .— On January 4, 2016, Nike filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. In April and May, 2016, we filed petitions with the United States Patent and Trademark Office’s Patent Trial and Appeal Board (the “PTAB”) for inter partes review of all eight design patents, seeking to invalidate those patents. In September and November 2016, the Patent Trial and Appeal Board denied each of our petitions. On January 6, 2017, we filed several additional petitions for inter partes review with the PTAB, seeking to invalidate seven of the eight designs patents that Nike is asserting. In July 2017, we were notified that the PTAB granted our petitions and instituted inter partes review proceedings with respect to two of the seven design patents but denied our petitions as to the others. In June 2017, we filed a motion to transfer venue from the District of Oregon to the Central District of California based on a recent United States Supreme Court decision and the motion was granted in late 2017. While it is too early to predict the outcome of either the District Court or the PTAB proceedings or whether an adverse result in the District Court case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +adidas America, Inc. and adidas AG v. Skechers USA, Inc. — On July 11, 2016, adidas filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-01400-AC, alleging that certain of our children’s styles (Boys’ Mega Blade 2.0 and 2.5) infringe two of adidas’ patents. The complaint seeks, among other things, injunctive relief and damages (including treble damages). On July 28, 2016, adidas filed a motion for a preliminary injunction, asking the Court to preliminarily restrain Skechers from importing, manufacturing, distributing, advertising, selling, or offering for sale any of the accused styles. In related activity, on April 26, 2017, the United States Patent and Trial Appeal Board (the “PTAB”) granted petitions by Skechers and instituted inter partes review proceedings as to certain claims under the two patents at issue in this litigation, finding that Skechers had “establishe[d] a reasonable likelihood that [it] will prevail in showing the unpatentability of at least one of the claims” in each patent. Trial on these issues before the PTAB has been set for January 8, 2018. The PTAB subsequently denied two other inter partes review petitions filed by Skechers with respect to the same two adidas patents, and then granted a third petition for additional claims in one of the same patents on August 15, 2017. On June 12, 2017, the Court denied adidas’ motion for a preliminary injunction and stayed the lawsuit pending the outcome of the PTAB proceedings. On July 10, 2017, adidas filed a notice of appeal of the Court’s denial of its motion for preliminary injunction, but subsequently abandoned that appeal. While it is too early to predict the outcome of either the District Court or the PTAB proceedings or whether an adverse result in the District Court case would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Steamfitters Local 449 Pension Plan v. Skechers USA, Inc., Robert Greenberg and David Weinberg. – On October 20, 2017, the Steamfitters Local 449 Pension Plan filed a securities class action, on behalf of itself and purportedly on behalf of other shareholders who purchased Skechers stock in a five-month period in 2015, against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:17-cv-08107. The lawsuit alleges that, between April 23 and October 22, 2015, we made materially false statements or omissions of material fact about the anticipated performance of our Domestic Wholesale segment and asserts claims for unspecified damages, attorneys' fees and equitable relief based on two counts for alleged violations of federal securities laws. Given the early stage of this proceeding and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. We believe we have meritorious defenses and intend to defend this matter vigorously. +26 +Monique Cadle v. Skechers U.S.A., Inc., Robert Greenberg and David Weinberg. – On October 27, 2017, Monique Cadle filed a securities class action, on behalf of herself and purportedly on behalf of other shareholders who purchased Skechers stock in a five-month period in 2015, against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:17-cv-08305. The lawsuit alleges that, between April 23 and October 22, 2015, we made materially false statements or omissions of material fact about the anticipated performance of our Domestic Wholesale segment and asserts claims for unspecified damages, attorneys' fees and equitable relief based on two counts for alleged violations of federal securities laws. Given the early stage of this proceeding and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adve rse impact on our operations or financial position. We believe we have meritorious defenses and intend to defend this matter vigorously. +Yolanda Zuniga v. Team One Employment Specialists, LLC, Skechers USA, Inc., Dolores Carte et al. – On December 20, 2017, our company was named as a defendant in an action filed by a former employee named Yolanda Zuniga in the Superior Court of California, County of Riverside, Case No. RIC 1723878, alleging discrimination, harassment, retaliation, violation of the Family Medical Leave Act/California Family Rights Act, breach of contract and wrongful termination, among other causes of action, and seeking compensatory damages, punitive and exemplary damages, and attorneys’ fees. Skechers believes it has meritorious defenses, vehemently denies the allegations and intends to defend this case vigorously. Notwithstanding, it is too early to predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. +In addition to the matters included in its reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +27 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” The following table sets forth, for the periods indicated, the high and low sales prices of our Class A Common Stock. +LOW +HIGH +Year Ended December 31, 2017 +First Quarter +$ +22.31 +$ +30.00 +Second Quarter +22.64 +29.75 +Third Quarter +24.02 +29.90 +Fourth Quarter +23.90 +38.92 +Year Ended December 31, 2016 +First Quarter +$ +25.47 +$ +34.27 +Second Quarter +25.89 +34.20 +Third Quarter +20.90 +32.71 +Fourth Quarter +18.81 +27.76 +HOLDERS +As of February 1, 2018, there were 99 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 34 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Share Repurchase Program +On February 6, 2018, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share (“Class A common stock”), for an aggregate repurchase price not to exceed $150 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A common stock and the program may be suspended or discontinued at any time. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +28 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our company’s Class A Common Stock from December 31, 2012 to December 31, 2017, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2012 in each of our company’s Class A Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our company’s Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +12/12 +12/13 +12/14 +12/15 +12/16 +12/17 +Skechers U.S.A., Inc. +100.00 +179.08 +298.65 +489.89 +398.59 +613.62 +Russell 2000 +100.00 +138.82 +145.62 +139.19 +168.85 +193.58 +Peer Group +100.00 +152.19 +152.92 +194.05 +192.22 +243.63 +29 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2017 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +(In thousands, except net earnings per share) +Years Ended December 31, +Statement of Earnings Data: +2017 +2016 +2015 +2014 +2013 +Net sales +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +$ +1,846,361 +Gross profit +1,938,889 +1,634,596 +1,424,008 +1,071,905 +818,792 +Earnings from operations +382,880 +370,518 +350,824 +209,071 +93,609 +Earnings before income taxes +384,260 +359,484 +333,497 +191,380 +82,215 +Net earnings attributable to Skechers U.S.A., Inc. +179,190 +243,493 +231,912 +138,811 +54,788 +Net earnings per share: (1) +Basic +1.15 +1.58 +1.52 +0.91 +0.36 +Diluted +1.14 +1.57 +1.50 +0.91 +0.36 +Weighted average shares: (1) +Basic +155,651 +154,169 +152,847 +151,839 +151,090 +Diluted +156,523 +155,084 +154,200 +153,079 +151,690 +As of December 31, +Balance Sheet Data: +2017 +2016 +2015 +2014 +2013 +Working capital +$ +1,507,676 +$ +1,206,036 +$ +971,179 +$ +779,277 +$ +704,506 +Total assets +2,735,082 +2,393,670 +2,039,878 +1,674,918 +1,408,570 +Long-term borrowings, excluding current installments +71,103 +67,159 +68,942 +15,081 +116,488 +Skechers U.S.A., Inc. equity +1,829,064 +1,603,633 +1,327,556 +1,075,249 +930,322 +(1) +Basic earnings per share represents net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. All share and per share information has been retroactively adjusted for the three-for-one stock split that was effective on October 16, 2015. +30 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +GENERAL +We design, market and sell contemporary footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own retail stores, distributor and licensee-owned international retail stores and our e-commerce websites. Our objective is to continue to profitably grow our domestic operations while leveraging our brand name to expand internationally. +Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and retail sales, which includes our e-commerce sales. We evaluate segment performance based primarily on net sales and gross margins. See detailed segment information in Note 18 – Segment and Geographic Reporting in our Consolidated Financial Statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our net sales for 2017 increased $600.9 million, or 16.9%, to $4.164 billion, compared to net sales of $3.563 billion in 2016. The increase in net sales was broad based across all our segments with the largest increases coming from our international subsidiaries and international retail businesses which with our international distributor business represented over 50% of our net sales. The largest increases in our domestic wholesale segment came in our Men’s Sport, Men’s U.S.A., Cali, You and Kid’s divisions. During 2017, earnings from operations increased $12.4 million, or 3.4%, to $382.9 million compared to $370.5 million in 2016. Net earnings attributable to Skechers U.S.A., Inc. were $179.2 million for 2017, a decrease of $64.3 million, or 26.4%, compared to net earnings of $243.5 million in 2016. Diluted earnings per share for 2017 were $1.14, which reflected a 27.4% decrease from the $1.57 diluted earnings per share reported in the prior year. The decrease in net earnings attributable to Skechers U.S.A., Inc. for 2017 was primarily the result of increased income tax expense of $99.9 million due to the enactment of the Tax Cuts and Jobs Act in December 2017 which was partially offset by increased net sales. Our working capital was $1.508 billion at December 31, 2017, which was an increase of $301.6 million from working capital of $1.206 billion at December 31, 2016. Our cash and cash equivalents increased $17.9 million to $736.4 million at December 31, 2017 from $718.5 million at December 31, 2016. The increase in cash and cash equivalents was primarily the result of our increased net earnings, which were partially offset by increased inventories, accounts receivable and increased capital investments. +2017 OVERVIEW +In 2017, we focused on product development, growing our position in our domestic wholesale accounts, growing our international market share, opening retail stores in key locations worldwide, continuing to develop our global infrastructure, and balance sheet and expense management. +New product design and delivery . Our success depends on our ability to design and deliver comfortable, stylish, affordable products to consumers across a broad range of demographics. In 2017, we focused on innovation and comfort across all of our core and existing styles, added fresh looks to our product lines, and developed new product lines that included lifestyle and performance footwear. This included updates to our running and walking lines, an updated collection of D’lites®, You by Skechers™ and Skecher Street™ and a broader offering of Kid’s lighted footwear. +Grow our domestic business. In 2017, our focus was on returning to growth domestically in our domestic wholesale accounts by delivering the right product to accounts at the right time, while finding new opportunities to add shelf space and expand into new locations with new Skechers categories. In 2017, we remained the number one walking, work, casual lifestyle, and casual dress footwear brand, and the number two casual athletic footwear brand. +Further develop our international businesses. During 2017, we continued to focus on improving our international sales by increasing our product offering to accounts around the world, delivering the right product to accounts at the right time, and increasing our shelf space with new and updated products as well as increasing our customer base. +Expand Skechers global retail base. Believing that Skechers retail stores are effective brand building tools, we continued to focus on opening Skechers stores around the world—both company-owned and third-party owned through our distributors, franchisees or joint venture partners. In 2017, we opened 41 additional company-owned domestic stores and 39 additional company-owned international stores. Additionally, we continued to expand our franchise retail base with more Skechers branded stores in countries where we directly handle the distribution of our product. +31 +Develop our global infrastructure. In 2017, through our joint-venture in China we purchased land to be used to construct our new China distribution center to support our increased sales in the region. We are currently in the process of designing the building, tenant improvements and equipment for this facility. +Balance sheet and expense management. During 2017, we continued to focus on managing our balance sheet and bringing our marketing expenses and general and administrative expenses in line with expected sales. +OUTLOOK FOR 2018 +During 2018, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. This includes increasing sales for our lifestyle and wellness line You by Skechers™ and the youthful lifestyle line Skecher Street™. The global footwear market is competitive; however, we believe demand for the brand globally will remain strong because our products are marketed at affordable prices and our styles resonate with consumers worldwide. We believe appeal for our product is broad and demand will continue to grow due to a team of brand ambassadors—including sports icons Joe Montana, Tony Romo, Sugar Ray Leonard and Howie Long for men; pop superstar Camila Cabello for women; actors and personalities Brooke Burke-Charvet, and Kelly Brooke for men and women; elite athletes Meb and Kara Goucher; and professional golfers Matt Kuchar, Belen Mozo, and Brooke Henderson. We expect to continue to broaden the targeted demographic profile of our consumer base, increase our shelf space and to open another 75 to 85 company-owned retail locations worldwide. In addition, we expect to complete the design and begin constructing of our China distribution center by the end of 2018, which will increase our capacity to support our growth in the China market. +DEFINITIONS +Comparable sales +As part of our discussion of our results of operations, we disclose comparable store sales, which exclude the impact of e‑commerce sales. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +Cost of sales or Gross margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative expenses +General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for our Rancho Belago, European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. +32 +YEAR ENDED DECEMBER 31, 2017 COMPARED TO THE YEA R ENDED DECEMBER 31, 2016 +Net sales +Net sales for 2017 were $4.164 billion, which was an increase of $600.9 million, or 16.9%, compared to net sales of $3.563 billion for 2016. The increase in net sales was broad based across all our segments with the largest increases coming from our international businesses. +Our domestic wholesale net sales increased $49.5 million, or 4.1%, to $1.249 billion for 2017 compared to $1.200 billion for 2016. The increase in our domestic wholesale segment’s net sales was primarily the result of a 7.8% unit sales volume increase to 56.5 million pairs in 2017 from 52.4 million pairs in 2016, which was partially offset by a decrease in average selling price per pair of 3.4%, to $22.11 per pair for 2017 from $22.89 in 2016. This net sales increase was attributable to higher sales in our Men’s Sport, Men’s U.S.A., Cali, You, and Kid’s divisions during 2017. The average selling price per pair decrease within the domestic wholesale segment was primarily the result of product sales mix with lower average selling prices. +Our international wholesale segment net sales increased $338.7 million, or 24.3%, to $1.730 billion for 2017 compared to sales of $1.391 billion for 2016. Our international wholesale sales consist of direct sales by our foreign subsidiaries – those sales we make to department stores and specialty retailers – and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries, including our joint ventures, increased $311.3 million, or 28.6%, to $1.399 billion for 2017 compared to sales of $1.088 billion for 2016. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Korea. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $27.4 million, or 9.0%, to $330.6 million for 2017, compared to sales of $303.2 million for 2016. This was primarily attributable to increased sales to our distributors in Australia and New Zealand, Indonesia, and Turkey. +Our retail segment sales increased $212.8 million to $1.185 billion for the year ended December 31, 2017, a 21.9% increase over sales of $972.2 million for 2016. The increase in retail sales was primarily attributable to increased comparable sales of 7.2%, which included increased sales within our Men’s and Women’s Sport, Men’s U.S.A., Kid’s, and Work divisions and a net increase of 36 domestic and 39 international stores compared to 2016. For the year ended December 31, 2017, our domestic retail sales, which includes e-commerce, increased 11.9% compared to 2016, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 6.4%, and our international retail store sales increased 50.3% compared to 2016, which was attributable to increased international store count and positive comparable international store sales of 10.1%. +We believe that we have established our presence in most major domestic retail markets. We had 449 domestic stores and 196 international retail stores as of February 15, 2018, and we currently plan to open approximately 75 to 85 stores in 2018. During 2017, we opened five new domestic concept stores, seven domestic factory outlet stores, 29 domestic warehouse outlet stores, 19 international concept stores, 16 international factory outlet stores, and four international warehouse outlet stores During 2017, we closed five domestic concept stores. We periodically review all of our stores for impairment. During 2017 and 2016, we did not record an impairment charge related to our retail stores. +Gross profit +Gross profit for 2017 increased $304.3 million, or 18.6% to $1.939 billion from $1.635 billion for 2016. Gross profit, as a percentage of net sales, or gross margin, increased slightly to 46.6% in 2017 from 45.9% for 2016. Our domestic wholesale segment gross profit increased $10.5 million, or 2.3%, to $464.6 million for 2017 from $454.1 million for 2016, which was attributable to an increase in pairs sold of 7.8%. Domestic wholesale margins decreased to 37.2% for 2017 from 37.8% for 2016. The decrease in domestic wholesale margins was primarily attributable to a product sales mix with lower average selling prices. +Gross profit for our international wholesale segment increased $170.6 million, or 27.7%, to $786.7 million for 2017 compared to $616.1 million for 2016. Gross margins for the international wholesale segment were 45.5% for 2017 compared to 44.3% for 2016. Gross margins for our international direct subsidiary sales, including our joint ventures, were 50.0% for 2017 as compared to 49.3% for 2016. The increase in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to sales of products with higher average selling prices. Gross margins for our international distributor sales were 26.3% for 2017 as compared to 26.2% for 2016. +Gross profit for our retail segment increased $123.2 million, or 21.8%, to $687.6 million for 2017 as compared to $564.4 million for 2016. Gross margins for all stores were 58.0% for 2017 compared to 58.1% for 2016. Gross margins for our domestic stores were 59.7% for 2017 as compared to 60.1% for 2016. Gross margins for our international stores were 54.5% for 2017 as compared to 52.3% for 2016. The decrease in our domestic retail margins were attributable to a product sales mix with lower average selling prices. +33 +Selling expenses +Selling expenses increased by $70.1 million, or 27.3%, to $327.2 million for 2017 from $257.1 million for 2016. As a percentage of net sales, selling expenses were 7.9% and 7.2% for 2017 and 2016, respectively. The increase in selling expenses was primarily the result of increased sales commissions of $22.7 million due to increased sales worldwide and $13.2 million from our South Korean joint‑venture and $47.3 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.8% in 2017 from 5.5% in 2016. +General and administrative expenses +General and administrative expenses increased by $224.7 million, or 22.0%, to $1.245 billion for 2017 from $1.021 billion for 2016. As a percentage of sales, general and administrative expenses were 29.9% and 28.6% for 2017 and 2016, respectively. The increase in general and administrative expenses was primarily attributable to $109.5 million related to supporting our growing international operations in China, Japan, South Korea and Latin America, increased store operating costs of $73.8 million primarily attributable to an additional 75 stores and increased domestic wholesale general and administrative expenses of $41.4 million primarily due to increased headcount in the United States to support our brand worldwide. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $32.3 million, due to increased shipments, to $219.6 million from $187.3 million for 2017 and 2016, respectively. +Other income (expense) +Interest income was $2.4 million for 2017 compared to $1.2 million for 2016. Interest expense for 2017 increased $0.4 million to $6.7 million compared to $6.3 million in 2016. Gain or loss on foreign currency transactions for 2017 increased $11.3 million to a gain of $6.3 million compared to a $5.0 million loss in 2016. This increased foreign currency exchange gain was primarily attributable to the impact of a weaker U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2017 decreased $0.5 million to a loss of $0.6 million as compared to a loss of $1.1 million in 2016. +Income taxes +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affected our financial results for the year ended December 31, 2017, including, but not limited to: (1) requiring a one-time Transition Tax, payable over eight years, on certain unrepatriated earnings of foreign subsidiaries; (2) a future reduction of the U.S. federal corporate tax rate from 35% to 21% that affects the current value of our deferred tax assets (“DTAs”) and deferred tax liabilities (“DTLs”); and (3) bonus depreciation that allows for full expensing of qualified property placed in service after September 27, 2017. In addition, the Tax Act establishes new tax laws that will affect our financial results for the year ending December 31, 2018, including, but not limited to: (1) a reduction of the U.S. federal corporate tax rate from 35% to 21%; (2) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (3) a new provision designed to tax global intangible low-taxed income (“GILTI”); (4) limitations on the deductibility of certain executive compensation; and (5) limitations on the use of Federal Tax Credit (“FTC’s”) to reduce the U.S. income tax liability. +The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for us to complete the accounting under Accounting Standards Codification 740 (“ASC 740”). In accordance with SAB 118, we must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that our accounting for certain income tax effects of the Tax Act is incomplete but we are able to determine a reasonable estimate, we must record a provisional estimate in the financial statements. If we cannot determine a provisional estimate to be included in the financial statements, we should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. +In connection with our initial analysis of the impact of the Tax Act, we have recorded a provisional one-time net tax expense of $99.9 million for the year-ended December 31, 2017. This net tax expense primarily consists of the $1.9 million net tax impact to our DTA’s from the corporate rate reduction and a net expense for the Transition Tax of $98.0 million. For various reasons that are discussed more fully below, we have not completed our accounting for the income tax effects of certain elements of the Tax Act. If we were able to make reasonable estimates of the effects of elements for which our analysis is not yet complete, we recorded provisional adjustments. +Our accounting for the following elements of the Tax Act is provisional. However, we were able to make reasonable estimates of certain effects and, therefore, recorded the following provisional adjustments: +Transition Tax : The Transition Tax is a one-time tax on previously untaxed current and accumulated earnings and profits (“E&P”) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, we must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. We were able to make a reasonable estimate of the Transition Tax and recorded a provisional Transition Tax liability of +34 +$98 .0 million. However, during the measurement period, we are continuing to gather additional information to more precisely compute the amount of the Transition Tax. +Reduction of U.S. federal corporate tax rate : The Tax Act reduces the corporate tax rate from 35% to 21%, effective January 1, 2018. As a result, we have recorded a provisional decrease in value of our net DTAs of $1.9 million, with a corresponding net adjustment to deferred income tax expense of $1.9 million for the year ended December 31, 2017. While we are able to make a reasonable estimate of the impact of the reduction in the corporate tax rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, our calculation of deemed repatriation of deferred foreign income and the state tax effect of adjustments made to federal temporary differences. +Cost recovery : While we have completed most of the computations necessary and are in the process of completing a final inventory of our 2017 expenditures that qualify for immediate expensing, we have recorded a decrease in our current income tax payable of approximately $5.9 million based on our provisional estimates related to the additional federal expense allowed as a result of the Tax Act. In addition, we have recorded a corresponding increase in our DTLs of approximately $3.5 million, which is less than the $5.9 million liability amount due to the reduction in the corporate tax rate from 35% to 21%, effective January 1, 2018. The $2.4 million net benefit from the reduction in the future tax rate is included in the $1.9 million decrease in value of the net DTAs discussed above. +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34% . Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes . +Our earnings (loss) before income taxes and income tax expense for 2017, 2016 and 2015 are as follows (in thousands): +Years Ended December 31, +2017 +2016 +2015 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +25,628 +$ +113,607 +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +Peoples Republic of China (“China”) +95,668 +12,971 +72,584 +11,720 +49,027 +11,084 +Jersey (2) +198,048 +— +146,880 +— +123,721 +— +Non-benefited loss operations (3) +(17,350 +) +3,306 +(16,189 +) +12 +(16,719 +) +164 +Other jurisdictions (4) +82,266 +19,272 +50,620 +17,739 +40,742 +9,029 +Earnings before income taxes +$ +384,260 +$ +149,156 +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +Effective tax rate (5) +38.8 +% +20.6 +% +21.7 +% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the Tax Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Macau, Panama, and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom, +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2017, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2017, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $ 25.6 million, with income tax expense of $113.6 million, which is an average rate of 443% . The U.S. tax expense includes a provisional one-time tax expense of $99.9 million related to the enactment of the Tax Act on December 22, 2017. Earnings (loss) before income taxes in non-U.S. jurisdictions were $ 358.6 million, with an aggregate income tax expense of $ 35.5 million, which is an average rate of 9.9% . Combined, this results in consolidated earnings before income taxes for the period of $ 384.3 million, and consolidated income tax expense for the period of $ 149.2 million, resulting in an effective tax rate of 38.8% . For 2017, of our $ 358.6 million in earnings before income tax earned outside the U.S., $ 198.0 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, +35 +earnings before income taxes increase d by $ 51.1 million, or 35 %, to $198.0 million in 2017 from $ 146.9 million in 2016. This increase was primarily attributable to an increase of $ 435.6 million in net sales in the “Other international” geographic area for 2017 (see Note 18 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissio ns under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increase s in net sales in the “Other international” geographic area from 2016 to 2017 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $17.4 million for which no tax benefit was recognized during the year ended December 31, 2017 because of the provision of offsetting valuation allowances, but in which $ 3.3 million in nonrefundabl e and other withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. +As of December 31, 2017, we had approximately $736.4 million in cash and cash equivalents, of which $391.6 million, or 53.2%, was held outside the U.S. Of the $391.6 million held by our non-U.S. subsidiaries, approximately $227.5 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2017. +We believe our cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. However, in anticipation of the needs of our share repurchase program and the need to provide payment of our provisional Transition Tax liability, we plan to begin the repatriation of certain funds held outside the U.S. for which tax has been fully provided as of December 31, 2017. Because of the need for cash for operating capital and continued overseas expansion, we also do not foresee the need for any of our foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to U.S. income taxes but may be subject to applicable non-U.S. income and withholding taxes. As of December 31, 2017, U.S. income taxes have been provided but non-U.S. income taxes have not been provided on cumulative total earnings of $ 178.8 million. As of December 31, 2016, U.S. and non-U.S. income taxes have not been provided on cumulative total earnings of $ 699.6 million. +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2017 increased $14.0 million to $55.9 million as compared to $41.9 million for 2016 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +YEAR ENDED DECEMBER 31, 2016 COMPARED TO THE YEAR ENDED DECEMBER 31, 2015 +Net sales +Net sales for 2016 were $3.563 billion, which was an increase of $416.0 million, or 13.2%, compared to net sales of $3.147 billion for 2015. The increase in net sales was primarily from our international wholesale and retail segments offset by a decrease in our domestic wholesale segment. +Our domestic wholesale net sales decreased $20.0 million, or 1.6%, to $1.200 billion for 2016 compared to $1.220 billion for 2015. The decrease in our domestic wholesale segment’s net sales was primarily the result of average selling price per pair decreasing 2.7%, to $22.89 per pair for 2016 from $23.53 for 2015, which was partially offset by a 1.1% unit sales volume increase to 52.4 million pairs in 2016 from 51.8 million pairs in 2015. This net sales decrease was also attributable to lower sales in our Women’s and Men’s Go, Women’s Active and Men’s USA divisions which was partially offset by increases in our Men’s and Women’s Sport and Work divisions during 2016. The average selling price per pair decrease within the domestic wholesale segment was primarily the result of decreased selling prices for our Women’s GO and Women’s Active divisions. +Our international wholesale segment net sales increased $296.8 million, or 27.1%, to $1.391 billion for 2016 compared to sales of $1.094 billion for 2015. Direct sales by our foreign subsidiaries increased $319.8 million, or 41.6%, to $1.088 billion for 2016 compared to sales of $768.2 million for 2015. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Hong Kong. The increases are primarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales decreased $23.0 million, or 7.0%, to $303.2 million for 2016, compared to sales of $326.2 million for 2015. This was primarily attributable to decreased sales to our distributors in Australia and New Zealand, Turkey, the United Arab Emirates (“UAE”) and South Korea, which was transitioned from a distributor to a joint-venture in 2016. +Our retail segment sales increased $139.1 million to $972.2 million for the year ended December 31, 2016, a 16.7% increase over sales of $833.1 million for 2015. The increase in retail sales was primarily attributable to increased comparable sales of 4.1%, +36 +which included increased sales within our Men’s and Women’s Go, Men’s and Women’s Sport, and Work divisions and a net increase of 23 domestic and 30 international stores compared to 2015. For the year ended December 31, 2016, our dome stic retail sales, which includes e-commerce, increased 9.7% compared to 2015, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 2.2% and, and our international retail store sales increase d 42.6% compared to 2015, which was attributable to increased international store count and positive comparable international store sales of 11.8%. +During 2016, we opened four new domestic concept stores, eight domestic factory outlet stores, 18 domestic warehouse outlet stores, 21 international concept stores, and 10 international factory outlet stores. We also took over the operations of three international concept stores and 11 international outlet stores from our distributor in South Korea. During 2016, we closed six domestic concept stores, one domestic warehouse store and one international concept store. +Gross profit +Gross profit for 2016 increased $210.6 million to $1.635 billion from $1.424 billion for 2015. Gross profit, as a percentage of net sales, or gross margin, increased slightly to 45.9% in 2016 from 45.2% for 2015. Our domestic wholesale segment gross profit decreased $17.0 million, or 3.6%, to $454.1 million for 2016 from $471.1 million for 2015, which was attributable to decreased sales volumes and selling prices. Domestic wholesale margins decreased to 37.8% for 2016 from 38.6% for 2015. The decrease in domestic wholesale margins was primarily attributable to lower margins in our Women’s GO and Women’s Active lines. +Gross profit for our international wholesale segment increased $161.4 million, or 35.5%, to $616.1 million for 2016 compared to $454.7 million for 2015. Gross margins for the international wholesale segment were 44.3% for 2016 compared to 41.5% for 2015. Gross margins for our international direct subsidiary sales were 49.3% for 2016 as compared to 47.2% for 2015. The increase in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to sales of products with higher average selling prices. Gross margins for our international distributor sales decreased to 26.2% for 2016 as compared to 28.1% for 2015 primarily from sales of products with lower average selling prices. +Gross profit for our retail segment increased $66.2 million, or 13.3%, to $564.4 million for 2016 as compared to $498.2 million for 2015. Gross margins for all stores were 58.1% for 2016 compared to 59.8% for 2015. Gross margins for our domestic stores were 60.1% for 2016 as compared to 61.5% for 2015. Gross margins for our international stores were 52.3% for 2016 as compared to 53.4% for 2015. The decrease in our retail margins were primarily attributable to lower margins in our Women’s GO, Women’s Active and Women’s USA products. +Selling expenses +Selling expenses increased by $21.5 million, or 9.1%, to $257.1 million for 2016 from $235.6 million for 2015. As a percentage of net sales, selling expenses were 7.2% and 7.5% for 2016 and 2015, respectively. The increase in selling expenses was primarily the result of $26.3 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.5% in 2016 from 5.4% in 2015. +General and administrative expenses +General and administrative expenses increased by $171.5 million, or 20.2%, to $1.021 billion for 2016 from $849.3 million for 2015. As a percentage of sales, general and administrative expenses were 28.6% and 27.0% for 2016 and 2015, respectively. The increase in general and administrative expenses was primarily attributable to $81.9 million related to supporting our growing international operations in China, Japan, South Korea and Latin America, increased store operating costs of $70.5 million primarily attributable to an additional 53 stores and increased domestic wholesale general and administrative expenses of $19.1 million primarily due to increased headcount in the United States to support our brand worldwide. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $20.0 million, due to increased shipments, to $187.3 million from $167.3 million for 2016 and 2015, respectively. +Other income (expense) +Interest income was $1.2 million for 2016 compared to $0.7 million for 2015. Interest expense for 2016 decreased $4.4 million to $6.3 million compared to $10.7 million in 2015. The decrease was primarily due to decreased interest expense of $3.0 million primarily attributable to our domestic distribution center equipment loans being paid in December 2015 and June 2016. Loss on foreign currency transactions for 2016 decreased $1.6 million to $5.0 million compared to $6.6 million in 2015. This decreased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our +37 +foreign subsidiaries. Loss on disposal of assets for 2016 increased $0.4 million to a loss of $1.1 million as compared to a loss of $0.7 million in 2015. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes. +Our earnings (loss) before income taxes and income tax expense for 2016, 2015 and 2014 are as follows (in thousands): +Years Ended December 31, +2016 +2015 +2014 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +(benefit) +United States +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +$ +82,778 +$ +32,500 +Peoples Republic of China (“China”) +72,584 +11,720 +49,027 +11,084 +15,201 +1,179 +Jersey (1) +146,880 +— +123,721 +— +77,555 +— +Non-benefited loss operations (2) +(16,189 +) +12 +(16,719 +) +164 +(13,021 +) +— +Other jurisdictions (3) +50,620 +17,739 +40,742 +9,029 +28,867 +5,505 +Earnings before income taxes +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +$ +191,380 +$ +39,184 +Effective tax rate (4) +20.6 +% +21.7 +% +20.5 +% +(1) +Jersey does not assess income tax on corporate net earnings. +(2) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Panama, Poland, Romania, and South Korea. +(3) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom, +(4) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2016, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2016, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $105.6 million, with income tax expense of $44.7 million, which is an average rate of 42.3%. Earnings (loss) before income taxes in non-U.S. jurisdictions were $253.9 million, with an aggregate income tax expense of $29.5 million, which is an average rate of 11.6%. Combined, this results in consolidated earnings before income taxes for the period of $359.5 million, and consolidated income tax expense for the period of $74.1 million, resulting in an effective tax rate of 20.6%. For 2016, of our $253.9 million in earnings before income tax earned outside the U.S., $146.9 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $23.2 million, or 18.7%, from $123.7 million in 2015 to $146.9 million in 2016. This increase was primarily attributable to us experiencing an increase of $344.9 million in net sales in the “Other international” geographic area for 2016 (see Note 18 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2015 to 2016 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $16.2 million for which no tax benefit was recognized during the year ended December 31, 2016 because of the provision of offsetting valuation allowances, but in which $12 thousand in nonrefundable withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. Unremitted earnings of non-U.S. subsidiaries are expected to be reinvested outside of the U.S. indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2016, we had approximately $718.5 million in cash and cash equivalents, of which $368.4 million, or 51.3%, was held outside the U.S. Of the $368.4 million held by our non-U.S. subsidiaries, approximately $33.4 million is available for +38 +repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 201 6. We believe our cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect that we will need to repatriate any of the funds presentl y designated as indefinitely reinvested outside the U.S. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would be subject to U.S. i ncome taxes and applicable non-U.S. income and withholding taxes. As of December 31, 2016 and 2015, U.S. income taxes have not been provided on cumulative total earnings of approximately $699.6 million and $482.7 million, respectively. +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2016 increased $12.8 million to $41.9 million as compared to $29.1 million for 2015 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +LIQUIDITY AND CAPITAL RESOURCES +Cash Flows +Our working capital at December 31, 2017 was $1.508 billion, an increase of $301.6 million from working capital of $1.206 billion at December 31, 2016. Our cash and cash equivalents at December 31, 2017 was $736.4 million, compared to $718.5 million at December 31, 2016. This increase in cash and cash equivalents of $17.9 million, after consideration of the effect of exchange rates, was the result of our net earnings of $235.1 million, increased accrued expenses and other long-term liabilities of $86.0 million, reduced contributions from non-controlling interests and increased proceeds on long-term borrowings of $5.7 million, which was partially offset by increased inventories of $158.6 million and increased receivables of $102.2 million, decreased payables of $12.8 million and increased capital expenditures of $136.0 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $159.3 million for 2017 and $361.6 million for 2016. On a comparative year‑to‑year basis, the $202.3 million decrease in cash flows from operating activities in 2017 from cash used in operating activities in 2016 primarily resulted from a larger increase in inventories of $100.5 million to support expected increased sales worldwide, a larger increase in accounts receivable of $91.9 million from increased sales and a $51.1 million decrease in accounts payable from increased factory payments, which were partially offset by a larger increase in accrued expenses and other long-term liabilities of $76.7 million, primarily from increased income taxes due to the Tax Act as of December 31, 2017 when compared to December 31, 2016. +Investing Activities +Net cash used in investing activities was $138.3 million for 2017, as compared to $145.6 million in 2016. The decrease in cash used in investing activities in 2017 as compared to 2016 was due to an increase in capital expenditures of $16.5 million partially offset by a decrease in acquisitions of $22.5 million. Capital expenditures for 2017 were approximately $136.0 million, which primarily consisted of $68.5 million for new store openings and remodels, and additional $19.9 million for land to be used for our China distribution center, $12.0 million for new retail locations in our China joint venture, $15.4 million to support our international wholesale operations and $5.3 million for corporate showroom and office upgrades. This was compared to capital expenditures of $119.5 million in the prior year, which primarily consisted of $37.3 million for new store openings and remodels, $17.5 million for the automation upgrades for our European Distribution Center equipment, $17.5 million for the improvement of our international corporate offices and showrooms, $7.0 million related to property purchases for potential future corporate development. Excluding the costs of building our China distribution center and new corporate office building we expect our ongoing capital expenditures for 2018 to be between $45.0 million and $50.0 million, which include opening 75 to 85 retail stores, store remodels, and for infrastructure in our international joint ventures, corporate office and information technology upgrades. We believe our current cash, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. +39 +Financing Activities +Net cash used in financing activities was $14.5 million during 2017, compared to net cash used of $3.5 million during 2016. The increase in cash used by financing activities was primarily attributable to the increase in distributions to non-controlling interests of $8.2 million. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On February 6, 2018, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share (“Class A common stock”), for an aggregate repurchase price not to exceed $150.0 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A common stock and the program may be suspended or discontinued at any time. +Financing Arrangements +On June 30, 2015, we entered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits us and certain of our subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at our election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. We pay a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. We paid closing and arrangement fees of $1.1 million on this facility, which are being amortized to interest expense over the five-year life of the facility. As of December 31, 2017, there was $0.1 million outstanding under this credit facility, which is classified as short-term borrowings in our consolidated balance sheets. +On April 30, 2010, the JV, through HF Logistics-SKX T1, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the JV ("HF-T1"), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the Project on the Property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV through HF-T1 entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF agreed that we would make an additional capital contribution of $38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment +40 +equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with t he New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement ) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 20 15, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pu rsuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the rel ated interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under our credit agreement dated June 30, 2015. We had $66.6 million outstanding under the Amende d Loan Agreement, which is included in long-term borrowings as of December 31, 2017. +As of December 31, 2017, outstanding short-term and long-term borrowings were $80.9 million, of which $67.2 million relates to loans for our domestic distribution center and the remaining relates to our international operations. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants under the Amended Loan Agreement and the Credit Agreement as of the date of this annual report. +We believe that anticipated cash flows from operations, available borrowings under our credit agreement, existing cash balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least through March 31, 2019. Our future capital requirements will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of our footwear, the number and timing of new store openings, the success of our international operations, costs associated with constructing our China distribution center and distribution center equipment, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, costs associated with constructing new corporate offices, any potential acquisitions of other brands or companies and the amount of share repurchases. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition and results of operations. In addition, if additional capital is raised through the sale of additional equity or convertible securities, dilution to our stockholders could occur. +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2017 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +8,011 +$ +8,011 +$ +— +$ +— +$ +— +Long-term borrowings (1) +74,225 +4,512 +69,713 +— +— +Operating lease obligations (2) +1,549,108 +238,665 +396,689 +327,691 +586,063 +Purchase obligations (3) +1,125,289 +1,125,289 +— +— +— +Minimum payments related to other arrangements +40,369 +13,784 +17,197 +9,388 +— +Total (4) +$ +2,797,002 +$ +1,390,261 +$ +483,599 +$ +337,079 +$ +586,063 +1) +Amounts include anticipated interest payments based on interest rates currently in effect. +(2) +Operating lease obligations consists primarily of real property leases for our retail stores, corporate offices, European and other international distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +41 +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $177.4 million, (ii) outstandi ng letters of credit of $4.4 million and (iii) open purchase commitments with our foreign manufacturers for $943.4 million. We currently expect to fund these commitments with cash flows from operations and existing cash balances. +(4) +Our consolidated balance sheet, as of December 31, 2017, included $7.4 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. In addition, the table above does not include payments of $99.9 million over the next eight years related to the provisional one-time tax liability recorded due to the Tax Act. +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves, and tax estimates and valuation of deferred income taxes. +Revenue Recognition . We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. Domestically, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For our international wholesale customers in the European community, product is shipped FOB shipping point direct from our distribution center in Liege, Belgium. For our distributor sales, the goods are generally delivered directly from the independent factories to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. We generate retail revenues primarily from the sale of footwear to customers at retail locations or through our websites. For our in-store sales, we recognize revenue at the point of sale. For sales made through our websites, we recognize revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from e-commerce or retail customers are excluded from reported revenues. +Generally, wholesale customers do not have the right to return goods, however, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. +Royalty income is earned from our licensing arrangements. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. Typically, at each quarter-end, we receive correspondence from our licensees indicating actual sales for the period, which is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements +42 +issued by the customer and our experience with the account. When a customer’s account becomes significantly past due, we generally pla ce a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countrie s or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowance for returns, sales allowances and customer chargeba cks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and e-commerce receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase . As such we have determined that no allowance for doubtful accounts is necessary. +We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. Gross trade accounts receivable were $457.1 million and $368.5 million, and the allowance for bad debts, returns, sales allowances and customer chargebacks were $51.2 million and $41.6 million, at December 31, 2017 and 2016, respectively. Our credit losses charged to expense for the years ended December 31, 2017, 2016, and 2015 were $12.8 million, $12.7 million, and $5.2 million, respectively. In addition, we recorded sales return and allowance expense for the years ended December 31, 2017, 2016 and 2015 of $5.6 million, $18.1 million, and $2.3 million, respectively. +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. Our gross inventory value was $ 881.8 million and $ 712.0 million, and our inventory reserve was $ 8.8 million and $ 11.5 million, at December 31, 2017 and 2016, respectively. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances: +• +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets; +• +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +• +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +• +overall financial performance such as negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; +• +other relevant entity-specific events such as changes in management, key personnel, strategy, customers, contemplation of bankruptcy, or litigation; +• +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and +• +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. We base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. We review all of our stores for impairment annually or more +43 +frequently if events or changes in circumsta nces require it. We prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. For the years ended December 31, 2017, 2016 and 2015, respectively we did not record an i mpairment charge. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates and valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. As of December 31, 2017, we had net deferred tax assets of $57.1 million reduced by a valuation allowance of $27.3 million primarily related to loss carry-forwards not expected to be utilized by certain foreign subsidiaries. +On December 22, 2017, the SEC staff issued SAB 118 to address the accounting implications of the 2017 Tax Act. SAB 118 permits a company to recognize provisional amounts for the one-time tax effects of the Tax Act upon enactment when it does not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the change in tax law. The measurement period to finalize our calculations cannot extend beyond one year of the enactment date. Key provisions that have a significant impact on our consolidated financial statements and where we have recognized estimated amounts include the recognition of a tax liability for a one-time Transition Tax on the accumulated earnings of our foreign subsidiaries, and the remeasurement of certain net deferred tax assets and liabilities as a result of the decrease in the U.S. corporate tax rate from 35% to 21%. +Due to the Transition Tax on the accumulated earnings of our foreign subsidiaries, previously unremitted earnings for which no U.S. deferred tax liability had been provided have now been subject to U.S. tax. While we have provided U.S. tax on all our unremitted foreign earnings, we have not provided for additional foreign taxes which may arise upon repatriation of those amounts of unremitted foreign earnings which we believe are indefinitely reinvested outside the U.S. +INFLATION +We do not believe that the rates of inflation experienced in the United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2017 and 2016, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — The Company and Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +44 +ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2017, we have $8.0 million and $66.6 million of outstanding short-term and long-term borrowings, respectively, subject to changes in interest rates. A 200 basis point increase in interest rates would have increased interest expense by less than $0.2 million for the year ended December 31, 2017. We do not expect any changes in interest rates to have a material impact on our financial condition or results of operations during the remainder of 2018. The interest rate charged on our domestic secured line of credit facility is based on the prime rate of interest and our domestic distribution center loan is based on the one month LIBOR. Changes in the prime rate of interest or the LIBOR interest rate will have an effect on the interest charged on outstanding balances. As of December 31, 2017, there was $0.1 million outstanding under this credit facility and $ 66.6 million outstanding on our domestic distribution center loan. +We have entered into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on our long-term debt. We will not enter into derivative transactions for speculative purposes. We had one derivative instrument in place as of December 31, 2017 to hedge the cash flows on our $66.6 million variable rate debt on our domestic distribution center. This instrument was a variable to fixed derivative with a notional amount of $66.6 million at December 31, 2017. Our average receive rate was one month LIBOR and the average pay rate was 2.08%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest expense. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not engage in hedging activities with respect to such exchange rate risks. +Assets and liabilities outside the United States are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, the Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. Accordingly, we do not hedge these net investments. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation gain of $11.9 million and a cumulative foreign currency translation loss of $0.3 million for the years ended December 31, 2017 and 2016, respectively, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2017 would have reduced the values of our net investments by approximately $24.8 million. +45 +ITEM 8. +FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +47 +CONSOLIDATED BALANCE SHEETS +48 +CONSOLIDATED STATEMENTS OF EARNINGS +49 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +50 +CONSOLIDATED STATEMENTS OF EQUITY +51 +CONSOLIDATED STATEMENTS OF CASH FLOWS +52 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +53 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +78 +46 +Report of Independent Regist ered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 1, 2018 expressed an unqualified opinion thereon. +Change in Accounting Method related to Stock Compensation +As discussed in Note 12 to the consolidated financial statements, the Company has changed its method of accounting for stock compensation on January 1, 2017 due to the adoption of Accounting Standards Update 2016-09. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +March 1, 2018 +47 +SKECHERS U.S.A., INC. AND SUB SIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +December 31, +2017 +2016 +ASSETS +Current assets: +Cash and cash equivalents +$ +736,431 +$ +718,536 +Trade accounts receivable, less allowances of $51,180 in 2017 and $41,647 in 2016 +405,921 +326,844 +Other receivables +27,083 +19,191 +Total receivables +433,004 +346,035 +Inventories +873,016 +700,515 +Prepaid expenses and other current assets +62,573 +62,680 +Total current assets +2,105,024 +1,827,766 +Property, plant and equipment, net +541,601 +494,473 +Deferred tax assets +29,922 +26,043 +Other assets, net +58,535 +45,388 +Total non-current assets +630,058 +565,904 +TOTAL ASSETS +$ +2,735,082 +$ +2,393,670 +LIABILITIES AND EQUITY +Current liabilities: +Current installments of long-term borrowings +$ +1,801 +$ +1,783 +Short-term borrowings +8,011 +6,086 +Accounts payable +505,334 +520,437 +Accrued expenses +82,202 +93,424 +Total current liabilities +597,348 +621,730 +Long-term borrowings, excluding current installments +71,103 +67,159 +Deferred tax liabilities +161 +412 +Other long-term liabilities +118,259 +18,855 +Total non-current liabilities +189,523 +86,426 +Total liabilities +786,871 +708,156 +Commitments and contingencies +Stockholders’ equity: +Preferred stock, $0.001 par value; 10,000 shares authorized; none issued +and outstanding +— +— +Class A common stock, $0.001 par value; 500,000 shares authorized; +131,784 and 130,386 shares issued and outstanding at December 31, 2017 +and December 31, 2016, respectively +132 +130 +Class B convertible common stock, $0.001 par value; 75,000 shares +authorized; 24,545 shares issued and outstanding at +December 31, 2017 and December 31, 2016 +24 +24 +Additional paid-in capital +453,417 +419,038 +Accumulated other comprehensive loss +(14,744 +) +(26,604 +) +Retained earnings +1,390,235 +1,211,045 +Skechers U.S.A., Inc. equity +1,829,064 +1,603,633 +Non-controlling interests +119,147 +81,881 +Total stockholders' equity +1,948,211 +1,685,514 +TOTAL LIABILITIES AND EQUITY +$ +2,735,082 +$ +2,393,670 +See accompanying notes to consolidated financial statements. +48 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Years Ended December 31, +2017 +2016 +2015 +Net sales +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +Cost of sales +2,225,271 +1,928,715 +1,723,315 +Gross profit +1,938,889 +1,634,596 +1,424,008 +Royalty income +16,666 +13,885 +11,745 +1,955,555 +1,648,481 +1,435,753 +Operating expenses: +Selling +327,201 +257,129 +235,586 +General and administrative +1,245,474 +1,020,834 +849,343 +1,572,675 +1,277,963 +1,084,929 +Earnings from operations +382,880 +370,518 +350,824 +Other income (expense): +Interest income +2,420 +1,186 +722 +Interest expense +(6,677 +) +(6,270 +) +(10,728 +) +Other, net +5,637 +(5,950 +) +(7,321 +) +Total other income (expense) +1,380 +(11,034 +) +(17,327 +) +Earnings before income tax expense +384,260 +359,484 +333,497 +Income tax expense +149,156 +74,125 +72,450 +Net earnings +235,104 +285,359 +261,047 +Less: Net earnings attributable to non-controlling interests +55,914 +41,866 +29,135 +Net earnings attributable to Skechers U.S.A., Inc. +$ +179,190 +$ +243,493 +$ +231,912 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +1.15 +$ +1.58 +$ +1.52 +Diluted +$ +1.14 +$ +1.57 +$ +1.50 +Weighted average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +155,651 +154,169 +152,847 +Diluted +156,523 +155,084 +154,200 +See accompanying notes to consolidated financial statements. +49 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2017 +2016 +2015 +Net earnings +$ +235,104 +$ +285,359 +$ +261,047 +Other comprehensive income: +Gain (loss) on foreign currency translation adjustment +19,119 +(4,698 +) +(13,167 +) +Comprehensive income +254,223 +280,661 +247,880 +Less: Comprehensive income attributable to noncontrolling interests +63,173 +37,467 +26,196 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +191,050 +$ +243,194 +$ +221,684 +See accompanying notes to consolidated financial statements. +50 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +NON +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +CONTROLLING +STOCKHOLDERS' +STOCK +STOCK +STOCK +STOCK +CAPITAL +INCOME (LOSS) +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at January 1, 2015 +120,862 +31,410 +$ +120 +$ +31 +$ +355,535 +$ +(16,077 +) +$ +735,640 +$ +1,075,249 +$ +58,858 +$ +1,134,107 +Net earnings +— +— +— +— +— +— +231,912 +231,912 +29,135 +261,047 +Foreign currency translation adjustment +— +— +— +— +— +(10,228 +) +— +(10,228 +) +(2,939 +) +(13,167 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +2,272 +2,272 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(39,148 +) +(39,148 +) +Stock compensation expense +— +— +— +— +18,296 +— +— +18,296 +— +18,296 +Proceeds from issuance of common stock under the +employee stock purchase plan +224 +— +1 +— +4,317 +— +— +4,318 +— +4,318 +Shares issued under the Incentive Award Plan +1,106 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +8,009 +— +— +8,009 +— +8,009 +Conversion of Class B Common Stock into Class A +Common Stock +5,132 +(5,132 +) +5 +(5 +) +— +— +— +— +— +— +Balance at December 31, 2015 +127,324 +26,278 +$ +127 +$ +26 +$ +386,156 +$ +(26,305 +) +$ +967,552 +$ +1,327,556 +$ +48,178 +$ +1,375,734 +Net earnings +— +— +— +— +— +— +243,493 +243,493 +41,866 +285,359 +Foreign currency translation adjustment +— +— +— +— +— +(299 +) +— +(299 +) +(4,399 +) +(4,698 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +13,980 +13,980 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(17,744 +) +(17,744 +) +Stock compensation expense +— +— +— +— +23,081 +— +— +23,081 +— +23,081 +Proceeds from issuance of common stock under the +employee stock purchase plan +221 +— +— +— +5,120 +— +— +5,120 +— +5,120 +Shares issued under the Incentive Award Plan +1,108 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +4,682 +— +— +4,682 +— +4,682 +Conversion of Class B Common Stock into Class A +Common Stock +1,733 +(1,733 +) +2 +(2 +) +— +— +— +— +— +— +Balance at December 31, 2016 +130,386 +24,545 +$ +130 +$ +24 +$ +419,038 +$ +(26,604 +) +$ +1,211,045 +$ +1,603,633 +$ +81,881 +$ +1,685,514 +Net earnings +— +— +— +— +— +— +179,190 +179,190 +55,914 +235,104 +Foreign currency translation adjustment +— +— +— +— +— +11,860 +— +11,860 +7,259 +19,119 +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +46 +46 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(25,953 +) +(25,953 +) +Stock compensation expense +— +— +— +— +28,902 +— +— +28,902 +— +28,902 +Proceeds from issuance of common stock under the +employee stock purchase plan +240 +— +— +— +5,479 +— +— +5,479 +— +5,479 +Shares issued under the Incentive Award Plan +1,158 +— +2 +— +(2 +) +— +— +— +— +— +Balance at December 31, 2017 +131,784 +24,545 +$ +132 +$ +24 +$ +453,417 +$ +(14,744 +) +$ +1,390,235 +$ +1,829,064 +$ +119,147 +$ +1,948,211 +See accompanying notes to consolidated financial statements +51 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Years Ended December 31, +2017 +2016 +2015 +Cash flows from operating activities: +Net earnings +$ +235,104 +$ +285,359 +$ +261,047 +Adjustments to reconcile net earnings to net cash provided by operating activities: +Depreciation and amortization of property, plant and equipment +82,764 +66,083 +52,433 +Amortization of other assets +13,746 +13,099 +1,214 +Provision for bad debts and returns +18,398 +30,820 +7,520 +Non-cash share-based compensation +28,902 +23,081 +18,296 +Deferred income taxes +(3,947 +) +(11,936 +) +(4,844 +) +Gain (loss) on non-current assets +(2,187 +) +413 +656 +Net foreign currency adjustments +(7,749 +) +(3,949 +) +— +(Increase) decrease in assets: +Receivables +(102,222 +) +(10,350 +) +(100,032 +) +Inventories +(158,628 +) +(58,152 +) +(176,062 +) +Prepaid expenses and other current assets +(9,145 +) +(15,343 +) +(2,082 +) +Other assets +(8,916 +) +(5,056 +) +(6,423 +) +Increase (decrease) in liabilities: +Accounts payable +(12,806 +) +38,247 +130,075 +Accrued expenses and other long-term liabilities +86,023 +9,306 +50,416 +Net cash provided by operating activities +159,337 +361,622 +232,214 +Cash flows from investing activities: +Capital expenditures +(135,976 +) +(119,471 +) +(118,144 +) +Intangible asset additions +(214 +) +— +(55 +) +Purchases of investments +(2,344 +) +(3,810 +) +(8,428 +) +Proceeds from sales of investments +284 +170 +144 +Acquisition of South Korea distributor +— +(22,534 +) +— +Net cash used in investing activities +(138,250 +) +(145,645 +) +(126,483 +) +Cash flows from financing activities: +Net proceeds from the issuances of common stock through employee stock purchase plan +5,479 +5,120 +4,318 +Payments on long-term debt +(1,783 +) +(15,653 +) +(32,656 +) +Proceeds from long-term debt +5,745 +— +762 +Proceeds (payments) on short-term borrowings +1,925 +6,091 +(1,733 +) +Excess tax benefits from share-based compensation +— +4,682 +8,009 +Contribution from non-controlling interests of consolidated entity +46 +13,980 +2,272 +Distributions to non-controlling interests of consolidated entity +(25,953 +) +(17,744 +) +(39,148 +) +Net cash used in financing activities +(14,541 +) +(3,524 +) +(58,176 +) +Net increase in cash and cash equivalents +6,546 +212,453 +47,555 +Effect of exchange rates on cash and cash equivalents +11,349 +(1,908 +) +(6,249 +) +Cash and cash equivalents at beginning of the year +718,536 +507,991 +466,685 +Cash and cash equivalents at end of the year +$ +736,431 +$ +718,536 +$ +507,991 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +6,392 +$ +5,724 +$ +9,891 +Income taxes, net +56,633 +65,260 +63,479 +See accompanying notes to consolidated financial statements. +52 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2017, 2016 and 2015 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company operates 449 domestic and 196 international retail stores and an e-commerce business as of December 31, 2017. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +(c) +Revenue Recognition +The Company recognizes revenue on wholesale sales when products are shipped and the customer takes title and assumes risk of loss, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This generally occurs at time of shipment. Related costs paid to third-party shipping companies are recorded as a cost of sales. Generally, wholesale customers do not have the right to return goods, however, the Company periodically decides to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. The Company generates retail revenues primarily from the sale of footwear to customers at retail locations or through websites. For in-store sales, the Company recognizes revenue at the point of sale. For sales made through websites, the Company recognizes revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from e-commerce or retail customers are excluded from reported revenues. +Royalty income is earned from licensing arrangements. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue as earned. The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. Typically, at each quarter-end, the Company receives correspondence from licensees indicating actual sales for the period, which is used to calculate and accrue the related royalties currently receivable based on the terms of the agreement. +(d) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic wholesale, international wholesale, and retail, which includes e-commerce sales. Information regarding these segments is summarized in Note 18 – Segment and Geographic Reporting. +(e) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Asia and the Middle East or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) 810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has determined that it is the primary beneficiary for these VIE’s because the Company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity, or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated financial statements, even though the Company may not hold a majority equity interest. There have been no changes +53 +during 2017 in the accounti ng treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The assets of these joint ventures are restricted in that they are not available for general business use outside the contex t of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Company does not have a variable interest in any unconsolidated VIEs. +(f) +Fair Value of Financial Instruments +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, investments, accounts receivable, accounts payable and accrued expenses, approximate fair value due to the relatively short maturity of such instruments. +The carrying amount of the Company’s long-term borrowings are considered Level 2 liabilities, which approximates fair value, based upon current rates and terms available to the Company for similar debt. +As of August 12, 2015, the Company entered into an interest rate swap agreement concurrent with refinancing its domestic distribution center construction loan (see Note 6, Derivative Instruments). The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with U.S. GAAP, credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The majority of the inputs used to value the interest rate swap were within Level 2 of the fair value hierarchy. As of December 31, 2017, the interest rate swap was a Level 2 derivative and was classified as other long-term liabilities in the Company’s consolidated balance sheets. +(g) +Cash and Cash Equivalents +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +(h) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectability, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the account. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and e-commerce receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, the Company has determined that no allowance for doubtful accounts is necessary. +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high-risk, the Company provides a reserve based upon its historical loss rate as a percentage of sales. +(i) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market (net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories, and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +54 +I n July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No 2015-11, “ Inventory (Topic 330): Simplifying the Measurement of Inventory ” (“ASU 2015-11”). ASU 2015-11 requires that inventory within the scope of this standard be measured at the lower of cost and net realizable value. Net realizable value is the estima ted selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments apply to inventory that is measured using first-in, first-out or average cost. Effective January 1, 2017, t he Company adopted ASU 2015-11. The adoption of ASU 2015-11 did not have a material impact on the Company’s consolidated financial statements. +(j) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method, which based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, +whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company reviews both quantitative and qualitative factors to assess whether a triggering event occurred. The Company reviews all stores for impairment annually or more frequently if events or changes in circumstances require it. The Company prepares a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of 24 months are then reviewed in detail to determine whether impairment exists. Recoverability of assets or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. The Company did not record impairment charges during the years ended December 31, 2017, 2016 or 2015. +(k) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +(l) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Translation adjustments for subsidiaries where the functional currency is its local currency are included in other comprehensive income. Foreign currency transaction gains (losses) resulting from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +(m) +Comprehensive Income +Comprehensive income is presented in the consolidated statements of comprehensive income. Comprehensive income consists of net earnings, foreign currency translation adjustments, and income attributable to non-controlling interests. +(n) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run, or over the life of the endorsement contract. Advertising expense for the years ended December 31, 2017, 2016 and 2015 was approximately $260.4 million, $213.1 million and $188.1 million, respectively. Prepaid advertising costs were $8.6 million and $9.8 million at December 31, 2017, and 2016, respectively. Prepaid amounts outstanding at December 31, 2017 and 2016 represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run, as of December 31, 2017 and 2016, respectively. +55 +(o) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses, when incurred. Product design and development costs aggregated approximately $18.8 million, $13.6 million, and $11.2 million during the years ended December 31, 2017, 2016 and 2015, respectively. +(p) +Warehouse and Distribution Costs +The Company’s distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $219.6 million, $187.3 million and $167.3 million for 2017, 2016 and 2015, respectively. +(q) +Recent Accounting Pronouncements +In October 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016‑16, “ Accounting for Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory .” The standard requires that the income tax impact of intra-entity sales and transfers of property, except for inventory, be recognized when the transfer occurs. The standard will become effective for the Company’s annual and interim reporting periods beginning January 1, 2018 and will require any deferred taxes not yet recognized on intra-entity transfers to be recorded to retained earnings under a modified retrospective approach. Early adoption is permitted. The Company will adopt ASU 2016-16 in the first quarter of 2018 and does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In February 2016, the FASB issued ASU No. 2016-02, “ Leases (Topic 842) ” (“ASU 2016-02”). The new standard requires lessees to recognize most leases on the balance sheet, which will increase lessees’ reported assets and liabilities. ASU 2016-02 is effective for the Company’s annual and interim reporting periods beginning January 1, 2019. ASU 2016-02 mandates a modified retrospective transition method. The Company is currently assessing the impact of the new standard on its consolidated financial statements, but anticipates an increase in assets and liabilities due to the recognition of the required right-of-use asset and corresponding liability for all lease obligations that are currently classified as operating leases, such as real estate leases for corporate headquarters, administrative offices, retail stores, showrooms, and distribution facilities, as well as additional disclosure on all our lease obligations. The income statement recognition of lease expense is not expected to materially change from the current methodology. +In May 2014, the FASB issued ASU No. 2014-09 “ Revenue from Contracts with Customers ,” which amended the FASB Accounting Standards Codification (“ASC”) and created a new Topic ASC 606, “ Revenue from Contracts with Customers ” (“ASC 606”). This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in ASC Topic 605, “ Revenue Recognition ,” and most industry-specific guidance throughout the Industry Topics of the Codification. For the Company’s annual and interim reporting periods the mandatory adoption date of ASC 606 is January 1, 2018, and there will be two methods of adoption allowed, either a full retrospective adoption or a modified retrospective adoption. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to the first quarter of 2018. In March 2016, April 2016, May 2016, and December 2016, the FASB issued ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20, respectively, as clarifications to ASU 2014-09. ASU 2016‑08 clarifies how to identify the unit of accounting for the principal versus agent evaluation, how to apply the control principle to certain types of arrangements, such as service transactions, and reframed the indicators in the guidance to focus on evidence that an entity is acting as a principal rather than as an agent. ASU 2016-10 clarifies the existing guidance on identifying performance obligations and licensing implementation. ASU 2016-12 adds practical expedients related to the transition for contract modifications and further defines a completed contract, clarifies the objective of the collectability assessment and how revenue is recognized if collectability is not probable, and when non-cash considerations should be measured. ASU 2016-20 corrects or improves guidance in thirteen narrow focus aspects of the guidance. The effective dates for these ASUs are the same as the effective date for ASU No. 2014-09, for the Company’s annual and interim periods beginning January 1, 2018. These ASU’s also require enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows. The Company will adopt the new revenue standards in the first quarter of 2018 using the modified retrospective method. The Company has completed the assessment of the impact of these ASUs on its consolidated financial statements and does not expect that the adoption of these ASUs will have a material impact on its consolidated financial statements. +56 +(2) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2017 and 2016 is summarized as follows (in thousands): +2017 +2016 +Land +$ +83,163 +$ +83,163 +Buildings and improvements +208,351 +207,665 +Furniture, fixtures and equipment +330,644 +297,540 +Leasehold improvements +357,920 +289,847 +Total property, plant and equipment +980,078 +878,215 +Less accumulated depreciation and amortization +438,477 +383,742 +Property, plant and equipment, net +$ +541,601 +$ +494,473 +(3) +ACCRUED EXPENSES +Accrued expenses at December 31, 2017 and 2016 are summarized as follows (in thousands): +2017 +2016 +Accrued inventory purchases +$ +20,509 +$ +48,087 +Accrued payroll and taxes +61,693 +45,337 +Accrued expenses +$ +82,202 +$ +93,424 +(4) +LINE OF CREDIT AND SHORT-TERM BORROWINGS +On June 30, 2015, the Company entered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits the Company and certain of its subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at the Company’s election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. The Company pays a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose of assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. The Company paid closing and arrangement fees of $1.1 million on this facility, which are included in Other Assets in the consolidated balance sheets, and are being amortized to interest expense over the five-year life of the facility. As of December 31, 2017 and December 31, 2016, there was $0.1 million outstanding under the Company’s credit facilities, classified as short-term borrowings in the Company’s consolidated balance sheets. The remaining balance in short-term borrowings as of December 31, 2017 is related to the Company’s joint venture in India. +57 +(5) +LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2017 and 2016 are as follows (in thousands): +2017 +2016 +Note payable to banks, due in monthly installments of $302.0 +(includes principal and interest), variable-rate interest at +3.57% per annum, secured by property, balloon payment of +$62,843 due August 2020 +$ +66,604 +$ +68,059 +Note payable to Luen Thai Enterprise, Ltd., balloon payment +of $5,745 due January 2021 +5,745 +— +Note payable to TCF Equipment Finance, Inc., due in monthly +installments of $30.5 (includes principal and interest), fixed- +rate interest at 5.24% per annum, due July 2019 +555 +883 +Subtotal +72,904 +68,942 +Less current installments +1,801 +1,783 +Total long-term borrowings +$ +71,103 +$ +67,159 +The aggregate maturities of long-term borrowings at December 31, 2017 are as follows (in thousands): +2018 +$ +1,801 +2019 +1,666 +2020 +63,692 +2021 +5,745 +$ +72,904 +The Company’s long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. +On April 30, 2010, HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the project on certain property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV, through HF-T1, entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF Logistics (“HF”) agreed that the Company would make an additional capital contribution of $38.7 million to the JV, through HF-T1, to make a payment on the Original Loan based on the Company’s 50% equity interest in the JV. The payment equaled the Company’s 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV, through HF-T1, to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in the Company’s consolidated statements of equity within non-controlling interests. The +58 +Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Credit Agreement dated June 30, 2015 (see Note 6, Derivative Instruments). The Company is in compliance with its non-financial covenants, including any cros s default provisions, and financial covenants of its short-term and long-term borrowings as of December 31, 2017. +(6) +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company used an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. On August 12, 2015, in connection with refinancing its domestic distribution center loan, described in Note 5 above, the Company entered into a variable-to-fixed interest rate swap agreement with Bank of America, N.A., to hedge the cash flows on the Company’s $70.0 million variable rate debt. As of December 31, 2017, the swap agreement has an aggregate notional amount of $66.6 million and a maturity date of August 12, 2022, subject to early termination commencing on August 1, 2020 at the option of HF Logistics-SKX T1, LLC (“HF-T1”), a wholly-owned subsidiary of the Company’s joint venture HF Logistics-SKX, LLC (the “JV”). Under the terms of the swap agreement, the Company will pay a weighted-average fixed rate of 2.08% on the $66.6 million notional amount and receive payments from the counterparty based on the 30-day LIBOR rate. The rate swap agreement utilized by the Company effectively modifies its exposure to interest rate risk by converting the Company’s floating-rate debt to a fixed-rate of 4.08% for the life of the loan thus reducing the impact of interest-rate changes on future interest expense. Pursuant to the terms of the JV, HF Logistics is responsible for any amounts related to the Swap Agreement. +By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2017, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +(7) +OTHER LONG-TERM LIABILITIES +Other long-term liabilities at December 31, 2017 and 2016 are as follows (in thousands): +2017 +2016 +Other long term liabilities +$ +19,059 +$ +13,862 +Income taxes payable +99,200 +4,993 +$ +118,259 +$ +18,855 +(8) +COMMITMENTS AND CONTINGENCIES +(a) +Leases +The Company leases facilities under operating lease agreements expiring through November 1, 2031. The Company pays taxes, maintenance and insurance in addition to the lease obligations. Leases may provide for renewal options and rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of gross sales in excess of a base annual rent. The Company also leases certain equipment and automobiles under operating lease agreements expiring at various dates through May 1, 2021. Rent expense for the years ended December 31, 2017, 2016 and 2015 approximated $223.7 million, $171.0 million and $137.8 million, respectively. +Minimum lease payments, which take into account escalation clauses, are recognized on a straight-line basis over the minimum lease term. Reimbursements for leasehold improvements are recorded as liabilities and are amortized as a reduction to rent expense over the lease term. Lease concessions, usually a free rent period, are considered in the calculation of the minimum lease payments for the minimum lease term. +59 +Future minimum lease payments under noncancellable leases at December 31, 2017 are as follows (in thousands): +OPERATING +LEASES +Year ending December 31: +2018 +$ +238,665 +2019 +208,292 +2020 +188,397 +2021 +167,634 +2022 +160,057 +Thereafter +586,063 +$ +1,549,108 +(b) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0% and 0.5% for 30- to 60-day financing. The amounts outstanding under these arrangements at December 31, 2017 and 2016 were $177.4 million and $260.7 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $4.8 million in 2017, $4.4 million in 2016, and $5.4 million in 2015. The Company has open purchase commitments with its foreign manufacturers at December 31, 2017 of $943.4 million, which are not included in the accompanying 2017 consolidated balance sheet. +(c) +Litigation +The Company recognizes legal expense in connection with loss contingencies as incurred. +Personal Injury Lawsuits Involving Shape-ups — As previously reported, on February 20, 2011, Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group were named as defendants in a lawsuit that alleged, among other things, that Shape-ups were defective and unreasonably dangerous, negligently designed and/or manufactured, and did not conform to representations made by the Company, and that the Company failed to provide adequate warnings of alleged risks associated with Shape-ups. Other personal injury lawsuits involving Shape-ups (some on behalf of multiple plaintiffs) subsequently were filed in various courts, alleging varying injuries but employing similar legal theories and asserting similar claims to those made in the first case, as well as claims for breach of express and implied warranties, loss of consortium, and fraud. Although there are variations in the relief sought, the plaintiffs generally seek compensatory and/or economic damages, exemplary and/or punitive damages, and attorneys’ fees and costs. As detailed below, the Company is named as a defendant in one currently active, pending case. +On December 19, 2011, the Judicial Panel on Multidistrict Litigation issued an order establishing a multidistrict litigation (“MDL”) proceeding in the United States District Court for the Western District of Kentucky entitled In re Skechers Toning Shoe Products Liability Litigation, case no. 11-md-02308-TBR. Since 2011, a total of 1,235 personal injury cases have been filed in or transferred to the MDL proceeding. The Company has resolved 1,766 personal injury claims in the MDL proceedings, comprised of 1,154 that were filed as formal actions and 612 that were submitted by plaintiff fact sheets. The Company has also settled another 13 claims in principle—8 filed cases and 5 claims submitted by plaintiff fact sheets—either directly or pursuant to a global settlement program that has been approved by the claimants’ attorneys (described in greater detail below). Further, 72 cases in the MDL proceeding have been dismissed either voluntarily or on motions by the Company and 40 unfiled claims submitted by plaintiff fact sheet have been abandoned. Between the consummated settlements and cases subject to the settlement program, all but one of the personal injury cases pending in the MDL have been or are expected to be resolved. Fact discovery in that case has been completed and a court-ordered mediation is scheduled in March 2018. No trial date has been set. +Skechers U.S.A., Inc., Skechers U.S.A., Inc. II and Skechers Fitness Group also have been named as defendants in a total of 72 personal injury actions filed in various Superior Courts of the State of California that were brought on behalf of 920 individual plaintiffs (360 of whom also submitted MDL court-approved questionnaires for mediation purposes in the MDL proceeding). Of those cases, 68 were originally filed in the Superior Court for the County of Los Angeles (the “LASC cases”). On August 20, 2014, the Judicial Council of California granted a petition by the Company to coordinate all personal injury actions filed in California that relate to Shape-ups with the LASC cases (collectively, the “LASC Coordinated Cases”). On October 6, 2014, three cases that had been pending in other counties were transferred to and coordinated with the LASC Coordinated Cases. On April 17, 2015, an additional case was transferred to and coordinated with the LASC Coordinated Cases. +60 +Fifty-seven actions brought on behalf of a total of 647 plaintiffs have been settled and fully dismissed in the LASC Coordinated Cases. Twelve actions have been partially dismissed, with the claims of 224 plaintiffs in those actions having been fully resolved and dismissed. The claim of one other plaintiff from these partially settled multi-plaintiff lawsuits has been settled in principle and sh ould be dismissed in the short term. One single-plaintiff lawsuit and the claims of 28 additional plaintiffs in multi-plaintiff lawsuits have been dismissed entirely, either voluntarily or on motion by the Company. The claims of 21 additional persons have been dismissed in part, either voluntarily or on motions by the Company. +Fourteen cases—two single-plaintiff actions and 12 partially dismissed, multi-plaintiff actions—remain pending in the LASC Coordinated Cases. The two single-plaintiff cases have been settled in principle and should be dismissed in the short term. With respect to the 12 multi-plaintiff actions, the claims of only 17 individual plaintiffs remain. Skechers has moved to dismiss the claims of 16 of those 17 individual plaintiffs for violation of court orders and failure to prosecute their claims, and anticipates bringing a similar motion relating to the last individual plaintiff in the near future. No discovery has been taken in any of those actions and no trial dates have been set. If the two settlements are consummated and the 17 individual plaintiffs’ claims are dismissed for failure to prosecute, then there will be no more claims pending LASC Coordinated Cases. +In other state courts, a total of 12 personal injury actions (some on behalf of numerous plaintiffs) have been filed that have not been removed to federal court and transferred to the MDL. All of those actions have been resolved and dismissed. +With respect to the global settlement programs referenced above, the personal injury cases in the MDL and LASC Coordinated Cases and in other state courts were largely solicited and handled by the same plaintiffs law firms. Accordingly, mediations to discuss potential resolution of the various lawsuits brought by these firms were held on May 18, June 18, and July 24, 2015. At the conclusion of those mediations, the parties reached an agreement in principle on a global settlement program that is expected to resolve all or substantially all of the claims by persons represented by those firms. A master settlement agreement was executed as of March 24, 2016 and the parties are in the process of completing individual settlements. To the extent that the settlements with individual claimants are not finalized or otherwise consummated such that the litigation proceeds, it is too early to predict the outcome of any case, whether adverse results in any single case or in the aggregate would have a material adverse impact on our operations or financial position, and whether insurance coverage will be adequate to cover any losses. The settlements have been reached for business purposes in order to end the distraction of litigation, and the Company continues to believe it has meritorious defenses and intends to defend any remaining cases vigorously. In addition, it is too early to predict whether there will be future personal injury cases filed which are not covered by the global settlement program, whether adverse results in any single case or in the aggregate would have a material adverse impact on the Company’s operations or financial position, and whether insurance coverage will be available and/or adequate to cover any losses. +In accordance with U.S. GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2017, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. +(9) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $.001 per share, 75 million shares of Class B Common Stock, par value $.001 per share, and 10 million shares of preferred stock, par value $.001 per share. +During 2017, no Class B Common Stock was converted to Class A Common Stock. During 2016 and 2015, certain Class B stockholders converted 1,733,270 shares and 5,131,296 shares, respectively, of Class B Common Stock to Class A Common Stock (see Note 11 – Earnings Per Share). +61 +(10) +NONCONTROLLI NG INTERESTS +The following VIEs are consolidated into the Company’s consolidated financial statements and the carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics-SKX, LLC +December 31, 2017 +December 31, 2016 +Current assets +$ +1,540 +$ +2,006 +Non-current assets +103,407 +108,668 +Total assets +$ +104,947 +$ +110,674 +Current liabilities +$ +2,718 +$ +2,469 +Non-current liabilities +66,367 +68,168 +Total liabilities +$ +69,085 +$ +70,637 +Distribution joint ventures (1) +December 31, 2017 +December 31, 2016 +Current assets +$ +389,687 +$ +289,227 +Non-current assets +90,972 +49,229 +Total assets +$ +480,659 +$ +338,456 +Current liabilities +$ +188,700 +$ +132,518 +Non-current liabilities +9,201 +2,214 +Total liabilities +$ +197,901 +$ +134,732 +(1) Distribution joint ventures include Skechers Limited (Israel), Skechers China Limited, Skechers Korea Limited, Skechers Southeast Asia Limited, Skechers (Thailand) Limited, Skechers Retail India Private Limited, and Skechers South Asia Private Limited. +The following is a summary of net earnings attributable to, distributions to and contributions from non-controlling interests (in thousands): +Years Ended December 31, +2017 +2016 +2015 +Net earnings attributable to non-controlling +Interests +$ +55,914 +$ +41,866 +$ +29,135 +Distributions to: +HF Logistics-SKX, LLC +3,787 +4,091 +38,092 +Skechers China Limited +20,620 +11,922 +450 +Skechers Southeast Asia Limited +1,347 +1,280 +— +Skechers Hong Kong Limited +199 +451 +— +Contributions from: +India distribution joint ventures +— +2,943 +2,273 +Skechers Korea Co., Ltd. +— +8,273 +— +Skechers Footwear Ltd. (Israel) +46 +2,764 +— +(11) +EARNINGS PER SHARE +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential dilutive common shares using the treasury stock method. +The Company has two classes of issued and outstanding common stock; Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted +62 +net earnings per share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or ent ity who is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating earnings per share (in thousands): +Basic earnings per share +2017 +2016 +2015 +Net earnings attributable to Skechers U.S.A., Inc. +$ +179,190 +$ +243,493 +$ +231,912 +Weighted average common shares outstanding +155,651 +154,169 +152,847 +Basic earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.15 +$ +1.58 +$ +1.52 +Diluted earnings per share +2017 +2016 +2015 +Net earnings attributable to Skechers U.S.A., Inc. +$ +179,190 +$ +243,493 +$ +231,912 +Weighted average common shares outstanding +155,651 +154,169 +152,847 +Dilutive effect of nonvested shares +872 +915 +1,353 +Weighted average common shares outstanding +156,523 +155,084 +154,200 +Diluted earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.14 +$ +1.57 +$ +1.50 +There were 116,762 and 346,912 shares excluded from the computation of diluted earnings per share for the year ended December 31, 2017 and 2016, respectively because they are anti-dilutive. There were no shares excluded from the computation of diluted earnings per share for the year ended December 31, 2015. +(12) +STOCK COMPENSATION +(a) +Incentive Award Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007 and expired pursuant to its terms on May 24, 2017. +On April 17, 2017, the Company’s Board of Directors adopted the 2017 Incentive Award Plan (the “2017 Plan”), which became effective upon approval by the Company’s stockholders on May 23, 2017. The 2017 Plan replaced and superseded in its entirety the 2007 Plan. A total of 10,000,000 shares of Class A Common Stock are reserved for issuance under the 2017 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2017 Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. +63 +A summary of the status and changes of nonvested shares related to the 2007 Plan and the 2017 Plan, as of and for the year ended December 31, 2017 is presented below: +SHARES +WEIGHTED-AVERAGE +GRANT-DATE FAIR VALUE +Nonvested at January 1, 2015 +3,791,499 +$ +14.46 +Granted +40,500 +29.83 +Vested/Released +(1,106,499 +) +11.81 +Nonvested at December 31, 2015 +2,725,500 +15.77 +Granted +1,444,000 +31.69 +Vested/Released +(1,108,336 +) +12.32 +Cancelled +(18,000 +) +17.81 +Nonvested at December 31, 2016 +3,043,164 +24.57 +Granted +495,600 +24.69 +Vested/Released +(1,157,207 +) +20.73 +Cancelled +(78,000 +) +32.62 +Nonvested at December 31, 2017 +2,303,557 +26.25 +As of December 31, 2017, a total of 9,888,500 shares remain available for grant as equity awards under the 2017 Plan. +The Company recognized in the consolidated statements of earnings compensation expense of $28.9 million, $23.1 million and $18.3 million for grants under its stock compensation plans for the years ended December 31, 2017, 2016, and 2015. Related excess income tax benefits of $4.7 million, and $8.0 million for grants under its stock compensation plans for the years ended December 31, 2016, and 2015, respectively, were recorded in additional paid-in capital and $2.6 million of excess tax benefits for the year ended December 31, 2017 was recorded in the statement of earnings. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. There was $39.6 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2017, which is expected to be recognized over a weighted average period of 2.1 years. The total fair value of shares vested during the year ended December 31, 2017 and 2016 was $24.0 million and $13.7 million, respectively. +In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). The updated guidance changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. As of January 1, 2017, the calculation of diluted weighted average shares outstanding was changed prospectively to no longer include excess tax benefits as assumed proceeds. This change did not have a material impact on the Company’s calculation of diluted earnings per share. Additionally, this ASU requires the recognition of excess tax benefits and deficiencies as income tax benefits or expenses in the income statement rather than to additional paid-in capital, which has been applied on a prospective basis to settlements of share-based payment awards occurring on or after January 1, 2017. The Company adopted ASU 2016-09 effective January 1, 2017. The Company recorded a $2.6 million excess tax benefit in the consolidated statement of earnings for the year ended December 31, 2017. +(b) +Stock Purchase Plan +On April 17, 2017, the Company’s Board of Directors adopted the 2018 Employee Stock Purchase Plan (the “2018 ESPP”), which the Company’s stockholders approved on May 23, 2017. The 2018 ESPP will replace the Company’s current employee stock purchase plan, the Skechers U.S.A., Inc. 2008 Employee Stock Purchase Plan (the “2008 ESPP”), which expired pursuant to its terms on January 1, 2018. The 2018 Employee Stock Purchase Plan provides eligible employees of the Company and its subsidiaries with the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85% of the Class A Common Stock’s fair market value on the first trading day or last trading day of each purchase period, whichever is lower. The 2018 ESPP generally provides for two six-month purchase periods every twelve months: June 1 through November 30 and December 1 through May 31, except that the initial purchase period under the 2018 ESPP will have a duration of five months, commencing on January 1, 2018 and ending on May 31, 2018. Eligible employees participating in the 2018 ESPP for a purchase period will be able to invest up to 15% of their compensation through payroll deductions during each purchase period. A total of 5,000,000 shares of Class A Common Stock will be available for sale under the 2018 ESPP. +During 2017, 2016 and 2015, 240,000 shares, 220,844 shares and 223,892 shares were issued under the 2008 ESPP for which the Company received approximately $5.5 million, $5.1 million and $4.3 million, respectively. +64 +( 13) +INCOME TAXES +The provisions for income tax expense (benefit) were as follows (in thousands): +2017 +2016 +2015 +Federal: +Current +$ +110,448 +$ +45,258 +$ +45,095 +Deferred +3,768 +(3,961 +) +2,774 +Total federal +114,216 +41,297 +47,869 +State: +Current +2,747 +3,406 +2,506 +Deferred +(3,356 +) +(49 +) +1,798 +Total state +(609 +) +3,357 +4,304 +Foreign: +Current +40,147 +31,046 +21,204 +Deferred +(4,598 +) +(1,575 +) +(927 +) +Total foreign +35,549 +29,471 +20,277 +Total income taxes (benefit) +$ +149,156 +$ +74,125 +$ +72,450 +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affected the Company’s financial results for the year ended December 31, 2017, including, but not limited to: (1) requiring a one-time Transition Tax (payable over eight years) on certain unrepatriated earnings of foreign subsidiaries; (2) a future reduction of the U.S. federal corporate tax rate from 35% to 21% that reduces the current value of the Company’s deferred tax assets (“DTAs”) and deferred tax liabilities (“DTLs”); and (3) bonus depreciation that allows for full expensing of qualified property place in service after September 27, 2017. In addition, the Tax Act establishes new tax laws that will affect the Company’s financial results for the year ending December 31, 2018, including, but not limited to: (1) a reduction of the U.S. federal corporate tax rate from 35% to 21%; (2) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (3) a new provision designed to tax global intangible low-taxed income (“GILTI”); (4) limitations on the deductibility of certain executive compensation; and (5) limitations on the use of Federal Tax Credit (“FTC’s”) to reduce the U.S. income tax liability. +The SEC staff issued Staff Accounting Bulletin 118, (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under Accounting Standards Codification 740 (“ASC 740”). In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. +In connection with its initial analysis of the impact of the Tax Act, the Company recorded a provisional one-time net tax expense of $99.9 million for the year-ended December 31, 2017. This net tax expense primarily consists of the $1.9 million net tax impact to the Company’s DTA’s from the corporate rate reduction and a net expense for the Transition Tax of $98.0 million. For various reasons that are discussed more fully below, the Company has not completed the accounting for the income tax effects of certain elements of the Tax Act. If the Company were able to make reasonable estimates of the effects of elements for which the analysis is not yet complete, the Company recorded provisional adjustments. +The Company’s accounting for the following elements of the Tax Act is provisional. However, the Company was able to make reasonable estimates of certain effects and, therefore, recorded the following provisional adjustments: +Transition Tax : The Transition Tax is a one-time tax on previously untaxed current and accumulated earnings and profits (“E&P”) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, the Company must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company was able to make a reasonable estimate of the Transition Tax and recorded a provisional Transition Tax liability of $98.0 million. However, during the measurement period the Company will continue to gather additional information to more precisely compute the amount of the Transition Tax. +65 +Reduction of U.S. federal corporate tax rate : The Tax Act reduces the corporate tax rate from 35% to 21%, effective January 1, 2018. As a result, the Company recorded a provisional decrease in value of its net DTAs of $1.9 million, with a corresponding net adjustment to deferred income tax expense of $1.9 million for the year ended December 31, 2017. While the Company was able to make a reasonable estimate of the impact of the reduction in the corporate tax rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, the Company’s calculation of deemed repatriation of deferred foreign income and the state tax effect of adjustments made to federal temporary differences. +Cost recovery : While the Company has completed most of the computations necessary and is in the process of completing a final inventory of its 2017 expenditures that qualify for immediate expensing, the Company recorded a decrease in its current income tax payable of approximately $5.9 million based on the Company’s provisional estimates related to the additional federal expense allowed as a result of the Tax Act. In addition, the Company recorded a corresponding increase in its DTLs of approximately $3.5 million, which is less than the $5.9 million liability amount due to the reduction in the corporate tax rate from 35% to 21%, effective January 1, 2018. The $2.4 million net benefit from the reduction in the future tax rate is included in the $1.9 million decrease in value of the net DTAs discussed above. +The Company’s provision for income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. The Company’s provision for income tax expense (benefit) was calculated using the applicable statutory rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +The Company’s earnings (loss) before income taxes and income tax expense (benefit) for 2017, 2016 and 2015 are as follows (in thousands): +Years Ended December 31, +2017 +2016 +2015 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +25,628 +$ +113,607 +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +Peoples Republic of China (“China”) +95,668 +12,971 +72,584 +11,720 +49,027 +11,084 +Jersey (2) +198,048 +— +146,880 +— +123,721 +— +Non-benefited loss operations (3) +(17,350 +) +3,306 +(16,189 +) +12 +(16,719 +) +164 +Other jurisdictions (4) +82,266 +19,272 +50,620 +17,739 +40,742 +9,029 +Earnings before income taxes +$ +384,260 +$ +149,156 +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +Effective tax rate (5) +38.8 +% +20.6 +% +21.7 +% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the United States Tax Cuts & Jobs Act on December 22, 2017. +(2) Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Macau, Panama and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom. +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2017, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2017, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $ 25.6 million, with income tax expense of $ 113.6 million, which is an average rate of 443 %. The U.S. tax expense includes a provisional one-time tax expense of $99.9 million related to the enactment of the U.S. Tax Cuts & Jobs Act on December 22, 2017. Earnings (loss) before income taxes in non-U.S. jurisdictions were $ 358.6 million, with an aggregate income tax expense of $ 35.5 million, which is an +66 +average rate of 9.9 %. Combined, this results in consolidated earnings before income taxes for the year of $ 384.3 million, and consolidated income tax expense for the period of $ 149.2 million, resulting in an effective tax rate of 38. 8 %. For 2017, of the $ 358.6 million in earnings before income tax earned outside the U.S., $ 198.0 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increase d by $ 51.1 million, or 35 %, to $ 198.0 million in 2017 from $ 146.9 million in 2016 . This increase was primarily attributable to the Company experiencing an increase of $ 435.6 million in net sales in the “Other international” geographic area for 2017 (see Note 18 – Segment and Geograp hic Reporting), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increase s in net sales in the “Other international” geographic area from 2016 to 2017 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $ 17.4 million for which no tax benefit was recognized during the year ended December 31, 2017 because of the provision of offsetting valuation allowances, but in which $3.3 million in nonrefundable withholding and other taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” i n the table above had earnings greater than 5% of the Company’s consolidated earnings (loss) before taxes in any of the years shown. Unremitted earnings of non-U.S. subsidiaries for which no tax has been provided are expected to be reinvested outside of th e U.S. indefinitely. Such earnings could become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2017, the Company had approximately $736.4 million in cash and cash equivalents, of which $391.6 million, or 53.2%, was held outside the U.S. Of the $391.6 million held by the Company’s non-U.S. subsidiaries, approximately $227.5 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s consolidated financial statements as of December 31, 2017. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months and the Company does not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. However, in anticipation of the needs of the Company’s share repurchase program and the need to provide payment of the Company’s provisional Transition Tax liability, the Company plans to begin the repatriation of certain funds held outside the U.S. for which tax has been fully provided as of December 31, 2017. Because of the need for cash for operating capital and continued overseas expansion, the Company also does not foresee the need for any of its foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to U.S. income taxes but may be subject to applicable non‑U.S. income and withholding taxes. As of December 31, 2017, U.S. income taxes have been provided but non-U.S. income taxes have not been provided on cumulative total earnings of $178.8 million. As of December 31, 2016, U.S. and non-U.S. income taxes have not been provided on cumulative total earnings of $699.6 million. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows (in thousands): +2017 +2016 +2015 +Expected income tax expense +$ +134,491 +$ +125,819 +$ +116,724 +State income tax, net of federal benefit +297 +2,335 +2,011 +Rate differential on foreign income +(95,565 +) +(58,508 +) +(44,541 +) +Change in unrecognized tax benefits +1,449 +135 +(2,233 +) +Non-deductible expenses +4,451 +2,330 +(350 +) +Excess tax benefit on share based compensation +(2,571 +) +— +— +U.S. tax rate change +1,923 +— +— +U.S. transition tax +98,015 +— +— +Other +(1,120 +) +575 +285 +Change in valuation allowance +7,786 +1,439 +554 +Total provision (benefit) for income taxes +$ +149,156 +$ +74,125 +$ +72,450 +Effective tax rate +38.8 +% +20.6 +% +21.7 +% +67 +The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2017 and 2016 are presented below (in thousands): +2017 +2016 +Deferred tax assets: +Inventory adjustments +$ +5,375 +$ +6,985 +Accrued expenses +33,984 +29,094 +Allowances for bad debts and chargebacks +3,470 +4,837 +Loss carryforwards +24,308 +20,891 +Business credit carryforward +6,562 +5,031 +Share-based compensation +4,154 +5,993 +Valuation allowance +(27,313 +) +(19,527 +) +Total deferred tax assets +50,540 +53,304 +Deferred tax liabilities: +Prepaid expenses +5,709 +8,422 +Depreciation on property, plant and equipment +15,069 +19,251 +Total deferred tax liabilities +20,778 +27,673 +Net deferred tax assets +$ +29,762 +$ +25,631 +The $7.8 million increase in the valuation allowance primarily relates to current year net operating losses in certain foreign non-benefited loss jurisdictions as discussed above. The Company believes it is more likely than not that the results of future operations in the remaining jurisdictions will generate sufficient taxable income to realize its net deferred tax assets. +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2017 were $6.6 million and $31.3 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2016 were $ 5.0 million and $ 31.7 million, respectively. These tax credit and net operating loss carry-forward amounts do not begin to expire until 2032 and 2025 , respectively. As of December 31, 2017 and 2016, no valuation allowance against the related deferred tax asset have been recorded for these credit and loss and credit carry-forwards as it is believed the carry-forwards will be fully utilized in reducing future taxable income. +As of December 31, 2017 and 2016, the Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $94.9 million and $ 69.4 million, respectively. Some of these net operating losses expire beginning in 2018; however others can be carried forward indefinitely. As of December 31, 2017 and 2016, valuation allowances of $21.4 million and $ 16.7 million, respectively, had been recorded against the related deferred tax assets for those loss carry-forwards that are not more likely than not to be fully utilized in reducing future taxable income. +The balance of unrecognized tax benefits included in prepaid expenses in the consolidated balance sheets increased by $0.8 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2017 +2016 +Beginning balance +$ +6,608 +$ +6,143 +Additions for current year tax positions +1,154 +1,069 +Additions for prior year tax positions +— +138 +Reductions for prior year tax positions +(26 +) +— +Settlement of uncertain tax positions +— +(616 +) +Reductions related to lapse of statute of limitations +(355 +) +(126 +) +Ending balance +$ +7,381 +$ +6,608 +If recognized, $1.6 million of unrecognized tax benefits would be recorded as a reduction in income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax expense and totaled $0.5 million, $ 0.4 million, and $ 0.6 million for the years ended December 31, 2017, 2016, and 2015, respectively. Accrued interest and penalties were $1.5 million and $ 1.1 million as of December 31, 2017 and 2016, respectively. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and +68 +circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are re solved, which may impact the Company’s effective tax rate. +As of December 31, 2017, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2013 , and in several Asian and European tax jurisdictions for years ending on or after December 31, 2007 . During the year, the Company reduced the balance of 2017 and prior year unrecognized tax benefits by $0.4 million as a result of expiring statutes. It is reasonably possible that certain domestic and foreign statutes will expire during the next twelve months which would reduce the balance of 2017 and prior year unrecognized tax benefits by $0.5 million. +The Company is currently under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2017, there was no reduction in the balance of 2017 and prior year unrecognized tax benefits due to settlements of examinations. It is reasonably possible that certain federal, state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2017 and prior year unrecognized tax benefits by $0.9 million. +(14) +EMPLOYEE BENEFIT PLAN +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have completed six months of service. Employees may contribute up to 15.0% of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company made a contribution of $1.6 million to the plan for the year ended December 31, 2017. The Company did not make a contribution to the plan for the years ended December 31, 2016 and 2015, respectively. +In May 2013, the Company established the Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”), which allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees, which will be determined by the Company’s Compensation Committee. The Company made a contribution of $0.2 million to the plan for the year ended December 31, 2017. The Company did not make a contribution to the plan for the year ended December 31, 2016 or 2015, respectively. The value of the deferred compensation is recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred liabilities are presented in the Company’s consolidated balance sheets. +(15) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates a significant portion of its sales in the United States; however, several of its products are sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $206.1 million and $169.4 million before allowances for bad debts and sales returns, and chargebacks at December 31, 2017 and 2016, respectively. Foreign accounts receivable, which are generally collateralized by letters of credit, amounted to $251.0 million and $199.1 million before allowance for bad debts, sales returns, and chargebacks at December 31, 2017 and 2016, respectively. International net sales amounted to $2.109 billion, $1.643 billion and $1.271 billion for the years ended December 31, 2017, 2016 and 2015, respectively. The Company’s credit losses charged to expense for the years ended December 31, 2017, 2016 and 2015 were $12.8 million, $12.7 million and $5.2 million, respectively. In addition, the Company recorded sales return expense for the years ended December 31, 2017, 2016 and 2015 were $5.6 million, $16.9 million and $2.3 million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the United States were $1.273 billion and $1.060 billion at December 31, 2017 and 2016, respectively. +During 2017, 2016 and 2015, no customer accounted for 10.0% or more of net sales. No customer accounted for more than 10% of net trade receivables at December 31, 2017 or 2016. During 2017, 2016 and 2015, net sales to the five largest customers were approximately 10.5%, 11.3% and 14.6%, respectively. +69 +The Company’s top five manufacturers produced the following for the years ended December 31, 2017, 2016 and 2015, respectively: +Percentage of Total Production +Years Ended December 31, +2017 +2016 +2015 +Manufacturer #1 +17.9 +% +22.9 +% +31.5 +% +Manufacturer #2 +11.1 +% +10.1 +% +9.1 +% +Manufacturer #3 +8.8 +% +8.8 +% +7.3 +% +Manufacturer #4 +5.4 +% +4.9 +% +5.0 +% +Manufacturer #5 +4.3 +% +4.3 +% +3.6 +% +47.5 +% +51.0 +% +56.5 +% +The majority of the Company’s products are produced in China and Vietnam. The Company’s operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce these risks by diversifying manufacturing among various factories. To date, these business risks have not had a material adverse impact on the Company’s operations. +(16) +RELATED PARTY TRANSACTIONS +The Company paid approximately $172,000, $111,000, and $180,000 during 2017, 2016 and 2015, respectively, to the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events, including the Company’s 2015 holiday party at the Shade Hotel in Manhattan Beach, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, owns a 12% beneficial ownership interest in MIOC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 5% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable with MIOC, the Shade Hotel in Manhattan Beach at December 31, 2017 or 2016. +The Company paid approximately $201,000 and $110,000 during 2017 and 2016 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, food and events, including the Company’s 2017 and 2016 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg, President and a director of the Company, owns a 5% beneficial ownership interest in RBHC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 3% beneficial ownership in RBHC. The Company had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2017 or 2016. +On July 29, 2010, the Company formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with the Company, and the Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer are also officers and directors of the Foundation. During the year ended December 31, 2017 and 2016, the Company made contributions of $1.0 million to the Foundation in each period. During the year ended December 31, 2015 the Company did not make any contributions to the Foundation. +The Company had receivables from officers and employees of $1.0 million and $0.8 million at December 31, 2017 and 2016, respectively. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +(17) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2017, to assess the need for potential recognition or disclosure in this filing. Based on this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. +70 +( 1 8) +SEGMENT AND GEOGRAPHIC REPORTING +The Company has three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. Management evaluates segment performance based primarily on net sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the Company’s segments. Net sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, and retail segments on a combined basis were as follows (in thousands): +2017 +2016 +2015 +Net sales +Domestic wholesale +$ +1,249,287 +$ +1,199,832 +$ +1,219,779 +International wholesale +1,729,906 +1,391,235 +1,094,395 +Retail +1,184,967 +972,244 +833,149 +Total +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +2017 +2016 +2015 +Gross profit +Domestic wholesale +$ +464,609 +$ +454,088 +$ +471,104 +International wholesale +786,675 +616,110 +454,665 +Retail +687,605 +564,398 +498,239 +Total +$ +1,938,889 +$ +1,634,596 +$ +1,424,008 +2017 +2016 +Identifiable assets +Domestic wholesale +$ +1,259,119 +$ +1,161,719 +International wholesale +1,116,928 +954,874 +Retail +359,035 +277,077 +Total +$ +2,735,082 +$ +2,393,670 +2017 +2016 +2015 +Additions to property, plant and equipment +Domestic wholesale +$ +20,055 +$ +33,677 +$ +38,080 +International wholesale +47,410 +44,286 +37,909 +Retail +68,511 +41,508 +42,155 +Total +$ +135,976 +$ +119,471 +$ +118,144 +71 +Geographic Information +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2017 +2016 +2015 +Net Sales (1) +United States +$ +2,055,475 +$ +1,920,051 +$ +1,876,201 +Canada +160,367 +130,555 +103,268 +Other international (2) +1,948,318 +1,512,705 +1,167,854 +Total +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +2017 +2016 +Property, plant and equipment, net +United States +$ +382,426 +$ +374,459 +Canada +9,888 +10,410 +Other international (2) +149,287 +109,604 +Total +$ +541,601 +$ +494,473 +(1) +The Company has subsidiaries in Asia, Central America, Europe, the Middle East, North America, and South America that generate net sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in Asia that generate net sales from those countries. The Company also has a subsidiary in Switzerland that generates net sales from that country in addition to net sales to distributors located in numerous non-European countries. External net sales are attributable to geographic regions based on the location of each of the Company’s subsidiaries. A subsidiary may earn revenue from external net sales and external royalties, or from inter-subsidiary net sales, royalties, fees and commissions provided in accordance with certain inter-subsidiary agreements. The resulting earnings of each subsidiary in its respective country are recognized under each respective country’s tax code. Inter-subsidiary revenues and expenses subsequently are eliminated in the Company’s consolidated financial statements and are not included as part of the external net sales reported in different geographic areas. +(2) +Other international consists of Asia, Central America, Europe, the Middle East, and South America. +In response to the State Department’s trade restrictions with Sudan and Syria, we do not authorize or permit any distribution or sales of our product in these countries, and we are not aware of any current or past distribution or sales of our product in Sudan or Syria. +72 +(19) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +Summarized unaudited financial data are as follows (in thousands, except per share data): +2017 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 (1) +Net sales +$ +1,072,808 +$ +1,025,934 +$ +1,094,829 +$ +970,589 +Gross profit +476,498 +488,321 +519,987 +454,083 +Net earnings (loss) +106,635 +73,400 +106,830 +(51,761 +) +Net earnings (loss) attributable to Skechers U.S.A., Inc. +93,995 +59,535 +92,310 +(66,650 +) +Net earnings (loss) per share: +Basic +0.61 +0.38 +0.59 +(0.43 +) +Diluted +0.60 +0.38 +0.59 +(0.43 +) +(1) +Fourth quarter 2017 net earnings (loss) includes a provisional one-time tax expense of $99.9 million recorded for our initial analysis of the impact of the Tax Act. +2016 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +978,794 +$ +877,810 +$ +942,417 +$ +764,290 +Gross profit +432,152 +416,254 +429,978 +356,212 +Net earnings +109,639 +84,009 +76,542 +15,169 +Net earnings attributable to Skechers U.S.A., Inc. +97,612 +74,107 +65,110 +6,664 +Net earnings per share: +Basic +0.63 +0.48 +0.42 +0.04 +Diluted +0.63 +0.48 +0.42 +0.04 +73 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOU NTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2017, which is set forth below. +74 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2017. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +75 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company and subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule and our report dated March 1, 2018 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +March 1, 2018 +76 +ITEM 9B. +OTHE R INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 46 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 78 of this annual report on Form 10-K. +3. +Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +77 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years Ended December 31, 2017, 2016, and 2015 +DESCRIPTION +BALANCE AT +BEGINNING OF +YEAR +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF YEAR +Year-ended December 31, 2015 +Allowance for chargebacks +$ +6,551 +$ +3,703 +$ +(3,189 +) +$ +7,065 +Allowance for doubtful accounts +5,441 +1,538 +(1,026 +) +5,953 +Reserve for sales returns and allowances +9,015 +2,279 +(52 +) +11,242 +Reserve for shrinkage +338 +2,014 +(1,945 +) +407 +Reserve for obsolescence +3,001 +10,321 +(10,041 +) +3,281 +Year-ended December 31, 2016 +Allowance for chargebacks +$ +7,065 +$ +10,882 +$ +(6,973 +) +$ +10,974 +Allowance for doubtful accounts +5,953 +1,837 +(2,170 +) +5,620 +Reserve for sales returns and allowances +11,242 +18,101 +(4,290 +) +25,053 +Reserve for shrinkage +407 +2,396 +(2,261 +) +542 +Reserve for obsolescence +3,281 +15,220 +(7,573 +) +10,928 +Year-ended December 31, 2017 +Allowance for chargebacks +$ +10,974 +$ +7,507 +$ +(5,674 +) +$ +12,807 +Allowance for doubtful accounts +5,620 +5,266 +(3,177 +) +7,709 +Reserve for sales returns and allowances +25,053 +5,625 +(14 +) +30,664 +Reserve for shrinkage +542 +2,020 +(825 +) +1,737 +Reserve for obsolescence +10,928 +130 +(4,039 +) +7,019 +See accompanying report of independent registered public accounting firm +78 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +10.1** +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2013). +10.2** +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.2(a)** +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.3** +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.4** +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K for the year ended December 31, 2007). +10.5** +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.6** +Form of Restricted Stock Agreement under 2017 Incentive Award Plan. +10.7** +2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.7(a)** +Amendment No. 1 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2010). +10.7(b)** +Amendment No. 2 to 2008 Employee Stock Purchase Plan (incorporated by reference to exhibit number 3.3 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +10.8** +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.9** +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +79 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.9(a)** +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +10.10 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.11 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.12** +Employment Agreement, executed August 7, 2015, effective as of January 1, 2015, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.12(a)** +Amendment to Employee Agreement dated December 5, 2017, between the Registrant and Michael Greenberg (incorporated by reference to exhibit 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2017) +10.13 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 7, 2015). +10.14 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.14(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.15 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.16 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 27, 2007). +10.16(a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010). +10.16(b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +80 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.17 +Lease Agreement, dated August 12, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.28 of the Registrant’s Form 10-K for the year ended December 31, 2002). +10.17(a) +Addendum to Lease Agreement, dated January 19, 2006, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.17(b) +Addendum 2 to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on May 27, 2008). +10.17(c) +Addendum 3 to Agreement dated June 11, 2013 and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.17(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 27, 2008). +10.18(a) +Addendum 1 to Lease Agreement, dated March 10, 2009, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.18(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(b) +Addendum 2 to Lease Agreement dated December 22, 2009 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(b) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(c) +Addendum 3 to Agreement dated June 11, 2013 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19 +Lease Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center III in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2015). +10.19(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Centers I, II and III in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.20 +Lease Agreement dated July 10, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +81 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.20(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.21 +Lease Agreement dated July 1, 2016 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and Warehouse and Industrial Properties (W.I.P.) SA, regarding Liegistics Park 34, Avenue du Parc Industriel in Milmort, Belgium (incorporated by reference to exhibit number 10.18 of the Registrant’s Form 10-K for the year ended December 31, 2016). +10.22 +Lease Agreement dated November 17, 2015 by and between the Registrant and Omni Manhattan Towers Limited Partnership, regarding 1240 Rosecrans Avenue, Suites 300 and 400, Manhattan Beach, California (incorporated by reference to exhibit number 10.19 of the Registrant’s Form 10-K for the year ended December 31, 2016). +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). +31.2 +Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.LAB +Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +** +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act. +82 +SIGNAT URES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 1st day of March 2018. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +March 1, 2018 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +March 1, 2018 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +March 1, 2018 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +March 1, 2018 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Jeffrey Greenberg +Director +March 1, 2018 +Jeffrey Greenberg +/s/ Geyer Kosinski +Director +March 1, 2018 +Geyer Kosinski +/s/ Morton D. Erlich +Director +March 1, 2018 +Morton D. Erlich +/s/ Richard Siskind +Director +March 1, 2018 +Richard Siskind +/s/ Thomas Walsh +Director +March 1, 2018 +Thomas Walsh +/s/ Rick Rappaport +Director +March 1, 2018 +Rick Rappaport +83 \ No newline at end of file diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/filing_metadata.csv b/raw/filings/0001065837/2017/0001564590-18-004045/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..e1f7e0975abd231a748188c3b8b4e65c9681c8e7 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2018-03-01,2017-12-31,2018-03-01T19:02:04.000Z,0001564590-18-004045,skx-10k_20171231.htm,10-K,12670184,1,0,https://www.sec.gov/Archives/edgar/data/1065837/000156459018004045/skx-10k_20171231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459018004045/,2017,2017,1 diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/item1.txt b/raw/filings/0001065837/2017/0001564590-18-004045/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..30d9171c6b03a5e25b58599cabb0db89793c6ca0 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/item1.txt @@ -0,0 +1,377 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. Our footwear reflects a combination of style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 15, 2018, we owned and operated 117 concept stores, 170 factory outlet stores and 162 warehouse outlet stores in the United States, and 120 concept stores, 67 factory outlet stores, and 9 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2017, the Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television and digital campaigns; marathons and other events for Skechers Performance and BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artists Camila Cabello; sports legends Sugar Ray Leonard, Howie Long, David Ortiz, Tony Romo and Joe Montana; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb, Kara Goucher, and Matt Kuchar; and professional golfers Ashlan Ramsey, Belen Mozo, Brooke Henderson, Billy Andrade and Colin Montgomerie as well as the newly signed Edward Cheserek, who won 17 National Collegiate Athletic Association (“NCAA”) distance titles before graduating from college in 2017. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets running and golf apparel under the Skechers Performance brand. The apparel is primarily available at Skechers ret ail stores, but is also available to domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit and Wide Fit. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials, Gen Y’s and young women, Skecher Street™ Los Angeles delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer +3 +embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest tren ds with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. At the core of the BOBS from Skechers line is its vast collection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home. Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents is donated to Best Friends to help save the lives of dogs and cats in America’s shelters. Skechers has committed to donating at least $3.0 million dollars to Best Friends Animal Society during the promotion period. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 15 million pairs of new kids’ shoes have been donated, including one million pairs in 2017. The charitable shoes are primarily donated to charity partner Delivering Good, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason Collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition features such as Skechers Nite Owl glow-in-the-dark technology or special colorways are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +4 +• +YOU by Skechers ™ . The v ersatile YOU by Skechers ™ footwear collection combines lifestyle with wellness in an eclectic assortment of easy-to-wear and comfortable knitted lace-up and slip-on sneakers for women. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, (v) Lighted footwear, (vi) Game Kicks. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; Elastika by Skechers is a line of girls’ sneakers with bungee closures marketed with the character Elastika; and Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories, featuring S-Lights and rechargeable technology with brands like Energy Lights by Skechers footwear. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features a variety of colors and light. +• +Game Kicks for boys and girls are innovative sneakers with a built-in interactive sound and light memory game that kids can play any time they’re wearing the shoes. Some styles include a remote control operating system. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. The new Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allowing our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2017, five of our contract manufacturers accounted for approximately 47.5% of total purchases. One manufacturer accounted for 17.9%, and another accounted for 11.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued +6 +after a lim ited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze h istorical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high s ell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 367-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by digital, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. Through our performance-inspired and image-driven advertising, we generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2017, our Skechers lifestyle endorsees included Camila Cabello, Brooke Burke-Charvet, Kelly Brook, Joe Montana, Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo. Our Skechers Performance Division 2017 endorsees included elite runner and Olympic medalist Meb, elite runners Kara Goucher and Edward Cheserek, and professional golfers Matt Kuchar, Belen Mozo, Brooke Henderson, Ashlan Ramsey, Billy Andrade and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including Korean pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications in the United States and around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2017, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also have commercials for our performance lines that feature elite athletes, and for our lifestyle lines that feature musicians, actors and retired athletes. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2017, many of our television commercials were translated into multiple languages and aired in numerous markets around the world. Further, select markets have created television commercials specific to their market with local celebrities, and many international Skechers teams have translated our television commercials and aired in their markets around the world. +7 +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outd oor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. I n addition, we advertised on perimeter boards at soccer matches and professional sporting events in Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key fashion and lifestyle magazines and television shows, and place our footwear on the feet of trend-setting influencers, celebrities and their families. We have been featured on leading business shows with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers, bloggers and vloggers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, Pinterest and Snapchat in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers ® , Skechers Performance™, Skecher Street™ and Mark Nason. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2017, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2017, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of The Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM and ISPO in Europe; and many other international shows. Our state-of-the-art trade show exhibits showcase our latest product offerings in a setting reflective of each of our brands. +Digital. In 2017, we launched marketing campaigns on YouTube, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +8 +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 46 licensees have opened and operate 616 distributor-owned or -licensed Skechers retail stores and 1,047 licensee-owned Skechers retail stores, respectively, in over 170 countries as of December 31, 2017. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. In 2015, we upgraded the technologies in many of our stores, providing visibility to our merchandise in other stores and at our distribution center in order to better serve our customers with an omni-channel approach to sales. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2018, we owned and operated 117 concept stores, 170 factory outlet stores and 162 warehouse outlet stores in the United States, and 120 concept stores, 67 factory outlet stores, and 9 warehouse outlet stores internationally. We plan to open 75 to 85 new stores in 2018. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop +9 +open-floor setting, providing the customer with the complete Skechers story. Second, retai l locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, Union Square, Westfield W orld Trade Center, and 34 th Street, in New York; Powell Street in San Francisco: Hollywood and Highland in Hollywood; Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; and Las Vegas’ Grand Canal Shoppes at the Venetian and Fashion Show Mal l. International locations include Westfield London and Westfield Stratford in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such res ponses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 2,500 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers throughout the United States. In addition, we have 67 international factory outlet stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,300 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2016 +Opened during 2017 +Closed during 2017 +Number of Store Locations December 31, 2017 +Domestic stores +Concept +117 +5 +(5 +) +117 +Factory Outlet +163 +7 +— +170 +Warehouse Outlet +133 +29 +— +162 +Domestic stores total +413 +41 +(5 +) +449 +International stores +Concept +101 +19 +— +120 +Factory Outlet +51 +16 +— +67 +Warehouse Outlet +5 +4 +— +9 +International stores total +157 +39 +— +196 +Joint venture stores +China Concept +68 +19 +(32 +) +55 +China Factory Outlet +28 +44 +(2 +) +70 +Hong Kong Concept +37 +3 +(4 +) +36 +Hong Kong Outlet +3 +4 +(3 +) +4 +India Concept +34 +11 +(1 +) +44 +India Outlet +1 +2 +(1 +) +2 +Israel Concept +6 +1 +— +7 +South Korea Concept +3 +3 +— +6 +South Korea Outlet +11 +2 +(2 +) +11 +South East Asia Concept +19 +4 +(1 +) +22 +South East Asia Outlet +2 +3 +— +5 +Joint venture stores total +212 +96 +(46 +) +262 +Total domestic, international and joint +venture stores +782 +176 +(51 +) +907 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungry as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +11 +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +12 +• Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2017, we also had agreements with 18 of these distributors and 46 licensees regarding 616 distributor-owned or -licensed Skechers retail stores and 1,047 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations December 31, 2016 +Opened during 2017 +Closed during 2017 +Number of Store Locations December 31, 2017 +Distributor, licensee and franchise stores +Africa Concept +37 +10 +(1 +) +46 +Asia Concept +601 +252 +(99 +) +754 +Asia Factory Outlet +157 +189 +(12 +) +334 +Australasia Concept +48 +12 +— +60 +Australasia Outlet +13 +2 +— +15 +Central America Concept +5 +2 +— +7 +Europe Concept +142 +50 +(18 +) +174 +Europe Factory Outlet +8 +7 +— +15 +Middle East Concept +118 +32 +(2 +) +148 +Middle East Factory Outlet +4 +— +— +4 +North America Concept +58 +6 +— +64 +North America Factory Outlet +16 +1 +— +17 +South America Concept +22 +3 +— +25 +Total distributor, licensee and franchise stores +1,229 +566 +(132 +) +1,663 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 18 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2018, we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded bags, backpacks and lunch boxes; belts, wallets and watches; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; and bicycles and safety gear. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks, lunchboxes, do-it-yourself fashion kits, sunglasses and hair accessories; and Skechers Work socks. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in the United Kingdom and Indonesia; socks throughout Europe; bags and backpacks in the Philippines, Taiwan, Indonesia, Australia, New Zealand, Europe and the Middle East; apparel, socks, bags, backpacks and luggage in Mexico; bags, backpacks, apparel, watches and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 133 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, +14 +Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in techn ology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and others includin g, Payless Holdings, and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displa ying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong bran d recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2018, we employed approximately 11,800 persons, of whom approximately 4,500 were employed on a full-time basis and approximately 7,300 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. \ No newline at end of file diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/item13.txt b/raw/filings/0001065837/2017/0001564590-18-004045/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..47d49986959a6eee1a9c35359bc9140e1976a0b7 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2017 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/item9a.txt b/raw/filings/0001065837/2017/0001564590-18-004045/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..1bd85a74beabb1ce6a4e67afc188fdcf46664369 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/item9a.txt @@ -0,0 +1,38 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2017, which is set forth below. +74 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2017. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +75 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company and subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule and our report dated March 1, 2018 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +March 1, 2018 +76 \ No newline at end of file diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/rp_note.txt b/raw/filings/0001065837/2017/0001564590-18-004045/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2017/0001564590-18-004045/rpt_disclosure.txt b/raw/filings/0001065837/2017/0001564590-18-004045/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..1cdeb0d3a51e820081e9fd3c165d34a79ff26eb1 --- /dev/null +++ b/raw/filings/0001065837/2017/0001564590-18-004045/rpt_disclosure.txt @@ -0,0 +1,43 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in +our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the +avoidance of conflicts of interest (which is discussed in our Code of Business Conduct and Ethics), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and +(iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of +March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will +or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten +percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy +statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A or Class B Common Stock or +(c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as +transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related +Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction shall be considered and, if the Committee determines it to be appropriate, +ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an +unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member shall participate in any discussion or approval of a transaction with a Related +Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and +assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The +following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2018. Each of these transactions was reviewed, and approved or ratified by the Audit +Committee, pursuant to the policies and procedures discussed herein. +41 +Related Person Transactions +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our +Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg has agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for an +additional year with the same terms and conditions effective as of February 1, 2019. +We paid $80,000 in 2018 to the Manhattan Inn +Operating Company, LLC (“MIOC”) for lodging, food and events at the Shade Hotel in Manhattan Beach, which is owned and operated by MIOC. Michael Greenberg, our President and a director of Skechers, owns a 12% beneficial ownership interest +in MIOC, and three other officers, directors and senior vice presidents of Skechers own in aggregate an additional 5% beneficial ownership in MIOC. Skechers had no outstanding accounts receivable or payable with MIOC or the Shade Hotel in Manhattan +Beach at December 31, 2018. +We paid $167,000 in 2018 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, +food and events, including the Company’s 2018 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg owns a 5% beneficial ownership interest in RBHC, and three other officers, directors and +senior vice presidents of Skechers own in aggregate an additional 3% beneficial ownership in RBHC. Skechers had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2018. +In October 2018, following an appraisal by an independent valuation firm, we sold real property located in Manhattan Beach to Michael +Greenberg for $5,118,000. +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, +Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2018, we made contributions of $1,000,000 to the Foundation. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the +siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $349,842, $3,276,757, $2,738,616 and $357,312, respectively, in 2018. Jeffrey Greenberg was also a +member of our Board of Directors in 2018, but did not earn any additional compensation for services provided as a director. +Andrew +Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $363,422 and $190,332, respectively, in 2018. \ No newline at end of file diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/filing.txt b/raw/filings/0001065837/2018/0001564590-19-005775/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..8f23d8896c9cef177d4d5dfed9d82dfc0176ae1a --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/filing.txt @@ -0,0 +1,4016 @@ +10-K +1 +skx-10k_20181231.htm +10-K +skx-10k_20181231.htm +Flicensint +c +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2018 +OR +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact Name of Registrant as Specified in Its Charter) +Delaware +95-4376145 +(State or Other Jurisdiction of +Incorporation or Organization) +(I.R.S. Employer +Identification No.) +228 Manhattan Beach Blvd., Manhattan Beach, California +90266 +(Address of Principal Executive Offices) +(Zip Code) +Registrant’s telephone number, including area code: (310) 318-3100 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class +Name of Each Exchange on Which Registered +Class A Common Stock, $0.001 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: +None +(Title of Class ) +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐ +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2018, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the Registrant was approximately $4.0 billion based upon the closing price of $30.01 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2019: 133,460,317. +The number of shares of Class B Common Stock outstanding as of February 15, 2019: 23,983,312. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2019 Annual Meeting of the Stockholders of the Registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended DECEMBER 31, 2018 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +15 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +24 +ITEM 2. +PROPERTIES +24 +ITEM 3. +LEGAL PROCEEDINGS +24 +ITEM 4. +MINE SAFETY DISCLOSURES +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +27 +ITEM 6. +SELECTED FINANCIAL DATA +29 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +30 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +45 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +46 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +75 +ITEM 9A. +CONTROLS AND PROCEDURES +75 +ITEM 9B. +OTHER INFORMATION +78 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +78 +ITEM 11. +EXECUTIVE COMPENSATION +78 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +78 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +78 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +78 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +79 +ITEM 16. +FORM 10-K SUMMARY +79 +This annual report includes our trademarks including Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , You by Skechers™, ® , ® , ® , Skechers Cali ™ , Relaxed Fit ® , Skecher Street™ , D’Lites ® , DLT-A™, Skechers Memory Foam™, BOBS ® , Energy Lights ® , and Twinkle Toes ® , each of which is our property. This report contains additional trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected 2019 operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +• +global economic, political and market conditions including the challenging consumer retail market in the United States; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; and +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. Our footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 1, 2019, we owned and operated 113 concept stores, 170 factory outlet stores and 187 warehouse outlet stores in the United States, and 134 concept stores, 78 factory outlet stores, and 10 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2018, the Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television and digital campaigns; marathons and other events for Skechers Performance and BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artists Camila Cabello; sports legends Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb Keflezighi, Kara Goucher, and Matt Kuchar; and professional golfers Ashlan Ramsey, Belen Mozo, Brooke Henderson, Russell Knox, Wesley Bryan, Billy Andrade, Colin Montgomerie and Edward Cheserek, who won 17 National Collegiate Athletic Association (“NCAA”) distance running titles. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets running and golf apparel under the Skechers Performance brand, as well as casual lifestyle apparel under the Skechers and BOBS brand s. The apparel is primarily available at Skechers retail stores, but is also available to domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. Collaborations of our fashion collections like Skechers D’Lites X One Piece that features colorways from the popular manga series help generate buzz and expand awareness the brand. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +3 +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials, Gen Y’s and young women, Skecher Street™ Los Ang eles delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest trends with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. At the core of the BOBS from Skechers line is its vast collection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home. Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents was donated to Best Friends to help save the lives of dogs and cats in America’s shelters totaling more than $3.9 million dollars to Best Friends Animal Society. This helped more than 583,000 shelter pets in the United States, including saving the lives of more than 241,000 animals. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 15.6 million pairs of new kids’ shoes have been donated, including approximately 395,000 pairs in 2018. The charitable shoes are primarily donated to charity partner Delivering Good, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition features such as Skechers Nite Owl glow-in-the-dark technology or special colorways are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb Keflezighi. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +4 +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +• +YOU by Skechers ™ . The versatile YOU by Skechers ™ footwear collection combines lifestyle with wellness in an eclectic assortment of easy-to-wear and comfortable knitted lace-up and slip-on sneakers for women. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, and (v) Lighted footwear. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; and Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories, featuring S-Lights and rechargeable technology with brands like Energy Lights by Skechers footwear. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features a variety of colors and light. Luminators feature an innovative illuminated mesh fabric upper for a bolder look. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. The Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allow our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2018, five of our contract manufacturers accounted for approximately 41.9% of total purchases. One manufacturer accounted for 12.8%, and another accounted for 10.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +6 +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are h ighlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develo p an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 343-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by digital, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. We generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2018, our Skechers lifestyle endorsees included Camila Cabello, Brooke Burke-Charvet, Kelly Brook, Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo. Our Skechers Performance Division 2018 endorsees included elite runner and Olympic medalist Meb Kelfezighi, elite runners Kara Goucher and Edward Cheserek, and professional golfers Matt Kuchar, Belen Mozo, Brooke Henderson, Ashlan Ramsey, Billy Andrade, Russell Knox, Wesley Bryan and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications in the United States and around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2018, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also had commercials for our golf collection lines that featured our elite golfers, and for our lifestyle lines that feature musicians, actors and retired athletes. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2018, many of our television commercials were translated into multiple languages and aired in numerous markets around the world. Further, select markets have created television commercials specific to their market with local celebrities. +7 +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include ma ll and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on peri meter boards at soccer matches and professional sporting events in Japan, Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key magazines and television shows, and place our footwear on the feet of trend-setting influencers, celebrities and their families. We have been featured in leading business publications with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers, bloggers and vloggers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, and YouTube in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers ® , Skechers Performance™, BOBS from Skechers and Mark Nason. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Line in Japan and Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2018, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2018, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of the Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM, Gallery and ISPO in Europe; and other international shows. +Digital. In 2018, we launched marketing campaigns on YouTube, Facebook and Instagram, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +8 +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 48 licensees have opened and operate 700 distributor-owned or -licensed Skechers retail stores and 1,813 licensee-owned Skechers retail stores, respectively, in over 170 countries as of December 31, 2018. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2019, we owned and operated 113 concept stores, 170 factory outlet stores and 187 warehouse outlet stores in the United States, and 134 concept stores, 78 factory outlet stores, and 10 warehouse outlet stores internationally. We plan to open 70 to 80 new stores in 2019. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +9 +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, SOHO, and 34 th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the United States and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,800 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2017 +Opened during 2018 +Closed during 2018 +Number of Store Locations December 31, 2018 +Domestic stores +Concept +117 +1 +(4 +) +114 +Factory Outlet +170 +1 +— +171 +Warehouse Outlet +162 +23 +— +185 +Domestic stores total +449 +25 +(4 +) +470 +International stores +Concept +120 +14 +— +134 +Factory Outlet +67 +11 +— +78 +Warehouse Outlet +9 +1 +— +10 +International stores total +196 +26 +— +222 +Joint venture stores +China Concept +55 +21 +(13 +) +63 +China Factory Outlet +70 +12 +(14 +) +68 +Hong Kong Concept +36 +6 +(3 +) +39 +Hong Kong Outlet +4 +— +— +4 +India Concept +44 +13 +— +57 +India Outlet +2 +2 +— +4 +Israel Concept +7 +3 +— +10 +Israel Outlet +— +2 +— +2 +South Korea Concept +6 +4 +(5 +) +5 +South Korea Outlet +11 +11 +(5 +) +17 +South East Asia Concept +22 +1 +(2 +) +21 +South East Asia Outlet +5 +2 +— +7 +Joint venture stores total +262 +77 +(42 +) +297 +Total domestic, international and joint +venture stores +907 +128 +(46 +) +989 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +11 +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have company-owned retail stores in key locations across Canada. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Bogota, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. In 2019, we entered into an agreement to purchase the minority interest in our India joint venture that we did not own for $82.5 million which will make our India joint venture a wholly owned subsidiary. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +12 +• Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 22 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2018, we also had agreements with 18 of these distributors and 48 licensees regarding 700 distributor-owned or licensed Skechers retail stores and 1,813 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations December 31, 2017 +Opened during 2018 +Closed during 2018 +Number of Store Locations December 31, 2018 +Distributor, licensee and franchise stores +Africa Concept +46 +8 +(9 +) +45 +Africa Outlet +— +1 +— +1 +Asia Concept +754 +261 +(67 +) +948 +Asia Factory Outlet +334 +105 +(39 +) +400 +Australasia Concept +60 +7 +— +67 +Australasia Outlet +15 +5 +— +20 +Central America Concept +7 +2 +— +9 +Europe Concept +174 +75 +(43 +) +206 +Europe Factory Outlet +15 +10 +— +25 +Middle East Concept +148 +10 +(2 +) +156 +Middle East Factory Outlet +4 +— +— +4 +North America Concept +64 +5 +— +69 +North America Factory Outlet +17 +— +— +17 +South America Concept +25 +4 +— +29 +Total distributor, licensee and franchise stores +1,663 +493 +(160 +) +1,996 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 19 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2019, we had 22 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and watches; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness, yoga and running accessories; consumer electronics; bicycles and safety gear and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks, lunchboxes, do-it-yourself fashion kits, sunglasses and hair accessories; and Skechers Work socks. We also have BOBS for DOGS pet accessories in Petco. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in the United Kingdom; socks throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe and the Middle East; apparel, socks, headwear, bags, backpacks in Indonesia; apparel, socks, bags in Mexico; bags, backpacks, luggage, wallets, apparel, watches, medical scrubs and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 139 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The +14 +intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in o ur operations. Our children’s shoes compete with footwear offered by these companies and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, p rice, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distribut ors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2019, we employed approximately 12,600 persons, of whom approximately 5,400 were employed on a full-time basis and approximately 7,200 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal +15 +markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our net sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale sales during 2018 or 2017. However, this may change in the future, and fluctuations in sales of any style representing a significant portion of our future net sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state, including the challenging consumer retail market in the United States, continues to negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of net sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product +16 +by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deter iorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +We Depend Upon A Relatively Small Group Of Customers For A Portion Of Our Sales. +During 2018, 2017 and 2016, our net sales to our five largest customers accounted for approximately 10.4%, 10.5% and 11.3% of total net sales, respectively. No customer accounted for more than 10.0% of our net sales during 2018, 2017 and 2016. No customer accounted for more than 10.0% of trade receivables at December 31, 2018 and 2017. These customers are primarily retailers who also distribute products for our competitors. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +We May Experience Losses Because Of The Inability To Collect Accounts Receivable If Our Customers Are Unable To Pay Their Debts To Us When Due. +We rely on our network of domestic and international wholesale customers, comprised of department, athletic and specialty stores and online retailers, to distribute our products. Certain of our wholesale customers may from time to time experience bankruptcy, insolvency, and/or an inability to pay their debts to us as they come due. If our wholesale customers suffer significant financial difficulty, they may be unable to pay their debts to us timely or at all, which could have a material adverse effect on our results of operations. It is possible that wholesale customers may contest their contractual obligations to us under bankruptcy laws or otherwise. Significant customer bankruptcies could further adversely affect our net sales and increase our operating expenses by requiring larger accruals for bad debt expense. In addition, even when our contracts with these customers are not contested, if customers are unable to meet their obligations on a timely basis, it could adversely affect our ability to collect receivables. Further, we may have to negotiate significant discounts and/or extended financing terms with these customers in such a situation. If we are unable to collect upon our accounts receivable as they come due in an efficient and timely manner, our business, financial condition, or results of operations may be materially adversely affected. We also face risk from international customers that file for bankruptcy protection in foreign jurisdictions, as the application of foreign bankruptcy laws may be more difficult to predict. Although we believe that we have sufficient reserves to cover anticipated customer bankruptcies, there can be no assurance that such reserves will be adequate, and if they are not adequate, our business, cash flows, operating results and financial condition would be adversely affected. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory and personnel. We have also made substantial operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to e-commerce and mobile channels, and our ability to effectively develop our e-commerce and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position and cash flows. +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders in the past, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest domestic sales generally occurring in our second and third quarters for the back-to-school selling season. Domestically, back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers +17 +could negatively impact our net sales and results of operations for our se cond or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels ar e partially based on our expectations of future net sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for our company, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars in which the cost of those products will vary depending on the foreign currency rates and will impact the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency rates. Although we typically work to mitigate this negative foreign currency transaction impact through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +Recent U.S. Tax Legislation May Materially Adversely Affect Our Financial Condition, Results of Operations and Cash Flows. +U.S. tax legislation enacted at the end of 2017 has significantly changed the U.S. federal income taxation of U.S. corporations, by reducing the U.S. corporate income tax rate, permitting immediate expensing of certain capital expenditures, adopting elements of a territorial tax system, imposing a one-time transition tax (“Transition Tax”) on all undistributed earnings and profits of certain U.S.-owned foreign corporations, revising the rules governing foreign tax credits, and introducing new anti-base-erosion provisions. Many of these changes were effective immediately, without any transition periods or grandfathering for existing transactions. The legislation is unclear in many respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementing regulations by the U.S. Treasury Department (“Treasury”) and U.S. Internal Revenue Service (“IRS”), any of which could lessen or increase certain adverse impacts of the legislation. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities. +While some of the changes made by the tax legislation may adversely affect the Company in one or more reporting periods and prospectively, other changes may be beneficial on a going forward basis. +An Increase In Our Effective Tax Rate Could Have A Material Adverse Effect On Our Results Of Operations And Financial Position. +A significant amount of our foreign earnings are generated in low or zero tax jurisdictions. As a result, our income tax expense has historically been lower than the tax computed at the U.S. statutory income tax rate. Our future effective tax rates could be unfavorably affected by a number of factors, including but not limited to, changes in the tax rates or the tax rules and regulations (including rules and regulations related to recently enacted U.S. tax legislation), or in the interpretation thereof, in the jurisdictions in which we do business; decreases in the amount of earnings in countries with low statutory tax rates; increases in the amount of earnings in countries with high statutory tax rates; or if we need to make significant taxable distributions of foreign earnings for which +18 +foreign taxes have not been provided. An increase in our effective tax rate could have a material adverse effect on our business, results of operations, financial position and cash flows. +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether there may be unfavorable changes in tax laws in the United States or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our net sales during the year ended December 31, 2018, were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the Communist Party of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +19 +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During 2018 and 2017, the top five manufacturers of our products produced approximately 41.9% and 47.5% of our total purchases, respectively. One manufacturer accounted for 12.8% and 17.9% of total purchases during 2018 and 2017, respectively. Another manufacturer accounted for 10.1% and 11.1% of our total purchases during 2018 and 2017, respectively. We do not have long-term contracts with manufacturers, and we compete with other footwear companies for production facilities. We could experience difficulties with these manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet production deadlines, or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries, or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business. +If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards, or higher lead times for delivery. If we are unable to provide products consistent with our standards, or the manufacture of our footwear is delayed or becomes more expensive, our business would be harmed. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistic and distribution systems include computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all of our products are distributed from a few key locations. Therefore, our operations could be interrupted by earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the adverse effects that could be caused by significant disruptions affecting our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of products to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our reputation in the United States, or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +20 +In addition, some or a substantial number of new stores could be opened in regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and res ults of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced net sales volumes in existing stores in those markets. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability our company may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Sport ® , Skechers USA ® , D’Lites ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Hyper Burst™, You by Skechers ® , ® , ® , ® , Skechers Cali ® , Relaxed Fit ® , Skecher Street ® , Air-Cooled Memory Foam ® , Skechers Memory Foam ™ , Skech-Air ® , BOBS ® , Energy Lights ® , S-Lights ® and Twinkle Toes ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the United States, and if we are +21 +unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condit ion could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, in particular, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2018, a substantial portion of our operations are located in California, including 99 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our net sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wild fire affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Two Principal Stockholders Are Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2018, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 77.0% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 13.4% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 30.6% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2018, Mr. Greenberg beneficially owned 35.9% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 45.1% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 19.7% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and +22 +operations. As a result of such influence, certain transactions are not likely without the approval of Mess rs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to substantially control or significantly influence, respectively, actions requiring stockholder approval , may result in our company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchase r view the superior voting rights of our Class B common shares to have value . +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +23 +ITEM 1B. +UNRESOLVE D STAFF COMME NTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Manhattan Beach, California, which consist of an aggregate of approximately 188,000 square feet. We own and lease portions of our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The lease for this facility expires in November 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is consolidated in our financial statements. +Our European Distribution Center occupies approximately 1.3 million square feet in Liege, Belgium under five operating leases, with base rents of approximately $5.5 million per year. These leases provide for original terms of 10-15 years, commencing between January 2016 and June 2016, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring between August 2019 and October 2033. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $103.6 million for the year ended December 31, 2018. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates between March 2019 and March 2029. Total base rent for the leased properties aggregated approximately $113.9 million for the year ended December 31, 2018. +ITEM 3. +LEGAL PROCEEDINGS +Converse, Inc. v. Skechers U.S.A., Inc. – On October 14, 2014, Converse filed an action against our company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014‑24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his interim decision finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and Bobs Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued a ruling affirming that Skechers Twinkle Toes and Bobs canvas shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bobs canvas shoes do not infringe. On June 26, 2017, we filed our responsive brief, on February 8, 2018 the court heard oral argument, and on June 7, 2018 the Court requested supplemental briefing on certain issues. On October 30, 2018, the United States Court of Appeals for the Federal Circuit vacated the ITC’s ruling and remanded the matter back to the ITC for further proceedings. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +24 +Nike, Inc. v. Skechers USA, Inc. – On January 4, 2016, Nike filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv -0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, disgorgemen t of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. In April and May, 2016, we filed petitions with the United States Patent and Trademark Office’s Patent Trial and Appeal Board ( the “PTAB”) for inter partes review of all eight design patents, seeking to invalidate those patents. In September and November 2016, the Patent Trial and Appeal Board denied each of our petitions. On January 6, 2017, we filed several additional petitions for inter partes review with the PTAB, seeking to invalidate seven of the eight designs patents that Nike is asserting. In July 2017, we were notified that the PTAB granted our petitions and instituted inter partes review proceedings with respect to two of the seven design patents but denied our petitions as to the others. In June 2017, we filed a motion to transfer venue from the District of Oregon to the Central District of California based on a recent United States Supreme Court decision and the motion w as granted in late 2017. On June 28, 2018, the PTAB issued final decisions in the two inter partes review proceedings, rejecting the invalidity challenges made by our company in those proceedings. On June 4, 2018, the Court, over Nike’s opposition, grante d our request for a claim construction hearing. A claim construction hearing was held on August 28, 2018 and we are currently waiting for a ruling. While it is too early to predict the outcome of the case or whether an adverse result would have a materi al adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Steamfitters Local 449 Pension Plan v. Skechers USA, Inc., Robert Greenberg and David Weinberg. – On October 20, 2017, the Steamfitters Local 449 Pension Plan filed a securities class action, on behalf of itself and purportedly on behalf of other shareholders who purchased Skechers stock in a five-month period in 2015, against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:17-cv-08107. On April 4, 2018, the plaintiffs filed an amended and consolidated complaint and on July 24, 2018 plaintiffs filed a second amended and consolidated complaint. The lawsuit alleges that, between April 23 and October 22, 2015, we made materially false statements or omissions of material fact about the anticipated performance of our Domestic Wholesale segment and asserts claims for unspecified damages, attorneys' fees and equitable relief based on two counts for alleged violations of federal securities laws. On November 21, 2018 we filed a motion to dismiss. On January 10, 2019 plaintiffs filed an opposition and on February 11, 2019 we filed a reply. There is no date set for the hearing. Given the early stage of this proceeding and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. We believe we have meritorious defenses and intend to defend this matter vigorously. +In Re Skechers Securities Litigation (formerly Laborers Local 235 Benefit Fund v. Skechers USA, Inc. Robert Greenberg, David Weinberg and John Vandemore) – On September 4, 2018, Laborers Local 235 Benefit Fund filed a securities class action on behalf of itself and purportedly on behalf of other shareholders who purchased the company’s stock between October 20, 2017 and July 19, 2018 (the “Class Period”), against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:18-cv-8039 . The complaint alleges that throughout the Class Period we made materially false statements or omissions of material fact regarding our sales growth and controlling expenses in an effort to artificially inflate the price of our stock for the personal gain of the Company’s founding family. Beginning October 17, 2018, copycat cases were filed and on January 22, 2019 a consolidated amended class action complaint was filed as In Re Skechers Securities Litigation . Given the early stages of these proceedings and the limited information available, we cannot predict the outcome of these legal proceedings or whether an adverse result in these cases would have a material adverse impact on our operations or financial position. We believe we have meritorious defenses and intend to defend these matters vigorously. +Kathleen Houseman v. Robert Greenberg, et al. – On November 27, 2018, the Company, the Board of Directors and CFO John Vandemore were sued by a shareholder and the Company in a derivative action in the United States District Court for the District of Delaware, Case No 1:18tc222. The complaint is based largely on the same underlying factual allegations as In Re Skechers Securities Litigation . By mutual agreement of the parties this case has been stayed pending the outcome of In Re Skechers Securities Litigation. We believe we have meritorious defenses and intend to defend this matter vigorously. Notwithstanding, given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. +Jesse Chen v. Robert Greenberg, et al. – On January 16, 2019, the Company, the Board of Directors and CFO John Vandemore were sued by a shareholder and the Company in a derivative action in the Superior Court for the State of California for the County of Los Angeles, Case No.19-STC-CV00393. The complaint mirrors the Houseman case, supra, and based largely on the same underlying factual allegations as In Re Skechers Securities Litigation . By mutual agreement of the parties this case has been stayed pending the outcome of In Re Skechers Securities Litigation. We believe we have meritorious defenses and intend to defend this matter vigorously. Notwithstanding, given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our operations or financial position. +25 +Yolanda Zuniga v. Team One Employment Specialists, LLC, Skechers USA, Inc., Dolores Carte et al. – On December 20, 2017, our company was named as a defendant in an action filed by a former emp loyee named Yolanda Zuniga in the Superior Court of California, County of Riverside, Case No. RIC 1723878, alleging discrimination, harassment, retaliation, violation of the Family Medical Leave Act/California Family Rights Act, breach of contract and wron gful termination, among other causes of action, and seeking compensatory damages, punitive and exemplary damages, and attorneys’ fees. This case was stayed pending the outcome of an arbitration between the parties involving identical claims. This case has been settled and the settlement funded by a co-defendant. The settlement did not have a material adverse impact on our operations or financial position. +Ealeen Wilk v. Skechers U.S.A., Inc . – On September 10, 2018, Ealeen Wilk filed a putative class action lawsuit against our company in the United States District Court for the Central District of California, Case No. 5:18-cv-01921, alleging violations of the California Labor Code, including unpaid overtime, unpaid wages due upon termination and unfair business practices. The complaint seeks actual, compensatory, special and general damages; penalties and liquidated damages; restitutionary and injunctive relief; attorneys’ fees and costs; and interest as permitted by law. While it is too early to predict the outcome of the litigation or a reasonable range of potential losses and whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe that we have meritorious defenses, vehemently deny the allegations, and intend to defend the case vigorously. +In addition to the matters included in its reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +26 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” +HOLDERS +As of February 1, 2019, there were 88 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 36 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Share Repurchase Program +On February 6, 2018, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share (“Class A common stock”), for an aggregate repurchase price not to exceed $150 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A common stock and the program may be suspended or discontinued at any time. +ISSUER PURCHASES OF EQUITY SECURITIES +The table below summarizes the number of shares of our Class A Common Stock that were repurchased during the three months ended December 31, 2018. +Month Ended +Total Number of Shares +Purchased (1) (2) +Average Price Paid Per Share +Total Number of Shares Purchased from Certain Employees (1) +Total Number of Shares Purchased under the Share Repurchase Program (2) +Maximum Dollar Value of Shares that May Yet Be Purchased under the Program +October 31, 2018 +133,945 +$ +27.25 +— +133,945 +$ +88,322,000 +November 30, 2018 +648,935 +$ +27.95 +96,200 +552,735 +72,964,000 +December 31, 2018 +976,947 +$ +23.49 +513 +976,434 +50,023,000 +Total +1,759,827 +$ +25.42 +96,713 +1,663,114 +$ +50,023,000 +(1) +The Company repurchased 96,713 shares from certain employees to facilitate income tax withholding payments pertaining to restricted stock awards that vested during the three months ended December 31, 2018. Such shares were not repurchased pursuant to a publicly announced plan or program. +(2) +As announced on February 6, 2018, the Board of Directors of the Company has approved a share repurchase program, authorizing the repurchase of up to an aggregate of $150.0 million of the Company’s Class A common stock. The program allows the Company to repurchase shares of Class A common stock from time to time for cash in the open market or privately negotiated transactions or other transactions, as market and business conditions warrant and subject to applicable legal requirements. The share repurchase program does not obligate the Company to repurchase any particular amount of common stock, and it could be modified, suspended or discontinued at any time. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +27 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our company’s Class A Common Stock from December 31, 2013 to December 31, 2018, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2013 in each of our company’s Class A Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our company’s Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +12/13 +12/14 +12/15 +12/16 +12/17 +12/18 +Skechers U.S.A., Inc. +100.00 +166.77 +273.56 +222.58 +342.65 +207.27 +Russell 2000 +100.00 +104.89 +100.26 +121.63 +139.44 +124.09 +Peer Group +100.00 +100.49 +127.51 +126.31 +160.09 +186.43 +28 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2018 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +(In thousands, except net earnings per share) +Years Ended December 31, +Statement of Earnings Data: +2018 +2017 +2016 +2015 +2014 +Net sales +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +$ +2,377,561 +Gross profit +2,223,605 +1,938,889 +1,634,596 +1,424,008 +1,071,905 +Earnings from operations +437,765 +382,880 +370,518 +350,824 +209,071 +Earnings before income taxes +431,884 +384,260 +359,484 +333,497 +191,380 +Net earnings attributable to Skechers U.S.A., Inc. +301,041 +179,190 +243,493 +231,912 +138,811 +Net earnings per share: (1) +Basic +1.93 +1.15 +1.58 +1.52 +0.91 +Diluted +1.92 +1.14 +1.57 +1.50 +0.91 +Weighted average shares: (1) +Basic +155,815 +155,651 +154,169 +152,847 +151,839 +Diluted +156,450 +156,523 +155,084 +154,200 +153,079 +As of December 31, +Balance Sheet Data: +2018 +2017 +2016 +2015 +2014 +Working capital +$ +1,621,918 +$ +1,507,676 +$ +1,206,036 +$ +971,179 +$ +779,277 +Total assets +3,228,255 +2,735,082 +2,393,670 +2,039,878 +1,674,918 +Long-term borrowings, excluding current installments +88,119 +71,103 +67,159 +68,942 +15,081 +Skechers U.S.A., Inc. equity +2,034,958 +1,829,064 +1,603,633 +1,327,556 +1,075,249 +(1) +Basic earnings per share represents net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. All share and per share information has been retroactively adjusted for the three-for-one stock split that was effective on October 16, 2015. +29 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +GENERAL +We design, market and sell contemporary footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own retail stores, distributor and licensee-owned international retail stores and our e-commerce websites. Our objective is to continue to profitably grow our domestic operations while leveraging our brand name to expand internationally. +Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and retail sales, which includes our e-commerce sales. We evaluate segment performance based primarily on net sales and gross margins. See detailed segment information in Note 19 – Segment and Geographic Reporting in our Consolidated Financial Statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our net sales for 2018 increased $477.9 million, or 11.5%, to $4.642 billion, compared to net sales of $4.164 billion in 2017. The increase in net sales primarily came from our international subsidiaries and retail businesses. Our international wholesale and international retail businesses represented 54.2% of our net sales during 2018. The largest increases in our domestic wholesale segment came in our Work, BOBS, Men’s U.S.A., Cali, and You divisions. During 2018, earnings from operations increased $54.9 million, or 14.3%, to $437.8 million compared to $382.9 million in 2017. Net earnings attributable to Skechers U.S.A., Inc. were $301.0 million for 2018, an increase of $121.8 million, or 68.0%, compared to net earnings of $179.2 million in 2017. Diluted earnings per share for 2018 were $1.92, which reflected a 68.4% increase from the $1.14 diluted earnings per share reported in the prior year. Our working capital was $1.622 billion at December 31, 2018, which was an increase of $114.2 million from working capital of $1.508 billion at December 31, 2017. Our cash and cash equivalents increased $135.8 million to $872.2 million at December 31, 2018 from $736.4 million at December 31, 2017. The increase in cash and cash equivalents was primarily the result of our increased net earnings and accounts payable which were partially offset by decreased accounts receivable, increased capital investments, increased investment and share repurchases. +2018 OVERVIEW +In 2018, we focused on product development, growing our position in our domestic wholesale accounts, growing our international market share, opening retail stores in key locations worldwide, continuing to develop our global infrastructure, and balance sheet and expense management. +New product design and delivery . In 2018, we focused on fresh updates to our core and existing styles—including Skechers GO Walk Joy, adding collaborations with accessible characters such as Garfield and Grumpy Cat as well as the more niche but still successful anime series One Piece, and broadening our reach to more trend-focused men and women through our heritage Skechers D’Lites collection. +Grow our domestic business. In 2018, our focus was on returning to growth domestically in our domestic wholesale accounts by delivering the right product to accounts at the right time, while finding new opportunities to add shelf space and expand into new locations with new Skechers categories. In 2018, we remained the number one walking, work, casual lifestyle, and casual dress footwear brand, and the number two casual athletic footwear brand. +Further develop our international businesses. During 2018, we continued to focus on improving our international sales by increasing our product offering to accounts around the world, delivering the right product to accounts at the right time, and increasing our shelf space with new and updated products as well as increasing our customer base. +Expand Skechers global retail base. Believing that Skechers retail stores are effective brand building tools, we continued to focus on opening Skechers stores around the world—both company-owned and third-party owned through our distributors, franchisees or joint venture partners. In 2018, we opened 25 additional company-owned domestic stores and 26 additional company-owned international stores. Additionally, we continued to expand our franchise retail base with more Skechers branded stores in countries where we directly handle the distribution of our product. +Develop our global infrastructure. In 2018, through our joint-venture in China we purchased land to construct our new China distribution center to support our sales in the region. We completed designing the building, tenant improvements and equipment for this facility and began construction in the fourth quarter of 2018. +30 +Balance sheet and expense management. During 2018, we continued to focus on managing our balance sheet and bringing our marketing expens es and general and administrative expenses in line with expected sales. During 2018, we returned $100.0 million to shareholders by repurchasing 3.7 million Class A shares. +OUTLOOK FOR 2019 +During 2019, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. This includes building on our heritage collection and chunky footwear offering with Skechers D’Lites, Skechers D’Lites 3.0, Skechers Stamina, and Skechers Energy, among others. The global footwear market is competitive; however, we believe demand for the brand globally will remain strong because our products are marketed at affordable prices and our styles resonate with consumers worldwide. We believe appeal for our product is broad and demand will continue to grow due to a team of brand ambassadors—including sports icons Tony Romo, David Ortiz, Sugar Ray Leonard and Howie Long for men; pop superstar Camila Cabello for women; elite athlete Meb Kelfezighi; and professional golfers Matt Kuchar and Brooke Henderson. We expect to continue to broaden the targeted demographic profile of our consumer base, increase our shelf space and to open another 70 to 80 company-owned retail locations worldwide. In addition, we will continue the construction of our new 1.62 million square foot distribution center in China to support our business in the region—with an expected completion date of 2020, and on the expansion of our corporate headquarters. In 2019, we entered into an agreement to purchase the minority interest in our India joint venture that we did not own for $82.5 million which will make our India joint venture a wholly owned subsidiary. In 2019, we also agreed in principle to form a joint venture with our distributor in Mexico. +DEFINITIONS +Comparable sales +As part of our discussion of our results of operations, we disclose comparable store sales, for which we typically include the impact of e‑commerce sales on our company-owned websites. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +Cost of sales or Gross margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative expenses +General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for our Rancho Belago, European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. +31 +YEAR ENDED DECEMBER 31, 2018 COMPARED TO T HE YEAR ENDED DECEMBER 31, 2017 +Net sales +Net sales for 2018 were $4.642 billion, which was an increase of $477.9 million, or 11.5%, compared to net sales of $4.164 billion for 2017. The increase in net sales primarily came from our international wholesale and retail businesses. +Our domestic wholesale net sales increased $10.3 million, or 0.8%, to $1.260 billion for 2018 compared to $1.250 billion for 2017. The increase in our domestic wholesale segment’s net sales was primarily the result of a 3.0% unit sales volume increase, to 58.1 million pairs in 2018 from 56.5 million pairs in 2017, which was partially offset by a decrease in average selling price per pair of 3.8%, to $21.26 per pair for 2018 from $22.11 in 2017. This net sales increase was attributable to higher sales in our Work, BOBS, Men’s U.S.A., Cali, and You divisions during 2018. The average selling price per pair decrease within the domestic wholesale segment was primarily the result of product sales mix. +Our international wholesale segment net sales increased $324.9 million, or 18.8%, to $2.055 billion for 2018 compared to sales of $1.730 billion for 2017. Our international wholesale sales consist of direct sales by our foreign subsidiaries – those sales we make to department stores and specialty retailers – and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries, including our joint ventures, increased $322.2 million, or 23.0%, to $1.722 billion for 2018 compared to sales of $1.399 billion for 2017. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China, India and Singapore. The increases are primarily attributable to sales of our Men’s and Women’s Sport, YOU, BOBS, and Men’s U.S.A., lines. Our distributor sales increased $2.7 million, or 0.8%, to $333.3 million for 2018, compared to sales of $330.6 million for 2017. This was primarily attributable to increased sales to our distributors in Russia, Indonesia and Turkey. +Our retail segment sales increased $142.7 million to $1.328 billion for the year ended December 31, 2018, a 12.0% increase over sales of $1.185 billion for 2017. The increase in retail sales was primarily attributable to increased comparable sales of 9.2%, which included increased sales within our Men’s and Women’s Sport, Men’s U.S.A., Kid’s, and Work divisions and a net increase of 25 domestic and 26 international stores compared to 2017. For the year ended December 31, 2018, our domestic retail sales, which includes e-commerce, increased 7.7% compared to 2017, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 6.4%, and our international retail store sales increased 21.2% compared to 2017, which was attributable to increased international store count and positive comparable international store sales of 15.5%. +We believe that we have established our presence in most major domestic retail markets. We had 470 domestic stores and 222 international retail stores as of February 15, 2019, and we currently plan to open approximately 70 to 80 stores in 2019. During 2018, we opened one new domestic concept store, one domestic factory outlet store, 23 domestic warehouse outlet stores, 14 international concept stores, 11 international factory outlet stores, and one international warehouse outlet store. During 2018, we closed four domestic concept stores. We periodically review all of our stores for impairment. During 2018 and 2017, we did not record an impairment charge related to our retail stores. +Gross profit +Gross profit for 2018 increased $284.6 million, or 14.7% to $2.224 billion from $1.939 billion for 2017. Gross profit, as a percentage of net sales, or gross margin, increased slightly to 47.9% in 2018 from 46.6% for 2017. Our domestic wholesale segment gross profit increased $3.7 million, or 0.8%, to $468.3 million for 2018 from $464.6 million for 2017, which was attributable to an increase in pairs sold of 3.0%. Domestic wholesale gross margins were 37.2% for 2018 and 2017. +Gross profit for our international wholesale segment increased $190.0 million, or 24.2%, to $976.7 million for 2018 compared to $786.7 million for 2017. Gross margins for the international wholesale segment were 47.5% for 2018 compared to 45.5% for 2017. Gross margins for our international direct subsidiary sales, including our joint ventures, were 51.7% for 2018 as compared to 50.0% for 2017. The increase in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to an increased mix of sales of products with higher gross margins. Gross margins for our international distributor sales were 25.9% for 2018 as compared to 26.3% for 2017. +Gross profit for our retail segment increased $90.9 million, or 13.2%, to $778.5 million for 2018 as compared to $687.6 million for 2017. Gross margins for all stores were 58.6% for 2018 compared to 58.0% for 2017. Gross margins for our domestic stores were 61.3% for 2018 as compared to 59.7% for 2017. Gross margins for our international stores were 53.6% for 2018 as compared to 54.5% for 2017. The increase in our domestic retail margins were attributable to higher average selling prices and lower average product costs. +32 +Selling expenses +Selling expenses increased by $23.2 million, or 7.1%, to $350.4 million for 2018 from $327.2 million for 2017. As a percentage of net sales, selling expenses were 7.5% and 7.9% for 2018 and 2017, respectively. The increase in selling expenses was primarily the result of higher advertising expense of $17.6 million and increased sales commissions of $3.9 million due to increased sales worldwide. +General and administrative expenses +General and administrative expenses increased by $211.0 million, or 16.9%, to $1.456 billion for 2018 from $1.245 billion for 2017. As a percentage of sales, general and administrative expenses were 31.4% and 29.9% for 2018 and 2017, respectively. The increase in general and administrative expenses was primarily attributable to $99.9 million related to supporting our growing international operations in China, Japan, South Korea and Latin America, increased store operating costs of $52.7 million primarily attributable to an additional net 47 stores and increased domestic wholesale general and administrative expenses of $57.8 million primarily due to increased distribution costs of $30.0 million. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products were $249.6 million for 2018 compared to $219.6 million for 2017. +Other income (expense) +Interest income was $10.1 million for 2018 compared to $2.4 million for 2017. The increase in interest income was primarily due to increased interest rates and higher average cash and investment balances as compared to the prior year. Interest expense for 2018 decreased $0.9 million to $5.8 million compared to $6.7 million in 2017. Interest expense decreased primarily due to reduced interest paid to our foreign manufacturers. Loss on foreign currency transactions for 2018 was $9.2 million compared to a $6.3 million gain in 2017. This increased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2018 decreased $0.1 million to a loss of $0.5 million as compared to a loss of $0.6 million in 2017. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34.6%. Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes. +Our earnings (loss) before income taxes and income tax expense for 2018, 2017 and 2016 are as follows (in thousands): +Years Ended December 31, +2018 +2017 +2016 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense (benefit) +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +16,597 +$ +11,500 +$ +25,628 +$ +113,607 +$ +105,589 +$ +44,654 +Peoples Republic of China (“China”) +89,429 +19,595 +95,668 +12,971 +72,584 +11,720 +Hong Kong +48,352 +8,106 +17,778 +5,030 +15,156 +5,206 +Jersey (2) +213,327 +— +198,048 +— +146,880 +— +Non-benefited loss operations (3) +(11,422 +) +(3,387 +) +(17,350 +) +3,306 +(16,189 +) +12 +Other jurisdictions (4) +75,601 +24,797 +64,488 +14,242 +35,464 +12,533 +Earnings before income taxes +$ +431,884 +$ +60,611 +$ +384,260 +$ +149,156 +$ +359,484 +$ +74,125 +Effective tax rate (5) +14.0 +% +38.8 +% +20.6 +% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the Tax Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Barbados, Brazil, China, India, Israel, Japan, Panama, Romania, Thailand, and South Korea. +33 +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of cons olidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hungary, India, Italy, Kosovo, Macau, Macedonia, Malaysia, Montenegro, Netherlands, P anama, Peru, Poland, Portugal, Serbia, Singapore, Spain, Switzerland, Vietnam, and the United Kingdom, +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2018, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 26%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2018, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $16.6 million, with income tax expense of $11.5 million, which is an average rate of 69.3%. This rate is higher than the 26% U.S. statutory rate primarily due to the impact of U.S. non-deductible expenses. Earnings (loss) before income taxes in non-U.S. jurisdictions were $415.3 million, with an aggregate income tax expense of $49.1 million, which is an average rate of 11.8%. Combined, this results in consolidated earnings before income taxes for the period of $431.9 million, and consolidated income tax expense for the period of $60.6 million, resulting in an effective tax rate of 14.0%. For 2018, of our $415.3 million in earnings before income tax earned outside the U.S., $213.3 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $15.3 million to $ 213.3 million in 2018 from $ 198.0 million in 2017. This increase was primarily attributable to an increase in international sales which resulted in an increase in earnings before income taxes in Jersey from royalties and commissions under the terms of our inter-subsidiary agreements. In addition, there were foreign losses of $11.2 million for which no tax benefit was recognized during the year ended December 31, 2018, because of the provision of offsetting valuation allowances, but for which $3.4 million in prior year tax refund were received. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. +As of December 31, 2018, we had approximately $872.2 million in cash and cash equivalents, of which $522.2 million, or 59.9%, was outside the U.S. Of the $522.2 million held by our non-U.S. subsidiaries, approximately $276.9 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2018. +We believe our cash and cash equivalents and investments held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. However, in anticipation of the needs of our share repurchase program and the need to provide payment of our provisional Transition Tax liability, we plan to begin the repatriation of certain funds held outside the U.S. for which tax has been fully provided as of December 31, 2018. We have provided for the tax impact of expected distributions from our joint venture in China as well as from our subsidiary in Chile to our intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, we do not foresee the need for any of our other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to U.S. income taxes but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2018 increased $14.3 million to $70.2 million as compared to $55.9 million for 2017 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +YEAR ENDED DECEMBER 31, 2017 COMPARED TO THE YEAR ENDED DECEMBER 31, 2016 +Net sales +Net sales for 2017 were $4.164 billion, which was an increase of $600.9 million, or 16.9%, compared to net sales of $3.563 billion for 2016. The increase in net sales was broad based across all our segments with the largest increases coming from our international businesses. +Our domestic wholesale net sales increased $49.5 million, or 4.1%, to $1.249 billion for 2017 compared to $1.200 billion for 2016. The increase in our domestic wholesale segment’s net sales was primarily the result of a 7.8% unit sales volume increase to 56.5 million pairs in 2017 from 52.4 million pairs in 2016, which was partially offset by a decrease in average selling price per pair of 3.4%, to $22.11 per pair for 2017 from $22.89 in 2016. This net sales increase was attributable to higher sales in our Men’s Sport, Men’s U.S.A., Cali, You, and Kid’s divisions during 2017. The average selling price per pair decrease within the domestic wholesale segment was primarily the result of product sales mix with lower average selling prices. +34 +Our international wholesale segment net sales increased $338.7 million, or 24.3%, to $1.730 billion for 2017 compared to sales of $1.391 billion for 2016. Direct sales by our foreign subsidiaries, including our joint ventures, increased $311.3 million, or 28.6%, to $1.399 billion for 2017 compared to sales of $1.088 billion for 2016. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany and Spain, and our joint ventures in China and Korea. The increases are p rimarily attributable to sales of our Women’s and Men’s Go, Women’s Active and Men’s and Women’s Sport lines. Our distributor sales increased $27.4 million, or 9.0%, to $330.6 million for 2017, compared to sales of $303.2 million for 2016. This was primari ly attributable to increased sales to our distributors in Australia and New Zealand, Indonesia, and Turkey. +Our retail segment sales increased $212.8 million to $1.185 billion for the year ended December 31, 2017, a 21.9% increase over sales of $972.2 million for 2016. The increase in retail sales was primarily attributable to increased comparable sales of 7.2%, which included increased sales within our Men’s and Women’s Sport, Men’s U.S.A., Kid’s, and Work divisions and a net increase of 36 domestic and 39 international stores compared to 2016. For the year ended December 31, 2017, our domestic retail sales, which includes e-commerce, increased 11.9% compared to 2016, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 6.4%, and our international retail store sales increased 50.3% compared to 2016, which was attributable to increased international store count and positive comparable international store sales of 10.1%. +During 2017, we opened five new domestic concept stores, seven domestic factory outlet stores, 29 domestic warehouse outlet stores, 19 international concept stores, 16 international factory outlet stores, and four international warehouse outlet stores During 2017, we closed five domestic concept stores. We periodically review all of our stores for impairment. During 2017 and 2016, we did not record an impairment charge related to our retail stores. +Gross profit +Gross profit for 2017 increased $304.3 million, or 18.6% to $1.939 billion from $1.635 billion for 2016. Gross profit, as a percentage of net sales, or gross margin, increased slightly to 46.6% in 2017 from 45.9% for 2016. Our domestic wholesale segment gross profit increased $10.5 million, or 2.3%, to $464.6 million for 2017 from $454.1 million for 2016, which was attributable to an increase in pairs sold of 7.8%. Domestic wholesale margins decreased to 37.2% for 2017 from 37.8% for 2016. The decrease in domestic wholesale margins was primarily attributable to a product sales mix with lower average selling prices. +Gross profit for our international wholesale segment increased $170.6 million, or 27.7%, to $786.7 million for 2017 compared to $616.1 million for 2016. Gross margins for the international wholesale segment were 45.5% for 2017 compared to 44.3% for 2016. Gross margins for our international direct subsidiary sales, including our joint ventures, were 50.0% for 2017 as compared to 49.3% for 2016. The increase in gross margins for our international wholesale segment and international direct subsidiary sales were primarily attributable to sales of products with higher average selling prices. Gross margins for our international distributor sales were 26.3% for 2017 as compared to 26.2% for 2016. +Gross profit for our retail segment increased $123.2 million, or 21.8%, to $687.6 million for 2017 as compared to $564.4 million for 2016. Gross margins for all stores were 58.0% for 2017 compared to 58.1% for 2016. Gross margins for our domestic stores were 59.7% for 2017 as compared to 60.1% for 2016. Gross margins for our international stores were 54.5% for 2017 as compared to 52.3% for 2016. The decrease in our domestic retail margins were attributable to a product sales mix with lower average selling prices. +Selling expenses +Selling expenses increased by $70.1 million, or 27.3%, to $327.2 million for 2017 from $257.1 million for 2016. As a percentage of net sales, selling expenses were 7.9% and 7.2% for 2017 and 2016, respectively. The increase in selling expenses was primarily the result of increased sales commissions of $22.7 million due to increased sales worldwide and $13.2 million from our South Korean joint‑venture and $47.3 million in higher advertising expenses, which slightly increased as a percentage of net sales to 5.8% in 2017 from 5.5% in 2016. +General and administrative expenses +General and administrative expenses increased by $224.7 million, or 22.0%, to $1.245 billion for 2017 from $1.021 billion for 2016. As a percentage of sales, general and administrative expenses were 29.9% and 28.6% for 2017 and 2016, respectively. The increase in general and administrative expenses was primarily attributable to $109.5 million related to supporting our growing international operations in China, Japan, South Korea and Latin America, increased store operating costs of $73.8 million primarily attributable to an additional 75 stores and increased domestic wholesale general and administrative expenses of $41.4 million primarily due to increased headcount in the United States to support our brand worldwide. In addition, expenses related to our distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of our products increased $32.3 million, due to increased shipments, to $219.6 million from $187.3 million for 2017 and 2016, respectively. +35 +Other income (expense) +Interest income was $2.4 million for 2017 compared to $1.2 million for 2016. Interest expense for 2017 increased $0.4 million to $6.7 million compared to $6.3 million in 2016. Gain or loss on foreign currency transactions for 2017 increased $11.3 million to a gain of $6.3 million compared to a $5.0 million loss in 2016. This increased foreign currency exchange gain was primarily attributable to the impact of a weaker U.S. dollar on our intercompany balances in our foreign subsidiaries. Loss on disposal of assets for 2017 decreased $0.5 million to a loss of $0.6 million as compared to a loss of $1.1 million in 2016. +Income taxes +On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affected our financial results for the year ended December 31, 2017, including, but not limited to: (1) requiring a one-time Transition Tax, payable over eight years, on certain unrepatriated earnings of foreign subsidiaries; (2) a future reduction of the U.S. federal corporate tax rate from 35% to 21% that affects the current value of our deferred tax assets (“DTAs”) and deferred tax liabilities (“DTLs”); and (3) bonus depreciation that allows for full expensing of qualified property placed in service after September 27, 2017. In addition, the Tax Act establishes new tax laws that will affect our financial results for the year ending December 31, 2018, including, but not limited to: (1) a reduction of the U.S. federal corporate tax rate from 35% to 21%; (2) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (3) a new provision designed to tax global intangible low-taxed income (“GILTI”); (4) limitations on the deductibility of certain executive compensation; and (5) limitations on the use of Foreign Tax Credit (“FTC’s”) to reduce the U.S. income tax liability. +The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for us to complete the accounting under Accounting Standards Codification 740 (“ASC 740”). In accordance with SAB 118, we must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that our accounting for certain income tax effects of the Tax Act is incomplete but we are able to determine a reasonable estimate, we must record a provisional estimate in the financial statements. If we cannot determine a provisional estimate to be included in the financial statements, we should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. +In connection with our initial analysis of the impact of the Tax Act, we have recorded a provisional one-time net tax expense of $99.9 million for the year-ended December 31, 2017. This net tax expense primarily consists of the $1.9 million net tax impact to our DTA’s from the corporate rate reduction and a net expense for the Transition Tax of $98.0 million. For various reasons that are discussed more fully below, we did not completed our accounting for the income tax effects of certain elements of the Tax Act. If we were able to make reasonable estimates of the effects of elements for which our analysis was not yet complete, we recorded provisional adjustments. +Our accounting for the following elements of the Tax Act was provisional. However, we were able to make reasonable estimates of certain effects and, therefore, recorded the following provisional adjustments: +Transition Tax : The Transition Tax is a one-time tax on previously untaxed current and accumulated earnings and profits (“E&P”) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, we must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. We were able to make a reasonable estimate of the Transition Tax and recorded a provisional Transition Tax liability of $98.0 million at December 31, 2017. However, during the measurement period, we continued to gather additional information to more precisely compute the amount of the Transition Tax. As a result of the additional information gathered, we reduced the provisional estimate from $98.0 million to $87.1 million and recorded a $10.9 million adjustment to reduce the tax provision for the year ended December 31, 2018. +Reduction of U.S. federal corporate tax rate : The Tax Act reduces the corporate tax rate from 35% to 21%, effective January 1, 2018. As a result, we have recorded a provisional decrease in value of our net DTAs of $1.9 million, with a corresponding net adjustment to deferred income tax expense of $1.9 million for the year ended December 31, 2017. No additional adjustment to this provisional estimate of the impact of the Tax Act on our net DTA’s was necessary, and no related adjustment was recorded in the tax provision for the year ended December 31, 2018. +Cost recovery : We completed provisional computations for expenditures that qualified for immediate expensing and recorded a decrease in our current income tax payable of approximately $5.9 million based on our estimates related to the additional federal expense allowed as a result of the Tax Act. In addition, we have recorded a corresponding increase in our DTLs of approximately $3.5 million, which is less than the $5.9 million liability amount due to the reduction in the corporate tax rate from 35% to 21%, effective January 1, 2018. The $2.4 million net benefit from the reduction in the future tax rate is included in the $1.9 million decrease in value of the net DTAs discussed above. No additional adjustment to this provisional estimate of the impact of the Tax Act on our cost recovery was necessary, and no related adjustment was recorded in the tax provision for the year ended December 31, 2018. +36 +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnin gs (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34%. Our provision for income tax expense was calculated using t he applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes. +Our earnings (loss) before income taxes and income tax expense for 2017, 2016 and 2015 are as follows (in thousands): +Years Ended December 31, +2017 +2016 +2015 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +25,628 +$ +113,607 +$ +105,589 +$ +44,654 +$ +136,726 +$ +52,173 +Peoples Republic of China (“China”) +95,668 +12,971 +72,584 +11,720 +49,027 +11,084 +Jersey (2) +198,048 +— +146,880 +— +123,721 +— +Non-benefited loss operations (3) +(17,350 +) +3,306 +(16,189 +) +12 +(16,719 +) +164 +Other jurisdictions (4) +82,266 +19,272 +50,620 +17,739 +40,742 +9,029 +Earnings before income taxes +$ +384,260 +$ +149,156 +$ +359,484 +$ +74,125 +$ +333,497 +$ +72,450 +Effective tax rate (5) +38.8 +% +20.6 +% +21.7 +% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the Tax Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Brazil, India, Israel, Japan, Macau, Panama, and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hong Kong, Hungary, India, Italy, Kosovo, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Romania, Serbia, Singapore, Spain, Switzerland, Thailand, Vietnam, and the United Kingdom. +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2017, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 39%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2017, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $25.6 million, with income tax expense of $113.6 million, which is an average rate of 443%. The U.S. tax expense includes a provisional one-time tax expense of $99.9 million related to the enactment of the Tax Act on December 22, 2017. Earnings (loss) before income taxes in non-U.S. jurisdictions were $358.6 million, with an aggregate income tax expense of $35.5 million, which is an average rate of 9.9%. Combined, this results in consolidated earnings before income taxes for the period of $384.3 million, and consolidated income tax expense for the period of $149.2 million, resulting in an effective tax rate of 38.8%. For 2017, of our $358.6 million in earnings before income tax earned outside the U.S., $198.0 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $51.1 million, or 35%, to $198.0 million in 2017 from $146.9 million in 2016. This increase was primarily attributable to an increase of $435.6 million in net sales in the “Other international” geographic area for 2017 (see Note 18 – Segment and Geographic Reporting in our consolidated financial statements included under Part II, Item 8 of this annual report), which resulted in a significant increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. Due to the scalability of our operations, increases in net sales in the “Other international” geographic area from 2016 to 2017 resulted in a disproportionately greater increase in earnings before income taxes in Jersey. In addition, there were foreign losses of $17.4 million for which no tax benefit was recognized during the year ended December 31, 2017 because of the provision of offsetting valuation allowances, but in which $3.3 million in nonrefundable and other withholding taxes were paid. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. +As of December 31, 2017, we had approximately $736.4 million in cash and cash equivalents, of which $391.6 million, or 53.2%, was held outside the U.S. Of the $391.6 million held by our non-U.S. subsidiaries, approximately $227.5 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2017. As of December 31, 2017, U.S. income taxes have been provided but non-U.S. income taxes have not been provided on cumulative total earnings of $178.8 million. As of December 31, 2016, U.S. and non-U.S. income taxes have not been provided on cumulative total earnings of $699.6 million. +37 +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2017 increased $14.0 million to $55.9 million as compared to $41.9 million for 2016 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +LIQUIDITY AND CAPITAL RESOURCES +Cash Flows +Our working capital at December 31, 2018 was $1.622 billion, an increase of $114.2 million from working capital of $1.508 billion at December 31, 2017. Our cash and cash equivalents at December 31, 2018 was $872.2 million, compared to $736.4 million at December 31, 2017. This increase in cash and cash equivalents of $135.8 million, after consideration of the effect of exchange rates, was the result of our net earnings of $371.3 million, and increased accrued expenses and other long-term liabilities of $19.7 million, which was partially offset by increased receivables of $136.2 million, capital expenditures of $143.0 million and share repurchases of $100.0 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $568.6 million for 2018 and $159.3 million for 2017. On a comparative year‑to‑year basis, the $409.3 million increase in cash flows from operating activities in 2018 primarily resulted from $187.1 million increase in accounts payable, a smaller increase in inventories of $151.4 million, which were partially offset by a larger increase in accounts receivable of $34.0 million and a smaller increase in accrued expenses and other long-term liabilities of $66.4 million. +Investing Activities +Net cash used in investing activities was $319.4 million for 2018, as compared to $138.3 million in 2017. The increase in cash used in investing activities in 2018 as compared to 2017 was due to a net increase in investment purchases of $176.4 million and increased capital expenditures of $7.1 million. Capital expenditures for 2018 were approximately $143.0 million, which primarily consisted of $50.0 million for new store openings and remodels, $28.8 million for the construction for our China distribution center, $20.6 million to support our international wholesale operations, $17.6 million for the upgrades to our domestic distribution center, and $10.5 million for new retail locations in our China joint venture. This compares to capital expenditures of $136.0 million in the prior year, which primarily consisted of $68.5 million for new store openings and remodels, $19.9 million for land for our China distribution center, $15.4 million to support our international wholesale operations and $12.0 million for new retail locations in our China joint venture. We expect capital expenditures for 2019 to be between $275.0 million and $300.0 million, which includes the construction of our China distribution center, upgrades for our domestic and European distribution centers, opening 70 to 80 retail stores, store remodels, corporate office and information technology upgrades. We believe our current cash, investments, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. +Financing Activities +Net cash used in financing activities was $119.7 million during 2018, compared $14.5 million during 2017. The increase in cash used by financing activities was primarily attributable to repurchases of our Class A common stock of $100.0 million and increased payments for taxes related to net share settlement of equity awards of $14.2 million. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On February 6, 2018, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share (“Class A common stock”), for an aggregate repurchase price not to exceed $150.0 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A common stock and the program may be suspended or discontinued at any time. As of December 31, 2018, there was $50.0 million available under the Share Repurchase Program. +38 +Acquisitions +In 2019, we entered into an agreement to purchase the minority interest in our India joint venture that we did not own for $82.5 million which will make our India joint venture a wholly owned subsidiary. Also, in 2019, we agreed in principle to form a joint venture with our distributor in Mexico. +Financing Arrangements +On October 24, 2018, through our Chinese joint venture, we entered into a $17.5 million loan agreement with The Hongkong and Shanghai Banking Corporation Limited (the “China Loan Agreement”). The China Loan Agreement allows for partial drawdown. Interest will be paid at one, two or three months, depending on the period of the drawdown. The interest rate will be based upon the London Interbank Offered Rate (“LIBOR”) plus 1.2% per annum. As specified in the China Loan Agreement, the principal of the loan will be repayable by fifteen equal quarterly installments of $437,550, commencing fifteen months after drawdown plus a final installment of $10,937,500. The loan has a term of 5 years. The China Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type. The obligations of our Chinese joint venture under the China Loan Agreement are jointly and severally guaranteed by the Company and Luen Thai Enterprises Ltd. There was no amount outstanding as of December 31, 2018. +On October 19, 2018, through a subsidiary of our Chinese joint venture (“the TC Subsidiary”), we entered into a 50 million yuan revolving loan agreement with China Construction Bank Corporation (“the China DC Revolving Loan Agreement”). The proceeds from the China DC Revolving Loan Agreement will be used to finance the construction and operation of our distribution center in China. Interest will be paid quarterly. The interest rate will be based upon the prime rate from the People’s Bank of China less a discount. As specified in the China DC Revolving Loan Agreement, the entire principal balance of the loan will be repaid when the China DC Revolving Loan Agreement matures on October 18, 2019. The TC Subsidiary has the option to extend the China DC Revolving Agreement, conditioned upon the satisfaction of certain terms. The China DC Revolving Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the TC Subsidiary, to among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Revolving Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The obligations of the TC Subsidiary under the China DC Revolving Loan Agreement are jointly and severally guaranteed by our Chinese joint venture. There is no amount outstanding as of December 31, 2018. +On September 29, 2018, through the TC subsidiary, we entered into a 700 million yuan loan agreement with China Construction Bank Corporation (“the China DC Loan Agreement”). The proceeds from the China DC Loan Agreement will be used to finance the construction of our distribution center in China. Interest will be paid quarterly. The interest rate will float and be calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2018 was 4.28% and may increase or decrease over the life of the loan, and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan Agreement. The China DC Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the joint venture to, among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The China DC Loan Agreement matures on September 28, 2023. The obligations of the TC Subsidiary under the China DC Loan Agreement are jointly and severally guaranteed by our Chinese joint venture. As of December 31, 2018 there was $18.6 million outstanding under this credit facility, which is classified as long-term borrowings in our consolidated balance sheets. +On September 20, 2018, through two subsidiaries of our Chinese joint venture (the “SGZ and SSH Subsidiaries”), we entered into a 125 million yuan revolving loan agreement with HSBC Bank (China) Company Limited, Guangzhou Branch (the “Revolving Loan Agreement”). The Revolving Loan Agreement is comprised of two tranches: a 125 million yuan revolving loan facility and a 15 million yuan non-financial bank guarantee facility. The proceeds from the Revolving Loan Agreement will be used to finance the SGZ and SSH Subsidiaries’ working capital requirements. Interest will be paid at one, two or three months, depending on the term of each loan. The interest rate will be equal to 100% of the applicable People’s Bank of China (PBOC) Benchmark Lending Rate, provided that if the PBOC Benchmark Lending Rate changes during the term of a loan, the applicable interest rate for that loan will not change until the next rollover date of that loan (if any). The Revolving Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the joint venture to, among other things, allow external investment to be added, pledge assets and issue debt with priority over the Revolving Loan Agreement. The term of each loan will be one, three or six months or such other period as agreed by the lender. The term of a loan, including any extension or rollover, shall not exceed twelve months. The obligations of the Subsidiary under the Revolving Loan Agreement are guaranteed by the Company, Luen Thai Enterprises Ltd., Skechers Guangzhou Co., Ltd and Skechers Trading (Shanghai) Co Ltd. There was no amount outstanding as of December 31, 2018. +39 +On June 30, 2015, we e ntered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Ag reement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits us and certain of our subsidiaries to borrow based on a percentage of eligible accounts r eceivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at our election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0% , in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. We pay a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100 .0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affili ates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. We paid closing and arrangement fees of $1.1 million on this facility, which are being amortized to interest expense over the five-year life of the facil ity. As of December 31, 2018 , there was $0.1 million outstanding under this credit facility, which is classified as short-term borrowings in our consolidated balance sheets. +On April 30, 2010, the JV, through HF Logistics-SKX T1, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the JV (“HF-T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the Project on the Property (the "Original Loan"). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV through HF-T1 entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF agreed that we would make an additional capital contribution of $38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the “New Loan”). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under our credit agreement dated June 30, 2015. We had $65.1 million outstanding under the Amended Loan Agreement, which is included in long-term borrowings as of December 31, 2018. +40 +As of December 31, 2018, outstanding short-term and long-term borrowings were $97.0 million, of which $65.4 million relates to loans for our domestic distribution center and the remaining relates to our international operations. Our long-term debt obligations contain both financi al and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. +We believe that anticipated cash flows from operations, available borrowings under our credit agreement, existing cash and investments balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least through March 31, 2020. Our future capital requirements will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of our footwear, the number and timing of new store openings, the success of our international operations, costs associated with constructing our China distribution center and distribution center equipment, the costs of upgrading our domestic and European distribution centers, the amount and timing of share repurchases, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, costs associated with constructing new corporate offices, and any potential acquisitions of other brands or companies. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition and results of operations. In addition, if additional capital is raised through the sale of additional equity or convertible securities, dilution to our stockholders could occur. +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2018 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +7,222 +$ +7,222 +$ +— +$ +— +$ +— +Long-term borrowings (1) +96,364 +5,097 +87,707 +3,560 +— +Operating lease obligations (2) +1,641,384 +251,711 +432,695 +360,077 +596,901 +Purchase obligations (3) +1,071,537 +1,071,537 +— +— +— +Warehouse and equipment (4) +220,200 +159,800 +60,400 +— +— +Corporate construction contracts (5) +134,500 +61,700 +72,800 +— +— +Minimum payments related to other arrangements +51,777 +18,921 +32,856 +— +— +Total (6) +$ +3,222,984 +$ +1,575,988 +$ +686,458 +$ +363,637 +$ +596,901 +(1) +Amounts include anticipated interest payments based on interest rates currently in effect. +(2) +Operating lease obligations consists primarily of real property leases for our retail stores, corporate offices, European and other international distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash and investment balances. +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $180.5 million, (ii) outstanding letters of credit of $3.2 million and (iii) open purchase commitments with our foreign manufacturers for $887.9 million. We currently expect to fund these commitments with cash flows from operations and existing cash and investment balances. +(4) +Amounts include warehouse and equipment upgrades for our China, Rancho Belago, and European distribution centers. +(5) +During 2018, we entered into construction agreements with McCarthy Construction Company for the construction of additional corporate facilities in Manhattan Beach, California. +(6) +Our consolidated balance sheet, as of December 31, 2018, included $8.0 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. In addition, the table above does not include payments of $79.8 million over the next seven years related to the provisional one-time tax liability recorded due to the Tax Act. +41 +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves, and tax estimates and valuation of deferred income taxes. +Revenue Recognition. We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. We recognize revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. For North America, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For international wholesale customers product is shipped FOB shipping point, (i) direct from our distribution center in Liege, Belgium, (ii) to third-party distribution centers in Central America, South America and Asia, (iii) directly from third-party manufacturers to our other international customers. For our distributor sales, the goods are generally delivered directly from the independent factories to third-party distribution centers or to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales upon shipment as that is when the customer obtains control of the promised goods. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost and not as a separate performance obligation. We generate retail revenues primarily from the sale of footwear to customers at retail locations or through our websites. For our in-store sales, we recognize revenue at the point of sale. For sales made through our websites, we recognize revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from e-commerce or retail customers are excluded from reported revenues. +We record accounts receivable at the time of shipment when the Company’s right to the consideration becomes unconditional. We typically extends credit terms to our wholesale customers based on their creditworthiness and generally we do not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. Retail and e-commerce sales generally represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, we have determined that no allowance for doubtful accounts for retail and e-commerce sales is necessary. +We earn royalty income from its licensing arrangements which qualify as symbolic licenses rather than functional licenses. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to us or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. We calculate and accrue estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales. +42 +Judgments +We considered several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, we have a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment. We accrue a liability for product returns at the time of sale based on our historical experience. We also accrue amounts for goods expected to be returned in salable condition. As of December 31, 2018 and December 31, 2017, the Company’s sales returns liability totaled $67.3 million and $43.4 million, respectively, and was included in accrued expenses and accounts receivable in the consolidated balance sheets, respectively. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. When a customer’s account becomes significantly past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and e-commerce receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such we have determined that no allowance for doubtful accounts is necessary. +We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. Gross trade accounts receivable were $527.5 million and $457.1 million, and the allowance for bad debts, returns, sales allowances and customer chargebacks were $74.1 million and $51.2 million, at December 31, 2018 and 2017, respectively. Our credit losses charged to expense for the years ended December 31, 2018, 2017, and 2016 were $15.5 million, $12.8 million, and $12.7 million, respectively. In addition, we recorded sales return and allowance expense for the years ended December 31, 2018, 2017 and 2016 of $20.2 million, $5.6 million, and $18.1 million, respectively. +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. Our gross inventory value was $876. 0 million and $ 881.8 million, and our inventory reserve was $12.8 million and $ 8.8 million, at December 31, 2018 and 2017, respectively. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances: +• +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets; +• +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +• +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +• +overall financial performance such as negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; +43 +• +other relevant entity-specific events such as changes in management, key personnel, strategy, customers, contemplation of bankruptcy, or litigation; +• +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and +• +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. We base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. For the years ended December 31, 2018, 2017 and 2016, respectively we did not record an impairment charge. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates and valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. As of December 31, 2018, we had a total deferred tax assets of $69.2 million which was reduced by a valuation allowance of $30.2 million and resulted in a net deferred tax assets of $39.0 primarily related to loss carry-forwards not expected to be utilized by certain foreign subsidiaries. +On December 22, 2017, the SEC staff issued SAB 118 to address the accounting implications of the 2017 Tax Act. SAB 118 permits a company to recognize provisional amounts for the one-time tax effects of the Tax Act upon enactment when it does not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the change in tax law. The measurement period to finalize our calculations cannot extend beyond one year of the enactment date. Key provisions that have a significant impact on our consolidated financial statements and where we have recognized estimated amounts include the recognition of a tax liability for a one-time Transition Tax on the accumulated earnings of our foreign subsidiaries, and the remeasurement of certain net deferred tax assets and liabilities as a result of the decrease in the U.S. corporate tax rate from 35% to 21%. +Due to the Transition Tax on the accumulated earnings of our foreign subsidiaries, previously unremitted earnings for which no U.S. deferred tax liability had been provided have now been subject to U.S. tax. While we have provided U.S. tax on all our unremitted foreign earnings, we have not provided for additional taxes which may arise upon repatriation of those amounts of unremitted foreign earnings which we believe are indefinitely reinvested outside the U.S. +INFLATION +We do not believe that the rates of inflation experienced in the United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +44 +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2018 and 2017, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — The Company and Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2018, we have $7.2 million and $83.8 million of outstanding short-term and long-term borrowings, respectively, subject to changes in interest rates. A 200 basis point increase in interest rates would have increased interest expense by less than $0.2 million for the year ended December 31, 2018. We do not expect any changes in interest rates to have a material impact on our financial condition or results of operations during the remainder of 2019. The interest rate charged on our domestic secured line of credit facility is based on the prime rate of interest, our domestic distribution center loan is based on the one month LIBOR and our China DC Loan is based on a reference rate provided by the People’s Bank of China. Changes in these interest rates will have an effect on the interest charged on outstanding balances. As of December 31, 2018, there was $0.1 million outstanding under this credit facility, $ 65.1 million outstanding on our domestic distribution center loan and $18.6 million on our China DC Loan. +We have entered into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on our long-term debt. We will not enter into derivative transactions for speculative purposes. We had one derivative instrument in place as of December 31, 2018 to hedge the cash flows on our $65.1 million variable rate debt on our domestic distribution center. This instrument was a variable to fixed derivative with a notional amount of $65.1 million at December 31, 2018. Our average receive rate was one month LIBOR and the average pay rate was 2.08%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest expense. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not engage in hedging activities with respect to such exchange rate risks. +Assets and liabilities outside the United States are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, the Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. Accordingly, we do not hedge these net investments. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation loss of $16.7 million and a cumulative foreign currency translation gain of $11.9 million for the years ended December 31, 2018 and 2017, respectively, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2018 would have reduced the values of our net investments by approximately $31.3 million. +45 +ITEM 8. +FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +47 +CONSOLIDATED BALANCE SHEETS +48 +CONSOLIDATED STATEMENTS OF EARNINGS +49 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +50 +CONSOLIDATED STATEMENTS OF EQUITY +51 +CONSOLIDATED STATEMENTS OF CASH FLOWS +52 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +53 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +80 +46 +Report of Independent Regist ered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) and subsidiaries as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and schedule (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 1, 2019 expressed an unqualified opinion thereon. +Change in Accounting Method Related to Revenue +As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for revenue during the year ended December 31, 2018 due to the adoption of the Accounting Standards Codification 606, “Revenue from Contracts with Customers. ” +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +March 1, 2019 +47 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +December 31, +2018 +2017 +ASSETS +Current assets: +Cash and cash equivalents +$ +872,237 +$ +736,431 +Short-term investments +100,029 +— +Trade accounts receivable, less allowances of $25,616 in 2018 and $51,180 in 2017 +501,913 +405,921 +Other receivables +55,683 +27,083 +Total receivables +557,596 +433,004 +Inventories +863,260 +873,016 +Prepaid expenses and other current assets +79,018 +62,573 +Total current assets +2,472,140 +2,105,024 +Property, plant and equipment, net +585,457 +541,601 +Deferred tax assets +39,431 +29,922 +Long-term investments +93,745 +17,396 +Other assets, net +37,482 +41,139 +Total non-current assets +756,115 +630,058 +TOTAL ASSETS +$ +3,228,255 +$ +2,735,082 +LIABILITIES AND EQUITY +Current liabilities: +Current installments of long-term borrowings +$ +1,666 +$ +1,801 +Short-term borrowings +7,222 +8,011 +Accounts payable +679,553 +505,334 +Accrued expenses +161,781 +82,202 +Total current liabilities +850,222 +597,348 +Long-term borrowings, excluding current installments +88,119 +71,103 +Deferred tax liabilities +451 +161 +Other long-term liabilities +100,188 +118,259 +Total non-current liabilities +188,758 +189,523 +Total liabilities +1,038,980 +786,871 +Commitments and contingencies +Stockholders’ equity: +Preferred stock, $0.001 par value; 10,000 shares authorized; none issued +and outstanding +— +— +Class A common stock, $0.001 par value; 500,000 shares authorized; +129,525 and 131,784 shares issued and outstanding at December 31, 2018 +and December 31, 2017, respectively +129 +132 +Class B common stock, $0.001 par value; 75,000 shares authorized; +23,983 and 24,545 shares issued and outstanding at December 31, 2018 +and December 31, 2017, respectively +24 +24 +Additional paid-in capital +375,017 +453,417 +Accumulated other comprehensive loss +(31,488 +) +(14,744 +) +Retained earnings +1,691,276 +1,390,235 +Skechers U.S.A., Inc. equity +2,034,958 +1,829,064 +Non-controlling interests +154,317 +119,147 +Total stockholders' equity +2,189,275 +1,948,211 +TOTAL LIABILITIES AND EQUITY +$ +3,228,255 +$ +2,735,082 +See accompanying notes to consolidated financial statements. +48 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Years Ended December 31, +2018 +2017 +2016 +Net sales +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +Cost of sales +2,418,463 +2,225,271 +1,928,715 +Gross profit +2,223,605 +1,938,889 +1,634,596 +Royalty income +20,582 +16,666 +13,885 +2,244,187 +1,955,555 +1,648,481 +Operating expenses: +Selling +350,435 +327,201 +257,129 +General and administrative +1,455,987 +1,245,474 +1,020,834 +1,806,422 +1,572,675 +1,277,963 +Earnings from operations +437,765 +382,880 +370,518 +Other income (expense): +Interest income +10,128 +2,420 +1,186 +Interest expense +(5,847 +) +(6,677 +) +(6,270 +) +Other, net +(10,162 +) +5,637 +(5,950 +) +Total other income (expense) +(5,881 +) +1,380 +(11,034 +) +Earnings before income tax expense +431,884 +384,260 +359,484 +Income tax expense +60,611 +149,156 +74,125 +Net earnings +371,273 +235,104 +285,359 +Less: Net earnings attributable to non-controlling interests +70,232 +55,914 +41,866 +Net earnings attributable to Skechers U.S.A., Inc. +$ +301,041 +$ +179,190 +$ +243,493 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +1.93 +$ +1.15 +$ +1.58 +Diluted +$ +1.92 +$ +1.14 +$ +1.57 +Weighted average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +155,815 +155,651 +154,169 +Diluted +156,450 +156,523 +155,084 +See accompanying notes to consolidated financial statements. +49 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2018 +2017 +2016 +Net earnings +$ +371,273 +$ +235,104 +$ +285,359 +Other comprehensive income: +Gain (loss) on foreign currency translation adjustment +(24,806 +) +19,119 +(4,698 +) +Comprehensive income +346,467 +254,223 +280,661 +Less: Comprehensive income attributable to noncontrolling interests +62,170 +63,173 +37,467 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +284,297 +$ +191,050 +$ +243,194 +See accompanying notes to consolidated financial statements. +50 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +NON +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +CONTROLLING +STOCKHOLDERS' +STOCK +STOCK +STOCK +STOCK +CAPITAL +INCOME (LOSS) +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at January 1, 2016 +127,324 +26,278 +$ +127 +$ +26 +$ +386,156 +$ +(26,305 +) +$ +967,552 +$ +1,327,556 +$ +48,178 +$ +1,375,734 +Net earnings +— +— +— +— +— +— +243,493 +243,493 +41,866 +285,359 +Foreign currency translation adjustment +— +— +— +— +— +(299 +) +— +(299 +) +(4,399 +) +(4,698 +) +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +13,980 +13,980 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(17,744 +) +(17,744 +) +Stock compensation expense +— +— +— +— +23,081 +— +— +23,081 +— +23,081 +Proceeds from issuance of common stock under the +employee stock purchase plan +221 +— +— +— +5,120 +— +— +5,120 +— +5,120 +Shares issued under the Incentive Award Plan +1,108 +— +1 +— +(1 +) +— +— +— +— +— +Tax benefit of stock options exercised +— +— +— +— +4,682 +— +— +4,682 +— +4,682 +Conversion of Class B Common Stock into Class A +Common Stock +1,733 +(1,733 +) +2 +(2 +) +— +— +— +— +— +— +Balance at December 31, 2016 +130,386 +24,545 +$ +130 +$ +24 +$ +419,038 +$ +(26,604 +) +$ +1,211,045 +$ +1,603,633 +$ +81,881 +$ +1,685,514 +Net earnings +— +— +— +— +— +— +179,190 +179,190 +55,914 +235,104 +Foreign currency translation adjustment +— +— +— +— +— +11,860 +— +11,860 +7,259 +19,119 +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +46 +46 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(25,953 +) +(25,953 +) +Stock compensation expense +— +— +— +— +28,902 +— +— +28,902 +— +28,902 +Proceeds from issuance of common stock under the +employee stock purchase plan +240 +— +— +— +5,479 +— +— +5,479 +— +5,479 +Shares issued under the Incentive Award Plan +1,158 +— +2 +— +(2 +) +— +— +— +— +— +Balance at December 31, 2017 +131,784 +24,545 +$ +132 +$ +24 +$ +453,417 +$ +(14,744 +) +$ +1,390,235 +$ +1,829,064 +$ +119,147 +$ +1,948,211 +Net earnings +— +— +— +— +— +— +301,041 +301,041 +70,232 +371,273 +Foreign currency translation adjustment +— +— +— +— +— +(16,744 +) +— +(16,744 +) +(8,062 +) +(24,806 +) +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +(27,000 +) +(27,000 +) +Stock compensation expense +— +— +— +— +30,468 +— +— +30,468 +— +30,468 +Proceeds from issuance of common stock under the +employee stock purchase plan +222 +— +— +— +5,297 +— +— +5,297 +— +5,297 +Shares issued under the Incentive Award Plan +1,018 +— +1 +— +(1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +(405 +) +— +(1 +) +— +(14,190 +) +— +— +(14,191 +) +— +(14,191 +) +Conversion of Class B Common Stock into Class A +Common Stock +562 +(562 +) +— +— +— +— +— +— +— +— +Repurchases of common stock +(3,656 +) +— +(3 +) +— +(99,974 +) +— +— +(99,977 +) +— +(99,977 +) +Balance at December 31, 2018 +129,525 +23,983 +$ +129 +$ +24 +$ +375,017 +$ +(31,488 +) +$ +1,691,276 +$ +2,034,958 +$ +154,317 +$ +2,189,275 +See accompanying notes to consolidated financial statements +51 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Years Ended December 31, +2018 +2017 +2016 +Cash flows from operating activities: +Net earnings +$ +371,273 +$ +235,104 +$ +285,359 +Adjustments to reconcile net earnings to net cash provided by operating activities: +Depreciation and amortization of property, plant and equipment +98,966 +82,764 +66,083 +Amortization of other assets +10,714 +13,746 +13,099 +Provision for bad debts and returns +35,730 +18,398 +30,820 +Non-cash share-based compensation +30,468 +28,902 +23,081 +Deferred income taxes +(9,767 +) +(3,947 +) +(11,936 +) +Gain (loss) on non-current assets +550 +(2,187 +) +413 +Net foreign currency adjustments +10,072 +(7,749 +) +(3,949 +) +(Increase) decrease in assets: +Receivables +(136,188 +) +(102,222 +) +(10,350 +) +Inventories +(7,212 +) +(158,628 +) +(58,152 +) +Prepaid expenses and other current assets +(28,356 +) +(9,145 +) +(15,343 +) +Other assets +(1,713 +) +(8,916 +) +(5,056 +) +Increase (decrease) in liabilities: +Accounts payable +174,352 +(12,806 +) +38,247 +Accrued expenses and other long-term liabilities +19,663 +86,023 +9,306 +Net cash provided by operating activities +568,552 +159,337 +361,622 +Cash flows from investing activities: +Capital expenditures +(143,036 +) +(135,976 +) +(119,471 +) +Intangible asset additions +— +(214 +) +— +Purchases of investments +(446,127 +) +(2,344 +) +(3,810 +) +Proceeds from sales of investments +269,749 +284 +170 +Acquisition of South Korea distributor +— +— +(22,534 +) +Net cash used in investing activities +(319,414 +) +(138,250 +) +(145,645 +) +Cash flows from financing activities: +Net proceeds from the issuances of common stock through employee stock purchase plan +5,297 +5,479 +5,120 +Payments on long-term debt +(1,683 +) +(1,783 +) +(15,653 +) +Proceeds from long-term debt +18,626 +5,745 +— +Proceeds (payments) on short-term borrowings +(787 +) +1,925 +6,091 +Payments for taxes related to net share settlement of equity awards +(14,191 +) +— +— +Excess tax benefits from share-based compensation +— +— +4,682 +Repurchase of Class A common stock +(99,977 +) +— +— +Distributions to non-controlling interests of consolidated entity +(27,000 +) +(25,953 +) +(17,744 +) +Contribution from non-controlling interests of consolidated entity +— +46 +13,980 +Net cash used in financing activities +(119,715 +) +(14,541 +) +(3,524 +) +Net increase in cash and cash equivalents +129,423 +6,546 +212,453 +Effect of exchange rates on cash and cash equivalents +6,383 +11,349 +(1,908 +) +Cash and cash equivalents at beginning of the year +736,431 +718,536 +507,991 +Cash and cash equivalents at end of the year +$ +872,237 +$ +736,431 +$ +718,536 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +5,568 +$ +6,392 +$ +5,724 +Income taxes, net +93,041 +56,633 +65,260 +See accompanying notes to consolidated financial statements. +52 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2018, 2017 and 2016 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company operates 470 domestic and 222 international retail stores and an e-commerce business as of December 31, 2018. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to consolidated financial statements of prior years to conform to the current year presentation. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +(c) +Revenue Recognition +In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 “ Revenue from Contracts with Customers ,” (“ASU 2014-09”) which amended the FASB Accounting Standards Codification (“ASC”) and created a new Topic ASC 606, “ Revenue from Contracts with Customers ” (“ASC 606”). This amendment prescribes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The amendment supersedes the revenue recognition requirements in ASC Topic 605, “ Revenue Recognition ,” and most industry-specific guidance throughout the Industry Topics of the Codification. For the Company’s annual and interim reporting periods the mandatory adoption date of ASC 606 was January 1, 2018, and two methods of adoption were allowed, either a full retrospective adoption or a modified retrospective adoption. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to January 1, 2018. In March 2016, April 2016, May 2016, and December 2016, the FASB issued ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20, respectively, as clarifications to ASU 2014-09. ASU 2016‑08 clarifies how to identify the unit of accounting for the principal versus agent evaluation, how to apply the control principle to certain types of arrangements, such as service transactions, and reframed the indicators in the guidance to focus on evidence that an entity is acting as a principal rather than as an agent. ASU 2016-10 clarifies the existing guidance on identifying performance obligations and licensing implementation. ASU 2016-12 adds practical expedients related to the transition for contract modifications and further defines a completed contract, clarifies the objective of the collectability assessment and how revenue is recognized if collectability is not probable, and when non-cash considerations should be measured. ASU 2016-20 corrects or improves guidance in thirteen narrow focus aspects of the guidance. The effective dates for these ASUs are the same as the effective date for ASU No. 2014-09, for the Company’s annual and interim periods beginning January 1, 2018. These ASU’s also require enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows. The Company adopted the new revenue standard effective January 1, 2018 using the modified retrospective method. The adoption of these standards did not have a material impact on the Company’s consolidated financial statements. +The Company recognizes revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company derives income from the sale of footwear and royalties earned from licensing the Skechers brand. For North America, goods are shipped Free on Board (“FOB”) shipping point directly from the Company’s domestic distribution center in Rancho Belago, California. For international wholesale customers product is shipped FOB shipping point, (i) direct from the Company’s distribution center in Liege, Belgium, (ii) to third-party distribution centers in Central America, South America and Asia, (iii) directly from third-party manufacturers to our other international customers. For our distributor sales, the goods are generally delivered directly from the independent factories to third-party distribution centers or to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. The Company recognizes revenue on wholesale sales upon shipment as that is when the customer obtains control of the promised goods. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost and not as a separate performance obligation. The Company generates retail revenues primarily from the sale of footwear to customers at retail locations or through the Company’s websites. For our in-store sales, the Company recognizes revenue at the point of sale. For sales made through the Company’s websites, the Company recognizes revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from e-commerce or retail customers are excluded from reported revenues. +53 +The Company records accounts receivable at the time of shipment when the Company’s right to the consideration becomes unconditional. The Company typically extends credit terms to our whol esale customers based on their creditworthiness and generally does not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, the Company periodically decides to accept returns or provide customers with cre dits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. Retail and e-commerce sales represent amounts due from credit card companies and are generally collected within a few d ays of the purchase. As such, the Company has determined that no allowance for doubtful accounts for retail and e-commerce sales is necessary. +The Company earns royalty income from its licensing arrangements which qualify as symbolic licenses rather than functional licenses. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The Company applies the sales-based royalty exception for the royalty income based on sales and recognizes revenue only when subsequent sales occur. The Company calculates and accrues estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales. +Judgments +The Company considered several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment. The Company accrues a liability for product returns at the time of sale based on our historical experience. The Company also accrues amounts for goods expected to be returned in salable condition. During the first quarter of 2018, the Company reclassified $30.7 million of its sales return and allowance from accounts receivable to accrued expenses, which increased both assets and liabilities by $30.7 million. As of December 31, 2018 and December 31, 2017, the Company’s sales returns liability totaled $67.3 million and $43.4 million, respectively, and was included in accrued expenses and accounts receivable in the consolidated balance sheets, respectively. +Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historic revenue recognition methodology under ASC 605, Revenue Recognition . +(d) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic wholesale, international wholesale, and retail, which includes e-commerce sales. Information regarding these segments is summarized in Note 19 – Segment and Geographic Reporting. +(e) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Asia and the Middle East or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) 810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has determined that it is the primary beneficiary for these VIE’s because the Company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity, or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated financial statements, even though the Company may not hold a majority equity interest. There have been no changes during 2018 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The assets of these joint ventures are restricted in that they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Company does not have a variable interest in any unconsolidated VIEs. +54 +(f) +Fair Value of Financial Instruments +The accounting standard for fair value measurements provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. This accounting standard established a fair value hierarchy, which requires an entity to maximize the use of observable inputs, where available. The following summarizes the three levels of inputs required: +• +Level 1 – Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 non-derivative investments primarily include money market funds and U.S. Treasury securities. +• +Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s Level 2 non-derivative investments primarily include corporate notes and bonds, asset-backed securities, U.S. Agency securities, and actively traded mutual funds. The Company has one Level 2 derivative which is an interest rate swap related to the refinancing of its domestic distribution center (see below). +• +Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability. The Company currently does not have any Level 3 assets or liabilities. +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, short-term investments, accounts receivable, long-term investments, accounts payable and accrued expenses approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based upon current rates and terms available to the Company for similar debt. +As of August 12, 2015, the Company entered into an interest rate swap agreement concurrent with refinancing its domestic distribution center construction loan (see Note 7, Derivative Instruments). The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with U.S. GAAP, credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The majority of the inputs used to value the interest rate swap were within Level 2 of the fair value hierarchy. As of December 31, 2018, the interest rate swap was a Level 2 derivative and was classified as other long-term liabilities in the Company’s consolidated balance sheets. +(g) +Cash and Cash Equivalents +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +(h) +Investments +In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments consist of U.S. Treasury Bonds, U.S. Agency securities, corporate notes and bonds, asset-backed securities and actively traded mutual funds. +(i) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectability, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the account. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and e-commerce receivables represent +55 +amounts due from credit card companies and are generally collected within a few days of the purchase. As such, the Company has determined that no allowance for doubtful accounts is necessary. +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high-risk, the Company provides a reserve based upon its historical loss rate as a percentage of sales. +(j) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market (net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories, and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +(k) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method, which based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, +whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company reviews both quantitative and qualitative factors to assess whether a triggering event occurred. The Company reviews all stores for impairment annually or more frequently if events or changes in circumstances require it. The Company prepares a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of 24 months are then reviewed in detail to determine whether impairment exists. Recoverability of assets or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. The Company did not record impairment charges during the years ended December 31, 2018, 2017 or 2016. +(l) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +(m) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Translation adjustments for subsidiaries where the functional currency is its local currency are included in other comprehensive income. Foreign currency transaction gains (losses) resulting from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +56 +(n) +Comprehensive Income +Comprehensive income is presented in the consolidated statements of comprehensive income. Comprehensive income consists of net earnings, foreign currency translation adjustments, and income attributable to non-controlling interests. +(o) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run, or over the life of the endorsement contract. Advertising expense for the years ended December 31, 2018, 2017 and 2016 was approximately $278.4 million, $260.4 million and $213.1 million, respectively. Prepaid advertising costs were $4.4 million and $8.6 million at December 31, 2018, and 2017, respectively. Prepaid amounts outstanding at December 31, 2018 and 2017 represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run, as of December 31, 2018 and 2017, respectively. +(p) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses, when incurred. Product design and development costs aggregated approximately $18.5 million, $18.8 million, and $13.6 million during the years ended December 31, 2018, 2017 and 2016, respectively. +(q) +Warehouse and Distribution Costs +The Company’s distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $249.6 million, $219.6 million and $187.3 million for 2018, 2017 and 2016, respectively. +(r) +Recent Accounting Pronouncements +In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02 “ Leases (Topic 842) ,” (“ASU 2016-02”). ASU 2016-02 is intended to increase transparency and comparability among organizations relating to leases. Lessees will be required to recognize a liability to make lease payments and a right-of-use asset representing the right to use the underlying asset for the lease term. The FASB retained a dual model for lease classification, requiring leases to be classified as finance or operating leases to determine recognition in the earnings statement and cash flows; however, substantially all leases will be required to be recognized on the balance sheet. ASU 2016-02 will also require quantitative and qualitative disclosures regarding key information about leasing arrangements. ASU 2016-02 is effective using a modified retrospective approach for fiscal years and interim periods beginning after December 15, 2018, with early adoption permitted. As originally issued, ASU 2016-02 requires application at the beginning of the earliest comparative period presented at the time of adoption. In July 2018, the FASB issued ASU No. 2018-10, “Codification Improvements to Topic 842, Leases,” (“ASU 2018-10”). This ASU makes various targeted amendments to the leasing standard. In July 2018, the FASB issued ASU 2018-11, “ Leases (Topic 842): Targeted Improvements ,” (“ASU No. 2018-11”). This standard allows entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The standard also provides for certain practical expedients. We adopted this ASU on January 1, 2019, using the optional transition method and also elected to use the 'package of practical expedients', which allows us not to continue to reassess our previous conclusions about lease identification, lease classification and initial direct costs. The Company is still assessing the impact of the new standard on its consolidated financial statements and its internal controls process and finalizing the present value calculation for its right-of-use asset. The Company anticipates a material increase in assets and liabilities due to the recognition of the required right-of-use asset and corresponding liability for all lease obligations that are currently classified as operating leases such as retail stores, real estate leases for corporate headquarters, administrative offices, showrooms, and distribution facilities, as well as the significant new quantitative and qualitative disclosure requirements on all of the Company’s lease obligations. The Company expects the right of use asset will be the present value of the remaining lease payments as noted in Note 9 – Commitments and Contingencies. The earnings statement recognition of lease expense is expected to be similar to the Company’s current methodology. +In February 2018, the FASB issued ASU No. 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” (“ASU 2018-02”). The standard permits a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. ASU 2018-02 is effective for the Company’s annual and interim reporting periods beginning December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of ASU 2018-02; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In August 2018, the FASB issued ASU No. 2018-13 “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement,” (“ASU No. 2018-13”), which modifies the disclosure requirements on +57 +fair value measurements, including the consideration of costs and benefits. ASU 2018-13 is effective for all entities for fiscal years beginning after December 15, 2019, but entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The Company is currently evaluating the impact of ASU 2018-13; however, at the current time the Company does not expect that the adoption of this ASU will ha ve a material impact on its consolidated financial statements. +In August 2018, the FASB issued ASU No. 2018-15 “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract,” (“ASU 2018-15”). ASU 2018-15 requires that issuers follow the internal-use software guidance in Accounting Standards Codification (ASC) 350-40 to determine which costs to capitalize as assets or expense as incurred. The ASC 350-40 guidance requires that certain costs incurred during the application development stage be capitalized and other costs incurred during the preliminary project and post-implementation stages be expensed as they are incurred. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019. The Company is currently evaluating the impact of ASU 2018-15; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In June 2016, the FASB issued ASU No. 2016-13, “ Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument,” (“ASU 2016-13”). The new standard amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which may result in earlier recognition of losses. Public business entities should apply the guidance in ASU 2016-13 for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption will be permitted for annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of ASU 2016-13; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +(2) CASH, CASH EQUIVALENTS, SHORT-TERM AND LONG-TERM INVESTMENTS +The Company’s investments consists of mutual funds held in the company’s deferred compensation plan and classified as trading securities, U.S. Treasury securities, corporate notes and bonds and U.S. Agency securities, that the Company has the intent and ability to hold to maturity and therefore, are classified as held-to-maturity. The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category as of December 31, 2018 and 2017 (in thousands): +December 31, 2018 +Adjusted Cost +Unrealized Gains +Unrealized Losses +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +713,624 +$ +- +$ +- +$ +713,624 +$ +713,624 +$ +- +$ +- +Level 1: +Money market funds +158,613 +- +- +158,613 +158,613 +- +- +U.S. Treasury securities +6,955 +- +- +6,955 +- +4,979 +1,976 +Total level 1 +165,568 +- +- +165,568 +158,613 +4,979 +1,976 +Level 2: +- +- +- +Corporate notes and bonds +132,280 +- +- +132,280 +- +88,412 +43,868 +Asset-backed securities +23,310 +- +- +23,310 +- +2,115 +21,195 +U.S. Agency securities +10,272 +- +- +10,272 +- +4,523 +5,749 +Mutual funds +20,957 +- +- +20,957 +- +- +20,957 +Total level 2 +186,819 +- +- +186,819 +- +95,050 +91,769 +TOTAL +$ +1,066,011 +$ +- +$ +- +$ +1,066,011 +$ +872,237 +$ +100,029 +$ +93,745 +December 31, 2017 +Adjusted Cost +Unrealized Gains +Unrealized Losses +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +736,431 +$ +- +$ +- +$ +736,431 +$ +736,431 +$ +- +$ +- +Level 2: +Mutual funds +17,396 +- +- +17,396 +- +- +17,396 +TOTAL +$ +753,827 +$ +- +$ +- +$ +753,827 +$ +736,431 +$ +- +$ +17,396 +The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are typically less than two years. +58 +The Company considers declines in market value of its marketable securities investment portfolio to be temporary in nature. The Company typically invests in highly-rated securities, and its investment policy generally limits the amount of credit exposure to any one issuer. The policy generally requires investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were d etermined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s cost basis. A s of December 31, 2018 , the Company does not consider any of its investments to be other-than-temporarily impaired. +(3) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2018 and 2017 is summarized as follows (in thousands): +2018 +2017 +Land +$ +83,163 +$ +83,163 +Buildings and improvements +246,893 +208,351 +Furniture, fixtures and equipment +374,706 +330,644 +Leasehold improvements +401,514 +357,920 +Total property, plant and equipment +1,106,276 +980,078 +Less accumulated depreciation and amortization +520,819 +438,477 +Property, plant and equipment, net +$ +585,457 +$ +541,601 +(4) +ACCRUED EXPENSES +Accrued expenses at December 31, 2018 and 2017 are summarized as follows (in thousands): +2018 +2017 +Accrued inventory purchases +$ +40,493 +$ +20,509 +Accrued payroll and taxes +72,822 +61,693 +Return reserve liability +48,466 +— +Accrued expenses +$ +161,781 +$ +82,202 +(5) +LINE OF CREDIT AND SHORT-TERM BORROWINGS +On October 24, 2018, through our Chinese joint venture, we entered into a $17.5 million loan agreement with The Hongkong and Shanghai Banking Corporation Limited (the “China Loan Agreement”). The China Loan Agreement allows for partial drawdown. Interest will be paid at one, two or three months, depending on the period of the drawdown. The interest rate will be based upon the London Interbank Offered Rate (“LIBOR”) plus 1.2% per annum. As specified in the China Loan Agreement, the principal of the loan will be repayable by fifteen equal quarterly installments of $437,550, commencing fifteen months after drawdown plus a final installment of $10,937,500. The loan has a term of 5 years. The China Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type. The obligations of the our Chinese joint venture under the China Loan Agreement are jointly and severally guaranteed by the Company and Luen Thai Enterprises Ltd. There was no amount outstanding as of December 31, 2018. +On October 19, 2018, through a subsidiary of our Chinese joint venture (“the TC Subsidiary”), the Company entered into a 50 million yuan revolving loan agreement with China Construction Bank Corporation (“the China DC Revolving Loan Agreement”). The proceeds from the China DC Revolving Loan Agreement will be used to finance the construction and operation of the Company’s distribution center in China. Interest will be paid quarterly. The interest rate will be based upon the prime rate from the People’s Bank of China less a discount. As specified in the China DC Revolving Loan Agreement, the entire principal balance of the loan will be repaid when the China DC Revolving Loan Agreement matures on October 18, 2019. The TC Subsidiary has the option to extend the China DC Revolving Agreement, conditioned upon the satisfaction of certain terms. The China DC Revolving Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the TC Subsidiary, to among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Revolving Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The obligations of the TC Subsidiary under the China DC Revolving Loan Agreement are jointly and severally guaranteed by our Chinese joint venture. Currently there is no amount outstanding as of December 31, 2018. +59 +On September 20, 2018, through two subsidiaries of our Chinese joint venture (the “SGZ and SSH Subsidiaries”), we entered into a 125 million yuan revolving loan agreement with HSBC Bank (China) Company Limited, Guangzhou Branch (the “Revolving Loan Agreement”). The Revolving Loan Agreement is comprised of two tranches: a 125 million yuan revolving loan facility and a 15 million yuan non-financial bank guarantee facility. The proceeds from the Revolving Loan Agreement will be used to finance the SGZ and SSH Subsidiaries’ working capital requirements. Interest will be paid at one, two or three months, depending on th e term of each loan. The interest rate will be equal to 100% of the applicable People’s Bank of China (“PBOC”) Benchmark Lending Rate, provided that if the PBOC Benchmark Lending Rate changes during the term of a loan, the applicable interest rate for tha t loan will not change until the next rollover date of that loan (if any). The Revolving Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the joi nt venture to, among other things, allow external investment to be added, pledge assets and issue debt with priority over the Revolving Loan Agreement. The term of each loan will be one, three or six months or such other period as agreed by the lender. T he term of a loan, including any extension or rollover, shall not exceed twelve months. The obligations of the Subsidiary under the Revolving Loan Agreement are guaranteed by the Company, Luen Thai Enterprises Ltd., Skechers Guangzhou Co., Ltd and Skecher s Trading (Shanghai) Co Ltd. There was no amount outstanding as of December 31, 2018. +On June 30, 2015, the Company entered into a $250.0 million loan and security agreement, subject to increase by up to $100.0 million, (the “Credit Agreement”), with the following lenders: Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association. The Credit Agreement matures on June 30, 2020. The Credit Agreement replaces the credit agreement dated June 30, 2009, which expired on June 30, 2015. The Credit Agreement permits the Company and certain of its subsidiaries to borrow based on a percentage of eligible accounts receivable plus the sum of (a) the lesser of (i) a percentage of eligible inventory to be sold at wholesale and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at wholesale, plus (b) the lesser of (i) a percentage of the value of eligible inventory to be sold at retail and (ii) a percentage of net orderly liquidation value of eligible inventory to be sold at retail, plus (c) the lesser of (i) a percentage of the value of eligible in-transit inventory and (ii) a percentage of the net orderly liquidation value of eligible in-transit inventory. Borrowings bear interest at the Company’s election based on (a) LIBOR or (b) the greater of (i) the Prime Rate, (ii) the Federal Funds Rate plus 0.5% and (iii) LIBOR for a 30-day period plus 1.0%, in each case, plus an applicable margin based on the average daily principal balance of revolving loans available under the Credit Agreement. The Company pays a monthly unused line of credit fee of 0.25%, payable on the first day of each month in arrears, which is based on the average daily principal balance of outstanding revolving loans and undrawn amounts of letters of credit outstanding during such month. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $100.0 million. The Credit Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that will limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose of assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The Credit Agreement also requires compliance with a minimum fixed-charge coverage ratio if Availability drops below 10% of the Revolver Commitments (as such terms are defined in the Credit Agreement) until the date when no event of default has existed and Availability has been over 10% for 30 consecutive days. The Company paid closing and arrangement fees of $1.1 million on this facility, which are included in Other Assets in the consolidated balance sheets, and are being amortized to interest expense over the five-year life of the facility. As of December 31, 2018 and December 31, 2017, there was $0.1 million outstanding under the Company’s credit facilities, classified as short-term borrowings in the Company’s consolidated balance sheets. The remaining balance in short-term borrowings as of December 31, 2018 is related to the Company’s joint venture in India. +60 +(6) +LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2018 and 2017 are as follows (in thousands): +2018 +2017 +Note payable to banks, due in monthly installments of $364 +(includes principal and interest), variable-rate interest at +4.52% per annum, secured by property, balloon payment of +$62,843 due August 2020 +$ +65,148 +$ +66,604 +Note payable to Luen Thai Enterprise, Ltd., balloon payment +of $5,800 due January 2021 +5,800 +5,745 +Note payable to TCF Equipment Finance, Inc., due in monthly +installments of $31 (includes principal and interest), fixed- +rate interest at 5.24% per annum, due July 2019 +210 +555 +Loan payable to a bank, variable-rate interest at 4.28% per +annum, due September 2023 +18,626 +— +Subtotal +89,785 +72,904 +Less current installments +1,666 +1,801 +Total long-term borrowings +$ +88,119 +$ +71,103 +The aggregate maturities of long-term borrowings at December 31, 2018 are as follows (in thousands): +2019 +$ +1,666 +2020 +63,693 +2021 +20,941 +2022 +3,485 +2023 +— +$ +89,785 +On September 29, 2018, through the TC subsidiary, the Company entered into a 700 million yuan loan agreement with China Construction Bank Corporation (“the China DC Loan Agreement”). The proceeds from the China DC Loan Agreement will be used to finance the construction of the Company’s distribution center in China. Interest will be paid quarterly. The interest rate will float and be calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2018 was 4.28% and may increase or decrease over the life of the loan, and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan Agreement. The China DC Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the Subsidiary to, among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The China DC Loan Agreement matures on September 28, 2023. The obligations of the TC Subsidiary under the China DC Loan Agreement are jointly and severally guaranteed by the Company’s Chinese joint venture. As of December 31, 2018 there was $18.6 million outstanding under this credit facility, which is classified as long-term borrowings in the Company’s consolidated balance sheets. +On April 30, 2010, HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the “Construction Loan Agreement”), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the project on certain property (the “Original Loan”). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the “Modification”), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV, through HF-T1, entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the “Amended Loan Agreement”), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF Logistics (“HF”) agreed that the Company would make an additional capital contribution of $38.7 million to the JV, through HF-T1, to make a payment on the Original Loan based on the Company’s 50% equity interest in the JV. The payment equaled the Company’s 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the “New Loan”). The New Loan is being used by the JV, through HF-T1, to (i) refinance all amounts owed on the Original Loan after +61 +taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other clo sing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined i n the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) to govern derivative and/or hedging transactions that HF-T1 concurrently entered into w ith Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in the Company’s consolidated statements of equity within non-con trolling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Credit Agreement dated June 30, 2015 (see Note 7, De rivative Instruments). +The Company’s short-term and long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. The Company is in compliance with its non-financial covenants, including any cross default provisions, and financial covenants of its short-term and long-term borrowings as of December 31, 2018. +(7) +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company used an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. On August 12, 2015, in connection with refinancing its domestic distribution center loan, described in Note 6 above, the Company entered into a variable-to-fixed interest rate swap agreement with Bank of America, N.A., to hedge the cash flows on the Company’s $70.0 million variable rate debt. As of December 31, 2018, the swap agreement has an aggregate notional amount of $65.1 million and a maturity date of August 12, 2022, subject to early termination commencing on August 1, 2020 at the option of HF Logistics-SKX T1, LLC (“HF-T1”), a wholly-owned subsidiary of the Company’s joint venture HF Logistics-SKX, LLC (the “JV”). Under the terms of the swap agreement, the Company will pay a weighted-average fixed rate of 2.08% on the $65.1 million notional amount and receive payments from the counterparty based on the 30-day LIBOR rate. The rate swap agreement utilized by the Company effectively modifies its exposure to interest rate risk by converting the Company’s floating-rate debt to a fixed-rate of 4.08% for the life of the loan thus reducing the impact of interest-rate changes on future interest expense. Pursuant to the terms of the JV, HF Logistics is responsible for any amounts related to the Swap Agreement. +By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2018, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +(8) +OTHER LONG-TERM LIABILITIES +Other long-term liabilities at December 31, 2018 and 2017 are as follows (in thousands): +2018 +2017 +Other long term liabilities +$ +21,458 +$ +19,059 +Income taxes payable +78,730 +99,200 +$ +100,188 +$ +118,259 +62 +(9) +COMMITMENTS AND CONTINGENCIES +(a) +Leases +The Company leases facilities under operating lease agreements expiring through October 13, 2033. The Company pays taxes, maintenance and insurance in addition to the lease obligations. Leases may provide for renewal options and rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of gross sales in excess of a base annual rent. The Company also leases certain equipment and automobiles under operating lease agreements expiring at various dates through November 30, 2021. Rent expense for the years ended December 31, 2018, 2017 and 2016 approximated $257.6 million, $223.7 million and $171.0 million, respectively. +Minimum lease payments, which take into account escalation clauses, are recognized on a straight-line basis over the minimum lease term. Reimbursements for leasehold improvements are recorded as liabilities and are amortized as a reduction to rent expense over the lease term. Lease concessions, usually a free rent period, are considered in the calculation of the minimum lease payments for the minimum lease term. +Future minimum lease payments under noncancellable leases at December 31, 2018 are as follows (in thousands): +OPERATING +LEASES +Year ending December 31: +2019 +$ +251,711 +2020 +228,716 +2021 +203,979 +2022 +178,850 +2023 +181,227 +Thereafter +596,901 +$ +1,641,384 +(b) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0% and 0.5% for 30- to 60-day financing. The amounts outstanding under these arrangements at December 31, 2018 and 2017 were $180.5 million and $177.4 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $3.3 million in 2018, $4.8 million in 2017, and $4.4 million in 2016. The Company has open purchase commitments with its foreign manufacturers at December 31, 2018 of $887.9 million, which are not included in the accompanying 2018 consolidated balance sheet. +(c) +Litigation +The Company recognizes legal expense in connection with loss contingencies as incurred. +In accordance with U.S. GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2018, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. +(10) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $.001 per share, 75 million shares of Class B Common Stock, par value $.001 per share, and 10 million shares of preferred stock, par value $.001 per share. +63 +During 2018 and 2016, certain Class B stockholders converted 561,876 and 1,733,270 shares, respectively, of Class B Common Stock to Class A Common Stock. During 2017, no Class B Common Stock was converted to Class A Common Stock. (see Note 13 – Earnings Per Share). +(11) +NONCONTROLLING INTERESTS +The following VIEs are consolidated into the Company’s consolidated financial statements and the carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics-SKX, LLC +December 31, 2018 +December 31, 2017 +Current assets +$ +2,121 +$ +1,540 +Non-current assets +98,148 +103,407 +Total assets +$ +100,269 +$ +104,947 +Current liabilities +$ +2,738 +$ +2,718 +Non-current liabilities +64,702 +66,367 +Total liabilities +$ +67,440 +$ +69,085 +Distribution joint ventures (1) +December 31, 2018 +December 31, 2017 +Current assets +$ +540,768 +$ +389,687 +Non-current assets +128,250 +90,972 +Total assets +$ +669,018 +$ +480,659 +Current liabilities +$ +294,640 +$ +188,700 +Non-current liabilities +26,444 +9,201 +Total liabilities +$ +321,084 +$ +197,901 +(1) +Distribution joint ventures include Skechers Limited (Israel), Skechers China Limited, Skechers Korea Limited, Skechers Southeast Asia Limited, Skechers (Thailand) Limited, Skechers Retail India Private Limited, and Skechers South Asia Private Limited. +The following is a summary of net earnings attributable to, distributions to and contributions from non-controlling interests (in thousands): +Year Ended December 31, +2018 +2017 +2016 +Net earnings attributable to non-controlling +interests +$ +70,232 +$ +55,914 +$ +41,866 +Distributions to: +HF Logistics-SKX, LLC +4,374 +3,787 +4,091 +Skechers China Limited +19,915 +20,620 +11,922 +Skechers Southeast Asia Limited +2,025 +1,347 +1,280 +Skechers Hong Kong Limited +618 +199 +451 +India distribution joint ventures +68 +— +— +Contributions from: +India distribution joint ventures +— +— +2,943 +Skechers Korea Co., Ltd. +— +— +8,273 +Skechers Footwear Ltd. (Israel) +— +46 +2,764 +64 +(12) +SHARE REPURCHASE PROGRAM +On February 6, 2018, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share (“Class A common stock”), for an aggregate repurchase price not to exceed $150 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A common stock and the program may be suspended or discontinued at any time. +The following table provides a summary of the Company’s stock repurchase activities during the year ended December 31, 2018: +Year ended December 31, 2018 +Shares repurchased +3,656,277 +Average cost per share +$ +27.34 +Total cost of shares repurchased (in thousands): +$ +99,977 +(13) +EARNINGS PER SHARE +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential dilutive common shares using the treasury stock method. +The Company has two classes of issued and outstanding common stock; Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted net earnings per share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating earnings per share (in thousands): +Basic earnings per share +2018 +2017 +2016 +Net earnings attributable to Skechers U.S.A., Inc. +$ +301,041 +$ +179,190 +$ +243,493 +Weighted average common shares outstanding +155,815 +155,651 +154,169 +Basic earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.93 +$ +1.15 +$ +1.58 +Diluted earnings per share +2018 +2017 +2016 +Net earnings attributable to Skechers U.S.A., Inc. +$ +301,041 +$ +179,190 +$ +243,493 +Weighted average common shares outstanding +155,815 +155,651 +154,169 +Dilutive effect of nonvested shares +635 +872 +915 +Weighted average common shares outstanding +156,450 +156,523 +155,084 +Diluted earnings per share attributable to +Skechers U.S.A., Inc. +$ +1.92 +$ +1.14 +$ +1.57 +65 +There were 352,169, 116,762, and 346,912 shares excluded from the computation of diluted earnings per share for the year ended December 31, 2018, 2017, and 2016 respectively because they are anti-dilutive. +(14) +STOCK COMPENSATION +(a) +Incentive Award Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007 and expired pursuant to its terms on May 24, 2017. +On April 17, 2017, the Company’s Board of Directors adopted the 2017 Incentive Award Plan (the “2017 Plan”), which became effective upon approval by the Company’s stockholders on May 23, 2017. The 2017 Plan replaced and superseded in its entirety the 2007 Plan. A total of 10,000,000 shares of Class A Common Stock are reserved for issuance under the 2017 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2017 Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. +A summary of the status and changes of nonvested shares related to the 2007 Plan and the 2017 Plan, as of and for the year ended December 31, 2018 is presented below: +SHARES +WEIGHTED-AVERAGE GRANT-DATE FAIR VALUE +Nonvested at January 1, 2016 +2,725,500 +$ +15.77 +Granted +1,444,000 +31.69 +Vested/Released +(1,108,336 +) +12.32 +Cancelled +(18,000 +) +17.81 +Nonvested at December 31, 2016 +3,043,164 +24.57 +Granted +495,600 +24.69 +Vested/Released +(1,157,207 +) +20.73 +Cancelled +(78,000 +) +32.62 +Nonvested at December 31, 2017 +2,303,557 +26.25 +Granted +1,811,000 +38.05 +Vested/Released +(1,018,283 +) +21.91 +Cancelled +(127,333 +) +29.71 +Nonvested at December 31, 2018 +2,968,941 +34.79 +As of December 31, 2018, a total of 8,090,500 shares remain available for grant as equity awards under the 2017 Plan. +The Company recognized in the consolidated statements of earnings compensation expense of $30.5 million, $28.9 million and $23.1 million for grants under its stock compensation plans for the years ended December 31, 2018, 2017, and 2016. Related excess income tax benefits of $1.6 million and $2.6 million was recorded in the statement of earnings for the years ended December 31, 2018 and December 31, 2017, respectively. Related excess income tax benefits of $4.7 million for grants under its stock compensation plans for the year ended December 31, 2016 was recorded in additional paid-in capital. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. There was $76.0 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2018, which is expected to be recognized over a weighted average period of 2.6 years. The total fair value of shares vested during the year ended December 31, 2018 and 2017 was $22.3 million and $24.0 million, respectively. +(b) +Stock Purchase Plan +On April 17, 2017, the Company’s Board of Directors adopted the 2018 Employee Stock Purchase Plan (the “2018 ESPP”), which the Company’s stockholders approved on May 23, 2017. The 2018 ESPP replaced the Company’s previous employee stock purchase plan, the Skechers U.S.A., Inc. 2008 Employee Stock Purchase Plan (the “2008 ESPP”), which expired pursuant to its terms on January 1, 2018. The 2018 Employee Stock Purchase Plan provides eligible employees of the Company and its subsidiaries with the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85% of the Class A +66 +Common Stock’s fair market value on the first trading day or last trading day of each purchase period, whichever is lower . The 2018 ESPP generally provides for two six-month purchase periods every twelve months: June 1 through November 30 and December 1 through May 31, except that the initial purchase period under the 2018 ESPP had a duration of five months, commencing on Ja nuary 1, 2018 and ending on May 31, 2018. Eligible employees participating in the 2018 ESPP for a purchase period will be able to invest up to 15% of their compensation through payroll deductions during each purchase period. A total of 5,000,000 shares of Class A Common Stock will be available for sale under the 2018 ESPP. +During 2018, 2017 and 2016, 221,889 shares, 240,000 shares and 220,844 shares were issued under the 2018 ESPP and 2008 ESPP for which the Company received approximately $5.3 million, $5.5 million and $5.1 million, respectively. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense which is computed using Black-Scholes options pricing model. +( 15) +INCOME TAXES +The provisions for income tax expense were as follows (in thousands): +2018 +2017 +2016 +Federal: +Current +$ +11,379 +$ +110,448 +$ +45,258 +Deferred +(3,971 +) +3,768 +(3,961 +) +Total federal +7,408 +114,216 +41,297 +State: +Current +5,408 +2,747 +3,406 +Deferred +(1,316 +) +(3,356 +) +(49 +) +Total state +4,092 +(609 +) +3,357 +Foreign: +Current +53,071 +40,147 +31,046 +Deferred +(3,960 +) +(4,598 +) +(1,575 +) +Total foreign +49,111 +35,549 +29,471 +Total income taxes (benefit) +$ +60,611 +$ +149,156 +$ +74,125 +Due to the enactment of Tax Cuts and Jobs Act (“the Tax Act”) in December 2017, the Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. Companies subject to GILTI have the option to account for the GILTI tax as a period cost if and when incurred, or to recognize deferred taxes for temporary differences including outside basis differences expected to reverse as GILTI. The Company has elected to account for GILTI as a period cost, and therefore has included GILTI expense in its effective tax rate calculation for the period. +The SEC staff issued Staff Accounting Bulletin 118, (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under Accounting Standards Codification 740 (“ASC 740”). In connection with its initial analysis of the impact of the Tax Act, the Company recorded a provisional one-time net tax expense of $99.9 million for the year-ended December 31, 2017. In 2018, the Company obtained additional information which reduced the Company’s provisional accounting for certain tax effects of the Tax Act by $10.9 million, from $99.9 million as reported at December 31, 2017, to $89.0 million. +The Company’s provision for income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0% to 34.6%. The Company’s provision for income tax expense (benefit) was calculated using the applicable statutory rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +67 +The Company’s earnings (loss) before income taxes and income tax expense (benefi t) for 2018, 2017 and 2016 are as follows (in thousands): +Years Ended December 31, +2018 +2017 +2016 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense (benefit) +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +16,597 +$ +11,500 +$ +25,628 +$ +113,607 +$ +105,589 +$ +44,654 +Peoples Republic of China (“China”) +89,429 +19,595 +95,668 +12,971 +72,584 +11,720 +Hong Kong +48,352 +8,106 +17,778 +5,030 +15,156 +5,206 +Jersey (2) +213,327 +— +198,048 +— +146,880 +— +Non-benefited loss operations (3) +(11,422 +) +(3,387 +) +(17,350 +) +3,306 +(16,189 +) +12 +Other jurisdictions (4) +75,601 +24,797 +64,488 +14,242 +35,464 +12,533 +Earnings before income taxes +$ +431,884 +$ +60,611 +$ +384,260 +$ +149,156 +$ +359,484 +$ +74,125 +Effective tax rate (5) +14.0 +% +38.8 +% +20.6 +% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the United States Tax Cuts & Jobs Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Barbados, Brazil, China, India, Israel, Japan, Panama, Romania, Thailand, and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hungary, India, Italy, Kosovo, Macau, Macedonia, Malaysia, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Serbia, Singapore, Spain, Switzerland, Vietnam, and the United Kingdom. +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2018, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 26%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2018, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $ 16.6 million, with income tax expense of $ 11.5 million, which is an average rate of 69 %. This rate is higher than the 26% U.S. statutory rate primarily due to the impact of U.S. non-deductible expenses. Earnings (loss) before income taxes in non-U.S. jurisdictions were $415.3 million, with an aggregate income tax expense of $49.1 million, which is an average rate of 11.8%. Combined, this results in consolidated earnings before income taxes for the period of $431.9 million, and consolidated income tax expense for the period of $60.6 million, resulting in an effective tax rate of 14.0%. For 2018, of our $415.3 million in earnings before income tax earned outside the U.S., $213.3 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $15.3 million to $213.3 million in 2018 from $ 198.0 million in 2017. This increase was primarily attributable to an increase in international sales which resulted in an increase in earnings before income taxes in Jersey from royalties and commissions under the terms of our inter-subsidiary agreements. In addition, there were foreign losses of $11.2 million for which no tax benefit was recognized during the year ended December 31, 2018 because of the provision of offsetting valuation allowances, but for which $3.4 million in prior year tax refunds were received. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. Unremitted earnings of non-U.S. subsidiaries for which no tax has been provided are expected to be reinvested outside of the U.S. indefinitely. Such earnings could become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. +As of December 31, 2018, we had approximately $872.2 million in cash and cash equivalents, of which $522.2 million, or 59.9%, was held outside the U.S. Of the $522.2 million held by our non-U.S. subsidiaries, approximately $276.9 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2018. +68 +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, in anticipation of the needs of the Company’s share repurchase program and the need to provide payment of the Com pany’s provisional Transition Tax liability, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2018. The Company has provided for the tax impact of expec ted distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds t he Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to income taxes but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows (in thousands): +2018 +2017 +2016 +Expected income tax expense +$ +90,696 +$ +134,491 +$ +125,819 +State income tax, net of federal benefit +3,051 +297 +2,335 +Rate differential on foreign income +(40,065 +) +(95,565 +) +(58,508 +) +Change in unrecognized tax benefits +820 +1,449 +135 +Non-deductible compensation +6,269 +6,592 +4,414 +Tax credits +(2,539 +) +(2,151 +) +(2,044 +) +Excess tax benefit on share based compensation +(1,557 +) +(2,571 +) +— +U.S. tax rate change +— +1,923 +— +U.S. transition tax +(10,963 +) +98,015 +— +U.S. tax on foreign earnings +9,956 +— +— +Other +2,077 +(1,110 +) +535 +Change in valuation allowance +2,866 +7,786 +1,439 +Total provision (benefit) for income taxes +$ +60,611 +$ +149,156 +$ +74,125 +Effective tax rate +14.0 +% +38.8 +% +20.6 +% +The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2018 and 2017 are presented below (in thousands): +2018 +2017 +Deferred tax assets: +Inventory adjustments +$ +5,779 +$ +5,375 +Accrued expenses +42,637 +33,983 +Allowances for bad debts and chargebacks +3,549 +3,470 +Loss carryforwards +24,834 +24,308 +Business credit carryforward +7,015 +6,562 +Share-based compensation +4,283 +4,154 +Valuation allowance +(30,179 +) +(27,313 +) +Total deferred tax assets +57,918 +50,539 +Deferred tax liabilities: +Prepaid expenses +6,263 +5,709 +Depreciation on property, plant and equipment +12,674 +15,069 +Total deferred tax liabilities +18,937 +20,778 +Net deferred tax assets +$ +38,981 +$ +29,761 +The $2.9 million increase in the valuation allowance primarily relates to increases in deferred tax assets in certain foreign non-benefited loss jurisdictions as discussed above. The Company believes it is more likely than not that the results of future operations in the remaining jurisdictions will generate sufficient taxable income to realize its net deferred tax assets. +69 +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2018 were $8.9 million and $31.1 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2017 were $6 .6 million and $31 .3 million, respectively. These tax credit and net operating loss carry-forward amounts do not begin to expire until 2032 and 2025 , respectively. As of December 31, 2018 and 2017, no valuation allowance against the related deferred tax asset have been recorded for these credit and loss carry-forwards as it is believed the carry-forwards will be fully utilized in reducing fut ure taxable income. +As of December 31, 2018 and 2017, the Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $121.5 million and $ 94.9 million, respectively. Some of these net operating losses expire beginning in 2019; however others can be carried forward indefinitely. As of December 31, 2018 and 2017, valuation allowances of $21.4 million and $21 .4 million, respectively, had been recorded against the related deferred tax assets for those loss carry-forwards that are not more likely than not to be fully utilized in reducing future taxable income. +The balance of unrecognized tax benefits included in prepaid expenses in the consolidated balance sheets increased by $0.6 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2018 +2017 +Beginning balance +$ +7,381 +$ +6,608 +Additions for current year tax positions +1,161 +1,154 +Reductions for prior year tax positions +(55 +) +(26 +) +Reductions related to lapse of statute of limitations +(512 +) +(355 +) +Ending balance +$ +7,975 +$ +7,381 +If recognized, $8.0 million of unrecognized tax benefits would be recorded as a reduction in income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax expense and totaled $0.2 million, $ 0.5 million, and $ 0.4 million for the years ended December 31, 2018, 2017, and 2016, respectively. Accrued interest and penalties were $1.8 million and $ 1.5 million as of December 31, 2018 and 2017, respectively. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +As of December 31, 2018, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2014 , and in several Asian and European tax jurisdictions for years ending on or after December 31, 2008 . During the year, the Company reduced the balance of 2018 and prior year unrecognized tax benefits by $0.5 million as a result of expiring statutes. It is reasonably possible that certain domestic and foreign statutes will expire during the next twelve months which would reduce the balance of 2018 and prior year unrecognized tax benefits by $0.8 million. +The Company is currently under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2018, there was no reduction in the balance of 2018 and prior year unrecognized tax benefits due to settlements of examinations. It is reasonably possible that certain federal, state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2018 and prior year unrecognized tax benefits by $0.9 million. +(16) +EMPLOYEE BENEFIT PLAN +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have completed six months of service. Employees may contribute up to 15.0% of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company made a contribution of $2.3 million and $1.6 million to the plan for the year ended December 31, 2018 and 2017 respectively. The Company did not make a contribution to the plan for the years ended December 31 2016. +70 +In May 2013, the Company established the Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”), which allows eligible empl oyees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees, which will be determined by the Company’s Compensation Committee. The Company made a contribution of $0.1 million and $0.2 million to the plan for the year ended December 31, 2018 and 2017 respectively. The Company did not make a contribution to the plan for the year ended December 31 2016. The value of the defer red compensation is recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred l iabilities are presented in the Company’s consolidated balance sheets. +(17) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates a significant portion of its sales in the United States; however, several of its products are sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $213.7 million and $206.1 million before allowances for bad debts and sales returns, and chargebacks at December 31, 2018 and 2017, respectively. Foreign accounts receivable, which are generally collateralized by letters of credit, amounted to $313.8 million and $251.0 million before allowance for bad debts, sales returns, and chargebacks at December 31, 2018 and 2017, respectively. International net sales amounted to $2.514 billion, $2.109 billion and $1.640 billion for the years ended December 31, 2018, 2017 and 2016, respectively. The Company’s credit losses charged to expense for the years ended December 31, 2018, 2017 and 2016 were $8.0 million, $12.8 million and $12.7 million, respectively. In addition, the Company recorded sales return expense for the years ended December 31, 2018, 2017 and 2016 were $20.2 million, $5.6 million and $16.9 million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the United States were $1.611 billion and $1.273 billion at December 31, 2018 and 2017, respectively. +During 2018, 2017 and 2016, no customer accounted for 10.0% or more of net sales. No customer accounted for more than 10% of net trade receivables at December 31, 2018 or 2017. During 2018, 2017 and 2016, net sales to the five largest customers were approximately 10.4%, 10.5% and 11.3%, respectively. +The Company’s top five manufacturers produced the following for the years ended December 31, 2018, 2017 and 2016, respectively: +Percentage of Total Production +Years Ended December 31, +2018 +2017 +2016 +Manufacturer #1 +12.8 +% +17.9 +% +22.9 +% +Manufacturer #2 +10.1 +% +11.1 +% +10.1 +% +Manufacturer #3 +8.6 +% +8.8 +% +8.8 +% +Manufacturer #4 +5.4 +% +5.4 +% +4.9 +% +Manufacturer #5 +5.0 +% +4.3 +% +4.3 +% +41.9 +% +47.5 +% +51.0 +% +The majority of the Company’s products are produced in China and Vietnam. The Company’s operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce these risks by diversifying manufacturing among various factories. To date, these business risks have not had a material adverse impact on the Company’s operations. +(18) +RELATED PARTY TRANSACTIONS +The Company paid approximately $80,000, $172,000, and $111,000 during 2018, 2017 and 2016, respectively, to the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, owns a 12% beneficial ownership interest in MIOC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 5% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable with MIOC, the Shade Hotel in Manhattan Beach at December 31, 2018 or 2017. +71 +The Company paid approximately $167,000 , $201,000 and $110,000 during 2018, 2017 2016 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, food and events, including the Company’s 2018, 2017 and 2016 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg, President and a director of the Company, owns a 5% beneficial ownership interest in RBHC, and three other officers, directors and senior vice preside nts of the Company own in aggregate an additional 3% beneficial ownership in RBHC. The Company had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2018 or 2017. +On July 29, 2010, the Company formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with the Company, and the Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer are also officers and directors of the Foundation. During the years ended December 31, 2018, 2017, and 2016 the Company made contributions of $1,000,000 million to the Foundation in each year. +The Company had receivables from officers and employees of $0.8 million and $1.0 million at December 31, 2018 and 2017, respectively. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +(19) +SEGMENT AND GEOGRAPHIC REPORTING +The Company has three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. Management evaluates segment performance based primarily on net sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the Company’s segments. Net sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, and retail segments on a combined basis were as follows (in thousands): +2018 +2017 +2016 +Net sales +Domestic wholesale +$ +1,259,615 +$ +1,249,287 +$ +1,199,832 +International wholesale +2,054,770 +1,729,906 +1,391,235 +Retail +1,327,683 +1,184,967 +972,244 +Total +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +2018 +2017 +2016 +Gross profit +Domestic wholesale +$ +468,340 +$ +464,609 +$ +454,088 +International wholesale +976,739 +786,675 +616,110 +Retail +778,526 +687,605 +564,398 +Total +$ +2,223,605 +$ +1,938,889 +$ +1,634,596 +2018 +2017 +Identifiable assets +Domestic wholesale +$ +1,428,463 +$ +1,259,119 +International wholesale +1,423,048 +1,116,928 +Retail +376,744 +359,035 +Total +$ +3,228,255 +$ +2,735,082 +2018 +2017 +2016 +Additions to property, plant and equipment +Domestic wholesale +$ +29,717 +$ +20,055 +$ +33,677 +International wholesale +63,316 +47,410 +44,286 +Retail +50,003 +68,511 +41,508 +Total +$ +143,036 +$ +135,976 +$ +119,471 +Geographic Information +72 +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2018 +2017 +2016 +Net Sales (1) +United States +$ +2,128,100 +$ +2,055,475 +$ +1,920,051 +Canada +171,864 +160,367 +130,555 +Other international (2) +2,342,104 +1,948,318 +1,512,705 +Total +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +2018 +2017 +Property, plant and equipment, net +United States +$ +385,584 +$ +382,426 +Canada +9,081 +9,888 +Other international (2) +190,792 +149,287 +Total +$ +585,457 +$ +541,601 +(1) +The Company has subsidiaries in Asia, Central America, Europe, the Middle East, North America, and South America that generate net sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in Asia that generate net sales from those countries. The Company also has a subsidiary in Switzerland that generates net sales from that country in addition to net sales to distributors located in numerous non-European countries. External net sales are attributable to geographic regions based on the location of each of the Company’s subsidiaries. A subsidiary may earn revenue from external net sales and external royalties, or from inter-subsidiary net sales, royalties, fees and commissions provided in accordance with certain inter-subsidiary agreements. The resulting earnings of each subsidiary in its respective country are recognized under each respective country’s tax code. Inter-subsidiary revenues and expenses subsequently are eliminated in the Company’s consolidated financial statements and are not included as part of the external net sales reported in different geographic areas. +(2) +Other international consists of Asia, Central America, Europe, the Middle East, and South America. +In response to the State Department’s trade restrictions with Sudan and Syria, we do not authorize or permit any distribution or sales of our product in these countries, and we are not aware of any current or past distribution or sales of our product in Sudan or Syria. +(20) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2018, to assess the need for potential recognition or disclosure in this filing. Based on this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. In 2019, the Company entered into an agreement to purchase the minority interest in its India joint venture that it did not own for $82.5 million which will make India a wholly owned subsidiary. In 2019, the Company also agreed in principle to form a joint venture with its distributor in Mexico. +(21) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the financial information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period. Summarized unaudited financial data are as follows (in thousands, except per share data): +2018 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Net sales +$ +1,250,078 +$ +1,134,797 +$ +1,176,395 +$ +1,080,798 +Gross profit +583,104 +560,957 +563,866 +515,678 +Net earnings +137,258 +60,859 +106,051 +67,105 +Net earnings attributable to Skechers U.S.A., Inc. +117,652 +45,284 +90,728 +47,377 +Net earnings per share: +Basic +0.21 +0.29 +0.58 +0.31 +Diluted +0.21 +0.29 +0.58 +0.31 +73 +2017 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 (1) +Net sales +$ +1,072,808 +$ +1,025,934 +$ +1,094,829 +$ +970,589 +Gross profit +476,498 +488,321 +519,987 +454,083 +Net earnings (loss) +106,635 +73,400 +106,830 +(51,761 +) +Net earnings (loss) attributable to Skechers U.S.A., Inc. +93,995 +59,535 +92,310 +(66,650 +) +Net earnings (loss) per share: +Basic +0.61 +0.38 +0.59 +(0.43 +) +Diluted +0.60 +0.38 +0.59 +(0.43 +) +(1) +Fourth quarter 2017 net earnings (loss) includes a provisional one-time tax expense of $99.9 million recorded for our initial analysis of the impact of the Tax Act. +74 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOU NTANT S ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2018, which is set forth below. +75 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2018. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +76 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company and subsidiaries as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and schedule and our report dated March 1, 2019 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +March 1, 2019 +77 +ITEM 9B. +OTHE R INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERT AIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. +78 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 47 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 80 of this annual report on Form 10-K. +3. +Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +79 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years Ended December 31, 2018, 2017, and 2016 +DESCRIPTION +BALANCE AT +BEGINNING OF +YEAR +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF YEAR +Year-ended December 31, 2016 +Allowance for chargebacks +$ +7,065 +$ +10,882 +$ +(6,973 +) +$ +10,974 +Allowance for doubtful accounts +5,953 +1,837 +(2,170 +) +5,620 +Liability for sales returns and allowances +11,242 +18,101 +(4,290 +) +25,053 +Reserve for shrinkage +407 +2,396 +(2,261 +) +542 +Reserve for obsolescence +3,281 +15,220 +(7,573 +) +10,928 +Year-ended December 31, 2017 +Allowance for chargebacks +$ +10,974 +$ +7,507 +$ +(5,674 +) +$ +12,807 +Allowance for doubtful accounts +5,620 +5,266 +(3,177 +) +7,709 +Liability for sales returns and allowances +25,053 +5,625 +(14 +) +30,664 +Reserve for shrinkage +542 +2,020 +(825 +) +1,737 +Reserve for obsolescence +10,928 +130 +(4,039 +) +7,019 +Year-ended December 31, 2018 +Allowance for chargebacks +$ +12,807 +$ +12,629 +$ +(6,663 +) +$ +18,773 +Allowance for doubtful accounts +7,709 +2,856 +(3,722 +) +6,843 +Liability for sales returns and allowances +30,664 +20,245 +(2,443 +) +48,466 +Reserve for shrinkage +1,737 +5,771 +(5,891 +) +1,617 +Reserve for obsolescence +7,019 +6,461 +(2,344 +) +11,136 +See accompanying report of independent registered public accounting firm +80 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2013). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.3* +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.4* +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K for the year ended December 31, 2007). +10.5* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.6* +Form of Restricted Stock Agreement under 2017 Incentive Award Plan. (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.7* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.8* +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +81 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.8(a)* +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +10.9 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.10 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.11* +Employment Agreement, executed August 7, 2015, effective as of January 1, 2015, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.11(a)* +Amendment to Employee Agreement dated December 5, 2017, between the Registrant and Michael Greenberg (incorporated by reference to exhibit 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2017) +10.12* +Employment Agreement, executed April 2, 2018, effective as of January 1, 2018, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on April 2, 2018). +10.13 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 7, 2015). +10.14 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.14(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.14(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company. +10.15 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.16 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 27, 2007). +10.16(a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010). +10.16(b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +82 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.16(c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(e) +Fourth Amendment to Lease Agreement, dated February 12, 2019, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California +10.17 +Lease Agreement, dated February 12, 2019, between the Registrant and HF Logistics – SKX T2, LLC, regarding expansion to distribution facility in Rancho Belago, California. +10.18 +Lease Agreement, dated August 12, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.28 of the Registrant’s Form 10-K for the year ended December 31, 2002). +10.18(a) +Addendum to Lease Agreement, dated January 19, 2006, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(b) +Addendum 2 to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on May 27, 2008). +10.18(c) +Addendum 3 to Agreement dated June 11, 2013 and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 27, 2008). +10.19(a) +Addendum 1 to Lease Agreement, dated March 10, 2009, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.18(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(b) +Addendum 2 to Lease Agreement dated December 22, 2009 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(b) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(c) +Addendum 3 to Agreement dated June 11, 2013 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +83 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.20 +Lease Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center III in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2015). +10.20(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Centers I, II and III in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.21 +Lease Agreement dated July 10, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.21(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.22 +Lease Agreement dated July 1, 2016 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and Warehouse and Industrial Properties (W.I.P.) SA, regarding Liegistics Park 34, Avenue du Parc Industriel in Milmort, Belgium (incorporated by reference to exhibit number 10.18 of the Registrant’s Form 10-K for the year ended December 31, 2016). +10.23 +Lease Agreement dated November 17, 2015 by and between the Registrant and Omni Manhattan Towers Limited Partnership, regarding 1240 Rosecrans Avenue, Suites 300 and 400, Manhattan Beach, California (incorporated by reference to exhibit number 10.19 of the Registrant’s Form 10-K for the year ended December 31, 2016). +10.24** +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.25 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.26 +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.27** +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). +31.2 +Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +84 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.LAB +Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +* +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** +The Company applied with the Secretary of the Securities and Exchange Commission for confidential treatment of certain information pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. The Company filed separately with its application a copy of the exhibit including all confidential portions, which may be made available for public inspection pending the Securities and Exchange Commission’s review of the application in accordance with Rule 24b-2. +** * +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act. +85 +SIGNAT URES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 1st day of March 2019. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +March 1, 2019 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +March 1, 2019 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +March 1, 2019 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +March 1, 2019 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Jeffrey Greenberg +Director +March 1, 2019 +Jeffrey Greenberg +/s/ Geyer Kosinski +Director +March 1, 2019 +Geyer Kosinski +/s/ Morton D. Erlich +Director +March 1, 2019 +Morton D. Erlich +/s/ Richard Siskind +Director +March 1, 2019 +Richard Siskind +/s/ Thomas Walsh +Director +March 1, 2019 +Thomas Walsh +/s/ Rick Rappaport +Director +March 1, 2019 +Rick Rappaport +86 \ No newline at end of file diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/filing_metadata.csv b/raw/filings/0001065837/2018/0001564590-19-005775/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..936438e40ea84b46f2f4f2ffbef0b4c8e2b450fb --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2019-03-01,2018-12-31,2019-03-01T20:02:29.000Z,0001564590-19-005775,skx-10k_20181231.htm,10-K,17030292,1,0,https://www.sec.gov/Archives/edgar/data/1065837/000156459019005775/skx-10k_20181231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459019005775/,2018,2018,1 diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/item1.txt b/raw/filings/0001065837/2018/0001564590-19-005775/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a8348e04929b761e9bf6667311bf7186a9189035 --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/item1.txt @@ -0,0 +1,380 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIE’s”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our Company” and “Skechers” unless otherwise indicated. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our corporate website, www.skx.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.skx.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. Our footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our brands are sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available at our e-commerce websites and our own retail stores. As of February 1, 2019, we owned and operated 113 concept stores, 170 factory outlet stores and 187 warehouse outlet stores in the United States, and 134 concept stores, 78 factory outlet stores, and 10 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of stylish and comfortable footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs and affordable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2018, the Skechers brand was supported by print, television, digital and outdoor campaigns for men and women; animated and live action kids’ television and digital campaigns; marathons and other events for Skechers Performance and BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artists Camila Cabello; sports legends Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo; and television personalities and actresses Brooke Burke-Charvet and Kelly Brook. For the Skechers Performance Division, we also had Olympians Meb Keflezighi, Kara Goucher, and Matt Kuchar; and professional golfers Ashlan Ramsey, Belen Mozo, Brooke Henderson, Russell Knox, Wesley Bryan, Billy Andrade, Colin Montgomerie and Edward Cheserek, who won 17 National Collegiate Athletic Association (“NCAA”) distance running titles. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our net sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, manufacturing support, and management expertise. To promote innovation and brand relevance, we manage our product lines separately by utilizing dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as skechers.com and numerous online accounts. Management evaluates segment performance based primarily on net sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets running and golf apparel under the Skechers Performance brand, as well as casual lifestyle apparel under the Skechers and BOBS brand s. The apparel is primarily available at Skechers retail stores, but is also available to domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam ™ insoles for total comfort. Collaborations of our fashion collections like Skechers D’Lites X One Piece that features colorways from the popular manga series help generate buzz and expand awareness the brand. +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +3 +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials, Gen Y’s and young women, Skecher Street™ Los Ang eles delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest trends with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. At the core of the BOBS from Skechers line is its vast collection of colorful, playful as well as basic espadrilles. The line now also includes wedges, vulcanized looks and comfortable faux fur styles for home. Many styles also include Skechers Memory Foam ™ . +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. We also have a collection with dog and cat prints for our BOBS for Dogs charitable offering. +• +BOBS’ vulcanized and sport looks have a very youthful and California lifestyle appeal. Primarily designed with canvas uppers but also jersey fabrics, the line features both classic retro looks and fresh colors and materials for a relevant style. +For each pair of specially packaged BOBS from Skechers sold in the United States from September 1, 2015 through August 31, 2018, twenty-five cents was donated to Best Friends to help save the lives of dogs and cats in America’s shelters totaling more than $3.9 million dollars to Best Friends Animal Society. This helped more than 583,000 shelter pets in the United States, including saving the lives of more than 241,000 animals. Skechers also continues to donate new shoes to children in need through the BOBS program for which more than 15.6 million pairs of new kids’ shoes have been donated, including approximately 395,000 pairs in 2018. The charitable shoes are primarily donated to charity partner Delivering Good, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason collection originally started in Italy with an exotic offering of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest 5GEN midsole compounds for comfort and an outsole that delivers responsive feedback. Limited edition features such as Skechers Nite Owl glow-in-the-dark technology or special colorways are featured across multiple product lines. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running. Skechers GOrun Ride features similar designs to their GOrun counterparts, with enhanced cushioning for elevated comfort and support. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb Keflezighi. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers GO FLEX Walk features a unique articulated, segmented flexible outsole that is designed to move with you. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +4 +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfer Matt Kuchar and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable softspikes on the outsole. +• +YOU by Skechers ™ . The versatile YOU by Skechers ™ footwear collection combines lifestyle with wellness in an eclectic assortment of easy-to-wear and comfortable knitted lace-up and slip-on sneakers for women. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, and (v) Lighted footwear. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as the company’s adult styles such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; and Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories, featuring S-Lights and rechargeable technology with brands like Energy Lights by Skechers footwear. S-Lights combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights by Skechers is a classic high-top or low-top sneaker with a rechargeable lighted outsole that features a variety of colors and light. Luminators feature an innovative illuminated mesh fabric upper for a bolder look. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable Shape-ups are ideal for the service industry. The Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +5 +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to generate fresh and innovative footwear in all of our product lines. Targeted to the active, youthful and style-savvy, we design our lifestyle line to be comfortable, fashionable and marketable to the 12- to 24-year-old consumer, with broader appeal to 5- to 50-year olds, and an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical fitness shoe. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and e-commerce customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allow our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our net sales from at least five different manufacturers. During 2018, five of our contract manufacturers accounted for approximately 41.9% of total purchases. One manufacturer accounted for 12.8%, and another accounted for 10.1% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +6 +We closely monitor sales activity after initial introduction of a product in our concept stores to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are h ighlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develo p an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 343-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has a multi-pronged approach: traditional print and television advertising, supported by digital, outdoor, trend-influenced marketing, public relations, social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected net sales. +The majority of our advertising is conceptualized by our in-house design team. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. We generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2018, our Skechers lifestyle endorsees included Camila Cabello, Brooke Burke-Charvet, Kelly Brook, Sugar Ray Leonard, Howie Long, David Ortiz, and Tony Romo. Our Skechers Performance Division 2018 endorsees included elite runner and Olympic medalist Meb Kelfezighi, elite runners Kara Goucher and Edward Cheserek, and professional golfers Matt Kuchar, Belen Mozo, Brooke Henderson, Ashlan Ramsey, Billy Andrade, Russell Knox, Wesley Bryan and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +With a targeted approach, our print ads appear in popular fashion, lifestyle and pop culture publications in the United States and around the world. +Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2018, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids featuring our own action heroes, as well as live action commercials that appeal to older kids and tweens. We also had commercials for our golf collection lines that featured our elite golfers, and for our lifestyle lines that feature musicians, actors and retired athletes. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. In 2018, many of our television commercials were translated into multiple languages and aired in numerous markets around the world. Further, select markets have created television commercials specific to their market with local celebrities. +7 +Outdoor. In an effort to reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include ma ll and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on peri meter boards at soccer matches and professional sporting events in Japan, Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations/Trend-Influenced Marketing. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key magazines and television shows, and place our footwear on the feet of trend-setting influencers, celebrities and their families. We have been featured in leading business publications with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. Additionally, we have partnered with influencers, bloggers and vloggers who have both appeared at events and posted on their social media channels about our footwear. +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, and YouTube in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers ® , Skechers Performance™, BOBS from Skechers and Mark Nason. The social platforms are divided into Skechers and Skechers Performance sites, as well as a BOBS page to feature our charitable footwear line. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Line in Japan and Weibo in China. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2018, we appeared at walks and at numerous marathons in Boston, New York, London, Paris, Santiago and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2018, the Skechers Performance Division was the footwear and apparel sponsor for the Houston Marathon, the title sponsor of the Skechers Performance Los Angeles Marathon, and the footwear sponsor for Ironman across Europe. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with Best Friends Animal Society, an organization dedicated to saving the lives of dogs and cats, in Strut your Mutt Dog donation events across the country. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand and reinforce the image, and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM, Gallery and ISPO in Europe; and other international shows. +Digital. In 2018, we launched marketing campaigns on YouTube, Facebook and Instagram, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our e-commerce sites in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +8 +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 48 licensees have opened and operate 700 distributor-owned or -licensed Skechers retail stores and 1,813 licensee-owned Skechers retail stores, respectively, in over 170 countries as of December 31, 2018. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Retail stores and e-commerce. We pursue our retail store strategy through our three integrated retail formats: concept stores, factory outlet stores and warehouse outlet stores. Our three store formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores to assess potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2019, we owned and operated 113 concept stores, 170 factory outlet stores and 187 warehouse outlet stores in the United States, and 134 concept stores, 78 factory outlet stores, and 10 warehouse outlet stores internationally. We plan to open 70 to 80 new stores in 2019. +Our retail stores are supported by our company-owned ecommerce businesses in the United States, Canada, United Kingdom, Germany, Spain, Chile and China, among other countries. These virtual storefronts are designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +9 +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, SOHO, and 34 th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; the Shinsaibashi shopping district of Osaka and Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 800 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in North America, Europe, Central America, South America and Asia. When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the United States and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 1,800 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +10 +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2017 +Opened during 2018 +Closed during 2018 +Number of Store Locations December 31, 2018 +Domestic stores +Concept +117 +1 +(4 +) +114 +Factory Outlet +170 +1 +— +171 +Warehouse Outlet +162 +23 +— +185 +Domestic stores total +449 +25 +(4 +) +470 +International stores +Concept +120 +14 +— +134 +Factory Outlet +67 +11 +— +78 +Warehouse Outlet +9 +1 +— +10 +International stores total +196 +26 +— +222 +Joint venture stores +China Concept +55 +21 +(13 +) +63 +China Factory Outlet +70 +12 +(14 +) +68 +Hong Kong Concept +36 +6 +(3 +) +39 +Hong Kong Outlet +4 +— +— +4 +India Concept +44 +13 +— +57 +India Outlet +2 +2 +— +4 +Israel Concept +7 +3 +— +10 +Israel Outlet +— +2 +— +2 +South Korea Concept +6 +4 +(5 +) +5 +South Korea Outlet +11 +11 +(5 +) +17 +South East Asia Concept +22 +1 +(2 +) +21 +South East Asia Outlet +5 +2 +— +7 +Joint venture stores total +262 +77 +(42 +) +297 +Total domestic, international and joint +venture stores +907 +128 +(46 +) +989 +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase net sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +11 +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have company-owned retail stores in key locations across Canada. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Bogota, Lima and Sao Paulo. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate net sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia and Singapore +We have a 50% interest in a joint venture in Malaysia and Singapore that operates and generates net sales in those countries. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +India +We have a 51% interest in Skechers South Asia Private Limited and Skechers Retail India Private Limited, which are both joint ventures, that operate and generate net sales in India. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Bangalore, Mumbai and New Delhi. These joint ventures are consolidated in our financial statements. In 2019, we entered into an agreement to purchase the minority interest in our India joint venture that we did not own for $82.5 million which will make our India joint venture a wholly owned subsidiary. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates net sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates net sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +12 +• Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 22 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2018, we also had agreements with 18 of these distributors and 48 licensees regarding 700 distributor-owned or licensed Skechers retail stores and 1,813 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations December 31, 2017 +Opened during 2018 +Closed during 2018 +Number of Store Locations December 31, 2018 +Distributor, licensee and franchise stores +Africa Concept +46 +8 +(9 +) +45 +Africa Outlet +— +1 +— +1 +Asia Concept +754 +261 +(67 +) +948 +Asia Factory Outlet +334 +105 +(39 +) +400 +Australasia Concept +60 +7 +— +67 +Australasia Outlet +15 +5 +— +20 +Central America Concept +7 +2 +— +9 +Europe Concept +174 +75 +(43 +) +206 +Europe Factory Outlet +15 +10 +— +25 +Middle East Concept +148 +10 +(2 +) +156 +Middle East Factory Outlet +4 +— +— +4 +North America Concept +64 +5 +— +69 +North America Factory Outlet +17 +— +— +17 +South America Concept +25 +4 +— +29 +Total distributor, licensee and franchise stores +1,663 +493 +(160 +) +1,996 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 19 – Segment and Geographic Reporting in the consolidated financial statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2019, we had 22 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and watches; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness, yoga and running accessories; consumer electronics; bicycles and safety gear and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks, lunchboxes, do-it-yourself fashion kits, sunglasses and hair accessories; and Skechers Work socks. We also have BOBS for DOGS pet accessories in Petco. We have international licensing agreements for the design and distribution of men’s, women’s and kids’ apparel in the United Kingdom; socks throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe and the Middle East; apparel, socks, headwear, bags, backpacks in Indonesia; apparel, socks, bags in Mexico; bags, backpacks, luggage, wallets, apparel, watches, medical scrubs and accessories in Latin America; and watches in the Philippines. +13 +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 139 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 21 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The +14 +intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in o ur operations. Our children’s shoes compete with footwear offered by these companies and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, p rice, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distribut ors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2019, we employed approximately 12,600 persons, of whom approximately 5,400 were employed on a full-time basis and approximately 7,200 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. \ No newline at end of file diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/item13.txt b/raw/filings/0001065837/2018/0001564590-19-005775/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..5c1c798d4739230e07cc78a090436efcb4ee236b --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2018 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/item9a.txt b/raw/filings/0001065837/2018/0001564590-19-005775/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a4eb844898f0cd7d8e2fd45ed6efff362198c30 --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/item9a.txt @@ -0,0 +1,38 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018, based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of such time. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2018, which is set forth below. +75 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2018. The results of our evaluation are discussed above in Management’s Report on Internal Control Over Financial Reporting. +76 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company and subsidiaries as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and schedule and our report dated March 1, 2019 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +March 1, 2019 +77 \ No newline at end of file diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/rp_note.txt b/raw/filings/0001065837/2018/0001564590-19-005775/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2018/0001564590-19-005775/rpt_disclosure.txt b/raw/filings/0001065837/2018/0001564590-19-005775/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..1cdeb0d3a51e820081e9fd3c165d34a79ff26eb1 --- /dev/null +++ b/raw/filings/0001065837/2018/0001564590-19-005775/rpt_disclosure.txt @@ -0,0 +1,43 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in +our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the +avoidance of conflicts of interest (which is discussed in our Code of Business Conduct and Ethics), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and +(iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of +March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will +or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten +percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy +statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A or Class B Common Stock or +(c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as +transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related +Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction shall be considered and, if the Committee determines it to be appropriate, +ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an +unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member shall participate in any discussion or approval of a transaction with a Related +Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and +assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The +following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2018. Each of these transactions was reviewed, and approved or ratified by the Audit +Committee, pursuant to the policies and procedures discussed herein. +41 +Related Person Transactions +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our +Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg has agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for an +additional year with the same terms and conditions effective as of February 1, 2019. +We paid $80,000 in 2018 to the Manhattan Inn +Operating Company, LLC (“MIOC”) for lodging, food and events at the Shade Hotel in Manhattan Beach, which is owned and operated by MIOC. Michael Greenberg, our President and a director of Skechers, owns a 12% beneficial ownership interest +in MIOC, and three other officers, directors and senior vice presidents of Skechers own in aggregate an additional 5% beneficial ownership in MIOC. Skechers had no outstanding accounts receivable or payable with MIOC or the Shade Hotel in Manhattan +Beach at December 31, 2018. +We paid $167,000 in 2018 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, +food and events, including the Company’s 2018 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg owns a 5% beneficial ownership interest in RBHC, and three other officers, directors and +senior vice presidents of Skechers own in aggregate an additional 3% beneficial ownership in RBHC. Skechers had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2018. +In October 2018, following an appraisal by an independent valuation firm, we sold real property located in Manhattan Beach to Michael +Greenberg for $5,118,000. +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, +Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2018, we made contributions of $1,000,000 to the Foundation. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the +siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $349,842, $3,276,757, $2,738,616 and $357,312, respectively, in 2018. Jeffrey Greenberg was also a +member of our Board of Directors in 2018, but did not earn any additional compensation for services provided as a director. +Andrew +Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $363,422 and $190,332, respectively, in 2018. \ No newline at end of file diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/filing.txt b/raw/filings/0001065837/2019/0001564590-20-007744/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..667c93ec05a9fddcb95ce84c4396e85b3b817be3 --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/filing.txt @@ -0,0 +1,5350 @@ +skx-10k_20191231.htm +false +2019 +FY +SKX +SKECHERS USA INC +0001065837 +--12-31 +Large Accelerated Filer +P30D +P60D +100000 +800000 +P10Y +P5Y +P5Y +P20Y +0001065837 +2019-01-01 +2019-12-31 +xbrli:shares +0001065837 +us-gaap:CommonClassAMember +2020-02-17 +0001065837 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+Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2019, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 4.2 billion based upon the closing price of $31.49 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 17, 2020: 134,497,828 . +The number of shares of Class B Common Stock outstanding as of February 17, 2020: 22,407,803 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2020 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended DECEMBER 31, 2019 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +16 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +25 +ITEM 2. +PROPERTIES +25 +ITEM 3. +LEGAL PROCEEDINGS +25 +ITEM 4. +MINE SAFETY DISCLOSURES +28 +PART II +ITEM 5. +MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +29 +ITEM 6. +SELECTED FINANCIAL DATA +31 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +32 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +44 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +45 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +77 +ITEM 9A. +CONTROLS AND PROCEDURES +77 +ITEM 9B. +OTHER INFORMATION +80 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +80 +ITEM 11. +EXECUTIVE COMPENSATION +80 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +80 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +80 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +80 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +80 +ITEM 16. +FORM 10-K SUMMARY +80 +SIGNATURES +87 +This annual report includes our trademarks including Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers GOtrain ® , Skechers on-the-GO ® , ® , ® , ® , , Skechers Cali ® , Skecher Street ® , Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work ™ , Mark Nason ® , D’Lites ® , DLT-A ® , BOBS ® , Energy Lights ® , Skech-Air ® , Twinkle Toes ® , Z-Strap ® , Mega-Flex ® , Luminators ® , Heart Lights ™ , Relaxed Fit ® , Arch Fit ™ , Ultra GO ® , Hyper Burst ® , Skechers Memory Foam ™ , and Air-cooled Memory Foam ® , each of which is our property. This report contains additional trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements with regards to future revenue, projected 2020 operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our company’s future performance. Factors that might cause or contribute to such differences include: +• +the recent coronavirus outbreak and its adverse impact on our operations in China and our business, sales and results of operations around the world; +• +global economic, political and market conditions, including the challenging consumer retail market in the United States; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; and +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and states securities laws. +1 +PART I +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our company” and “Skechers” unless otherwise indicated. Reference in this annual report to “Sales” refers to Skechers’ net sales reported under generally accepted accounting principles in the United States. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. We also design and market men’s and women’s Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, leather goods, eyewear and scrub manufacturers, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available on our direct-to-consumer websites and our own retail stores. As of February 1, 2020, we owned and operated 107 concept stores, 171 factory outlet stores and 219 warehouse outlet stores in the United States, and 199 concept stores, 93 factory outlet stores, and 10 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs, affordable and comfortable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2019, the Skechers brand was supported by print, television, digital, radio and outdoor campaigns targeted to men and women, boys and girls; marathons and other athletic events for Skechers Performance; and grass roots and donation events for BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artist Camila Cabello; sports legends Clayton Kershaw, Sugar Ray Leonard, Howie Long, Tony Romo, and David Ortiz; and television personality and actress Brooke Burke. For the Skechers Performance Division, we also had the following athletes appear in our marketing campaigns: professional golfers Matt Kuchar, Brooke Henderson, Russell Knox, Wesley Bryan, Billy Andrade, and Colin Montgomerie; triathlete Lionel Sanders; plus, elite runners Meb Keflezighi, Weldon Kirui and Edward Cheserek. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as www.skechers.com and numerous online accounts. Management evaluates segment performance based primarily on sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets a collection of lifestyles apparel for men, women and kids. The collection features the same Skechers characteristics that consumers around the world have come to expect from the brand—comfort, style, innovation and quality at a value. The activewear garments are designed to directly coordinate with the brand’s footwear initiatives. The Skechers apparel collection is sold at Skechers retail stores, to our domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits, including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit, Arch Fit, Wide Fit and Extra Wide. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the Skechers Energy and the Skechers D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam insoles for total comfort. Collaborations of our fashion collections with popular character brands like Line Friends and BT21 as well as specialized retailers generates buzz while exposing the brand to new demographics. Additionally, the Skechers Premium Heritage Limited Edition collection has featured five-packs of luxe Skechers Energy and Skechers D’Lites ® styles crafted with high-end materials and on-trend embellishments available in select markets. +3 +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skechers Cali. This collection typifies the California lifestyle with beach-inspired colors, vivid prints and funky accents. This line of hot summer-styled looks features an eclectic collection of flip flops, sandals, and wedges all perfect for young women everywhere who love the sun. +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials and young women, Skecher Street ™ delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest trends with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. The core of the BOBS from Skechers line is its vast assortment of colorful, playful and classic espadrilles. The line now also includes vulcanized and sport looks, sandals and comfortable faux fur styles for home. Many styles also feature Skechers Memory Foam. +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. It includes BOBS for Dogs’ and BOBS for Cats’ animated animal and mosaic styles, as well as looks featuring legendary characters like Garfield, Scooby Doo and Felix the Cat. +• +BOBS vulcanized, sport and sandal styles have a very youthful and California lifestyle appeal. Designed with canvas uppers and jersey fabrics, the line features classic retro designs, fresh colors and materials. +• +BOBS faux fur styles are available in classic, patterned and mosaic animal designs with Skechers Memory Foam insoles and outsoles suitable for home and the outdoors. +For each pair of specially packaged BOBS from Skechers footwear, select apparel items and pet accessories sold in the United States in 2019 , twenty-five cents was donated to Petco Foundation to help save the lives of dogs and cats in America’s shelters –Donations for this program totaled more than $1.5 million which helped more than 371,000 shelter pets in the United States, of which more than 348,000 were saved through pet adoptions. Since BOBS launched its mission to help shelter animals in 2015, the brand has raised over $5.0 million and helped more than 954,000 animals, including more than 588,000 animals have been saved to date. +Skechers also continues to donate new shoes to children in need through the BOBS program. Since 2011, more than 15.2 million pairs of new kids’ shoes have been donated, including approximately 289,000 pairs in 2019. The charitable shoes are primarily donated to charity partner Soles4Souls, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason collection originally started with Italian crafted exotic offerings of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest Hyper Burst midsole compounds for comfort and an outsole that delivers responsive feedback. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running and was recognized with 12 editorial awards in 2019. Skechers Max Cushioning offers maximized Ultra GO cushioning for extreme comfort. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb Keflezighi. Select styles in the latest generation of running products feature an innovative Hyper Burst midsole foam. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote +4 +natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfers Matt Kuchar, Brooke Henderson and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable soft spikes on the outsole. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, (v) Lighted footwear, and (vi) the Shaq by Skechers basketball collection. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as our adult styles, such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers, which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. Flip Kicks offer a reversable fun sequin design on the side. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character; and Mega Craft offer a fun, block-like design inspired by video games. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories. S-Lights and Heart Lights styles combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights and Ice Lights feature a rechargeable lighted outsole that can be set to a variety of colors and light patterns. Luminators feature an innovative illuminated mesh fabric upper for a bolder look. +• +Shaq by Skechers is a collection of court-ready kids’ basketball shoes developed in collaboration with basketball legend Shaquille O’Neal. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip +5 +safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable sneakers are ideal for the service industry. The Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our footwear is designed for active lifestyles and consumers needing comfort in their footwear from fashionable 18- to 34-year-olds, to a broader base of 5- to 50-year-olds, and even an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and direct-to-consumer customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +6 +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allow our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our sales from at least five different manufacturers. During 2019, five of our contract manufacturers accounted for approximately 40.6% of total purchases. One manufacturer accounted for 16.0%, and another accounted for 7.3% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores and on-line to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 355-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. We are committed to humane conditions for every individual who produces our product from beginning to end. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +7 +Sustainability. We have worked to make our packaging more sustainable for the more-than - 189 million pairs of Skechers that consumers purchase every year. Since 2016, we’ve reduced our products’ packaging plastics by 85% down to 10% of our foot forms, and have made all remaining plastics completely recyclable. Many facilities can now recycle 94% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging is now also recyclable and printed with soy-or water-based ink. We are proud to have 99% of our shoes packaged in shoeboxes that meet the FSC® standard for responsible resources – and we are continually looking out for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach as we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected sales. +The majority of our advertising is conceptualized by our in-house design team; however, some campaigns are designed in select international markets to reflect local culture. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. We generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +Brand Ambassadors. To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2019, our Skechers lifestyle endorsees included Camila Cabello and David Ortiz, as well as Brooke Burke, Sugar Ray Leonard, Howie Long, and Tony Romo. Additionally, we announced an agreement with Dodgers pitcher Clayton Kershaw to appear in marketing campaigns beginning in 2020, as well as to collaborate on performance training shoes and custom cleats for him to wear on the mound. Our 2019 Skechers Performance Division endorsees included elite runners Meb Kelfezighi, Weldon Kirui, Lionel Sanders and Edward Cheserek, and professional golfers Matt Kuchar, Brooke Henderson, Billy Andrade, Russell Knox, Wesley Bryan and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +Print. With a targeted approach, our print ads appear in specialized sport, popular fashion, lifestyle and pop culture publications in the United States and around the world. +Television. Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2019, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids, as well as live action commercials. We also had commercials for our golf collection lines that featured our elite golfers, and for our lifestyle lines that feature our team of ambassadors. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. Many of our television commercials are translated into multiple languages and aired in numerous markets around the world. Further, select markets have also created television commercials specific to their market with local celebrities. +Outdoor. To reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in Japan, Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key magazines and television shows. We have been featured in leading business publications with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. +8 +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, and YouTube in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers, Skechers Performance, BOBS from Skechers and Mark Nason Los Angeles. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Line in Japan and Weibo in China. We have also placed our footwear on the feet of trend-setting influencers, celebrities and their families, sharing this content across our channels. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2019, we appeared at walks and at numerous marathons in Boston, New York, Santiago, Mumbai, Shanghai, and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2019, the Skechers Performance Division was the title sponsor of the Skechers Performance Los Angeles Marathon, footwear and apparel sponsor for the Houston Marathon, and footwear sponsor for Ironman Pucon in Chile. Additionally, for golf, Skechers was footwear sponsor for the Charles Schwab Cup PGA Championship in the United States, sponsored the Solheim Cup European team and collaborated on an exclusive style for the Evian Championship in France. These were among the many Skechers-sponsored events worldwide. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States, which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with the Petco Foundation and donated more than $1.5 million in 2019 and have raised more than $5.0 million helping and saving animals to date. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand to reinforce the image and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM, Gallery and ISPO in Europe; and other international shows. +Digital. In 2019, we continued marketing campaigns on YouTube, Facebook and Instagram, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our direct-to-consumer sites in the United States, Canada, United Kingdom, Germany, Spain, Chile, India, Mexico, and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and direct-to-consumer sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 175 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 50 licensees have opened and operate 727 distributor-owned or -licensed Skechers retail stores and 1,666 licensee-owned Skechers retail stores, respectively, in over 175 countries as of December 31, 2019. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +9 +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: ecommerce, concept stores, factory outlet and warehouse outlet stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. +We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We assess the cash flows for each of our retail stores to evaluate the potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, we recognize the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2020, we owned and operated 107 concept stores, 171 factory outlet stores and 219 warehouse outlet stores in the United States, and 199 concept stores, 93 factory outlet stores, and 10 warehouse outlet stores internationally. We plan to open 115 to 125 new stores in 2020. +• +Ecommerce +Our company-owned ecommerce businesses offer virtual storefronts designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, SOHO, and 34 th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; and the Shinsaibashi shopping district of Osaka and Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +10 +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 600 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities around the world . When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the United States and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 850 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2018 +Opened during 2019 +Closed during 2019 +Number of Store Locations December 31, 2019 +Domestic stores +Concept +114 +— +(5 +) +109 +Factory Outlet +171 +1 +(1 +) +171 +Warehouse Outlet +185 +32 +— +217 +Domestic stores total +470 +33 +(6 +) +497 +International stores +Concept +191 +(1) +15 +(6 +) +200 +Factory Outlet +82 +(1) +11 +— +93 +Warehouse Outlet +10 +— +— +10 +International stores total +283 +26 +(6 +) +303 +Joint venture stores +China +131 +49 +(23 +) +157 +Hong Kong +43 +9 +(5 +) +47 +Israel +12 +3 +— +15 +Mexico +— +81 +— +81 +South Korea +22 +13 +(18 +) +17 +South East Asia +28 +9 +— +37 +Joint venture stores total +236 +164 +(46 +) +354 +Total domestic, international and joint +venture stores +989 +223 +(58 +) +1,154 +(1) +Includes the reclassification of 57 concept stores and 4 factory outlet stores from our joint venture in India. +11 +International Wholesale. Our products are sold in more than 175 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; and Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have company-owned retail stores in key locations across Canada. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; and Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Bogota and Lima. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +India +We currently merchandise, market and distribute product in through our wholly-owned subsidiary, Skechers South Asia Private Limited and Skechers Retail India Private Limited. We have retail stores in key locations such as Bangalore, Mumbai, and New Delhi. +12 +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia, Singapore and Thailand +We have a 50% interest in a joint venture in Malaysia and Singapore, and a 51% interest in a joint venture in Thailand that operates and generates sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +Mexico +We have a 60% interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”) , which is a joint venture that operates and generates sales in Mexico. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have over 80 retail stores in key locations such as Mexico City and Guadalajara. This joint venture is consolidated in our financial statements. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2019, we also had agreements with 18 of these distributors and 50 licensees regarding 727 distributor-owned or licensed Skechers retail stores and 1,666 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 175 countries around the world: +Number of Store Locations December 31, 2018 +Opened during 2019 +Closed during 2019 +Number of Store Locations December 31, 2019 +Distributor, licensee and franchise stores +Africa +46 +15 +(1 +) +60 +Asia +1,348 +464 +(118 +) +1,694 +Australasia +87 +22 +— +109 +Central America +9 +7 +— +16 +Europe +231 +79 +(7 +) +303 +Middle East +160 +11 +(7 +) +164 +North America +11 +(1) +1 +— +12 +South America +29 +6 +— +35 +Total distributor, licensee and franchise stores +1,921 +605 +(133 +) +2,393 +(1) +Includes the reclassification of 59 concept stores and 16 outlet stores from our licensed distributor in Mexico to joint venture stores. +13 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 20 – Segment and Geographic Reporting in the Consolidated Financial Statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2020, we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and travel accessories, and watches for adults and kids; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness, yoga and running accessories; consumer electronics; and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; and Skechers Work socks. We also have BOBS for DOGS pet accessories in Petco. We have international licensing agreements for the design and distribution of prescription and sunglass eyewear globally; men’s, women’s and kids’ apparel in the United Kingdom; socks and watches throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe and the Middle East; medical scrubs in the Middle East, Australia, and New Zealand; apparel, socks, headwear, bags, and backpacks in Indonesia; apparel, socks, and bags in Mexico; bags, backpacks, luggage, wallets, watches, medical scrubs and accessories in Latin America; apparel, bags, and backpacks, headwear, socks, and shoe care Turkey; and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +Our shipping methods at our factories reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recyclable materials and are 100% recyclable. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 142 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 23 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +14 +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2020, we employed approximately 13,100 persons, of whom approximately 4,000 were employed on a full-time basis and approximately 9,100 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +15 +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +We Have Significant Sales And Operations In China That Are Expected To Be Adversely Impacted By The Recent Coronavirus Outbreak And Face Risks That Could Impact Our Business, Including Our Results Of Operations. +Our business has been adversely impacted by the effects of a widespread outbreak of a contagious respiratory illness caused by a novel coronavirus first identified in Wuhan, Hubei Province, China in December 2019. +Since January 2020, in response to intensifying efforts to contain the spread of this coronavirus, a majority of our stores in China have been temporarily closed and we continue to monitor, and where appropriate, modify the operating hours of all of our stores in the market. Additional adverse effects of the coronavirus outbreak include temporary closures of our facilities and/or the facilities of our contract manufacturers in China, disruptions to our ability to manufacture our product in China, dramatically lower customer traffic and comparable store sales at our stores in China and restrictions on our ability to travel into or out of China, in addition to the temporary closures of our stores discussed above. These effects are expected to materially impact our sales and results of operations for the first quarter and full year of fiscal 2020. +At the time of this filing, the outbreak has been largely concentrated in China, although cases have been confirmed in other countries. The extent to which the coronavirus impacts our global business, sales and results of operations will depend on future developments, which are highly uncertain and cannot be predicted. This includes new information that may emerge concerning the severity of the coronavirus, the spread and proliferation of the coronavirus in China and around the world, and the actions taken to contain the coronavirus or treat its impact, among others. +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +16 +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style Or Group Of Styles. +If any single style or group of similar styles of our footwear were to represent a substantial portion of our sales, we could be exposed to risk should consumer demand for such style or group of styles decrease in subsequent periods. We attempt to mitigate this risk by offering a broad range of products, and no style comprised over 5% of our gross wholesale sales during 2019 or 2018. However, this may change in the future, and fluctuations in sales of any style representing a significant portion of our future sales could have a negative impact on our operating results. +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state, including the challenging consumer retail market in the United States, may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +17 +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +We Depend Upon A Relatively Small Group Of Customers For A Portion Of Our Sales. +During 2019, 2018 and 2017, our sales to our five largest customers accounted for approximately 9.6%, 10.4% and 10.5% of total sales, respectively. No customer accounted for more than 10.0% of our sales during 2019, 2018 and 2017. No customer accounted for more than 10.0% of trade receivables at December 31, 2019 and 2018. These customers are primarily retailers who also distribute products for our competitors. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Furthermore, the retail industry regularly experiences consolidation, contractions and closings which may result in our loss of customers or our inability to collect accounts receivable of major customers. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer, our business could be harmed. +We May Experience Losses Because Of The Inability To Collect Accounts Receivable If Our Customers Are Unable To Pay Their Debts To Us When Due. +We rely on our network of domestic and international wholesale customers, comprised of department, athletic and specialty stores and online retailers, to distribute our products. Certain of our wholesale customers may from time to time experience bankruptcy, insolvency, and/or an inability to pay their debts to us as they come due. If our wholesale customers suffer significant financial difficulty, they may be unable to pay their debts to us timely or at all, which could have a material adverse effect on our results of operations. It is possible that wholesale customers may contest their contractual obligations to us under bankruptcy laws or otherwise. Significant customer bankruptcies could further adversely affect our sales and increase our operating expenses by requiring larger accruals for bad debt expense. In addition, even when our contracts with these customers are not contested, if customers are unable to meet their obligations on a timely basis, it could adversely affect our ability to collect receivables. Further, we may have to negotiate significant discounts and/or extended financing terms with these customers in such a situation. If we are unable to collect upon our accounts receivable as they come due in an efficient and timely manner, our business, financial condition, or results of operations may be materially adversely affected. We also face risk from international customers that file for bankruptcy protection in foreign jurisdictions, as the application of foreign bankruptcy laws may be more difficult to predict. Although we believe that we have sufficient reserves to cover anticipated customer bankruptcies, there can be no assurance that such reserves will be adequate, and if they are not adequate, our business, cash flows, operating results and financial condition would be adversely affected. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory and personnel. We have also made substantial operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to direct-to-consumer and mobile channels, and our ability to effectively develop our direct-to-consumer and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position and cash flows. +18 +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders in the past, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest domestic sales generally occurring in our second and third quarters for the back-to-school selling season. Domestically, back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers could negatively impact our sales and results of operations for our second or third quarters. More specifically, the timing of when products are shipped is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for our company, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars in which the cost of those products will vary depending on the foreign currency rates and will impact the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency rates. Although we typically work to mitigate this negative foreign currency transaction impact through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +An Increase In Our Effective Tax Rate Could Have A Material Adverse Effect On Our Results Of Operations And Financial Position. +A significant amount of our foreign earnings are generated in low or zero tax jurisdictions. As a result, our income tax expense has historically been lower than the tax computed at the U.S. statutory income tax rate. Our future effective tax rates could be unfavorably affected by a number of factors, including but not limited to, changes in the tax rates or the tax rules and regulations (including rules and regulations related to recently enacted U.S. tax legislation), or in the interpretation thereof, in the jurisdictions in which we do business; decreases in the amount of earnings in countries with low statutory tax rates; increases in the amount of earnings in countries with high statutory tax rates; or if we need to make significant taxable distributions of foreign earnings for which foreign taxes have not been provided. An increase in our effective tax rate could have a material adverse effect on our business, results of operations, financial position and cash flows. +19 +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the United States, the European Union (“EU”) and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether there may be unfavorable changes in tax laws in the United States or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our sales during the year ended December 31, 2019, were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; and changes in domestic and foreign governmental policies. We have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the Communist Party of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. In addition, electrical shortages, labor shortages or work stoppages may extend the production time necessary to produce our orders, and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. +Changes to Trade Policy, including New Tariffs Imposed By The United States Government, Could Have A Material Adverse Effect On Our Results Of Operations. +Changes in social, political, regulatory and economic conditions or in laws and policies governing trade, manufacturing, development and investment in the countries from which we import our products, or conduct our business, as well as any negative sentiment toward the United States as a result of such changes, could adversely affect our business. The United States government has placed or proposed additional tariffs on certain goods imported from China and may enact new tariffs on additional goods imported from China, including footwear and other products that we import. China had imposed tariffs on a wide range of American products in retaliation and responded to the new proposed tariff by, among other things, adjusting the value of its currency. China and the United States have made progress and are in discussions to finalize a trade agreement, however there is no guarantee that any agreement between the countries will be reached. China could impose additional tariffs or take other actions if the countries are unable to come to an agreement. The majority of our products that we sell in the United States are manufactured in China. The United States government has also negotiated a replacement trade deal for NAFTA with Mexico and Canada, the United States-Mexico-Canada Agreement (the “USMCA”), which still needs to be ratified. There is also a concern that the imposition of additional tariffs by the United States could result in the adoption of additional tariffs by other countries as well. If the United States government does not reach a trade agreement +20 +with China or replaces NAFTA with USMCA, or if additional tariffs or trade restrictions are implemented by the United States or other countries in connection with a global trade war, the resulting escalation of trade tensions could have a significant, adverse effect on world trade and the world economy. While it is too early to predict whether or how the recent policy changes will impact our business, the imposition of tariffs on footwear, apparel or other items imported by us from China could require us to increase prices to our customers or, if unable to do so, result in lowering our gross margin on products sold. Tariffs on footwear imported from China could have a material adverse effect on our business and results of operations. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, is likely to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During 2019 and 2018, the top five manufacturers of our products produced approximately 40.6% and 41.9% of our total purchases, respectively. One manufacturer accounted for 16.0% and 12.8% of total purchases during 2019 and 2018, respectively. Another manufacturer accounted for 7.3% and 10.1% of our total purchases during 2019 and 2018, respectively. We do not have long-term contracts with manufacturers, and we compete with other footwear companies for production facilities. We could experience difficulties with these manufacturers, including reductions in the availability of production capacity, failure to meet our quality control standards, failure to meet production deadlines, or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries, or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business. +If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards, or higher lead times for delivery. If we are unable to provide products consistent with our standards, or the manufacture of our footwear is delayed or becomes more expensive, our business would be harmed. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistic and distribution systems include computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all of our products are distributed from a few key locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the adverse effects that could be caused by significant disruptions affecting our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of products to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +21 +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under United States law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the United States, it could result in adverse publicity for us, damage our reputation in the United States, or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of United States or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, some or a substantial number of new stores could be opened in regions of the United States in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced sales volumes in existing stores in those markets. If sales decline at our retail stores, whether through competition from online sites or other companies, we may decide to close stores, which could result in additional costs, expenses, asset impairments or asset write-downs. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +22 +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers GOtrain ® , Skechers on-the-GO ® , ® , ® , ® , , Skechers Cali ® , Skecher Street ® , Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Mark Nason ® , D’Lites ® , DLT-A ® , BOBS ® , Energy Lights ® , Skech-Air ® , Twinkle Toes ® , Z-Strap ® , Mega-Flex ® , Luminators ® , Heart Lights ™ , Relaxed Fit ® , Arch Fit ™ , Ultra GO ® , Hyper Burst ® , Skechers Memory Foam ™ , and Air-cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the United States will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the United States, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, in particular, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +23 +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2019, a substantial portion of our operations are located in California, including 100 of our retail stores, our headquarters in Manhattan Beach, and our domestic distribution center in Rancho Belago. Because a significant portion of our sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wildfire affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Two Principal Stockholders Are Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2019, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 82.4% of our outstanding Class B common shares, members of Mr. Greenberg’s immediate family beneficially owned an additional 12.3% of our outstanding Class B common shares, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 27.9% of our outstanding Class B common shares. The holders of Class A common shares and Class B common shares have identical rights except that holders of Class A common shares are entitled to one vote per share while holders of Class B common shares are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2019, Mr. Greenberg beneficially owned 37.2% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 45.7% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 17.4% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A common shares. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to substantially control or significantly influence, respectively, actions requiring stockholder approval, may result in our company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A common shares to the extent that investors or any potential future purchaser view the superior voting rights of our Class B common shares to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +24 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Manhattan Beach, California, which consist of an aggregate of approximately 200,000 square feet. We own and lease portions of our corporate headquarters. +Our U.S. distribution center is a 1.8 million square-foot facility located on approximately 110 acres in Rancho Belago, California. We are leasing the distribution center from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The lease for this facility expires in November 2031, with a base rent of $940,695 per month, or approximately $11.3 million per year. The JV is consolidated in our financial statements. +Our European distribution center occupies approximately 1.3 million square feet in Liege, Belgium under five operating leases, with base rents of approximately $5.5 million per year. These leases provide for original terms of 10 to 15 years, commencing between January 2016 and June 2016, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring between February 2020 and January 2033. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent expense related to our domestic retail stores and showrooms was $111.0 million for the year ended December 31, 2019. +We also lease all of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates between January 2020 and January 2033. +ITEM 3. +LEGAL PROCEEDINGS +Converse, Inc. v. Skechers U.S.A., Inc. – On October 14, 2014, Converse filed an action against our company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including our company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014‑24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his Initial Determination finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and Bobs Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued its Final Determination affirming that Skechers Twinkle Toes and Bobs Utopia shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bobs Utopia shoes do not infringe. On June 26, 2017, we filed our responsive brief, on February 8, 2018, the court heard oral argument, and on June 7, 2018, the Court requested supplemental briefing on certain issues. On October 30, 2018, the United States Court of Appeals for the Federal Circuit vacated portions of the ITC’s ruling and remanded the matter back to the ITC for further proceedings. Although Converse did not appeal the Commission’s non-infringement findings for Skechers Twinkle Toes and Bobs Utopia shoes to the Federal Circuit, Converse asked the Commission to reconsider its previous non-infringement findings on remand. On October 9, 2019, the ITC judge issued his Remand Initial Determination (the “RID”) finding that Converse did not have any rights in the subject intellectual property as to Skechers, and that Skechers Twinkle Toes, Bobs Utopia, and Hydee Hytop did not infringe Converse’s intellectual property but the discontinued Daddy’$ Money would infringe, but only if Converse had rights in the subject intellectual property as to Skechers (which the ITC judge found that Converse did not). On October 22, 2019, the parties filed petitions seeking review of the RID. Converse did not, however, seek review of the finding in the RID that Skechers Twinkle Toes and Bobs Utopia do not infringe. On February 7, 2020, the full ITC decided to review the RID, outlined the issues and set a briefing schedule. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our +25 +results of operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +Nike, Inc. v. Skechers USA, Inc. – On January 4, 2016, Nike filed an action against our company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. In April and May 2016, we filed petitions with the United States Patent and Trademark Office’s Patent Trial and Appeal Board (the “PTAB”) for inter partes review of all eight design patents, seeking to invalidate those patents. In September and November 2016, the PTAB denied each of our petitions. On January 6, 2017, we filed several additional petitions for inter partes review with the PTAB, seeking to invalidate seven of the eight designs patents that Nike is asserting. In July 2017, we were notified that the PTAB granted our petitions and instituted inter partes review proceedings with respect to two of the seven design patents but denied our petitions as to the others. In June 2017, we filed a motion to transfer venue from the District of Oregon to the Central District of California based on a recent United States Supreme Court decision and the motion was granted on November 17, 2017. On June 28, 2018, the PTAB issued final decisions in the two inter partes review proceedings, rejecting the invalidity challenges made by our company in those proceedings. On June 4, 2018, the Court, over Nike’s opposition, granted our request for a claim construction hearing. On March 28, 2019, the Court issued an order declining to issue a claim construction at this stage of the proceedings, but it did not foreclose the issue, instead observing that it might be appropriate to address claim construction at a later stage. The parties have now completed discovery and have filed summary judgement motions. Nike has also withdrawn its claim for treble or enhanced damages. The court heard the summary judgment motions on February 18, 2020, requested supplemental briefing on certain issues and took the motions under submission. While it is too early to predict the outcome of the case or whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc. v. Skechers USA, Inc. – On September 30, 2019, Nike filed an action against our company in the United States District Court for the Central District of California, Case No. 2:19-cv-08418, alleging that certain Skechers’ shoe designs (Skech-Air Atlas, Skech-Air 92, Skech-Air Stratus and Skech-Air Blast) infringe the claims of twelve design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. Skechers has filed its answer and the case is in the early stages. While it is too early to predict the outcome of the case or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc. v. Skechers USA, Inc. – On October 28, 2019, Nike filed an action against our company in the United States District Court for the Central District of California, Case No. 2:19-cv-09230, alleging that certain Skechers’ shoe designs (Skech-Air Jumpin’ Dots and Skech-Air Mega) infringe the claims of two utility patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. Skechers has answered the complaint and the case is in the early stages. While it is too early to predict the outcome of the case or whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Steamfitters Local 449 Pension Plan v. Skechers USA, Inc., Robert Greenberg and David Weinberg. – On October 20, 2017, the Steamfitters Local 449 Pension Plan filed a securities class action, on behalf of itself and purportedly on behalf of other shareholders who purchased Skechers stock in a five-month period in 2015, against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:17-cv-08107. On April 4, 2018, the plaintiffs filed an amended and consolidated complaint, and on July 24, 2018, plaintiffs filed a second amended and consolidated complaint. The lawsuit alleges that, between April 23 and October 22, 2015, we made materially false statements or omissions of material fact about the anticipated performance of our Domestic Wholesale segment and asserts claims for unspecified damages, attorneys' fees and equitable relief based on two counts for alleged violations of federal securities laws. On November 21, 2018, we filed a motion to dismiss. On January 10, 2019, plaintiffs filed an opposition, and on February 11, 2019, we filed a reply. On September 23, 2019, the court granted our motion to dismiss without leave to amend, on October 22, 2019, the plaintiffs appealed it to the United States Court of Appeals for the Second Circuit, and on February 4, 2020, filed appellants’ opening brief. Given the early stage of this proceeding and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our results of operations or financial position. We believe we have meritorious defenses and intend to defend this matter vigorously. +26 +In Re Skechers Securities Litigation (formerly Laborers Local 235 Benefit Fund v. Skechers USA, Inc. Robert Greenberg, David Weinberg and John Vandemore) – On September 4, 2018, Laborers Local 235 Benefit Fund filed a securities class action on behalf of itself and purportedly on behalf of other shareholders who purchased our company’s stock between October 20, 2017 and July 19, 2018 (the “Class Period”), against our company and certain of its officers in the United States District Court for the Southern District of New York, case number 1:18-cv-8039 . The complaint alleges that throughout the Class Period we made materially false statements or omissions of material fact regarding our sales growth and controlling expenses and asserts claims for unspecified damages and attorneys’ fees . Beginning October 17, 2018, copycat cases were filed , and on January 22, 2019 , a consolidated amended class action complaint was filed as In Re Skechers Securities Litigation . On May 13, 2019, we filed a motion to dismiss the complaint. On June 27, 2019, plaintiffs filed an opposition, and on July 29, 2019, we filed a reply. The court heard the motion on January 23, 2020 and took it under submission. We believe we have meritorious defenses and intend to defend these matters vigorously. Given the early stages of these proceedings and the limited information available, we cannot predict the outcome of these legal proceedings or whether an adverse result in these cases would have a material adverse impact on our results of operations or financial position. +Police & Fire Ret. Sys. of the City of Detroit, et al. v. Greenberg, et al . – On July 26, 2019, our company and most of the Board of Directors were sued by several shareholders on behalf of our company in a derivative action in the Court of Chancery of the State of Delaware, Case No. 2019-0578. The complaint alleges breach of fiduciary duty and waste of corporate assets in connection with the grant of compensation to certain officers. On October 8, 2019, we filed a motion to dismiss the complaint, which is not fully briefed. Mediation is scheduled for March 11, 2020. We believe we have meritorious defenses and intend to defend this matter vigorously. Given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our results of operations or financial position. +Kathleen Houseman v. Robert Greenberg, et al. – On November 27, 2018, our company, the Board of Directors and CFO John Vandemore were sued by a shareholder on behalf of our company in a derivative action in the United States District Court for the District of Delaware, Case No 1:18-cv-01878. The complaint is based largely on the same underlying factual allegations as In Re Skechers Securities Litigation . By mutual agreement of the parties this case has been stayed pending the outcome of In Re Skechers Securities Litigation. We believe we have meritorious defenses and intend to defend this matter vigorously. Notwithstanding, given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our results of operations or financial position. +Jesse Chen v. Robert Greenberg, et al. – On January 16, 2019, our company, the Board of Directors and CFO John Vandemore were sued by a shareholder on behalf of our company in a derivative action in the Superior Court for the State of California for the County of Los Angeles, Case No.19-STC-CV00393. The complaint mirrors the Houseman case, supra, and is based largely on the same underlying factual allegations as In Re Skechers Securities Litigation . By mutual agreement of the parties this case has been stayed pending the outcome of In Re Skechers Securities Litigation. We believe we have meritorious defenses and intend to defend this matter vigorously. Notwithstanding, given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our results of operations or financial position. +Ealeen Wilk v. Skechers U.S.A., Inc . – On September 10, 2018, Ealeen Wilk filed a putative class action lawsuit against our company in the United States District Court for the Central District of California, Case No. 5:18-cv-01921, alleging violations of the California Labor Code, including unpaid overtime, unpaid wages due upon termination and unfair business practices. The complaint seeks actual, compensatory, special and general damages; penalties and liquidated damages; restitutionary and injunctive relief; attorneys’ fees and costs; and interest as permitted by law. On July 5, 2019, the court granted, in part, plaintiff’s motion for conditional certification of a Fair Labor Standards Act (FLSA) collective action. On July 22, 2019, the parties submitted to the court an agreed upon notice to be sent to members of the collective. The parties are delaying the mailing of the Belaire-West privacy opt out notice until after mediation. The parties reached a settlement in principle as a result of a January 27, 2020 mediation but the details of the settlement still need to be worked out and the settlement has to be documented. The parties have agreed to an informal stay of discovery and have stipulated to continue all relevant discovery and motion deadlines accordingly. In the event the settlement is not concluded successfully the deadline for the Court to hear a motion for class certification and/or summary judgement is April 6, 2020 and trial is set for June 16, 2020. While it is too early to predict the outcome of the litigation or a reasonable range of potential losses and whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe that we have meritorious defenses, vehemently deny the allegations, and intend to defend the case vigorously. +27 +Jose Zavala Guzman v. Team One Employment Specialists, Skechers USA, Inc. et. al. – On April 2, 2019, Jose Guzman, a Team One employee, filed a class action lawsuit against Team One and our c ompany in the Superior Court of California, County of Los Angeles County, Case No. 19STCV11006. The complaint alleges various wage and hour violations, and seeks compensatory damages, liquidated damages, penalties, interest and restitution. This complaint was followed by a Private Attorney General’s Act Notice, specifying the same allegations raised in the complaint. This matter was tendered to our insurance carrier, and we are currently investigating the allegations. Co-defendant Team-One has filed a motion to compel arbitration, which our c ompany has joined in. The hearing that was originally set for January 30, 2020 was postponed pending a March 16, 2020 mediation and the matter is otherwise stayed until then. While it is too early to predict the outcome of the litigation or a reasonable range of potential losses and whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe that we have meritorious defenses, vehemently deny the allegations, and intend to defend the case vigorously . +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against our company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +28 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX”. +HOLDERS +As of February 1, 2020, there were 85 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 33 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND POLICY +Share Repurchase Program +On February 6, 2018, our Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which we may, from time to time, purchase shares of our Class A Common Stock, par value $0.001 per share (“Class A Common Stock”), for an aggregate repurchase price not to exceed $150.0 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate us to acquire any particular amount of shares of Class A Common Stock and the program may be suspended or discontinued at any time. +ISSUER PURCHASES OF EQUITY SECURITIES +The table below summarizes the number of shares of our Class A Common Stock that were repurchased during the three months ended December 31, 2019. +Month Ended +Total Number +of Shares +Purchased (1) (2) +Average Price Paid Per Share +Total Number of Shares Purchased from Certain Employees (1) +Total Number of Shares Purchased under the Share Repurchase Program (2) +Maximum Dollar Value of Shares that May Yet Be Purchased under the Program +October 31, 2019 +— +— +— +— +$ +20,003,000 +November 30, 2019 +14,659 +$ +37.98 +14,659 +— +$ +20,003,000 +December 31, 2019 +289 +$ +41.40 +289 +— +$ +20,003,000 +Total +14,948 +14,948 +— +$ +20,003,000 +(1) +We repurchased 14,948 shares from certain employees to facilitate income tax withholding payments pertaining to restricted stock awards that vested during the three months ended December 31, 2019. Such shares were not repurchased pursuant to a publicly announced plan or program. +(2) +As announced on February 6, 2018, our Board of Directors approved the Share Repurchase Program, authorizing the repurchase of up to an aggregate of $150.0 million of our Class A Common Stock. The Share Repurchase Program allows us to repurchase shares of Class A Common Stock from time to time for cash in the open market or privately negotiated transactions or other transactions, as market and business conditions warrant and subject to applicable legal requirements. The share repurchase program does not obligate us to repurchase any particular amount of Class A Common Stock, and it could be modified, suspended or discontinued at any time. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +29 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2014 to December 31, 2019, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2014 in each of our Class A Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +12/14 +12/15 +12/16 +12/17 +12/18 +12/19 +Skechers U.S.A., Inc. +100.00 +164.04 +133.47 +205.47 +124.29 +234.52 +Russell 2000 +100.00 +95.59 +115.95 +132.94 +118.30 +148.49 +Peer Group +100.00 +126.89 +125.70 +159.31 +185.53 +265.22 +30 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth our company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2019 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +(In thousands, except net earnings per share) +Years Ended December 31, +Statement of Earnings Data: +2019 +2018 +2017 +2016 +2015 +Sales +$ +5,220,051 +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +$ +3,147,323 +Gross profit +2,491,157 +2,223,605 +1,938,889 +1,634,596 +1,424,008 +Earnings from operations +518,443 +437,765 +382,880 +370,518 +350,824 +Earnings before income taxes +516,005 +431,884 +384,260 +359,484 +333,497 +Net earnings attributable to Skechers U.S.A., Inc. +346,560 +301,041 +179,190 +243,493 +231,912 +Net earnings per share: (1) +Basic +2.26 +1.93 +1.15 +1.58 +1.52 +Diluted +2.25 +1.92 +1.14 +1.57 +1.50 +Weighted average shares: (1) +Basic +153,392 +155,815 +155,651 +154,169 +152,847 +Diluted +154,151 +156,450 +156,523 +155,084 +154,200 +As of December 31, +Balance Sheet Data: +2019 +2018 +2017 +2016 +2015 +Working capital +$ +1,581,360 +$ +1,621,918 +$ +1,507,676 +$ +1,206,036 +$ +971,179 +Total assets +4,892,943 +3,228,255 +2,735,082 +2,393,670 +2,039,878 +Long-term borrowings, excluding current installments +49,183 +88,119 +71,103 +67,159 +68,942 +Skechers U.S.A., Inc. equity +2,314,665 +2,034,958 +1,829,064 +1,603,633 +1,327,556 +(1) +Basic earnings per share represents net earnings divided by the weighted-average number of Class A common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, reflects the potential dilution that could occur if options to issue Class A Common Stock were exercised or converted into Class A Common Stock. All share and per share information has been retroactively adjusted for the three-for-one stock split that was effective on October 16, 2015. +31 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. +This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 2018 filed with the SEC on March 1, 201 9. +GENERAL +We design, market and sell lifestyle and performance footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own direct-to-consumer stores and e-commerce sites, and distributor and licensee-owned international retail stores. Our objective is to design and market quality footwear that is comfortable, stylish and innovative, leverage our brand name and profitably grow our business across all channels of distribution. +Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and direct-to-consumer sales, which includes our company-owned retail stores and direct-to-consumer websites. We evaluate segment performance based primarily on sales and gross margins. See detailed segment information in Note 20 – Segment and Geographic Reporting in our Consolidated Financial Statements included under Part II, Item 8 of this annual report. +FINANCIAL OVERVIEW +Our sales for 2019 increased $578.0 million, or 12.5%, to $5,220.1 million, compared to sales of $4,642.1 million in 2018. The increase in sales primarily came from our international subsidiaries and retail businesses. Our international wholesale and international retail businesses represented 57.9% of our sales during 2019. During 2019, earnings from operations increased $80.6 million, or 18.4%, to $518.4 million compared to $437.8 million in 2018. Net earnings attributable to Skechers U.S.A., Inc. were $346.6 million for 2019, an increase of $45.6 million, or 15.1%, compared to net earnings of $301.0 million in 2018. Diluted earnings per share for 2019 were $2.25, which reflected a 17.2% increase from the $1.92 diluted earnings per share reported in the prior year. Our working capital was $1,581.4 million at December 31, 2019, which was a decrease of $40.5 million from working capital of $1,621.9 million at December 31, 2018. Our cash and cash equivalents decreased $47.3 million to $824.9 million at December 31, 2019 from $872.2 million at December 31, 2018. The decrease in cash and cash equivalents was primarily the result of the purchase of the minority interest of our India joint venture for $82.9 million and our investment of $100.7 million for the acquisition of our Mexico joint venture, which were partially offset by our increased net earnings and increased accounts payable. +2019 OVERVIEW +In 2019, we focused on developing comfortable product that is reflective of our expansive audience and changing trends, growing our position in our domestic wholesale accounts, growing our international market share, opening retail stores in key locations worldwide, continuing to develop our global infrastructure, and balance sheet and expense management. +New product design and delivery . Our success depends on our ability to design and deliver comfortable, stylish, affordable products to consumers across a broad range of demographics. In 2019, we focused on fresh updates to our core and existing styles as well as broadening our reach through collaborations, limited edition collections, and new innovations such as Arch Fit and Hyper Burst. +Grow our domestic business. In 2019, we delivered updates to our core and existing styles, launched collaborations with partners, including Atmos and Opening Ceremony, as well as with well-known properties including Scooby Doo, Doug the Pug and Grumpy Cat, and introduced the award-winning Hyper Burst technology in our Skechers Performance line. In addition, we updated our successful Skechers GO Walk collection by launching Skechers GO Walk Smart and Skechers GO Walk 5. In 2019, we remained a leading source for walking, work, casual lifestyle, sandals, and casual athletic footwear. +32 +Further develop our international businesses. During 2019 , we continued to focus on growing our international sales by expanding the products we deliver to our international markets and growing our presence with wholesale partners with solutions like shop - in - shops and focal walls . We also purchased the outstanding minority interest of our India joint venture and completed an investment into a new joint venture in Mexico . +Expand Skechers global direct-to-consumer base. Believing that Skechers retail stores are effective and profitable brand building tools, we continued to open Skechers stores around the world, both company and third-party owned. We also continued to enhance our e-commerce solutions by investing in people and technology to drive growth in the on-line channel. +Develop our global infrastructure. In 2019, we continued constructing a new China distribution center to support our operations in the region, and we expect it to be completed in 2020. We also added additional capacity in our European Distribution Center and commenced planning to expand our Rancho Belago distribution center to support the growth of our domestic wholesale and direct-to-consumer business. +Balance sheet and expense management. During 2019, we continued to focus on managing our balance sheet and bringing our marketing expenses and general and administrative expenses in line with expected sales. During 2019, we returned $30.0 million to stockholders by repurchasing 1.0 million shares of our Class A Common Stock. We also expanded and extended our existing credit facility during 2019 to provided additional liquidity to support our global growth. +OUTLOOK FOR 2020 +During 2020, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. This includes building on our fit offerings with the addition of Stretch Knit and Arch Fit; our Performance offering with new versions of GO Walk and the addition of Hyper Burst and Max Cushioning; and our heritage collection with Street Cleats, Skechers D’Lites, Skechers Stamina, and Skechers Energy, among others. The global footwear market is competitive, but we believe global demand for the brand will remain strong due to our strategy of delivering style, comfort, innovation and quality that is affordably priced. We believe appeal for our product is broad and our marketing is effective and impactful. We will continue to use local and global brand ambassadors—including sports icons Clayton Kershaw, Tony Romo, and Howie Long for men; Brooke Burke for women; elite athletes Meb Kelfezighi, Lionel Sanders and Edward Cheserek; and professional golfers Matt Kuchar, Brooke Henderson, and Colin Montgomerie. We expect to continue to increase our shelf space, and to open another 115 to 125 company-owned retail locations worldwide and to make investments in our direct-to-consumer technology infrastructure. In addition, we expect to complete the construction of our new distribution center in China, begin the expansion of our distribution center in the United States, and continue the construction of our corporate headquarters. +DEFINITIONS +Net sales +Reference in this annual report to “Sales” refers to Skechers’ net sales reported under generally accepted accounting principles in the United States. +Comparable sales +As part of our discussion of our results of operations, we disclose comparable store sales, for which we typically include the impact of direct-to-consumer sales on our company-owned websites. With respect to any reporting period, we define comparable store sales as sales for stores that are owned and operated for at least thirteen full calendar months as of the last day of any calendar month within the current reporting period, and include only those sales for each of the comparable full calendar months that the store is open within each period. When a store closes at the end of a lease during a reporting period, we include in comparable store sales the sales for the number of comparable full calendar months that the store was open within the reporting period. We include new stores in comparable store sales commencing with the fourteenth month of operations because we believe it provides a more meaningful comparison of operating results of months with stabilized operations, and excludes a new store’s first full calendar month of operations when operating results may not be representative for a variety of reasons. +Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +33 +Cost of sales or Gross margins +Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, tariffs, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. +Selling expenses +Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs. +General and administrative expenses +General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for our Rancho Belago, European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. +YEAR ENDED DECEMBER 31, 2019 COMPARED TO THE YEAR ENDED DECEMBER 31, 2018 +Sales +Sales for 2019 were $5,220.1 million, which was an increase of $578.0 million, or 12.5%, compared to sales of $4,642.1 million for 2018. The increase in sales primarily came from our international wholesale and retail businesses. +Our domestic wholesale sales decreased $12.0 million, or 1.0%, to $1,247.6 million for 2019 compared to $1,259.6 million for 2018. The decrease in our domestic wholesale segment’s sales was the result of a 1.9% unit sales volume decrease, to 57.0 million pairs in 2019 from 58.1 million pairs in 2018, which was partially offset by an increase in average selling price per pair of 1.9%, to $21.67 per pair for 2019 from $21.26 in 2018. This sales decrease was attributable to lower sales in our Women’s and Men’s Go, Kids and YOU divisions during 2019. The average selling price per pair increase within the domestic wholesale segment was primarily the result of product sales mix. +Our international wholesale segment sales increased $407.8 million, or 19.8%, to $2,462.6 million for 2019 compared to sales of $2,054.8 million for 2018. Our international wholesale sales consist of wholesale sales by our foreign subsidiaries, sales from our China joint venture and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries, including our joint ventures, increased $325.8 million, or 18.9%, to $2,047.3 million for 2019 compared to sales of $1,721.5 million for 2018. The largest sales increases during the year came from our subsidiaries in the United Kingdom, Germany, India and Spain, and our joint ventures in China, Korea and Mexico. The increases are primarily attributable to sales of our Men’s and Women’s Sport, Go, BOBS, and Men’s U.S.A., lines. Our distributor sales increased $82.0 million, or 24.6%, to $415.3 million for 2019, compared to sales of $333.3 million for 2018. This was primarily attributable to increased sales to our distributors in Russia, Indonesia and United Arab Emirates. +Our retail segment sales increased $182.2 million to $1,509.9 million for the year ended December 31, 2019, a 13.7% increase over sales of $1,327.7 million for 2018. The increase in retail sales was primarily attributable to increased comparable sales of 5.4%, which included increased sales within our Men’s and Women’s Sport, Men’s U.S.A. and Work divisions and a net increase of 27 domestic and 20 international stores compared to 2018. For the year ended December 31, 2019, our domestic retail sales, increased 9.4% compared to 2018, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 4.8%, and our international retail store sales increased 22.0% compared to 2018, which was attributable to increased international store count and positive comparable international store sales of 7.0%. +We believe that we have established our presence in most major domestic retail markets. We had 497 domestic stores and 302 international retail stores as of February 1, 2020, and we currently plan to open approximately 115 to 125 stores in 2020. During 2019, we opened one domestic factory outlet store, 32 domestic warehouse outlet stores, 15 international concept stores, 11 international factory outlet stores. During 2019, we closed five domestic concept stores, one domestic outlet store and six international concept stores. We periodically review all of our stores for impairment. During 2019 and 2018, we did not record an impairment charge related to our retail stores. +34 +Gross profit +Gross profit for 2019 increased $267.6 million, or 12.0%, to $2,491.1 million from $2,223.5 million for 2018. Gross profit, as a percentage of sales, or gross margin, decreased slightly to 47.7% in 2019 from 47.9% for 2018. Our domestic wholesale segment gross profit decreased $10.4 million, or 2.2%, to $457.9 million for 2019 from $468.3 million for 2018, which was primarily attributable due to lower sales. Domestic wholesale gross margins decreased to 36.7% for 2019 from 37.2% for 2018 primarily due to increased tariffs. +Gross profit for our international wholesale segment increased $156.9 million, or 16.1%, to $1,133.6 million for 2019 compared to $976.7 million for 2018. Gross margins for the international wholesale segment were 46.0% for 2019 compared to 47.5% for 2018. Gross margins for our international direct subsidiary sales, including our joint ventures, were 50.1% for 2019 as compared to 51.7% for 2018. The decrease was primarily attributable to promotional efforts to clear seasonal inventory in select markets. Gross margins for our international distributor sales were 25.8% for 2019 as compared to 25.9% for 2018. +Gross profit for our direct-to-consumer segment increased $121.1 million, or 15.6%, to $899.6 million for 2019 as compared to $778.5 million for 2018. Gross margins for all stores were 59.6% for 2019 compared to 58.6% for 2018. Gross margins for our domestic direct-to-consumer sales were 62.5% for 2019 as compared to 61.3% for 2018 primarily due to higher average selling prices. Gross margins for our international direct-to-consumer sales were 54.6% for 2019 as compared to 53.6% for 2018 primarily due to favorable product mix. The increase in our domestic retail margins was primarily attributable to higher average selling prices and lower average product costs. +Selling expenses +Selling expenses increased by $19.5 million, or 5.6%, to $369.9 million for 2019 from $350.4 million for 2018. As a percentage of sales, selling expenses were 7.1% and 7.5% for 2019 and 2018, respectively. The increase in selling expenses was primarily the result of higher advertising expense of $20.3 million. +General and administrative expenses +General and administrative expenses increased by $169.3 million, or 11.6%, to $1,625.3 million for 2019 from $1,456.0 million for 2018. As a percentage of sales, general and administrative expenses were 31.1% and 31.4% for 2019 and 2018, respectively. The increase in general and administrative expenses was primarily attributable to $61.1 million related to supporting our growing international operations, particularly in China and Mexico, increased store operating costs of $78.4 million primarily attributable to an additional net 47 stores, and increased domestic wholesale general and administrative expenses of $29.8 million primarily due to increased distribution costs of $26.8 million as a result of increased direct-to-consumer sales. +Other income (expense) +Interest income was $11.8 million for 2019 compared to $10.1 million for 2018. The increase in interest income was primarily due to higher average cash and investment balances and higher effective interest rates. Interest expense for 2019 increased $1.7 million to $7.5 million compared to $5.8 million in 2018. Interest expense increased primarily due to increased interest owed to our foreign manufacturers. Loss on foreign currency transactions for 2019 was $5.7 million compared to a $9.2 million loss in 2018. This decreased foreign currency exchange loss was primarily attributable to the impact of a stronger U.S. dollar on our intercompany balances in our foreign subsidiaries. +Income taxes +Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in the U.S., ranging from 0% to 34.6%. Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes. +35 +Our earnings (loss) before income taxes and income tax expense for 2019 , 2018 and 2017 are as follows (in thousands): +Years Ended December 31, +2019 +2018 +2017 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense (benefit) +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +4,999 +$ +24,887 +$ +16,597 +$ +11,500 +$ +25,628 +$ +113,607 +Peoples Republic of China (“China”) +121,702 +30,320 +89,429 +19,595 +95,668 +12,971 +Hong Kong +50,131 +4,303 +48,352 +8,106 +17,778 +5,030 +Jersey (2) +245,561 +— +213,327 +— +198,048 +— +Non-benefited loss operations (3) +(7,685 +) +1,184 +(11,422 +) +(3,387 +) +(17,350 +) +3,306 +Other jurisdictions (4) +101,297 +28,059 +75,601 +24,797 +64,488 +14,242 +Earnings before income taxes +$ +516,005 +$ +88,753 +$ +431,884 +$ +60,611 +$ +384,260 +$ +149,156 +Effective tax rate (5) +17.2% +14.0% +38.8% +(1) +United States income tax expense for 2017 includes a provisional one-time $99.9 million tax expense related to the enactment of the Tax Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Barbados, Brazil, China, India, Israel, Japan, Macau, Panama, Romania, Thailand, and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5% of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hungary, India, Israel, Italy, Kosovo, Macau, Macedonia, Malaysia, Mexico, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Serbia, Singapore, Spain, Switzerland, Vietnam, and the United Kingdom, +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2019, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2019, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $5.0 million, with income tax expense of $24.9 million, which is an average rate of 498%. This rate is higher than the 25% U.S. statutory rate primarily due to the taxation on global intangible low-taxed income (“GILTI”), in the U.S. Earnings (loss) before income taxes in non-U.S. jurisdictions were $511.0 million, with an aggregate income tax expense of $63.9 million, which is an average rate of 12.5%. Combined, this results in consolidated earnings before income taxes for the period of $516.0 million, and consolidated income tax expense for the period of $88.8 million, resulting in an effective tax rate of 17.2%. For 2019, of our $511.0 million in earnings before income tax earned outside the U.S., $245.6 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $32.3 million to $ 245.6 million in 2019 from $213.3 million in 2018. This increase was primarily attributable to an increase in international sales, which resulted in an increase in earnings before income taxes in Jersey from royalties and commissions under the terms of our inter-subsidiary agreements. In addition, there were foreign losses of $7.6 million for which no tax benefit was recognized during the year ended December 31, 2019 because of the provision of offsetting valuation allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. +As of December 31, 2019, we had approximately $824.9 million in cash and cash equivalents, of which $566.4 million, or 68.7%, was outside the U.S. Of the $566.4 million held by our non-U.S. subsidiaries, approximately $220.3 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as of December 31, 2019. +We believe our cash and cash equivalents and investments held in the U.S. and cash provided from operations are sufficient to meet our liquidity needs in the U.S. for the next twelve months, and we do not expect to repatriate any of the funds presently designated as indefinitely reinvested outside the U.S. We have provided for the tax impact of expected distributions from our joint venture in China as well as from our subsidiary in Chile to our intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, we do not foresee the need for any of our other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to U.S. income taxes but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. +36 +Non-controlling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to non-controlling interest for 2019 increased $10.5 million to $80.7 million as compared to $70.2 million for 2018 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +LIQUIDITY AND CAPITAL RESOURCES +Cash Flows +Our working capital at December 31, 2019 was $1,581.4 million, a decrease of $40.5 million from working capital of $1,621.9 million at December 31, 2018. Our cash and cash equivalents at December 31, 2019 was $824.9 million compared to $872.2 million at December 31, 2018. This decrease in cash and cash equivalents of $47.3 million, after consideration of the effect of exchange rates, was the result of capital expenditures of $236.1 million, increased receivables of $118.4 million and acquisitions of $100.7 million, which was partially offset by our net earnings of $427.3 million, and increased accounts payable of $154.5 million. Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $426.6 million for 2019 and $568.6 million for 2018. On a comparative year‑to‑year basis, the $142.0 million decrease in cash flows from operating activities in 2019 primarily resulted from increased inventories of $171.9 million. +Investing Activities +Net cash used in investing activities was $344.1 million for 2019 as compared to $319.4 million in 2018. The increase in cash used in investing activities in 2019 as compared to 2018 was due to net cash used in the acquisition of an interest in our Mexico joint venture of $100.7 million and increased capital expenditures of $93.1 million, offset by a net decrease in investment purchases of $163.5 million. Capital expenditures for 2019 were approximately $236.1 million, which primarily consisted of $51.9 million for new store openings and remodels, $53.0 million for the construction for our China distribution center, $33.8 million to support our international wholesale operations, $19.6 million for the upgrades to our domestic distribution center, and $15.6 million for new retail locations in our China joint venture. This compares to capital expenditures of $143.0 million in the prior year, which primarily consisted of $50.0 million for new store openings and remodels, $28.8 million for land for our China distribution center, $20.6 million to support our international wholesale operations, $10.5 million for new retail locations in our China joint venture, and $17.6 million for the upgrades to our domestic distribution center. We expect our ongoing capital expenditures for 2020 to be between $325.0 million and $350.0 million, which includes completing the construction of our China distribution center; the expansion of our U.S. distribution facility; opening 115 to 125 new company-owned Skechers stores and 20 to 30 store remodels, expansions and relocations; the expansion of our corporate headquarters; and technology investments, primarily in our direct-to-consumer business. We believe our current cash, investments, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. +Financing Activities +Net cash used in financing activities was $132.0 million during 2019 compared to $119.7 million during 2018. The increase in cash used by financing activities was primarily attributable to the purchases of the non-controlling interest of our India joint venture of $82.9 million, partially offset by a decrease of $70.0 million in repurchases of shares of our Class A Common Stock. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On February 6, 2018, our Board of Directors authorized the Share Repurchase Program, pursuant to which we may, from time to time, purchase shares of our Class A Common Stock for an aggregate repurchase price not to exceed $150.0 million. The Share Repurchase Program expires on February 6, 2021. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate us to acquire any particular amount of shares of Class A Common Stock and the program may be suspended or discontinued at any time. As of December 31, 2019, there was $20.0 million available under the Share Repurchase Program. +37 +Acquisitions +In the first quarter of 2019, we purchased the minority interest in our India joint venture for $82.9 million, which made our India joint venture entity a wholly-owned subsidiary. +In the second quarter of 2019, we purchased a 60% interest in Manhattan SKMX, de R.L. de C.V. (“Skechers Mexico”) for a total cash consideration of $100.7 million, net of cash acquired. Skechers Mexico is a joint venture that operates and generates sales in Mexico. As a result of this purchase, Skechers Mexico became a majority-owned subsidiary and the results are consolidated in our consolidated financial statements from the date of acquisition. The formation of the joint venture provides significant merchandising, supply chain and retail operations in Mexico. We are in the final process of completing the purchase price allocation, which will be completed by April 1, 2020. However, the finalization may result in changes in the assets acquired and tax-related items. Pro forma results of operations have not been presented because the effects of the acquisitions, individually and in the aggregate, were not material to our consolidated financial statements. +Financing Arrangements +On November 21, 2019, we entered into a $500.0 million senior unsecured revolving credit facility, which matures on November 21, 2024 (the “2019 Credit Agreement”), with Bank of America, N.A., as administrative agent and joint lead arranger, HSBC Bank USA, N.A. and JPMorgan Chase Bank, N.A., as joint lead arrangers, and other lenders. The 2019 Credit Agreement replaced our then existing $250.0 million loan and security agreement dated June 30, 2015 with Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association that was set to expire on June 30, 2020. The 2019 Credit Agreement may be increased by up to $250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $100.0 million and swingline loans up to a maximum of $25.0 million. We may use the proceeds from the 2019 Credit Agreement for working capital and other lawful corporate purposes. At our option, any loan (other than swingline loans) will bear interest at a rate equal to (a) LIBOR plus an applicable margin between 1.125% and 1.625% based upon our Total Adjusted Net Leverage Ratio (as defined in the 2019 Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the Bank of America prime rate and (iii) LIBOR plus 1.00%) plus an applicable margin between 0.125% and 0.625% based upon our Total Adjusted Net Leverage Ratio. Any swingline loan will bear interest at the base rate. We will pay a variable commitment fee of between 0.125% and 0.25% of the actual daily unused amount of each lender’s commitment, and will also pay a variable letter of credit fee of between 1.125% and 1.625% on the maximum amount available to be drawn under each issued and outstanding letter of credit, both of which are based upon our Total Adjusted Net Leverage Ratio. The 2019 Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type, including covenants that limit the ability of our company and our subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose of assets, effect a change of control of our company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The 2019 Credit Agreement also requires that the total adjusted net leverage ratio not exceed 3.75, except in the event of an acquisition in which case the ratio may be increased at our election to 4.25 for the quarter in which such acquisition occurs and for the next three quarters thereafter. The 2019 Credit Agreement provides for customary events of default including payment defaults, breaches of representations or warranties or covenants, cross defaults with certain other indebtedness to third parties, certain judgments/awards/orders, a change of control, bankruptcy and insolvency events, inability to pay debts, ERISA defaults, and invalidity or impairment of the 2019 Credit Agreement or any loan documentation related thereto, with, in certain circumstances, cure periods. Certain of the lenders party to the 2019 Credit Agreement, and their respective affiliates, have performed, and may in the future perform for us and our subsidiaries, various commercial banking, investment banking, underwriting and other financial advisory services, for which they have received, and will receive, customary fees and expenses. We paid origination, arrangement and legal fees of $1.6 million on the 2019 Credit Agreement, which are being amortized to interest expense over the five-year life of the 2019 Credit Agreement. As of December 31, 2019, there was no outstanding amount under the 2019 Credit Agreement. +On September 29, 2018, through a Taicang subsidiary, we entered into a 700 million yuan loan agreement with China Construction Bank Corporation (the “China DC Loan Agreement”). The proceeds from the China DC Loan Agreement are being used to finance the construction of our distribution center in China. Interest is paid quarterly. The interest rate was 4.275% at December 31, 2019, which floats and is calculated from a reference rate provided by the People’s Bank of China. The interest rate may increase or decrease over the life of the loan and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan Agreement. The China DC Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the joint venture to, among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The China DC Loan Agreement matures on September 28, 2023. The obligations of the TC Subsidiary under the China DC Loan Agreement are jointly and severally guaranteed by our Chinese joint venture. As of December 31, 2019, there was $48.8 million outstanding under this credit facility, which is classified as long-term borrowings in our consolidated balance sheets. +On April 30, 2010, HF Logistics-SKX,LLC (the “JV”), through HF Logistics-SKX T1, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the JV (“HF-T1”), entered into a construction loan agreement with Bank of America, +38 +N.A., as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the “ Construction Loan Agreement ” ), pursuant to which the JV obtained a loan of up to $55.0 million used for construction of the p roject on the p roperty (the “O riginal Loan ” ). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the “ Modification ” ), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $80.0 million and extended the maturity date of the Original Loan to October 30, 2015. On August 11, 2015, the JV through HF-T1 entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the “ Amended Loan Agreement ” ), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $77.3 million. In connection with this refinancing of the Original Loan, the JV, our company and HF agreed that we would make an additional capital contribution of $38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $70.0 million to HF-T1 (the “New Loan”). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan is August 12, 2020, which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015, HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022, subject to early termination at the option of HF-T1, commencing on August 1, 2020. The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under our credit agreement dated June 30, 2015. We had $63.7 million outstanding under the Amended Loan Agreement, which is included in short-term borrowings as of December 31, 2019. +As of December 31, 2019, outstanding short-term and long-term borrowings were $121.2 million, of which $115.4 million relates to loans for our domestic and China distribution center. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. +We believe that anticipated cash flows from operations, available borrowings under our credit agreement, existing cash and investments balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least through March 31, 2021. Our future capital requirements will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of our footwear, the number and timing of new store openings, the success of our international operations, costs associated with constructing our China distribution center and distribution center equipment, the costs of upgrading our domestic and European distribution centers, the amount and timing of share repurchases, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, costs associated with constructing new corporate offices, and any potential acquisitions of other brands or companies. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition, results of operations and cash flows. In addition, if additional capital is raised through the sale of additional equity or convertible securities, dilution to our stockholders could occur. +39 +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2019 (In thousands): +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Short-term borrowings +$ +5,789 +$ +5,789 +$ +— +$ +— +$ +— +Long-term borrowings (1) +117,138 +65,413 +51,725 +— +— +Operating lease obligations (2) +1,387,959 +236,604 +394,299 +317,290 +439,766 +Purchase obligations (3) +1,290,431 +1,290,431 +— +— +— +Warehouse and equipment (4) +302,940 +127,940 +175,000 +— +— +Corporate construction contracts (5) +152,450 +85,162 +67,288 +— +— +Minimum payments related to other arrangements +51,120 +22,266 +28,854 +— +— +Total (6) +$ +3,307,827 +$ +1,833,605 +$ +717,166 +$ +317,290 +$ +439,766 +(1) +Amounts include anticipated interest payments based on interest rates currently in effect. +( 2 ) +Operating lease obligations consists primarily of real properly leases for our retail stores, corporate offices, European and other international distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. We currently expect to fund these commitments with cash flows from operations and existing cash and investment balances. +(3) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $214.7 million, (ii) outstanding letters of credit of $3.8 million and (iii) open purchase commitments with our foreign manufacturers for $1,071.9 million. We currently expect to fund these commitments with cash flows from operations and existing cash and investment balances. +( 4 ) +Amounts include warehouse and equipment upgrades for our China and Rancho Belago distribution centers. +( 5 ) +During 2018, we entered into construction agreements with McCarthy Construction Company for the construction of additional corporate facilities in Manhattan Beach, California. +( 6 ) +Our consolidated balance sheet, as of December 31, 2019, included $10.6 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. In addition, the table above does not include payments of $72.8 million over the next six years related to the provisional one-time tax liability recorded due to the Tax Act. +OFF-BALANCE SHEET ARRANGEMENTS +We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. +40 +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, goodwill, litigation reserves, and tax estimates and valuation of deferred income taxes. +Revenue Recognition. We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. We recognize revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. For North America, goods are shipped Free on Board (“FOB”) shipping point directly from our domestic distribution center in Rancho Belago, California. For international wholesale customers, product is shipped FOB shipping point, (i) direct from our distribution center in Liege, Belgium, (ii) to third-party distribution centers in Central America, South America and Asia, and (iii) directly from third-party manufacturers to our other international customers. For our distributor sales, the goods are generally delivered directly from the independent factories to third-party distribution centers or to our distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. We recognize revenue on wholesale sales upon shipment as that is when the customer obtains control of the promised goods. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost and not as a separate performance obligation. We generate retail revenues primarily from the sale of footwear to customers at retail locations or through our websites. For our in-store sales, we recognize revenue at the point of sale. For sales made through our websites, we recognize revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from direct-to-consumer or retail customers are excluded from reported revenues. +We record accounts receivable at the time of shipment when our right to the consideration becomes unconditional. We typically extend credit terms to our wholesale customers based on their creditworthiness and generally we do not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. Retail and direct-to-consumer sales generally represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, we have determined that an allowance for doubtful accounts for direct-to-consumer sales is not necessary. +We earn royalty income from our licensing arrangements that qualify as symbolic licenses rather than functional licenses. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to us or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. We calculate and accrue estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales. +Judgments +We considered several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, we have a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment. We accrue a liability for product returns at the time of sale based on our historical experience. We also accrue amounts for goods expected to be returned in salable condition. As of December 31, 2019 and December 31, 2018, our sales returns liability totaled $86.5 million and $67.3 million, respectively, and was included in accrued expenses in the consolidated balance sheets. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. When a customer’s account becomes significantly past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and direct-to-consumer receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such we have determined that no allowance for doubtful accounts is necessary. +We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. +41 +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory write-downs . Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. +Valuation of intangibles and long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances: +• +macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets; +• +industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity’s products or services, or a regulatory or political development; +• +cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; +• +overall financial performance such as negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; +• +other relevant entity-specific events such as changes in management, key personnel, strategy, customers, contemplation of bankruptcy, or litigation; +• +events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and +• +a sustained decrease in share price. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. We base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. For the years ended December 31, 2019, 2018 and 2017, respectively we did not record an impairment charge. +Goodwill. We assess goodwill for impairment annually or more frequently if events or changes in circumstances require it. First, we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and the legal and regulatory environment. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several best estimates and assumptions, including future sales and operating results, and other factors that could affect fair value or otherwise indicate potential impairment. We also consider the reporting units’ projected ability to generate income from operations and positive cash flow in future periods, as well as perceived changes in consumer demand and acceptance of products, or factors impacting the industry generally. The fair value assessment could change materially if different estimates and assumptions were used. +42 +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates and valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +INFLATION +We do not believe that the rates of inflation experienced in the United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2019 and 2018, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — The Company and Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +43 +ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates, marketable debt security prices and foreign currency exchange rates. Changes in interest rates, marketable debt security prices and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2019, we have $72.0 million and $48.8 million of outstanding short-term and long-term borrowings, respectively, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by less than $1.1 million for the year ended December 31, 2019. We do not expect any changes in interest rates to have a material impact on our financial condition or results of operations during the remainder of 2020. The interest rate charged on our domestic secured line of credit facility is based on the prime rate of interest, our domestic distribution center loan is based on the one month LIBOR and our China DC Loan is based on a reference rate provided by the People’s Bank of China. Changes in these interest rates will have an effect on the interest charged on outstanding balances. As of December 31, 2019, there was no amount outstanding under our domestic credit facility, $ 63.7 million outstanding on our domestic distribution center loan and $51.3 million on our China DC Loan. +We have entered into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on our long-term debt. We will not enter into derivative transactions for speculative purposes. We had one derivative instrument in place as of December 31, 2019 to hedge the cash flows on our $63.7 million variable rate debt on our domestic distribution center. This instrument was a variable to fixed derivative with a notional amount of $63.7 million at December 31, 2019. Our average receive rate was one month LIBOR and the average pay rate was 2.08%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest expense. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have the effect of increasing the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. We do not engage in hedging activities with respect to such exchange rate risks. +Assets and liabilities outside the United States are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, the Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. Accordingly, we do not hedge these net investments. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation gain of $1.5 million and a cumulative foreign currency translation loss of $16.7 million for the years ended December 31, 2019 and 2018, respectively, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2019 would have reduced the values of our net investments by approximately $52.0 million. +44 +ITEM 8. +FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +46 +CONSOLIDATED BALANCE SHEETS +49 +CONSOLIDATED STATEMENTS OF EARNINGS +50 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +51 +CONSOLIDATED STATEMENTS OF EQUITY +52 +CONSOLIDATED STATEMENTS OF CASH FLOWS +53 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +54 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +81 +45 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 28, 2020 expressed an unqualified opinion thereon. +Change in Accounting Method Related to Leases and Revenue +As discussed in Notes 1 and 3 to the consolidated financial statements, the Company has changed its method of accounting for leases during the year ended December 31, 2019 due to the adoption of the Accounting Standards Codification (“ASC”). – Leases (“ASC 842”). +As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for revenue during the year ended December 31, 2018 due to the adoption of the ASC 606, “ Revenue from Contracts with Customers. ” +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +46 +Adoption of ASC 842 Leases Accounting Standard +As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company adopted ASC 842 - Leases, on January 1, 2019, using the modified retrospective transition method. On the date of adoption, the Company recorded operating lease right-of-use assets totaling $1,035.0 million. +We identified the adoption of ASC 842 as a critical audit matter. In implementing the new accounting standard, management’s judgments included: (i) evaluation of the new accounting standard and establishment of new accounting policies and practices, (ii) configuring and implementing the new lease system module according to the new standard, (iii) determining the completeness and accuracy of lease contracts as of the adoption date, and (iv) evaluating inputs and assumptions used in recording the impact of the adoption including application of the practical expedients and the incremental borrowing rates. Auditing the Company’s adoption of ASC 842 was especially challenging and complex due to the audit effort required to analyze the effect of the adoption on the significant number of lease contracts that are disaggregated in various countries and the specialized skills and knowledge needed to assess the reasonableness of the incremental borrowing rates. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls related to the Company’s adoption of ASC 842 including controls over: (i) evaluation of the completeness and accuracy of lease contracts at the date of adoption, (ii) assessment of the accuracy of the lease system module’s calculation of right-of-use assets, lease liabilities, and the associated amortization expense, and (iii) evaluation of the incremental borrowing rates. +• +Evaluating management’s accounting policies and practices, including the reasonableness of management’s judgments and assumptions related to: (i) evaluation of the incremental borrowing rates, and (ii) evaluation of practical expedients.  +• +Testing a sample of lease contracts and relevant inputs and assumptions to evaluate management’s calculation of the operating lease right-of-use asset and operating lease liability balances including testing the completeness and accuracy of relevant inputs and outputs including the terms of the leases used in the adoption of ASC 842.    +• +Testing the completeness and accuracy of lease contracts included in the new lease system module. +• +Utilizing personnel with specialized knowledge and skill in valuation to assist in assessing the reasonableness of the Company’s incremental borrowing rates at the adoption date. +Ongoing Accounting for Leases +As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company adopted ASC 842 on January 1, 2019. As of December 31, 2019, the Company’s right-of-use asset was $1,073.7 million and the lease liability was $1,157.1 million. The Company operates in the United States and various foreign countries and continues to expand its operations. The Company continues to execute new lease contracts and negotiate extensions and amendments of existing lease contracts. +We identified the ongoing accounting for leases under ASC 842 as a critical audit matter. The Company’s ongoing lease processes include the following: (i) ensuring the completeness of new leases, lease extensions and amendments, and (ii) assessment of incremental borrowing rate for each lease. Auditing these elements involved especially challenging auditor judgment and additional audit effort due to the significant number of leases that are disaggregated in various countries and the specialized skills and knowledge needed to assess the reasonableness of the incremental borrowing rates. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) the completeness and accuracy of newly executed lease contracts, extensions, and amendments to existing lease contracts, and (ii) the determination of the incremental borrowing rates. +• +Testing the appropriateness of the calculation of the right-of-use asset balance, operating lease liability and a corresponding amortization expense for a sample of lease contracts. +• +Testing the completeness and accuracy of lease contracts included in the new lease system module. +• +Utilizing personnel with specialized knowledge and skill in valuation to assist in assessing the reasonableness of the Company’s incremental borrowing rates.   +47 +Accounting for Income Taxes +As described in Note 16 to the Company’s consolidated financial statements, the Company’s total tax expense for the fiscal year ended December 31, 2019 was $88.8 million, of which $19.3 million represented U.S. Federal tax expense, $5.6 million represented U.S. State tax expense, and the remaining $63.9 million represented foreign tax expense. The Company operates in multiple jurisdictions worldwide through its wholly-owned subsidiaries and several joint ventures. +We identified accounting for the Company’s income tax provision as a critical audit matter. The Company’s tax provision processes include the following: (i) reporting and data accumulation from multiple foreign jurisdictions, (ii) evaluation of potential impact of recent changes in regulations and tax laws in the United States and various foreign jurisdictions, (iii) evaluation of assumptions in the Company’s assessment of deferred tax assets and liabilities and related valuation allowances, (iv) development of complex assumptions used in transfer pricing studies and related determinations, and (v) assessment of repatriation of foreign earnings and cash balances. Auditing these elements involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) completeness and accuracy of reporting and data accumulation from multiple foreign jurisdictions, (ii) potential implications of recent changes in regulations and tax laws in various foreign jurisdictions, and (iii) reasonableness of assumptions used in valuation allowances, transfer pricing studies and repatriation of foreign earnings and cash balances. +• +Evaluating management’s computation of deferred tax assets and liabilities and assessing the reasonableness of assumptions used in the Company’s valuation allowances for certain significant jurisdictions. +• +Assessing management’s application of new and updated regulatory and legislative guidance and tax laws in various jurisdictions. +• +Testing mathematical accuracy and computation of the tax provision and reviewing relevant source documents. +• +Utilizing personnel with specialized skill and knowledge in transfer pricing to assist in evaluating the reasonableness of the Company’s assumptions, inputs and overall conclusions reached related to transfer pricing studies over inter-company transactions. +• +Utilizing personnel with specialized skill and knowledge in domestic and foreign taxes to assist in evaluating the reasonableness of the Company’s assumptions, inputs and methods used to estimate certain tax reserves and appropriateness of conclusions reached related to foreign earnings repatriations. +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +February 28, 2020 +48 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands, except par values) +December 31, +December 31, +2019 +2018 +ASSETS +Current assets: +Cash and cash equivalents +$ +824,876 +$ +872,237 +Short-term investments +112,037 +100,029 +Trade accounts receivable, less allowances of $ 24,106 in 2019 and $ 25,616 in 2018 +645,303 +501,913 +Other receivables +53,932 +55,683 +Total receivables +699,235 +557,596 +Inventories +1,069,863 +863,260 +Prepaid expenses and other current assets +113,580 +79,018 +Total current assets +2,819,591 +2,472,140 +Property, plant and equipment, net +738,925 +585,457 +Operating lease right-of-use assets +1,073,660 +— +Deferred tax assets +49,088 +39,431 +Long-term investments +94,589 +93,745 +Other assets, net +117,090 +37,482 +Total non-current assets +2,073,352 +756,115 +TOTAL ASSETS +$ +4,892,943 +$ +3,228,255 +LIABILITIES AND EQUITY +Current liabilities: +Current installments of long-term borrowings +$ +66,234 +$ +1,666 +Short-term borrowings +5,789 +7,222 +Accounts payable +764,844 +679,553 +Operating lease liabilities +191,129 +— +Accrued expenses +210,235 +161,781 +Total current liabilities +1,238,231 +850,222 +Long-term borrowings, excluding current installments +49,183 +88,119 +Long-term operating lease liabilities +966,011 +— +Deferred tax liabilities +322 +451 +Other long-term liabilities +103,089 +100,188 +Total non-current liabilities +1,118,605 +188,758 +Total liabilities +2,356,836 +1,038,980 +Commitments and contingencies +Stockholders’ equity: +Preferred stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; +131,071 and 129,525 shares issued and outstanding at December 31, 2019 +and December 31, 2018, respectively +131 +129 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; +22,408 and 23,983 shares issued and outstanding at December 31, 2019 +and December 31, 2018, respectively +22 +24 +Additional paid-in capital +306,669 +375,017 +Accumulated other comprehensive loss +( 29,993 +) +( 31,488 +) +Retained earnings +2,037,836 +1,691,276 +Skechers U.S.A., Inc. equity +2,314,665 +2,034,958 +Non-controlling interests +221,442 +154,317 +Total stockholders' equity +2,536,107 +2,189,275 +TOTAL LIABILITIES AND EQUITY +$ +4,892,943 +$ +3,228,255 +See accompanying notes to consolidated financial statements. +49 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share data) +Years Ended December 31, +2019 +2018 +2017 +Sales +$ +5,220,051 +$ +4,642,068 +$ +4,164,160 +Cost of sales +2,728,894 +2,418,463 +2,225,271 +Gross profit +2,491,157 +2,223,605 +1,938,889 +Royalty income +22,493 +20,582 +16,666 +2,513,650 +2,244,187 +1,955,555 +Operating expenses: +Selling +369,901 +350,435 +327,201 +General and administrative +1,625,306 +1,455,987 +1,245,474 +1,995,207 +1,806,422 +1,572,675 +Earnings from operations +518,443 +437,765 +382,880 +Other income / (expense): +Interest income +11,782 +10,128 +2,420 +Interest expense +( 7,509 +) +( 5,847 +) +( 6,677 +) +Other, net +( 6,711 +) +( 10,162 +) +5,637 +Total other income / (expense) +( 2,438 +) +( 5,881 +) +1,380 +Earnings before income tax expense +516,005 +431,884 +384,260 +Income tax expense +88,753 +60,611 +149,156 +Net earnings +427,252 +371,273 +235,104 +Less: Net earnings attributable to non-controlling interests +80,692 +70,232 +55,914 +Net earnings attributable to Skechers U.S.A., Inc. +$ +346,560 +$ +301,041 +$ +179,190 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +2.26 +$ +1.93 +$ +1.15 +Diluted +$ +2.25 +$ +1.92 +$ +1.14 +Weighted average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +153,392 +155,815 +155,651 +Diluted +154,151 +156,450 +156,523 +See accompanying notes to consolidated financial statements. +50 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended December 31, +2019 +2018 +2017 +Net earnings +$ +427,252 +$ +371,273 +$ +235,104 +Other comprehensive income: +Gain (loss) on foreign currency translation adjustment +1,298 +( 24,806 +) +19,119 +Comprehensive income +428,550 +346,467 +254,223 +Less: Comprehensive income attributable to noncontrolling interests +80,495 +62,170 +63,173 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +348,055 +$ +284,297 +$ +191,050 +See accompanying notes to consolidated financial statements. +51 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +(In thousands) +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +NON +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +CONTROLLING +STOCKHOLDERS' +STOCK +STOCK +STOCK +STOCK +CAPITAL +INCOME (LOSS) +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at January 1, 2017 +130,386 +24,545 +$ +130 +$ +24 +$ +419,038 +$ +( 26,604 +) +$ +1,211,045 +$ +1,603,633 +$ +81,881 +$ +1,685,514 +Net earnings +— +— +— +— +— +— +179,190 +179,190 +55,914 +235,104 +Foreign currency translation adjustment +— +— +— +— +— +11,860 +— +11,860 +7,259 +19,119 +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +46 +46 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +( 25,953 +) +( 25,953 +) +Stock compensation expense +— +— +— +— +28,902 +— +— +28,902 +— +28,902 +Proceeds from issuance of common stock under the +employee stock purchase plan +240 +— +— +— +5,479 +— +— +5,479 +— +5,479 +Shares issued under the Incentive Award Plan +1,158 +— +2 +— +( 2 +) +— +— +— +— +— +Balance at December 31, 2017 +131,784 +24,545 +$ +132 +$ +24 +$ +453,417 +$ +( 14,744 +) +$ +1,390,235 +$ +1,829,064 +$ +119,147 +$ +1,948,211 +Net earnings +— +— +— +— +— +— +301,041 +301,041 +70,232 +371,273 +Foreign currency translation adjustment +— +— +— +— +— +( 16,744 +) +— +( 16,744 +) +( 8,062 +) +( 24,806 +) +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +- +( 27,000 +) +( 27,000 +) +Stock compensation expense +— +— +— +— +30,468 +— +- +30,468 +- +30,468 +Proceeds from issuance of common stock under the +employee stock purchase plan +222 +— +— +— +5,297 +— +— +5,297 +- +5,297 +Shares issued under the Incentive Award Plan +1,018 +— +1 +— +( 1 +) +— +— +- +- +- +Shares redeemed for employee tax withholdings +( 405 +) +— +( 1 +) +— +( 14,190 +) +— +— +( 14,191 +) +- +( 14,191 +) +Conversion of Class B Common Stock into Class A +Common Stock +562 +( 562 +) +— +— +— +— +— +— +— +— +Repurchases of common stock +( 3,656 +) +— +( 3 +) +— +( 99,974 +) +— +— +( 99,977 +) +— +( 99,977 +) +Balance at December 31, 2018 +129,525 +23,983 +$ +129 +$ +24 +$ +375,017 +$ +( 31,488 +) +$ +1,691,276 +$ +2,034,958 +$ +154,317 +$ +2,189,275 +Net earnings +— +— +— +— +— +— +346,560 +346,560 +80,692 +427,252 +Foreign currency translation adjustment +— +— +— +— +— +1,495 +— +1,495 +( 197 +) +1,298 +Contribution from noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +36,934 +36,934 +Distribution to noncontrolling interest of consolidated +entity +— +— +— +— +— +— +— +— +( 38,675 +) +( 38,675 +) +Purchase of non-controlling interest +— +— +— +— +( 71,265 +) +— +— +( 71,265 +) +( 11,629 +) +( 82,894 +) +Stock compensation expense +— +— +— +— +41,076 +— +— +41,076 +— +41,076 +Proceeds from issuance of common stock under the +employee stock purchase plan +261 +— +— +— +6,173 +— +— +6,173 +— +6,173 +Shares issued under the Incentive Award Plan +1,117 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 438 +) +— +— +— +( 14,313 +) +— +— +( 14,313 +) +— +( 14,313 +) +Conversion of Class B Common Stock into Class A +Common Stock +1,575 +( 1,575 +) +2 +( 2 +) +— +— +— +— +— +— +Repurchases of common stock +( 969 +) +— +( 1 +) +— +( 30,018 +) +— +— +( 30,019 +) +— +( 30,019 +) +Balance at December 31, 2019 +131,071 +22,408 +$ +131 +$ +22 +$ +306,669 +$ +( 29,993 +) +$ +2,037,836 +$ +2,314,665 +$ +221,442 +$ +2,536,107 +See accompanying notes to consolidated financial statements +52 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Years Ended December 31, +2019 +2018 +2017 +Cash flows from operating activities: +Net earnings +$ +427,252 +$ +371,273 +$ +235,104 +Adjustments to reconcile net earnings to net cash provided by operating activities: +Depreciation and amortization +111,515 +109,680 +96,510 +Provision for bad debts and returns +52,456 +35,730 +18,398 +Share based compensation +41,076 +30,468 +28,902 +Deferred income taxes +( 7,568 +) +( 9,767 +) +( 3,947 +) +Other items, net +334 +550 +( 2,187 +) +Net foreign currency adjustments +2,114 +10,072 +( 7,749 +) +(Increase) decrease in assets: +Receivables +( 118,390 +) +( 136,188 +) +( 102,222 +) +Inventories +( 171,903 +) +( 7,212 +) +( 158,628 +) +Other assets +( 69,234 +) +( 30,069 +) +( 18,061 +) +Increase (decrease) in liabilities: +Accounts payable +154,464 +174,352 +( 12,806 +) +Other liabilities +4,436 +19,663 +86,023 +Net cash provided by operating activities +426,552 +568,552 +159,337 +Cash flows from investing activities: +Capital expenditures +( 236,111 +) +( 143,036 +) +( 135,976 +) +Acquisitions, net of cash acquired +( 100,658 +) +— +— +Proceeds from sale of property, plant and equipment +5,547 +— +( 214 +) +Purchases of investments +( 189,624 +) +( 446,127 +) +( 2,344 +) +Proceeds from sales and maturities of investments +176,773 +269,749 +284 +Net cash used in investing activities +( 344,073 +) +( 319,414 +) +( 138,250 +) +Cash flows from financing activities: +Net proceeds from the issuances of common stock through employee stock purchase plan +6,173 +5,297 +5,479 +Repayments on long-term debt +( 4,108 +) +( 1,683 +) +( 1,783 +) +Proceeds from long-term debt +33,296 +18,626 +5,745 +Proceeds (payments) on short-term borrowings +( 1,433 +) +( 787 +) +1,925 +Payments for taxes related to net share settlement of equity awards +( 14,313 +) +( 14,191 +) +— +Repurchase of Class A Common Stock +( 30,019 +) +( 99,977 +) +— +Cash used for purchase of India non-controlling interest +( 82,894 +) +— +— +Distributions to non-controlling interests of consolidated entity +( 38,675 +) +( 27,000 +) +( 25,953 +) +Contribution from non-controlling interests of consolidated entity +— +— +46 +Net cash used in financing activities +( 131,973 +) +( 119,715 +) +( 14,541 +) +Effect of exchange rates on cash and cash equivalents +2,133 +6,383 +11,349 +Net change in cash and cash equivalents +( 47,361 +) +135,806 +17,895 +Cash and cash equivalents at beginning of the year +872,237 +736,431 +718,536 +Cash and cash equivalents at end of the year +$ +824,876 +$ +872,237 +$ +736,431 +Supplemental disclosures of cash flow information: +Cash paid during the year for: +Interest +$ +7,140 +$ +5,568 +$ +6,392 +Income taxes, net +88,753 +93,041 +56,633 +Non-cash transactions: +Land and other assets contribution from non-controlling interest +36,934 +— +— +See accompanying notes to consolidated financial statements. +53 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2019, 2018 and 2017 +(1) +THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +(a) +The Company and Basis of Presentation +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company operates 497 domestic and 303 international retail stores and direct-to-consumer business as of December 31, 2019. +The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the consolidated financial statements in prior years to conform to the current year presentation. +(b) +Use of Estimates +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, goodwill, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +(c) +Revenue Recognition +In accordance with Accounting Standards Update (“ASU”) No. 2014-09, “ Revenue from Contracts with Customers ,” (“ASU 2014-09”), the Company recognizes revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company derives income from the sale of footwear and royalties earned from licensing the Skechers brand. For North America, goods are shipped Free on Board (“FOB”) shipping point directly from the Company’s domestic distribution center in Rancho Belago, California. For international wholesale customers product is shipped FOB shipping point, (i) direct from the Company’s distribution center in Liege, Belgium, (ii) to third-party distribution centers in Central America, South America and Asia, (iii) directly from third-party manufacturers to other international customers. For distributor sales, the goods are generally delivered directly from the independent factories to third-party distribution centers or to distributors’ freight forwarders on a Free Named Carrier (“FCA”) basis. The Company recognizes revenue on wholesale sales upon shipment as that is when the customer obtains control of the promised goods. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost and not as a separate performance obligation. The Company generates direct-to-consumer revenues primarily from the sale of footwear to customers at retail locations or through the Company’s websites. For in-store sales, the Company recognizes revenue at the point of sale. For sales made through its websites, the Company recognizes revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from direct-to-consumer customers are excluded from reported revenues. +The Company records accounts receivable at the time of shipment when the Company’s right to the consideration becomes unconditional. The Company typically extends credit terms to its wholesale customers based on their creditworthiness and generally does not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, the Company periodically decides to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. Retail and direct-to-consumer sales represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, the Company has determined that an allowance for doubtful accounts for retail and direct-to-consumer sales is not necessary. +The Company earns royalty income from its licensing arrangements, which qualify as symbolic licenses rather than functional licenses. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The Company applies the sales-based royalty exception for the royalty income based on sales and recognizes revenue only when subsequent sales occur. The Company calculates and accrues estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales. +54 +Judgments +The Company considered several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment. The Company accrues a liability for product returns at the time of sale based on historical experience. The Company also accrues amounts for goods expected to be returned in salable condition. As of December 31, 2019, and December 31, 2018, the Company’s sales returns liability totaled $ 86.5 million and $ 67.3 million, respectively, and was included in accrued expenses in the consolidated balance sheets. +Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic revenue recognition methodology under ASC 605, Revenue Recognition . +(d) +Business Combinations +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Goodwill and intangible assets with indefinite lives are not amortized but are tested at least annually for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Fair value determinations require judgment and may involve the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives, and market multiples, among other items. The purchase price allocation is subject to adjustment until the Company has completed its analysis within the measurement period. In the second quarter of 2019, the Company purchased a 60 % interest in Manhattan SKMX, de R.L. de C.V. (“Skechers Mexico”), for a total cash consideration of $ 100.7 million, net of cash acquired. Skechers Mexico is a joint venture that operates and generates sales in Mexico. As a result of this purchase, Skechers Mexico became a majority-owned subsidiary and the results are consolidated in the consolidated financial statements. The Company is in the final process of completing the purchase price allocation, which will be completed by April 1, 2020. However, the finalization may result in changes in the assets acquired and tax-related items. Pro forma results of operations have not been presented because the effects of the acquisition, individually and in the aggregate, were not material to the Company’s consolidated financial statements. +( e ) +Business Segment Information +The Company’s operations and segments are organized along its distribution channels and consist of the following: domestic wholesale, international wholesale, and direct-to-consumer sales. Information regarding these segments is summarized in Note 20 – Segment and Geographic Reporting. +( f ) +Noncontrolling Interests +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Mexico, Asia and the Middle East or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”)’s under Accounting Standards Codification (“ASC”) 810-10-15-14. The Company’s determination of the primary beneficiary of a VIE considers all relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. The Company has determined that it is the primary beneficiary for these VIE’s because the Company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity, or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. Accordingly, the Company includes the assets and liabilities and results of operations of these entities in its consolidated financial statements, even though the Company may not hold a majority equity interest. There have been no changes during 2019 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The assets of these joint ventures are restricted in that they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. The Company does not have a variable interest in any unconsolidated VIEs. +55 +( g ) +Fair Value of Financial Instruments +The accounting standard for fair value measurements provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. This accounting standard established a fair value hierarchy, which requires an entity to maximize the use of observable inputs, where available. The following summarizes the three levels of inputs required: +• +Level 1 – Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 non-derivative investments primarily include money market funds and U.S. Treasury securities. +• +Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s Level 2 non-derivative investments primarily include corporate notes and bonds, asset-backed securities, U.S. Agency securities, and actively traded mutual funds. The Company has one Level 2 derivative which is an interest rate swap related to the refinancing of its domestic distribution center (see below). +• +Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability. The Company currently does not have any Level 3 assets or liabilities. +The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, short-term investments, accounts receivable, long-term investments, accounts payable and accrued expenses approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based upon current rates and terms available to the Company for similar debt. +As of August 12, 2015 , the Company entered into an interest rate swap agreement concurrent with refinancing its domestic distribution center construction loan (see Note 8 - Derivative Instruments). The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with U.S. GAAP, credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The majority of the inputs used to value the interest rate swap were within Level 2 of the fair value hierarchy. As of December 31, 2019, the interest rate swap was a Level 2 derivative and was classified as other long-term liabilities in the Company’s consolidated balance sheets. +( h ) +Cash and Cash Equivalents +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +( i ) +Investments +In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments consist of U.S. Treasury Bonds, U.S. Agency securities, corporate notes and bonds, asset-backed securities and actively traded mutual funds. +( j ) +Allowance for Bad Debts, Returns, Sales Allowances and Customer Chargebacks +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectability, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the account. When a customer’s account becomes significantly past due, the Company generally places a hold on the account and discontinues further shipments to that customer, minimizing further risk of loss. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. Allowance for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and direct-to-consumer receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, the Company has determined that no allowance for doubtful accounts is necessary. +56 +The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions, and nature of the chargeback receivables. The Company also reserves for potential sales returns and allowances based on historical trends. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or environment. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high-risk, the Company provides a reserve based upon its historical loss rate as a percentage of sales. +( k ) +Inventories +Inventories, principally finished goods, are stated at the lower of cost (based on the first-in, first-out method) or market (net realizable value). Cost includes shipping and handling fees and costs, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventories, and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +( l ) +Property, Plant and Equipment +Depreciation and amortization of property, plant and equipment is computed using the straight-line method, which based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Useful life or remaining lease term, +whichever is shorter +Property, plant and equipment subject to depreciation and amortization is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The Company reviews both quantitative and qualitative factors to assess whether a triggering event occurred. The Company reviews all stores for impairment annually or more frequently if events or changes in circumstances require it. The Company prepares a summary of store cash flows from its retail stores to assess potential impairment of the fixed assets, leasehold improvements, and operating lease right-of-use assets. Stores with negative cash flows which have been open in excess of 24 months are then reviewed in detail to determine whether impairment exists. Recoverability of assets or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. The Company did no t record impairment charges during the years ended December 31, 2019, 2018 or 2017. +(m) +Goodwill +Goodwill is assigned to reporting units. Goodwill is not amortized, but the Company assesses goodwill for impairment annually or more frequently if events or changes in circumstances require it. First, the Company determines if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include historical financial performance, macroeconomic and industry conditions and the legal and regulatory environment. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment involves calculating an estimated fair value of each reporting unit based on projected future cash flows and comparing the estimated fair values of the reporting units to their carrying amounts, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying value, including goodwill, no impairment is recognized. However, if the carrying amount of a reporting unit, including goodwill, exceeds its fair value, an impairment loss is recognized in an amount equal to the excess, limited to the total goodwill balance of the reporting unit. The quantitative assessment requires an analysis of several best estimates and assumptions, including future sales and operating results, and other factors that could affect fair value or otherwise indicate potential impairment. The Company also considers the reporting units’ projected ability to generate income from operations and positive cash flow in future periods, as well as perceived changes in consumer demand and acceptance of products, or factors impacting the industry generally. The fair value assessment could change materially if different estimates and assumptions were used. +57 +( n ) +Income Taxes +The Company accounts for income taxes in accordance with ASC 740-10, which requires that the Company recognize deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +( o ) +Foreign Currency Translation +In accordance with ASC 830-30, certain international operations use the respective local currencies as their functional currency, while other international operations use the U.S. Dollar as their functional currency. The Company considers the U.S. dollar as its reporting currency. The Company operates internationally through several foreign subsidiaries. Skechers S.a.r.l. located in Switzerland, operates with a functional currency of the U.S. dollar. Translation adjustments for subsidiaries where the functional currency is its local currency are included in other comprehensive income. Foreign currency transaction gains (losses) resulting from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of the foreign operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +( p ) +Comprehensive Income +Comprehensive income is presented in the consolidated statements of comprehensive income. Comprehensive income consists of net earnings, foreign currency translation adjustments, and income attributable to non-controlling interests. +( q ) +Advertising Costs +Advertising costs are expensed in the period in which the advertisements are first run, or over the life of the endorsement contract. Advertising expense for the years ended December 31, 2019, 2018 and 2017 was approximately $ 297.1 million, $ 278.4 million and $ 260.4 million, respectively. Prepaid advertising costs were $ 6.4 million and $ 4.4 million at December 31, 2019 and 2018, respectively. Prepaid amounts outstanding at December 31, 2019 and 2018 represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run, as of December 31, 2019 and 2018, respectively. +( r ) +Product Design and Development Costs +The Company charges all product design and development costs to general and administrative expenses, when incurred. Product design and development costs aggregated approximately $ 16.8 million, $ 18.5 million, and $ 18.8 million during the years ended December 31, 2019, 2018 and 2017, respectively. +( s ) +Warehouse and Distribution Costs +The Company’s distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its products totaled $ 276.4 million, $ 249.6 million and $ 219.6 million for 2019, 2018 and 2017, respectively. +( t ) +Recent Accounting Pronouncements +In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02 “ Leases (Topic 842) ,” (“ASU 2016-02”). ASU 2016-02 is intended to increase transparency and comparability among organizations relating to leases. Lessees are required to recognize a liability to make lease payments and a right-of-use asset representing the right to use the underlying asset for the lease term. The FASB retained a dual model for lease classification, requiring leases to be classified as finance or operating leases to determine recognition in the earnings statement and cash flows; however, substantially all leases are required to be recognized on the balance sheet. ASU 2016-02 requires quantitative and qualitative disclosures regarding key information about leasing arrangements. This standard allows entities to initially apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The standard also provides for certain practical expedients. The Company adopted this ASU on January 1, 2019, using the optional transition method and also elected to use the ‘package of practical expedients’, which allows the Company not to continue to reassess previous conclusions about lease +58 +identification, lease classification and initial direct costs. The Company did not recognize any adjustment to opening balance of retained earnings. +In June 2016, the FASB issued ASU No. 2016-13, “ Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument,” (“ASU 2016-13”). The new standard amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which may result in earlier recognition of losses. Public business entities should apply the guidance in ASU 2016-13 for annual periods beginning after December 15, 2019, including interim periods within those annual periods. The Company is currently evaluating the impact of ASU 2016-13; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In February 2018, the FASB issued ASU No. 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” (“ASU 2018-02”). The standard permits a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Effective January 1, 2019, the Company adopted ASU 2018-02 and the adoption of ASU 2018-02 did not have a material impact on the Company’s consolidated financial statements. +In August 2018, the FASB issued ASU No. 2018-13 “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement,” (“ASU No. 2018-13”), which modifies the disclosure requirements on fair value measurements, including the consideration of costs and benefits. ASU 2018-13 is effective for all entities for fiscal years beginning after December 15, 2019, but entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The Company is currently evaluating the impact of ASU 2018-13; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In August 2018, the FASB issued ASU No. 2018-15 “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract,” (“ASU 2018-15”). ASU 2018-15 requires that issuers follow the internal-use software guidance in Accounting Standards Codification (ASC) 350-40 to determine which costs to capitalize as assets or expense as incurred. The ASC 350-40 guidance requires that certain costs incurred during the application development stage be capitalized and other costs incurred during the preliminary project and post-implementation stages be expensed as they are incurred. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019. The Company is currently evaluating the impact of ASU 2018-15; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +In December 2019, the FASB issued ASU no. 2019-12, “ Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, ” (“ASU No. 2019-12”). The amendment removes certain exceptions to the general income tax accounting methodology including an exception for the recognition of a deferred tax liability when a foreign subsidiary becomes an equity method investment and an exception for interim periods showing operating losses in excess of anticipated operating losses for the year. The amendment also reduces the complexity surrounding franchise tax recognition; the step up in the tax basis of goodwill in conjunction with business combinations; and the accounting for the effect of changes in tax laws enacted during interim periods. The amendments in this update are effective for the Company for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company is currently evaluating the impact of ASU 2019-12; however, at the current time the Company does not expect that the adoption of this ASU will have a material impact on its consolidated financial statements. +59 +(2) +CASH, CASH EQUIVALENTS, SHORT-TERM AND LONG-TERM INVESTMENTS +The Company’s investments consists of mutual funds held in the Company’s deferred compensation plan and classified as trading securities, U.S. Treasury securities, corporate notes and bonds and U.S. Agency securities, that the Company has the intent and ability to hold to maturity and therefore, are classified as held-to-maturity. The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category as of December 31, 2019 and 2018 (in thousands): +December 31, 2019 +Adjusted Cost +Unrealized Gains +Unrealized Losses +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +662,355 +$ +- +$ +- +$ +662,355 +$ +662,355 +$ +- +$ +- +Level 1: +Money market funds +162,521 +- +- +162,521 +162,521 +- +- +U.S. Treasury securities +9,686 +- +- +9,686 +- +1,679 +8,007 +Total level 1 +172,207 +- +- +172,207 +162,521 +1,679 +8,007 +Level 2: +- +- +- +Corporate notes and bonds +132,431 +- +- +132,431 +- +104,130 +28,301 +Asset-backed securities +23,614 +- +- +23,614 +- +263 +23,351 +U.S. Agency securities +12,352 +- +- +12,352 +- +5,965 +6,387 +Mutual funds +28,543 +- +- +28,543 +- +- +28,543 +Total level 2 +196,940 +- +- +196,940 +- +110,358 +86,582 +TOTAL +$ +1,031,502 +$ +- +$ +- +$ +1,031,502 +$ +824,876 +$ +112,037 +$ +94,589 +December 31, 2018 +Adjusted Cost +Unrealized Gains +Unrealized Losses +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +713,624 +$ +- +$ +- +$ +713,624 +$ +713,624 +$ +- +$ +- +Level 1: +Money market funds +158,613 +- +- +158,613 +158,613 +- +- +U.S. Treasury securities +6,955 +- +- +6,955 +- +4,979 +1,976 +Total level 1 +165,568 +- +- +165,568 +158,613 +4,979 +1,976 +Level 2: +- +- +- +Corporate notes and bonds +132,280 +- +- +132,280 +- +88,412 +43,868 +Asset-backed securities +23,310 +- +- +23,310 +- +2,115 +21,195 +U.S. Agency securities +10,272 +- +- +10,272 +- +4,523 +5,749 +Mutual funds +20,957 +- +- +20,957 +- +- +20,957 +Total level 2 +186,819 +- +- +186,819 +- +95,050 +91,769 +TOTAL +$ +1,066,011 +$ +- +$ +- +$ +1,066,011 +$ +872,237 +$ +100,029 +$ +93,745 +The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are typically less than two years . +The Company considers declines in market value of its marketable securities investment portfolio to be temporary in nature. The Company typically invests in highly-rated securities, and its investment policy generally limits the amount of credit exposure to any one issuer. The policy generally requires investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s cost basis. As of December 31, 2019, the Company does not consider any of its investments to be other-than-temporarily impaired. +60 +(3) +LEASES +The Company determines if an arrangement is a lease at inception, and, if a lease, what type of lease it is. The Company regularly enters into non-cancellable operating leases for automobiles, retail stores, and real estate leases for offices, showrooms and distribution facilities. Most leases have fixed rental payments. Leases for retail stores typically have initial terms ranging from 5 to 10 years . Other real estate or facility leases may have initial lease terms of up to 20 years. The Company considers renewal options in the lease term if they are reasonably certain to be exercised. These leases are included within operating lease ROU assets and liabilities on the Company’s consolidated balance sheet as of December 31, 2019. The predominant asset for most real estate leases is the right to occupy the space which the Company has determined is the single lease component. Many of the Company’s real estate leases include options to extend or to terminate the lease that are not reasonably certain at the time of determining the expected lease term. In addition, the Company’s real estate leases may also require additional payments for real estate taxes and other occupancy-related costs. Other occupancy-related costs which are considered as non-lease components. Percentage rent expense, which is specified in the lease agreement, is owed when sales at individual retail store locations exceed a base amount. Percentage rent expense is recognized in the consolidated financial statements when incurred. Rent expense for leases having rent holidays, landlord incentives or scheduled rent increases is recorded on a straight-line basis over the earlier of the beginning of the lease term or when the Company takes possession or control of the leased premises. The amount of the excess straight-line rent expense over scheduled payments is recorded as an operating lease liability. Operating lease ROU assets and operating lease liabilities are recognized based upon the present value of the future lease payments over the lease term at the commencement date. Most of the Company’s leases do not provide an implicit borrowing rate. Therefore, the Company uses an estimated incremental borrowing rate based upon a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. The incremental borrowing rate is then used at the commencement date of the lease to determine the present value of future lease payments. The operating lease ROU asset also includes lease payments made and lease incentives and initial direct costs incurred. Lease expense for fixed lease payments is recognized on a straight-line basis over the lease term. Rent expense for the years ended December 31, 2018 and 2017 approximated $ 257.6 million, and $ 223.7 million, respectively. As of December 31, 2019, current liabilities related to operating leases were $ 191.1 million. +The future minimum obligations under operating leases in effect as of December 31, 2019 having a noncancelable term in excess of one year as determined prior to the adoption of ASU 842 are as follows (in thousands): +December 31, 2019 +2020 +$ +236,604 +2021 +211,466 +2022 +182,833 +2023 +164,467 +2024 +152,823 +Thereafter +439,766 +Total lease payments +1,387,959 +Less: Imputed interest +( 230,819 +) +$ +1,157,140 +Operating lease cost and other information (in thousands): +Year ended +December 31, 2019 +Fixed lease cost +$ +246,296 +Variable lease cost +13,104 +Operating cash flows used for leases +264,424 +Noncash right-of-use assets recorded for lease liabilities: +For January 1 adoption of Topic 842 +1,035,062 +In exchange for new lease liabilities during the period +122,078 +Weighted-average remaining lease term +4.66 years +Weighted-average discount rate +4.20 % +As of December 31, 2019, the Company has additional operating leases, primarily for new retail stores, that have not yet commenced which will generate additional right-of-use assets of $ 30.8 million. These operating leases will commence in 2020 with lease terms ranging from 1 year to 10 years. +61 +(4) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment at December 31, 2019 and 2018 is summarized as follows (in thousands): +2019 +2018 +Land +$ +90,862 +$ +83,163 +Buildings and improvements +349,066 +246,893 +Furniture, fixtures and equipment +454,837 +374,706 +Leasehold improvements +453,805 +401,514 +Total property, plant and equipment +1,348,570 +1,106,276 +Less accumulated depreciation and amortization +609,645 +520,819 +Property, plant and equipment, net +$ +738,925 +$ +585,457 +( 5 ) +ACCRUED EXPENSES +Accrued expenses at December 31, 2019 and 2018 are summarized as follows (in thousands): +2019 +2018 +Accrued inventory purchases +$ +48,923 +$ +40,493 +Accrued payroll and taxes +92,264 +72,822 +Return reserve liability +69,048 +48,466 +Accrued expenses +$ +210,235 +$ +161,781 +( 6 ) +LINE OF CREDIT +On November 21, 2019, the Company entered into a $ 500.0 million senior unsecured revolving credit facility, which matures on November 21, 2024 (the “2019 Credit Agreement”), with Bank of America, N.A., as administrative agent and joint lead arranger, HSBC Bank USA, N.A. and JPMorgan Chase Bank, N.A., as joint lead arrangers, and other lenders. The 2019 Credit Agreement replaced the Company’s then existing $ 250.0 million loan and security agreement dated June 30, 2015 with Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association that was set to expire on June 30, 2020 . The 2019 Credit Agreement may be increased by up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $ 100.0 million and swingline loans up to a maximum of $ 25.0 million. The Company may use the proceeds from the 2019 Credit Agreement for working capital and other lawful corporate purposes. At the Company’s option, any loan (other than swingline loans) will bear interest at a rate equal to (a) LIBOR plus an applicable margin between 1.125 % and 1.625 % based upon the Company’s Total Adjusted Net Leverage Ratio (as defined in the 2019 Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate and (iii) LIBOR plus 1.00 %) plus an applicable margin between 0.125 % and 0.625 % based upon the Company’s Total Adjusted Net Leverage Ratio. Any swingline loan will bear interest at the base rate. The Company will pay a variable commitment fee of between 0.125 % and 0.25 % of the actual daily unused amount of each lender’s commitment, and will also pay a variable letter of credit fee of between 1.125 % and 1.625 % on the maximum amount available to be drawn under each issued and outstanding letter of credit, both of which are based upon the Company’s Total Adjusted Net Leverage Ratio. The 2019 Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type, including covenants that limit the ability of the Company and its subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose of assets, effect a change of control of the Company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The 2019 Credit Agreement also requires that the total adjusted net leverage ratio not exceed 3.75 , except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 for the quarter in which such acquisition occurs and for the next three quarters thereafter. The 2019 Credit Agreement provides for customary events of default including payment defaults, breaches of representations or warranties or covenants, cross defaults with certain other indebtedness to third parties, certain judgments/awards/orders, a change of control, bankruptcy and insolvency events, inability to pay debts, ERISA defaults, and invalidity or impairment of the 2019 Credit Agreement or any loan documentation related thereto, with, in certain circumstances, cure periods. Certain of the lenders party to the 2019 Credit Agreement, and their respective affiliates, have performed, and may in the future perform for the Company and the Company’s subsidiaries, various commercial banking, investment banking, underwriting and other financial advisory services, for which they have received, and will receive, customary fees and expenses. The Company paid origination, arrangement and legal fees of $ 1.6 million on the 2019 Credit Agreement, which are being amortized to interest expense over the five-year life of the facility. As of December 31, 2019 , there was no amount outstanding under the Company’s 2019 Credit Agreement. The remaining balance in short-term borrowings as of December 31, 2019 is related to the Company’s international operations. +62 +( 7 ) +SHORT AND LONG-TERM BORROWINGS +Long-term borrowings at December 31, 2019 and 2018 are as follows (in thousands): +2019 +2018 +Note payable to banks, due in monthly installments of $ 348 +(includes principal and interest), variable-rate interest at +5.24 % per annum, secured by property, balloon payment of +$ 62,843 due August 2020 +$ +63,692 +$ +65,148 +Note payable to Luen Thai Enterprise, Ltd., balloon payment +of $ 393 due January 2021 +393 +5,800 +Note payable to TCF Equipment Finance, Inc., due in monthly +installments of $ 30 (includes principal and interest), fixed- +rate interest at 5.24 % per annum, paid in July 2019 +— +210 +Loan payable to a bank, variable-rate interest at 4.275 % per +annum, due September 2023 +48,791 +18,626 +Loan payable to a bank, variable-rate interest at 3.915 % per +annum, due October 2020 +2,541 +— +Subtotal +115,417 +89,785 +Less: current installments +66,234 +1,666 +Total long-term borrowings +$ +49,183 +$ +88,119 +The aggregate maturities of long-term borrowings at December 31, 2019 are as follows (in thousands): +2020 +$ +63,692 +2021 +3,290 +2022 +36,848 +2023 +11,587 +2024 +— +$ +115,417 +On September 29, 2018, through the Taicang subsidiary, the Company entered into a 700 million yuan loan agreement with China Construction Bank Corporation (the “China DC Loan Agreement”). The proceeds from the China DC Loan Agreement is being used to finance the construction of the Company’s distribution center in China. Interest will be paid quarterly. The interest rate will float and be calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2019 was 4.275 % and may increase or decrease over the life of the loan, and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan Agreement. The China DC Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the Subsidiary to, among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The China DC Loan Agreement matures on September 28, 2023 . The obligations of the TC Subsidiary under the China DC Loan Agreement are jointly and severally guaranteed by the Company’s Chinese joint venture. As of December 31, 2019, there was $ 48.8 million outstanding under this credit facility, which is classified as long-term borrowings in the Company’s consolidated balance sheets. +On April 30, 2010, HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and as a lender, and Raymond James Bank, FSB, as a lender (collectively, the “Construction Loan Agreement”), pursuant to which the JV obtained a loan of up to $ 55.0 million used for construction of the project on certain property (the “Original Loan”). On November 16, 2012, HF-T1 executed a modification to the Construction Loan Agreement (the “Modification”), which added OneWest Bank, FSB as a lender, increased the borrowings under the Original Loan to $ 80.0 million and extended the maturity date of the Original Loan to October 30, 2015 . On August 11, 2015, the JV, through HF-T1, entered into an amended and restated loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. (formerly known as OneWest Bank, FSB) and Raymond James Bank, N.A., as lenders (collectively, the “Amended Loan Agreement”), which amends and restates in its entirety the Construction Loan Agreement and the Modification. +As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was $ 77.3 million. In connection with this refinancing of the Original Loan, the JV, the Company and HF Logistics (“HF”) agreed that the Company would make an additional capital contribution of $ 38.7 million to the JV, through HF-T1, to make a payment on the Original Loan based on +63 +the Company’s 50 % equity interest in the JV. The payment equaled the Company’s 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan $ 70.0 million to HF-T1 (the “New Loan”). The New Loan is being used by the JV, through HF-T1, to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay $ 0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of $ 31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2 %. The maturity date of the New Loan is August 12, 2020 , which HF-T1 has one option to extend by an additional 24 months, or until August 12, 2022, upon payment of a fee and satisfaction of certain customary conditions. On August 11, 2015, HF-T1 and Bank of America, N.A. entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) with Bank of America, N.A. The Interest Rate Swap has an effective date of August 12, 2015 and a maturity date of August 12, 2022 , subject to early termination at the option of HF-T1, commencing on August 1, 2020 . The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08 % per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense paid related to the New Loan has been included in non-controlling interests in the consolidated balance sheets. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the 2015 Credit Agreement dated June 30, 2015. As of December 31, 2019 , there was $ 63.7 million outstanding under the Amended Loan Agreement, which is included in current installments of long-term borrowings . +The Company’s short-term and long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. The Company is in compliance with its non-financial covenants, including any cross default provisions, and financial covenants of its short-term and long-term borrowings as of December 31, 2019. +( 8 ) +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company used an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. On August 12, 2015 , in connection with refinancing its domestic distribution center loan, described in Note 7 above, the Company entered into a variable-to-fixed interest rate swap agreement with Bank of America, N.A., to hedge the cash flows on the Company’s $ 70.0 million variable rate debt. As of December 31, 2019, the swap agreement has an aggregate notional amount of $ 63.7 million and a maturity date of August 12, 2022 , subject to early termination commencing on August 1, 2020 at the option of HF Logistics-SKX T1, LLC (“HF-T1”), a wholly-owned subsidiary of the Company’s joint venture HF Logistics-SKX, LLC (the “JV”). Under the terms of the swap agreement, the Company will pay a weighted-average fixed rate of 2.08 % on the $ 63.7 million notional amount and receive payments from the counterparty based on the 30-day LIBOR rate . The rate swap agreement utilized by the Company effectively modifies its exposure to interest rate risk by converting the Company’s floating-rate debt to a fixed-rate of 4.08 % for the life of the loan thus reducing the impact of interest-rate changes on future interest expense. Pursuant to the terms of the JV, HF Logistics is responsible for any amounts related to the Swap Agreement. +By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2019, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +( 9 ) +OTHER LONG-TERM LIABILITIES +Other long-term liabilities at December 31, 2019 and 2018 are as follows (in thousands): +2019 +2018 +Other long term liabilities +$ +30,675 +$ +21,458 +Income taxes payable +72,414 +78,730 +$ +103,089 +$ +100,188 +64 +( 10 ) +COMMITMENTS AND CONTINGENCIES +( a ) +Product and Other Financing +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.5 % for 30- to 60-day financing. The amounts outstanding under these arrangements at December 31, 2019 and 2018 were $ 214.7 million and $ 180.5 million, respectively, which are included in accounts payable in the accompanying consolidated balance sheets. Interest expense incurred by the Company under these arrangements amounted to $ 7.9 million in 2019, $ 3.3 million in 2018, and $ 4.8 million in 2017. The Company has open purchase commitments with its foreign manufacturers at December 31, 2019 of $ 1,071.9 million, which are not included in the accompanying 2019 consolidated balance sheets. +( b ) +Litigation +The Company recognizes legal expense in connection with loss contingencies as incurred. +In accordance with U.S. GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2019, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. +(1 1 ) +STOCKHOLDERS’ EQUITY +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10 million shares of preferred stock, par value $ 0.001 per share. +During 2019 and 2018, certain Class B stockholders converted 1,575,509 and 561,876 shares, respectively, of Class B Common Stock to Class A Common Stock. During 2017, no Class B Common Stock was converted to Class A Common Stock. (see Note 14 - Earnings Per Share). +65 +(1 2 ) +NONCONTROLLING INTERESTS +The following VIEs are consolidated into the Company’s consolidated financial statements and the carrying amounts and classification of assets and liabilities were as follows (in thousands): +HF Logistics (1) +December 31, 2019 +December 31, 2018 +Current assets +$ +5,297 +$ +2,121 +Non-current assets +104,527 +98,148 +Total assets +$ +109,824 +$ +100,269 +Current liabilities +$ +64,600 +$ +2,738 +Non-current liabilities +1,009 +64,702 +Total liabilities +$ +65,609 +$ +67,440 +Product distribution joint ventures +December 31, 2019 (2) +December 31, 2018 (3) +Current assets +$ +747,668 +$ +540,768 +Non-current assets +325,283 +128,250 +Total assets +$ +1,072,951 +$ +669,018 +Current liabilities +$ +430,282 +$ +294,640 +Non-current liabilities +135,903 +26,444 +Total liabilities +$ +566,185 +$ +321,084 +(1) +Includes HF Logistics-SKX, LLC and HF Logistics-SKX, T2, LLC. +(2) +Distribution joint ventures include Skechers Footwear Ltd. (Israel), Skechers China Limited, Skechers Korea Limited, Skechers Southeast Asia Limited, Skechers (Thailand) Limited, and Manhattan SKMX, S. de R.L. de C.V. (Mexico). +( 3 ) +Distribution joint ventures include Skechers Footwear Ltd. (Israel), Skechers China Limited, Skechers Korea Limited, Skechers Southeast Asia Limited, Skechers (Thailand) Limited, Skechers Retail India Private Limited, and Skechers South Asia Private Limited. +The following is a summary of net earnings attributable to, distributions to and contributions from non-controlling interests (in thousands): +Year Ended December 31, +2019 +2018 +2017 +Net earnings attributable to non-controlling +interests +$ +80,692 +$ +70,232 +$ +55,914 +Distributions to: +HF Logistics-SKX, LLC +3,784 +4,374 +3,787 +Skechers China Limited +32,245 +19,915 +20,620 +Skechers Southeast Asia Limited +2,028 +2,025 +1,347 +Skechers Hong Kong Limited +618 +618 +199 +India distribution joint ventures +— +68 +— +Contributions from: +Skechers Korea Co., Ltd. +6,594 +— +— +Skechers Footwear Ltd. (Israel) +— +— +46 +HF Logistics-SKX, LLC +7,565 +— +— +Manhattan SKMX, S. de R.L. de C.V. +22,776 +— +— +66 +(1 3 ) +SHARE REPURCHASE PROGRAM +On February 6, 2018, the Company’s Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, for an aggregate repurchase price not to exceed $ 150.0 million. The Share Repurchase Program expires on February 6, 2021 . Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate the Company to acquire any particular amount of shares of Class A Common Stock and the program may be suspended or discontinued at any time. +The following table provides a summary of the Company’s Class A Common Stock repurchase activities during the years ended December 31, 2019 and 2018, respectively: +Year Ended December 31, 2019 +Year Ended December 31, 2018 +Shares repurchased +968,724 +3,656,277 +Average cost per share +$ +30.99 +$ +27.34 +Total cost of shares repurchased (in thousands): +$ +30,019 +$ +99,977 +(1 4 ) +EARNINGS PER SHARE +Basic earnings per share represents net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share, in addition to the weighted average determined for basic earnings per share, includes potential dilutive common shares using the treasury stock method. +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share. Basic and diluted net earnings per share of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +The following is a reconciliation of net earnings and weighted average common shares outstanding for purposes of calculating earnings per share (in thousands): +Basic earnings per share +2019 +2018 +2017 +Net earnings attributable to Skechers U.S.A., Inc. +$ +346,560 +$ +301,041 +$ +179,190 +Weighted average common shares outstanding +153,392 +155,815 +155,651 +Basic earnings per share attributable to +Skechers U.S.A., Inc. +$ +2.26 +$ +1.93 +$ +1.15 +Diluted earnings per share +2019 +2018 +2017 +Net earnings attributable to Skechers U.S.A., Inc. +$ +346,560 +$ +301,041 +$ +179,190 +Weighted average common shares outstanding +153,392 +155,815 +155,651 +Dilutive effect of nonvested shares +759 +635 +872 +Weighted average common shares outstanding +154,151 +156,450 +156,523 +Diluted earnings per share attributable to +Skechers U.S.A., Inc. +$ +2.25 +$ +1.92 +$ +1.14 +There were 10,838 , 352,169 , and 116,762 shares excluded from the computation of diluted earnings per share for the year ended December 31, 2019, 2018, and 2017, respectively, because they are anti-dilutive. +67 +(1 5 ) +STOCK COMPENSATION +(a) +Incentive Award Plan +On April 16, 2007, the Company’s Board of Directors adopted the 2007 Incentive Award Plan (the “2007 Plan”), which became effective upon approval by the Company’s stockholders on May 24, 2007 and expired pursuant to its terms on May 24, 2017. +On April 17, 2017, the Company’s Board of Directors adopted the 2017 Incentive Award Plan (the “2017 Plan”), which became effective upon approval by the Company’s stockholders on May 23, 2017. The 2017 Plan replaced and superseded in its entirety the 2007 Plan. A total of 10,000,000 shares of Class A Common Stock were reserved for issuance under the 2017 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company and its subsidiaries. The 2017 Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. +A summary of the status and changes of nonvested shares related to the 2007 Plan and the 2017 Plan, as of and for the year ended December 31, 2019 is presented below: +SHARES +WEIGHTED-AVERAGE GRANT-DATE FAIR VALUE +Nonvested at January 1, 2017 +3,043,164 +$ +24.57 +Granted +495,600 +24.69 +Vested/Released +( 1,157,207 +) +20.73 +Cancelled +( 78,000 +) +32.62 +Nonvested at December 31, 2017 +2,303,557 +26.25 +Granted +1,811,000 +38.05 +Vested/Released +( 1,018,283 +) +21.91 +Cancelled +( 127,333 +) +29.71 +Nonvested at December 31, 2018 +2,968,941 +34.79 +Granted +1,603,000 +28.45 +Vested/Released +( 1,116,868 +) +32.46 +Cancelled +( 28,250 +) +39.40 +Nonvested at December 31, 2019 +3,426,823 +32.55 +As of December 31, 2019, a total of 6,515,750 shares remain available for grant as equity awards under the 2017 Plan. +The Company recognized in the consolidated statements of earnings compensation expense of $ 41.1 million, $ 30.5 million and $ 28.9 million for grants under its stock compensation plans for the years ended December 31, 2019, 2018, and 2017, respectively. Related excess income tax benefits of $ 0.3 million, $ 1.6 million, and $ 2.6 million was recorded in the statement of earnings for the years ended December 31, 2019, 2018 and 2017, respectively. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. There was $ 81.3 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2019, which is expected to be recognized over a weighted average period of 2.1 years. The total fair value of shares vested during the years ended December 31, 2019 and 2018 was $ 36.3 million and $ 22.3 million, respectively. +(b) +Stock Purchase Plan +On April 17, 2017, the Company’s Board of Directors adopted the 2018 Employee Stock Purchase Plan (the “2018 ESPP”), which the Company’s stockholders approved on May 23, 2017. The 2018 ESPP replaced the Company’s previous employee stock purchase plan, the Skechers U.S.A., Inc. 2008 Employee Stock Purchase Plan (the “2008 ESPP”), which expired pursuant to its terms on January 1, 2018. The 2018 Employee Stock Purchase Plan provides eligible employees of the Company and its subsidiaries with the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the Class A Common Stock’s fair market value on the first trading day or last trading day of each purchase period, whichever is lower. The 2018 ESPP generally provides for two six-month purchase periods every twelve months: June 1 through November 30 and December 1 through May 31, except that the initial purchase period under the 2018 ESPP had a duration of five months, commencing on January 1, 2018 and ending on May 31, 2018. Eligible employees participating in the 2018 ESPP for a purchase period will be able to invest up to 15 % of their compensation through payroll deductions during each purchase period. A total of 5,000,000 shares of Class A Common Stock are available for sale under the 2018 ESPP. +During 2019, 2018 and 2017, 260,630 shares, 221,889 shares and 240,000 shares were issued under the 2018 ESPP and 2008 ESPP for which the Company received approximately $ 6.2 million, $ 5.3 million and $ 5.5 million, respectively. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense, which is computed using Black-Scholes options pricing model. +68 +( 1 6 ) +INCOME TAXES +The provisions for income tax expense were as follows (in thousands): +2019 +2018 +2017 +Federal: +Current +$ +22,899 +$ +11,379 +$ +110,448 +Deferred +( 3,583 +) +( 3,971 +) +3,768 +Total federal +19,316 +7,408 +114,216 +State: +Current +6,384 +5,408 +2,747 +Deferred +( 813 +) +( 1,316 +) +( 3,356 +) +Total state +5,571 +4,092 +( 609 +) +Foreign: +Current +66,656 +53,071 +40,147 +Deferred +( 2,790 +) +( 3,960 +) +( 4,598 +) +Total foreign +63,866 +49,111 +35,549 +Total income taxes (benefit) +$ +88,753 +$ +60,611 +$ +149,156 +Due to the enactment of Tax Cuts and Jobs Act (the “Tax Act”) in December 2017, the Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. Companies subject to GILTI have the option to account for the GILTI tax as a period cost if and when incurred, or to recognize deferred taxes for temporary differences including outside basis differences expected to reverse as GILTI. The Company has elected to account for GILTI as a period cost, and therefore has included GILTI expense in its effective tax rate calculation for the period. +The SEC staff issued Staff Accounting Bulletin 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under Accounting Standards Codification 740 (“ASC 740”). In connection with its initial analysis of the impact of the Tax Act, the Company recorded a provisional one-time net tax expense of $ 99.9 million for the year ended December 31, 2017. In 2018, the Company obtained additional information which reduced the Company’s provisional accounting for certain tax effects of the Tax Act by $ 10.9 million, from $ 99.9 million as reported at December 31, 2017, to $ 89.0 million. +The Company’s provision for income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0.0 % to 34.6 %. The Company’s provision for income tax expense (benefit) was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) with application of transfer pricing considerations in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. +69 +The Company’s earnings (loss) before income taxes and income tax expense (benefit) for 2019 , 2018 and 2017 are as follows (in thousands): +Years Ended December 31, +2019 +2018 +2017 +Income tax jurisdiction +Earnings (loss) +before income +taxes +Income tax +expense +Earnings (loss) +before income +taxes +Income tax +expense (benefit) +Earnings (loss) +before income +taxes +Income tax +expense +United States (1) +$ +4,999 +$ +24,887 +$ +16,597 +$ +11,500 +$ +25,628 +$ +113,607 +Peoples Republic of China (“China”) +121,702 +30,320 +89,429 +19,595 +95,668 +12,971 +Hong Kong +50,131 +4,303 +48,352 +8,106 +17,778 +5,030 +Jersey (2) +245,561 +— +213,327 +— +198,048 +— +Non-benefited loss operations (3) +( 7,685 +) +1,184 +( 11,422 +) +( 3,387 +) +( 17,350 +) +3,306 +Other jurisdictions (4) +101,297 +28,059 +75,601 +24,797 +64,488 +14,242 +Earnings before income taxes +$ +516,005 +$ +88,753 +$ +431,884 +$ +60,611 +$ +384,260 +$ +149,156 +Effective tax rate (5) +17.2 % +14.0 % +38.8 % +(1) +United States income tax expense for 2017 includes a provisional one-time $ 99.9 million tax expense related to the enactment of the United States Tax Cuts & Jobs Act on December 22, 2017. +(2) +Jersey does not assess income tax on corporate net earnings. +(3) +Consists of entities in the following tax jurisdictions where no tax benefit is recognized in the period being reported because of the provision of offsetting valuation allowances: Barbados, Brazil, China, India, Japan, Macau, Panama, Romania, Thailand, and South Korea. +(4) +Consists of entities in the following tax jurisdictions, each of which comprises not more than 5 % of consolidated earnings (loss) before taxes in the period being reported: Albania, Austria, Belgium, Bosnia & Herzegovina, Canada, Chile, Colombia, Costa Rica, France, Germany, Hungary, India, Israel, Italy, Kosovo, Macau, Macedonia, Malaysia, Mexico, Montenegro, Netherlands, Panama, Peru, Poland, Portugal, Serbia, Singapore, Spain, Switzerland, Vietnam, and the United Kingdom. +(5) +The effective tax rate is calculated by dividing income tax expense by earnings before income taxes . +For 2019, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25 %, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2019, as reflected in the table above, earnings (loss) before income taxes in the U.S. were $ 5.0 million, with income tax expense of $ 24.9 million, which is an average rate of 498 %. This rate is higher than the 25 % U.S. statutory rate primarily due to the taxation of foreign earnings in the U.S. Earnings (loss) before income taxes in non-U.S. jurisdictions were $ 511.0 million, with an aggregate income tax expense of $ 63.9 million, which is an average rate of 12.5 %. Combined, this results in consolidated earnings before income taxes for the year of $ 516.0 million, and consolidated income tax expense for the year of $ 88.8 million, resulting in an effective tax rate of 17.2 %. For 2018, of $ 511.0 million in earnings before income tax earned outside the U.S., $245.6 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by $ 32.3 million to $ 245.6 million in 2019 from $ 213.3 million in 2018. This increase was primarily attributable to an increase in international sales which resulted in an increase in earnings before income taxes in Jersey from royalties and commissions under the terms of inter-subsidiary agreements. In addition, there were foreign losses of $ 7.6 million for which no tax benefit was recognized during the year ended December 31, 2019 because of the provision of offsetting valuation allowances. Individually, none of the other foreign jurisdictions included in “Other jurisdictions” in the table above had earnings greater than 5 % of consolidated earnings (loss) before taxes in any of the years shown. +As of December 31, 2019, the Company had approximately $ 824.9 million in cash and cash equivalents, of which $ 566.4 million, or 68.7 %, was held outside the U.S. Of the $ 566.4 million held by its non-U.S. subsidiaries, approximately $ 220.3 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s consolidated financial statements as of December 31, 2019. +70 +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, in anticipation of the needs of the Company’s share repurchase program and the need to provide payment of the Company’s provisional Transition Tax liability, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 201 9 . The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows (in thousands): +2019 +2018 +2017 +Expected income tax expense +$ +108,361 +$ +90,696 +$ +134,491 +State income tax, net of federal benefit +1,278 +3,051 +297 +Rate differential on foreign income +( 43,327 +) +( 40,065 +) +( 95,565 +) +Change in unrecognized tax benefits +2,739 +820 +1,449 +Non-deductible compensation +7,126 +6,269 +6,592 +Tax credits +( 3,264 +) +( 2,539 +) +( 2,151 +) +Excess tax benefit on share based compensation +( 251 +) +( 1,557 +) +( 2,571 +) +U.S. tax rate change +— +— +1,923 +U.S. transition tax +— +( 10,963 +) +98,015 +U.S. tax on foreign earnings +9,786 +9,956 +— +Other +3,440 +2,077 +( 1,110 +) +Change in valuation allowance +2,865 +2,866 +7,786 +Total provision (benefit) for income taxes +$ +88,753 +$ +60,611 +$ +149,156 +Effective tax rate +17.2 +% +14.0 +% +38.8 +% +The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2019 and 2018 are presented below (in thousands): +2019 +2018 +Deferred tax assets: +Inventory adjustments +$ +6,954 +$ +5,779 +Accrued expenses +50,847 +42,637 +Allowances for bad debts and chargebacks +4,809 +3,549 +Loss carryforwards +28,605 +24,834 +Business credit carryforward +8,262 +7,015 +Share-based compensation +4,521 +4,283 +Operating lease liabilities +261,984 +— +Valuation allowance +( 33,044 +) +( 30,179 +) +Total deferred tax assets +332,938 +57,918 +Deferred tax liabilities: +Prepaid expenses +5,586 +6,263 +Right-of-use assets +261,984 +— +Depreciation on property, plant and equipment +16,602 +12,674 +Total deferred tax liabilities +284,172 +18,937 +Net deferred tax assets +$ +48,766 +$ +38,981 +The $ 2.9 million increase in the valuation allowance primarily relates to increases in deferred tax assets in certain foreign non-benefited loss jurisdictions as discussed above. The Company believes it is more likely than not that the results of future operations in the remaining jurisdictions will generate sufficient taxable income to realize its net deferred tax assets. +71 +State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2019 were $ 10.5 million and $ 31.0 million, respectively. State tax credit and net operating loss carry-forward amounts remaining as of December 31, 2018 were $ 8.9 million and $ 31.1 million, respectively. These tax credit and net operating loss carry-forward amounts do not begin to expire until 2023 and 2032 , respectively. As of December 31, 2019 and 2018, no valuation allowance against the related deferred tax asset have been recorded for these credit and loss carry-forwards as it is believed the carry-forwards will be fully utilized in reducing future taxable income. +As of December 31, 2019, and 2018, the Company had combined foreign net operating loss carry-forwards available to reduce future taxable income of approximately $ 154.0 million and $ 121.5 million, respectively. Some of these net operating losses expire beginning in 2020; however, others can be carried forward indefinitely. As of December 31, 2019, and 2018, valuation allowances of $ 25.9 million and $ 21.4 million, respectively, had been recorded against the related deferred tax assets for those loss carry-forwards that are not more likely than not to be fully utilized in reducing future taxable income. +The balance of unrecognized tax benefits included in prepaid expenses in the consolidated balance sheets increased by $ 2.6 million during the year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2019 +2018 +Beginning balance +$ +7,975 +$ +7,381 +Additions for current year tax positions +1,795 +1,161 +Additions for prior year tax positions +1,638 +— +Reductions for prior year tax positions +— +( 55 +) +Reductions related to lapse of statute of limitations +( 842 +) +( 512 +) +Ending balance +$ +10,566 +$ +7,975 +If recognized, $ 10.6 million of unrecognized tax benefits would be recorded as a reduction in income tax expense. +Estimated interest and penalties related to the underpayment of income taxes are classified as a component of income tax expense and totaled $ 0.4 million, $ 0.2 million, and $ 0.5 million for the years ended December 31, 2019, 2018, and 2017, respectively. Accrued interest and penalties were $ 2.1 million and $ 1.8 million as of December 31, 2019 and 2018, respectively. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +As of December 31, 2019, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2015 , and in several Asian and European tax jurisdictions for years ending on or after December 31, 2009 . During the year, the Company reduced the balance of 2019 and prior year unrecognized tax benefits by $ 0.8 million as a result of expiring statutes. It is reasonably possible that certain domestic and foreign statutes will expire during the next twelve months which would reduce the balance of 2019 and prior year unrecognized tax benefits by $ 1.6 million. +The Company is currently under examination by a number of states and certain foreign jurisdictions. During the year ended December 31, 2019, there was no reduction in the balance of 2019 and prior year unrecognized tax benefits due to settlements of examinations. It is reasonably possible that certain federal, state and foreign examinations could be settled during the next twelve months which would reduce the balance of 2019 and prior year unrecognized tax benefits by $ 0.9 million. +(1 7 ) +EMPLOYEE BENEFIT PLAN +The Company has a 401(k) profit sharing plan covering all employees who are 21 years of age and have completed six months of service. Employees may contribute up to 15.0 % of annual compensation. Company contributions to the plan are discretionary and vest over a six year period. The Company made a contribution of $ 2.4 million and $ 2.3 million to the plan for the year ended December 31, 2019 and 2018, respectively. +72 +In May 2013, the Company established the Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”), which allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees, which will be determined by the Company’s Compensation Committee. The Company made contributions of $ 0.1 million to the Plan for each years ended December 31, 2019 and 2018, respectively. The value of the deferred compensation is recognized based on the fair value of the participants’ accounts as determined monthly. The Company has established a rabbi trust (the “Trust”) as a reserve for the benefits payable under the Plan. The assets of the Trust and deferred liabilities are presented in the Company’s consolidated balance sheets. +(1 8 ) +BUSINESS AND CREDIT CONCENTRATIONS +The Company generates a significant portion of its sales in the United States; however, several of its products are sold into various foreign countries, which subject the Company to the risks of doing business abroad. In addition, the Company operates in the footwear industry, which is impacted by the general economy, and its business depends on the general economic environment and levels of consumer spending. Changes in the marketplace may significantly affect the Company’s estimates and its performance. The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable, which generally do not require collateral from customers, amounted to $ 228.5 million and $ 213.7 million before allowances for bad debts and sales returns, and chargebacks at December 31, 2019 and 2018, respectively. Foreign accounts receivable, which are generally collateralized by letters of credit, amounted to $ 440.9 million and $ 313.8 million before allowance for bad debts, sales returns, and chargebacks at December 31, 2019 and 2018, respectively. International sales amounted to $ 3,022.6 million, $ 2,514.0 million and $ 2,108.7 million for the years ended December 31, 2019, 2018 and 2017, respectively. The Company’s credit losses charged to expense for the years ended December 31, 2019, 2018 and 2017 were $ 31.6 million, $ 8.0 million and $ 12.8 million, respectively. In addition, the Company recorded sales return expense for the years ended December 31, 2019, 2018 and 2017 were $ 46.1 million, $ 20.2 million and $ 5.6 million, respectively. +Assets located outside the United States consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the United States were $ 2,643.8 million and $ 1,611.2 million at December 31, 2019 and 2018, respectively. +During 2019, 2018 and 2017, no customer accounted for 10.0% or more of sales. No customer accounted for more than 10% of net trade receivables at December 31, 2019 or 2018. During 2019, 2018 and 2017, sales to the five largest customers were approximately 9.6 %, 10.4 % and 10.5 %, respectively. +The Company’s top five manufacturers produced the following for the years ended December 31, 2019, 2018 and 2017, respectively: +Percentage of Total Production +Year Ended December 31, +2019 +2018 +2017 +Manufacturer #1 +16.0 +% +12.8 +% +17.9 +% +Manufacturer #2 +7.3 +% +10.1 +% +11.1 +% +Manufacturer #3 +7.2 +% +8.6 +% +8.8 +% +Manufacturer #4 +5.1 +% +5.4 +% +5.4 +% +Manufacturer #5 +5.0 +% +5.0 +% +4.3 +% +40.6 +% +41.9 +% +47.5 +% +The majority of the Company’s products are produced in China and Vietnam. The Company’s operations are subject to the customary risks of doing business abroad, including but not limited to currency fluctuations and revaluations, custom duties and related fees, various import controls and other monetary barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. The Company believes it has acted to reduce these risks by diversifying manufacturing among various factories. To date, these business risks have not had a material adverse impact on the Company’s operations. +(1 9 ) +RELATED PARTY TRANSACTIONS +The Company paid approximately $ 58,000 , $ 80,000 , and $ 172,000 during 2019, 2018 and 2017, respectively, to the Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events, which is owned and operated by MIOC. Michael Greenberg, President and a director of the Company, owns a 12 % beneficial ownership interest in MIOC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 5 % beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable with MIOC or the Shade Hotel in Manhattan Beach at December 31, 2019 or 2018. +73 +The Company paid approximately $ 124,000 , $ 167,000 and $ 201,000 during 2019 , 2018 , and 2017 to the Redondo Beach Hospitality Company, LLC (“RBHC”) for lodging, food and events, including the Company’s 2019, 2018, and 2017 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. Michael Greenberg, President and a director of the Company, owns a 5 % beneficial ownership interest in RBHC, and three other officers, directors and senior vice presidents of the Company own in aggregate an additional 3 % beneficial ownership in RBHC. The Company had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach, at December 31, 2019 or 201 8 . +On July 29, 2010, the Company formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with the Company, and the Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are also officers and directors of the Foundation. During the years ended December 31, 2019, 2018, and 2017, the Company made contributions of $ 1.0 million to the Foundation in each year. +The Company had receivables from officers and employees of $ 0.8 million at December 31, 2019 and 2018, respectively. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +( 20 ) +SEGMENT AND GEOGRAPHIC REPORTING +The Company has three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, which includes direct-to-consumer sales. Management evaluates segment performance based primarily on sales and gross margins. All other costs and expenses of the Company are analyzed on an aggregate basis, and these costs are not allocated to the Company’s segments. Sales, gross margins and identifiable assets for the domestic wholesale, international wholesale, and retail segments on a combined basis were as follows (in thousands): +2019 +2018 +2017 +Sales +Domestic wholesale +$ +1,247,550 +$ +1,259,615 +$ +1,249,287 +International wholesale +2,462,632 +2,054,770 +1,729,906 +Retail +1,509,869 +1,327,683 +1,184,967 +Total +$ +5,220,051 +$ +4,642,068 +$ +4,164,160 +2019 +2018 +2017 +Gross profit +Domestic wholesale +$ +457,944 +$ +468,340 +$ +464,609 +International wholesale +1,133,573 +976,739 +786,675 +Retail +899,640 +778,526 +687,605 +Total +$ +2,491,157 +$ +2,223,605 +$ +1,938,889 +2019 +2018 +Identifiable assets +Domestic wholesale +$ +1,472,323 +$ +1,428,463 +International wholesale +2,100,042 +1,423,048 +Retail +1,320,578 +376,744 +Total +$ +4,892,943 +$ +3,228,255 +2019 +2018 +2017 +Additions to property, plant and equipment +Domestic wholesale +$ +75,037 +$ +29,717 +$ +20,055 +International wholesale +109,205 +63,316 +47,410 +Retail +51,869 +50,003 +68,511 +Total +$ +236,111 +$ +143,036 +$ +135,976 +74 +Geographic Information +The following summarizes the Company’s operations in different geographic areas as of and for the years ended December 31: +2019 +2018 +2017 +Sales (1) +United States +$ +2,197,391 +$ +2,128,100 +$ +2,055,475 +Canada +167,963 +171,864 +160,367 +Other international (2) +2,854,697 +2,342,104 +1,948,318 +Total +$ +5,220,051 +$ +4,642,068 +$ +4,164,160 +2019 +2018 +Property, plant and equipment, net +United States +$ +439,132 +$ +385,584 +Canada +7,286 +9,081 +Other international (2) +292,507 +190,792 +Total +$ +738,925 +$ +585,457 +(1) +The Company has subsidiaries in Asia, Central America, Europe, the Middle East, North America, and South America that generate sales within those respective countries and in some cases the neighboring regions. The Company has joint ventures in Asia and Mexico that generate sales from those regions. The Company also has a subsidiary in Switzerland that generates sales from that country in addition to sales to distributors located in numerous non-European countries. External sales are attributable to geographic regions based on the location of each of the Company’s subsidiaries. A subsidiary may earn revenue from external sales and external royalties, or from inter-subsidiary sales, royalties, fees and commissions provided in accordance with certain inter-subsidiary agreements. The resulting earnings of each subsidiary in its respective country are recognized under each respective country’s tax code. Inter-subsidiary revenues and expenses subsequently are eliminated in the Company’s consolidated financial statements and are not included as part of the external sales reported in different geographic areas. +(2) +Other international consists of Asia, Mexico, Central America, Europe, the Middle East, and South America. +In response to the State Department’s trade restrictions with Sudan and Syria, the Company does not authorize or permit any distribution or sales of its product in these countries, and the Company is not aware of any current or past distribution or sales of its product in Sudan or Syria. +(2 1 ) +SUBSEQUENT EVENTS +The Company has evaluated events subsequent to December 31, 2019, to assess the need for potential recognition or disclosure in this filing. Based on this evaluation, it was determined that no subsequent events occurred that require recognition in the consolidated financial statements. +75 +(2 2 ) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the financial information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period. Summarized unaudited financial data are as follows (in thousands, except per share data): +2019 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Sales +$ +1,276,756 +$ +1,258,565 +$ +1,353,998 +$ +1,330,732 +Gross profit +590,509 +609,835 +653,064 +637,749 +Net earnings +131,019 +91,998 +121,734 +82,501 +Net earnings attributable to Skechers U.S.A., Inc. +108,758 +75,180 +103,090 +59,532 +Net earnings per share: +Basic +0.71 +0.49 +0.67 +0.39 +Diluted +0.71 +0.49 +0.67 +0.39 +2018 +MARCH 31 +JUNE 30 +SEPTEMBER 30 +DECEMBER 31 +Sales +$ +1,250,078 +$ +1,134,797 +$ +1,176,395 +$ +1,080,798 +Gross profit +583,104 +560,957 +563,866 +515,678 +Net earnings (loss) +137,258 +60,859 +106,051 +67,105 +Net earnings (loss) attributable to Skechers U.S.A., Inc. +117,652 +45,284 +90,728 +47,377 +Net earnings (loss) per share: +Basic +0.21 +0.29 +0.58 +0.31 +Diluted +0.21 +0.29 +0.58 +0.31 +76 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2019, excluded Manhattan SKMX, S. de R.L. de C.V., which was acquired by the Company in the second quarter of 2019. Total assets and total sales of Skechers Mexico each constituted less than 3% of the consolidated total assets and total sales as of and for the year ended December 31, 2019. Companies are allowed to exclude acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company under guidelines established by the SEC. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2019. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2019, which is set forth below. +77 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2019. The results of our evaluation are discussed above in Management’s Report on Internal Control over Financial Reporting. +78 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2020, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +As indicated in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Manhattan SKMX, S. De R.L. De C.V. (“Skechers Mexico”), which was acquired on April 1, 2019, and which is included in the consolidated balance sheet of the Company as of December 31, 2019 and the related consolidated statements of earnings, comprehensive income, equity and cash flows for the year then ended. Skechers Mexico constituted 2.6% of total assets as of December 31, 2019 and 1.7% of total sales for the year ended December 31, 2019. Management did not assess the effectiveness of internal control over financial reporting of Skechers Mexico because of the timing of the acquisition which was on April 1, 2019. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Skechers Mexico. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 28, 2020 +79 +ITEM 9B. +OTHER INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. +PART IV +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 45 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 81 of this annual report on Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +80 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Years Ended December 31, 2019, 2018, and 2017 +DESCRIPTION +BALANCE AT +BEGINNING OF +YEAR +CHARGED TO +REVENUE +COSTS AND +EXPENSES +DEDUCTIONS +AND +WRITE-OFFS +BALANCE +AT END +OF YEAR +Year-ended December 31, 2017 +Allowance for chargebacks +$ +10,974 +$ +7,507 +$ +( 5,674 +) +$ +12,807 +Allowance for doubtful accounts +5,620 +5,266 +( 3,177 +) +7,709 +Liability for sales returns and allowances +25,053 +5,625 +( 14 +) +30,664 +Reserve for shrinkage +542 +2,020 +( 825 +) +1,737 +Reserve for obsolescence +10,928 +130 +( 4,039 +) +7,019 +Year-ended December 31, 2018 +Allowance for chargebacks +$ +12,807 +$ +12,629 +$ +( 6,663 +) +$ +18,773 +Allowance for doubtful accounts +7,709 +2,856 +( 3,722 +) +6,843 +Liability for sales returns and allowances +30,664 +20,245 +( 2,443 +) +48,466 +Reserve for shrinkage +1,737 +5,771 +( 5,891 +) +1,617 +Reserve for obsolescence +7,019 +6,461 +( 2,344 +) +11,136 +Year-ended December 31, 2019 +Allowance for chargebacks +$ +18,773 +$ +3,931 +$ +( 5,291 +) +$ +17,413 +Allowance for doubtful accounts +6,843 +2,471 +( 2,621 +) +6,693 +Liability for sales returns and allowances +48,466 +46,054 +( 25,472 +) +69,048 +Reserve for shrinkage +1,617 +5,149 +( 5,802 +) +964 +Reserve for obsolescence +11,136 +9,444 +( 14,816 +) +5,764 +See accompanying report of independent registered public accounting firm +81 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 20, 2007). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). +4.20 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2013). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on April 29, 2016). +10.3* +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 24, 2007). +10.4* +Form of Restricted Stock Agreement under 2007 Incentive Award Plan (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-K for the year ended December 31, 2007). +10.5* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.6* +Form of Restricted Stock Agreement under 2017 Incentive Award Plan. (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.7* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed with the Securities and Exchange Commission on May 1, 2017). +10.8* +Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.8(a)* +List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +10.9 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.10 +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +82 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.11* +Employment Agreement, executed August 7, 2015, effective as of January 1, 2015, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.11(a)* +Amendment to Employee Agreement dated December 5, 2017, between the Registrant and Michael Greenberg (incorporated by reference to exhibit 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2017) +10.12* +Employment Agreement, executed April 2, 2018, effective as of January 1, 2018, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on April 2, 2018). +10.13 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 7, 2015). +10.14 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.14(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.14(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018). +10.14(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company. +10.15 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 17, 2015). +10.16 +Lease Agreement dated September 25, 2007 between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 27, 2007). +10.16(a) +First Amendment to Lease Agreement, dated December 18, 2009, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended March 31, 2010). +10.16(b) +Second Amendment to Lease Agreement, dated April 12, 2010, between the Registrant and HF Logistics I, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +83 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.16(c) +Assignment of Lease Agreement, dated April 12, 2010, between HF Logistics I, LLC and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.5 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(d) +Third Amendment to Lease Agreement, dated August 18, 2010, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-Q for the quarter ended September 30, 2010). +10.16(e) +Fourth Amendment to Lease Agreement, dated February 12, 2019, between the Registrant and HF Logistics-SKX T1, LLC, regarding distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.16(e) of the Registrant’s Form 10-K for the year ended December 31, 2018). +10.17 +Lease Agreement, dated February 12, 2019, between the Registrant and HF Logistics – SKX T2, LLC, regarding expansion to distribution facility in Rancho Belago, California (incorporated by reference to exhibit number 10.17 of the Registrant’s Form 10-K for the year ended December 31, 2018). +10.18 +Lease Agreement, dated August 12, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.28 of the Registrant’s Form 10-K for the year ended December 31, 2002). +10.18(a) +Addendum to Lease Agreement, dated January 19, 2006, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(b) +Addendum 2 to Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on May 27, 2008). +10.18(c) +Addendum 3 to Agreement dated June 11, 2013 and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.18(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.17(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19 +Lease Agreement dated May 20, 2008 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III SPRL, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 27, 2008). +10.19(a) +Addendum 1 to Lease Agreement, dated March 10, 2009, between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.18(a) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(b) +Addendum 2 to Lease Agreement dated December 22, 2009 between Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium III BVBA, regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(b) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(c) +Addendum 3 to Agreement dated June 11, 2013 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(c) of the Registrant’s Form 10-K for the year ended December 31, 2015). +10.19(d) +Addendum 4 to Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center II in Liege, Belgium (incorporated by reference to exhibit number 10.18(d) of the Registrant’s Form 10-K for the year ended December 31, 2015). +84 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.20 +Lease Agreement dated October 17, 2014 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center III in Liege, Belgium (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q for the quarter ended March 31, 2015). +10.20(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Centers I, II and III in Liege, Belgium (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.21 +Lease Agreement dated July 10, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and ProLogis Belgium II BVBA, regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.21(a) +Addendum to Agreement dated August 3, 2015 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, ProLogis Belgium II BVBA, and ProLogis Belgium III BVBA regarding ProLogis Park Liege Distribution Center IV in Liege, Belgium (incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q for the quarter ended June 30, 2015). +10.22 +Lease Agreement dated July 1, 2016 by and among the Registrant, Skechers EDC SPRL, a subsidiary of the Registrant, and Warehouse and Industrial Properties (W.I.P.) SA, regarding Liegistics Park 34, Avenue du Parc Industriel in Milmort, Belgium (incorporated by reference to exhibit number 10.18 of the Registrant’s Form 10-K for the year ended December 31, 2016). +10.23 +Lease Agreement dated November 17, 2015 by and between the Registrant and Omni Manhattan Towers Limited Partnership, regarding 1240 Rosecrans Avenue, Suites 300 and 400, Manhattan Beach, California (incorporated by reference to exhibit number 10.19 of the Registrant’s Form 10-K for the year ended December 31, 2016). +10.24** +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.25 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.26 +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.27** +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.28 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.29 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +85 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data file - the cover page from the Company's Annual Report on Form 10-K for the year ended December 31, 2019 has been formatted in Inline XBRL. +* +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** +The Company applied with the Secretary of the Securities and Exchange Commission for confidential treatment of certain information pursuant to Rule 24b-2 of the Exchange Act. The Company filed separately with its application a copy of the exhibit including all confidential portions, which may be made available for public inspection pending the Securities and Exchange Commission’s review of the application in accordance with Rule 24b-2. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +86 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 28th day of February 2020. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 28, 2020 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 28, 2020 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 28, 2020 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 28, 2020 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Geyer Kosinski +Director +February 28, 2020 +Geyer Kosinski +/s/ Jeffrey Greenberg +Director +February 28, 2020 +Jeffrey Greenberg +/s/ Katherine Blair +Director +February 28, 2020 +Katherine Blair +/s/ Richard Siskind +Director +February 28, 2020 +Richard Siskind +/s/ Rick Rappaport +Director +February 28, 2020 +Rick Rappaport +/s/ Morton D. Erlich +Director +February 28, 2020 +Morton D. Erlich +/s/ Thomas Walsh +Director +February 28, 2020 +Thomas Walsh +87 \ No newline at end of file diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/filing_metadata.csv b/raw/filings/0001065837/2019/0001564590-20-007744/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1bbde73a9f000ee799fed277f5fa58bcc3c4e186 --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2020-02-28,2019-12-31,2020-02-28T19:32:09.000Z,0001564590-20-007744,skx-10k_20191231.htm,10-K,17269966,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000156459020007744/skx-10k_20191231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459020007744/,2019,2019,1 diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/item1.txt b/raw/filings/0001065837/2019/0001564590-20-007744/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..edf319b5c67df4ac238ef3964ad4b839aaa0f36a --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/item1.txt @@ -0,0 +1,340 @@ +ITEM 1. +BUSINESS +We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, as “we,” “us,” “our,” “our company” and “Skechers” unless otherwise indicated. Reference in this annual report to “Sales” refers to Skechers’ net sales reported under generally accepted accounting principles in the United States. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. We also design and market men’s and women’s Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, leather goods, eyewear and scrub manufacturers, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through department and specialty stores, athletic and independent retailers, boutiques and internet retailers. In addition to wholesale distribution, our footwear is available on our direct-to-consumer websites and our own retail stores. As of February 1, 2020, we owned and operated 107 concept stores, 171 factory outlet stores and 219 warehouse outlet stores in the United States, and 199 concept stores, 93 factory outlet stores, and 10 warehouse outlet stores internationally. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are style-conscious men and women attracted to our relevant brand image, fashion-forward designs, affordable and comfortable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2019, the Skechers brand was supported by print, television, digital, radio and outdoor campaigns targeted to men and women, boys and girls; marathons and other athletic events for Skechers Performance; and grass roots and donation events for BOBS from Skechers divisions. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns, including globally-known recording artist Camila Cabello; sports legends Clayton Kershaw, Sugar Ray Leonard, Howie Long, Tony Romo, and David Ortiz; and television personality and actress Brooke Burke. For the Skechers Performance Division, we also had the following athletes appear in our marketing campaigns: professional golfers Matt Kuchar, Brooke Henderson, Russell Knox, Wesley Bryan, Billy Andrade, and Colin Montgomerie; triathlete Lionel Sanders; plus, elite runners Meb Keflezighi, Weldon Kirui and Edward Cheserek. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for styling, quality, comfort, innovation and affordability. Our performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. Our product lines share back office services in order to limit our operating expenses and fully utilize our management’s vast experience in the footwear industry. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support, and are generally sold through department stores, footwear specialty stores, athletic retailers, Skechers retail stores as well as www.skechers.com and numerous online accounts. Management evaluates segment performance based primarily on sales and gross margins; however, sales and costs are not allocated to specific product lines. +2 +In addition, Skechers designs and markets a collection of lifestyles apparel for men, women and kids. The collection features the same Skechers characteristics that consumers around the world have come to expect from the brand—comfort, style, innovation and quality at a value. The activewear garments are designed to directly coordinate with the brand’s footwear initiatives. The Skechers apparel collection is sold at Skechers retail stores, to our domestic wholesale accounts and select international partners. +Lifestyle Brands +Skechers USA. Our Skechers USA category for men and women includes: (i) Dress Casuals and Modern Comfort, (ii) Casuals, (iii) Casual Athletic, and (iv) seasonal sandals and boots. Styles are available in several fits, including Classic Fit, Relaxed Fit, Wide Fit and Extra Wide. +• +The Dress Casuals category for men is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. The Dress Casuals line, which is also referred to as the Modern Comfort collection for women, is comprised of trend-influenced, stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim, and water-resistant materials. +• +The Casuals line for men and women is defined by lugged outsoles and utilizes value-oriented and leather materials in the uppers. For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design—some with industrial-inspired fashion features. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole and fashion boots, and casual sandals. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. +• +Our Casual Athletic line is comprised of low-profile, sport-influenced streetwear targeted to trend-conscious young men and women. The outsoles are primarily rubber and are sometimes adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh. +• +Our seasonal sandals and boots for men and women are designed with many of our existing and proven outsoles, stylized with basic or core uppers as well as fresh looks. These styles are generally made with quality leather uppers, but may also be in canvas or fabric for sandals, and water-resistant materials, faux fur and sherpa linings for boots. +Skechers Sport. Our Skechers Sport footwear collection for men and women includes: (i) lightweight sport athletic lifestyle products, (ii) classic athletic-inspired styles, (iii) sport sandals and booties, and (iv) retro and fashion. Many Skechers Sport styles are enhanced with comfort features such as Skechers Air-Cooled Memory Foam ™ insoles, lightweight designs, flexible outsoles and soft uppers such as bio-engineered mesh, soft knit fabrics and stretchable woven materials. Known for bright, multi-colored and solid basic-colored uppers, Skechers Sport is distinguished by its technical performance-inspired looks; however, we generally do not promote the technical performance features of these shoes. Styles are available in several fits including Classic Fit, Relaxed Fit, Arch Fit, Wide Fit and Extra Wide. +• +Our lightweight sport athletic product is designed with comfort and flexibility in mind. Careful attention is devoted to the cushioning, weight, design and construction by using innovative materials and technologies including Skech-Knit uppers. Designed as a versatile, trend-right athletic shoe suitable for all-day wear, the product line features styles in both bright and classic athletic colors. +• +Classic Skechers styles are core-proven looks that continue to be strong performers. With all-day comfort and durable rubber tread, these shoes are intended to be a mainstay of any footwear collection. Many of the designs are in white, black and natural shades, with some athletic accents. The uppers are designed in leather, suede and nubuck. +• +Our sport sandals and booties are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making comfortable seasonal footwear. +• +Retro and fashion styles feature throwback fashionable profiles with sport-inspired features and trend-right silhouettes. At the forefront is the Skechers Energy and the Skechers D’Lites ® collection with iconic Skechers sneaker looks updated with contemporary Skechers Air-Cooled Memory Foam insoles for total comfort. Collaborations of our fashion collections with popular character brands like Line Friends and BT21 as well as specialized retailers generates buzz while exposing the brand to new demographics. Additionally, the Skechers Premium Heritage Limited Edition collection has featured five-packs of luxe Skechers Energy and Skechers D’Lites ® styles crafted with high-end materials and on-trend embellishments available in select markets. +3 +Skechers Active and Skechers Sport Active. A natural companion to Skechers Sport, Skechers Active and Skechers Sport Active have grown from a casual everyday line into two complete lines of sneakers and casual sneakers for active females of all ages. The Skechers Active line, with lace-ups, Mary Janes, sandals and open back styles, is available in a multitude of colors as well as solid white or black, in knits, fabrics, leathers and meshes, and with various closures   —   traditional laces, zig-zag and cross straps, among others. The Skechers Sport Active line includes low-profile, lightweight, flexible and sporty styles, many of which have Skechers Air-Cooled Memory Foam ™ . +Skechers Cali. This collection typifies the California lifestyle with beach-inspired colors, vivid prints and funky accents. This line of hot summer-styled looks features an eclectic collection of flip flops, sandals, and wedges all perfect for young women everywhere who love the sun. +Skecher Street ™ . A bold urban street-inspired sneaker collection for millennials and young women, Skecher Street ™ delivers sneakers, platforms and fashion trainers with premium metallic finishes, sophisticated takes on glimmer embellishments and playful embroidered pairs with star and graphic treatments. Skecher Street™ styles pair the latest trends with comfort features including Air Cooled Memory Foam insoles, the brand’s patented Rise Fit technology and contoured barefoot liners. +BOBS from Skechers. The core of the BOBS from Skechers line is its vast assortment of colorful, playful and classic espadrilles. The line now also includes vulcanized and sport looks, sandals and comfortable faux fur styles for home. Many styles also feature Skechers Memory Foam. +• +The BOBS classic espadrille collection is designed in basic colors with canvas, tweed, crochet and boiled wool uppers, suede and patterned fabrics. It includes BOBS for Dogs’ and BOBS for Cats’ animated animal and mosaic styles, as well as looks featuring legendary characters like Garfield, Scooby Doo and Felix the Cat. +• +BOBS vulcanized, sport and sandal styles have a very youthful and California lifestyle appeal. Designed with canvas uppers and jersey fabrics, the line features classic retro designs, fresh colors and materials. +• +BOBS faux fur styles are available in classic, patterned and mosaic animal designs with Skechers Memory Foam insoles and outsoles suitable for home and the outdoors. +For each pair of specially packaged BOBS from Skechers footwear, select apparel items and pet accessories sold in the United States in 2019 , twenty-five cents was donated to Petco Foundation to help save the lives of dogs and cats in America’s shelters –Donations for this program totaled more than $1.5 million which helped more than 371,000 shelter pets in the United States, of which more than 348,000 were saved through pet adoptions. Since BOBS launched its mission to help shelter animals in 2015, the brand has raised over $5.0 million and helped more than 954,000 animals, including more than 588,000 animals have been saved to date. +Skechers also continues to donate new shoes to children in need through the BOBS program. Since 2011, more than 15.2 million pairs of new kids’ shoes have been donated, including approximately 289,000 pairs in 2019. The charitable shoes are primarily donated to charity partner Soles4Souls, which then donates the shoes to various reputable charity organizations in the United States and around the world. +Mark Nason. Inspired by classic rock and roll and its trends, the Mark Nason collection originally started with Italian crafted exotic offerings of boots and accessories. The high-end collection has evolved into Mark Nason Los Angeles, an expanded offering of dress, casual and active styles for style-conscious men, with many featuring Premium Relaxed Fit construction and Memory Foam Lux insoles for enhanced comfort. +Performance Brands +Skechers Performance. Skechers Performance is a collection of technical footwear designed with a focus on a specific activity to maximize performance and promote natural motion. Developed by the Skechers Performance Division, the footwear utilizes the latest advancements in materials and innovative design, including ultra-lightweight Resalyte or the latest Hyper Burst midsole compounds for comfort and an outsole that delivers responsive feedback. +• +Skechers GOrun. Skechers GOrun is a collection of lightweight, flexible running shoes that feature a midfoot strike design for efficient running and was recognized with 12 editorial awards in 2019. Skechers Max Cushioning offers maximized Ultra GO cushioning for extreme comfort. Skechers GOrun Forza offers extra stability on long runs . The Skechers GOmeb collection includes the high-performance racing and training shoes worn by elite marathon runner Meb Keflezighi. Select styles in the latest generation of running products feature an innovative Hyper Burst midsole foam. These flagship lines, as well as other Skechers GOrun products, are marketed to serious runners and recreational runners alike, and are available in running stores as well as other retailers. Special limited-edition collections of key running styles are released to commemorate major marathon events in cities like New York, Houston and Los Angeles. +• +Skechers GOwalk. Skechers GOwalk is designed for walking and casual wear, and offers performance features in a comfortable casual slip-on or lace-up sneaker. The product line features a lightweight and flexible design to promote +4 +natural foot movement when walking as well as more advanced performance technologies including a high-rebound GogaMax insole, comfortable 5GEN cushioning and Memory Form Fit for a custom-fit experience. Skechers GOwalk Joy adds knitted upper sneaker styles to the collection. Skechers on-the-GO footwear fuses iconic designs and premium materials with Skechers Performance technologies for comfort and style. +• +Skechers GOtrain. Skechers GOtrain is designed for the gym and features a wider forefoot and extended outriggers for maximum stability and control at lateral and medial strike points. This shoe is an all-encompassing trainer that meets the need of intense and rigorous workouts. +• +Skechers GOtrail. The Skechers GOtrail collection features the performance materials and innovations found in our running shoes with rugged designs that can protect against impact during all-terrain runs. +• +Skechers GO GOLF. Skechers GO GOLF is designed for the golf course and offers a zero heel drop design, which keeps feet in a neutral position that is low to the ground to promote a solid foundation while playing golf. A grip outsole helps with traction control and 5GEN cushioning delivers comfort. Styles in the Skechers GO GOLF Pro line, worn by PGA golfers Matt Kuchar, Brooke Henderson and a roster of other golf pros, also offers H2GO Shield waterproof protection and features replaceable soft spikes on the outsole. +Skechers Kids +The Skechers Kids line includes: (i) Skechers Kids, which is a range of infants’, toddlers’, boys’ and girls’ boots, shoes, high-tops, sneakers and sandals, (ii) Skechers’ athletic-inspired sneakers with Memory Foam, (iii) Twinkle Toes, (iv) character supported collections, (v) Lighted footwear, and (vi) the Shaq by Skechers basketball collection. +• +The Skechers Kids line is inspired by our many adult styles and includes embellishments or adornments such as fresh colors and fabrics. Some of these styles are also adapted for toddlers with softer, more pliable outsoles and for infants with soft, leather-sole crib shoes. The line’s Fashion Hi-Tops subcategory offers trend-forward high-top looks designed to appeal to fashion-conscious young girls. +• +Skechers’ athletic-inspired collection includes Memory Foam sneakers designed with many of the same meshes, knits and weaves as our adult styles, such as Skechers Sport in bright colors and patterns, Skechers GOrun and Skech-Air athletic sneakers, which have a unique visible air-cushioned outsole and a gel-infused memory foam insole. The collection is designed to offer the latest comfort innovations and appeal both to younger kids as well as tweens transitioning to adult shoes. +• +Twinkle Toes by Skechers is a line of girls’ sneakers and boots that feature bejeweled toe caps and brightly designed uppers. Some styles also include lights. The product line is marketed with the character Twinkle Toes. Flip Kicks offer a reversable fun sequin design on the side. +• +Along with Twinkle Toes, we market several of our collections with characters that resonate with younger consumers. Skechers Super Z-Strap is a line of athletic-styled sneakers with an easy “z”-shaped closure system marketed with the character Z-Strap; Mega Flex is a line of athletic sneakers with heel springs or articulated blades for boys based on a robot character; and Mega Craft offer a fun, block-like design inspired by video games. +• +Skechers’ lighted footwear collection for boys and girls includes multiple categories. S-Lights and Heart Lights styles combine patterns of lights on the outsoles and sides of the shoes, while Energy Lights and Ice Lights feature a rechargeable lighted outsole that can be set to a variety of colors and light patterns. Luminators feature an innovative illuminated mesh fabric upper for a bolder look. +• +Shaq by Skechers is a collection of court-ready kids’ basketball shoes developed in collaboration with basketball legend Shaquille O’Neal. +Skechers Kids lines include shoes that are designed as “takedowns” of their adult counterparts, allowing the younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. Each Skechers Kids line is marketed and packaged separately with a distinct shoe box. +Skechers Work +Skechers Work offers a complete line of men’s and women’s casuals such as field boots, hikers and athletic shoes, many of which may also include Skechers Memory Foam ™ . The Skechers Work line includes athletic-inspired, casual safety toe and non-slip +5 +safety toe categories that may feature lightweight aluminum safety toe, electrical hazard and slip-resistant technologies, as well as breathable, seam-sealed waterproof membranes. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles, and feature breathable lining, oil- and abrasion-resistant outsoles offering all-day comfort and prolonged durability. The Skechers Work line incorporates design elements from other Skechers men’s and women’s lines. The uppers are comprised of high-quality leather, nubuck, trubuck and durabuck. Our safety toe athletic sneakers, boots, hikers and casuals are ideal for environments requiring safety footwear, and offer comfort and safety in dry or wet conditions. Our slip-resistant boots, hikers, athletics, casuals, clogs and comfortable sneakers are ideal for the service industry. The Skechers Healthcare Pro SR Series offers slip and stain resistant footwear with air-cooled memory foam in a wide range of colors for medical professionals. Our safety toe products have been independently tested and certified to meet ASTM standards, and our slip-resistant soles have been tested pursuant to the Mark II testing method for slip-resistance. Skechers Work is typically sold through department stores, athletic footwear retailers and specialty shoe stores, and is marketed directly to consumers through business-to-business channels. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our footwear is designed for active lifestyles and consumers needing comfort in their footwear from fashionable 18- to 34-year-olds, to a broader base of 5- to 50-year-olds, and even an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. We are able to quickly translate the latest fashion trends into stylish, quality footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our retail and direct-to-consumer customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +The footwear design process typically begins about nine months before the start of a season. Our products are designed and developed primarily by our in-house design staff. To promote innovation and brand relevance, we utilize dedicated design teams, who report to our senior design executives and focus on each of the men’s, women’s and children’s categories. In addition, we utilize outside design firms on an item-specific basis to supplement our internal design efforts. The design process is extremely collaborative, as members of the design staff frequently meet with the heads of retail, merchandising, sales, production and sourcing to further refine our products to meet the particular needs of the target market. +6 +After a design team arrives at a consensus regarding the fashion themes for the coming season, the designers then translate these themes into our products. These interpretations include variations in product color, material structure and embellishments, which are arrived at after close consultation with our production department. Prototype blueprints and specifications are created and forwarded to our manufacturers for design prototypes. The design prototypes are then sent back to our design teams. Our major retail customers may also review these new design concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but also affords us an opportunity to foster deeper and more collaborative relationships with our customers. We also occasionally order limited production runs that may initially be tested in our concept stores with our test and react program, which gives us further insight into the strength of particular styles and allow our design teams to quickly modify and refine our designs. Generally, the production process can take six to nine months from design concept to commercialization. +For disclosure of product design and development costs during the last three fiscal years, see Note 1 - The Company and Summary of Significant Accounting Policies in the Consolidated Financial Statements included in this annual report. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in China and Vietnam. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. For disclosure of information regarding the risks associated with having our manufacturing operations abroad and relying on independent contract manufacturers, see the relevant risk factors under Item 1A of this annual report. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. We source product for styles that account for a significant percentage of our sales from at least five different manufacturers. During 2019, five of our contract manufacturers accounted for approximately 40.6% of total purchases. One manufacturer accounted for 16.0%, and another accounted for 7.3% of our total purchases. To date, we have not experienced difficulty in obtaining manufacturing services or with the availability of raw materials. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.5% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +We closely monitor sales activity after initial introduction of a product in our concept stores and on-line to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales, and market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to better manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the United States by our in-house production department and in Asia through a 355-person staff working from our offices in China and Vietnam. We believe that our Asian presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to certify that neither convicted, forced nor indentured labor (as defined under U.S. law), nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation will be paid according to local law, and that the factory is in compliance with local safety regulations. We are committed to humane conditions for every individual who produces our product from beginning to end. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +7 +Sustainability. We have worked to make our packaging more sustainable for the more-than - 189 million pairs of Skechers that consumers purchase every year. Since 2016, we’ve reduced our products’ packaging plastics by 85% down to 10% of our foot forms, and have made all remaining plastics completely recyclable. Many facilities can now recycle 94% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging is now also recyclable and printed with soy-or water-based ink. We are proud to have 99% of our shoes packaged in shoeboxes that meet the FSC® standard for responsible resources – and we are continually looking out for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach as we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, events and in-store. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites and trade shows are effective marketing tools to both consumers and wholesale accounts. We have historically budgeted advertising as a percentage of projected sales. +The majority of our advertising is conceptualized by our in-house design team; however, some campaigns are designed in select international markets to reflect local culture. We believe that our advertising strategies, methods and creative campaigns are directly related to our success. We generally seek to build and drive brand awareness, create purchase intent and inform the consumer about new innovations and lines. Our campaigns are designed to provide merchandise flexibility and to facilitate the brand’s direction. +Brand Ambassadors. To further build brand awareness and influence consumer spending, we have selectively signed endorsement agreements with celebrities whom we believe will reach new markets. In 2019, our Skechers lifestyle endorsees included Camila Cabello and David Ortiz, as well as Brooke Burke, Sugar Ray Leonard, Howie Long, and Tony Romo. Additionally, we announced an agreement with Dodgers pitcher Clayton Kershaw to appear in marketing campaigns beginning in 2020, as well as to collaborate on performance training shoes and custom cleats for him to wear on the mound. Our 2019 Skechers Performance Division endorsees included elite runners Meb Kelfezighi, Weldon Kirui, Lionel Sanders and Edward Cheserek, and professional golfers Matt Kuchar, Brooke Henderson, Billy Andrade, Russell Knox, Wesley Bryan and Colin Montgomerie. Additionally, several international markets signed local ambassadors for marketing campaigns. Along with these global ambassadors, we also had local or regional ambassadors including pop groups for numerous countries in Asia. From time to time, we may sign other celebrities to endorse our brand name and image in order to strategically market our products among specific consumer groups in the future. +Print. With a targeted approach, our print ads appear in specialized sport, popular fashion, lifestyle and pop culture publications in the United States and around the world. +Television. Our television commercials are produced both in-house and through producers that we have utilized in the past who are familiar with our brands. In 2019, we developed commercials for men, women and children for our Skechers brands, including our animated spots for kids, as well as live action commercials. We also had commercials for our golf collection lines that featured our elite golfers, and for our lifestyle lines that feature our team of ambassadors. We have found these to be cost-effective ways to advertise on key national and cable programming during high-selling seasons. Many of our television commercials are translated into multiple languages and aired in numerous markets around the world. Further, select markets have also created television commercials specific to their market with local celebrities. +Outdoor. To reach consumers where they shop and in high-traffic areas as they travel to and from work, at times we execute outdoor campaigns that may include mall and telephone kiosks, billboards, transportation systems and airports, and the covering of large stadiums and buildings around the world. In many markets these now include LED billboards that broadcast our commercials. In addition, we advertised on perimeter boards at soccer matches and professional sporting events in Japan, Europe, Latin America and Canada. We believe these mediums are an effective and efficient way to target specific consumers. +Public Relations. Our public relations objectives are to accurately position Skechers as a leading footwear brand within the business, general news and trade publications as well as to secure product placement in key magazines and television shows. We have been featured in leading business publications with interviews of our executives discussing our business strategy and position within the footwear market. We have amassed an array of prominent product placements in leading fashion, lifestyle, sports and pop culture magazines and websites. +8 +Social Media. With the goal of engaging with consumers, showcasing our product in relatable settings and relaying the latest news, we have built communities on Facebook, Twitter, Instagram, and YouTube in the United States and in countries around the world where our product is sold. To promote both our lifestyle and performance brands, we have developed several unique channels under Skechers, Skechers Performance, BOBS from Skechers and Mark Nason Los Angeles. The online communities also connect consumers around the world, allowing an easy glimpse into trends and events in other countries. Additionally, many countries also utilize platforms specific to their market, such as Line in Japan and Weibo in China. We have also placed our footwear on the feet of trend-setting influencers, celebrities and their families, sharing this content across our channels. +Promotions and Events. By applying creative sales techniques via a broad spectrum of media, our marketing team seeks to build brand recognition and drive traffic to Skechers retail stores, websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed in-store specials, charity events, product tie-ins and giveaways and collaborations with national retailers and radio stations. In 2019, we appeared at walks and at numerous marathons in Boston, New York, Santiago, Mumbai, Shanghai, and other cities with Skechers Performance branded booths to allow runners the ability to try on and often buy our products. In 2019, the Skechers Performance Division was the title sponsor of the Skechers Performance Los Angeles Marathon, footwear and apparel sponsor for the Houston Marathon, and footwear sponsor for Ironman Pucon in Chile. Additionally, for golf, Skechers was footwear sponsor for the Charles Schwab Cup PGA Championship in the United States, sponsored the Solheim Cup European team and collaborated on an exclusive style for the Evian Championship in France. These were among the many Skechers-sponsored events worldwide. Our products were made available to consumers directly or through key accounts at many of these events. In addition, we partnered with key accounts by donating BOBS footwear to children in need at donation events in cities throughout the United States, which built our relationships with these accounts as well as the local communities. As part of our BOBS for Dogs charity program we also partnered with the Petco Foundation and donated more than $1.5 million in 2019 and have raised more than $5.0 million helping and saving animals to date. +Visual Merchandising. Our in-house visual merchandising department supports wholesale customers, distributors and our retail stores by developing displays that effectively leverage our products at the point of sale. Our point-of-purchase display items include signage, graphics, displays, counter cards, banners and other merchandising items for each of our brands. These materials mirror the look and feel of each brand to reinforce the image and draw consumers into stores. +Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with our customers to ensure better sell-through at the retail level by generating greater consumer awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale customers on a regular basis to aid in proper display of our merchandise. They also run in-store promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers brand. We believe that these efforts help stimulate impulse sales and repeat purchases. +Trade Shows. To showcase our diverse products to footwear buyers in the United States and Europe and to distributors around the world, we regularly exhibit at leading trade shows. Along with specialty trade shows, we exhibit at FFANY, The Licensing Show and Outdoor Retailer in the United States; MICAM, Gallery and ISPO in Europe; and other international shows. +Digital. In 2019, we continued marketing campaigns on YouTube, Facebook and Instagram, and launched digital campaigns in many international markets to coincide with key selling time periods. We promote and sell our products through our direct-to-consumer sites in the United States, Canada, United Kingdom, Germany, Spain, Chile, India, Mexico, and China, among other countries, as well as through non-ecommerce sites in many other countries. Our websites are a venue for dialog and feedback from customers about our products, which enhances the Skechers brand experience while driving sales through all our retail channels. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: domestic wholesale sales, international wholesale sales, and direct-to-consumer sales. In the United States, our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 175 countries and territories via our global network of distributors, in addition to our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. In addition, 18 distributors and 50 licensees have opened and operate 727 distributor-owned or -licensed Skechers retail stores and 1,666 licensee-owned Skechers retail stores, respectively, in over 175 countries as of December 31, 2019. +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: department stores, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. While department stores and specialty retailers are the largest distribution channels, we believe that we appeal to a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +9 +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +We believe that we have developed a loyal account base through exceptional customer service. We believe that our close relationships with these accounts help us to maximize their retail sell-through. Our marketing teams work with our wholesale customers to ensure that our merchandise and marketing materials are properly presented. Sales executives and merchandise personnel work closely with accounts to ensure that appropriate styles are purchased for specific accounts and for specific stores within those accounts, as well as to ensure that appropriate inventory levels are carried at each store. Such information is then utilized to help develop sales projections and determine the product needs of our wholesale customers. The value-added services we provide our wholesale customers help us maintain strong relationships with our existing wholesale customers and attract potential new wholesale customers. +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: ecommerce, concept stores, factory outlet and warehouse outlet stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. In addition, most of our retail stores are profitable and have a positive effect on our operating results. +We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We assess the cash flows for each of our retail stores to evaluate the potential impairment of the fixed assets and leasehold improvements. If the assets are considered to be impaired, we recognize the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the period that the assets will generate revenues or otherwise be used by us. As of February 1, 2020, we owned and operated 107 concept stores, 171 factory outlet stores and 219 warehouse outlet stores in the United States, and 199 concept stores, 93 factory outlet stores, and 10 warehouse outlet stores internationally. We plan to open 115 to 125 new stores in 2020. +• +Ecommerce +Our company-owned ecommerce businesses offer virtual storefronts designed to provide a positive shopping and brand experience, showcasing our products in an easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear. These virtual stores provide a convenient, alternative shopping environment and brand experience, and are an additional efficient and effective retail distribution channel, which has improved our customer service. They enable consumers to shop, browse, find store locations, socially interact, post a shoe review, photo, video or question, and immerse themselves in our brands. +• +Concept Stores +Our concept stores are located at marquee street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the customer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, 5 th Avenue, SOHO, and 34 th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Buchanan Street in Glasgow; Princes Street in Edinburgh; Toronto’s Eaton Centre; Vancouver’s Pacific Centre; and the Shinsaibashi shopping district of Osaka and Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. +10 +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have opened concept stores as large as 8,000 square feet or as small as 600 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities around the world . When selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies, sales volume of neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall, where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to their venues. +• +Factory Outlet Stores +Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the United States and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 850 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores +Our free-standing and inline warehouse outlet stores, which are primarily located throughout the United States and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores and typically range in size from approximately 4,000 to 30,600 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations December 31, 2018 +Opened during 2019 +Closed during 2019 +Number of Store Locations December 31, 2019 +Domestic stores +Concept +114 +— +(5 +) +109 +Factory Outlet +171 +1 +(1 +) +171 +Warehouse Outlet +185 +32 +— +217 +Domestic stores total +470 +33 +(6 +) +497 +International stores +Concept +191 +(1) +15 +(6 +) +200 +Factory Outlet +82 +(1) +11 +— +93 +Warehouse Outlet +10 +— +— +10 +International stores total +283 +26 +(6 +) +303 +Joint venture stores +China +131 +49 +(23 +) +157 +Hong Kong +43 +9 +(5 +) +47 +Israel +12 +3 +— +15 +Mexico +— +81 +— +81 +South Korea +22 +13 +(18 +) +17 +South East Asia +28 +9 +— +37 +Joint venture stores total +236 +164 +(46 +) +354 +Total domestic, international and joint +venture stores +989 +223 +(58 +) +1,154 +(1) +Includes the reclassification of 57 concept stores and 4 factory outlet stores from our joint venture in India. +11 +International Wholesale. Our products are sold in more than 175 countries and territories throughout the world. We generate revenues from outside the United States from three principal sources: (i) direct sales to department stores and specialty retail stores through our joint ventures in Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Japan; (ii) sales to foreign distributors who distribute our footwear to department stores and specialty retail stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products outside the United States. +We believe that international distribution of our products represents a significant opportunity to increase sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global brand synonymous with trend-right casual shoes. +• +International Subsidiaries +Europe +We currently merchandise, market and distribute product in most of Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; and Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.3 million square-foot distribution center in Liege, Belgium. +Canada +We currently merchandise, market and distribute product in Canada through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in Rancho Belago, California. We have company-owned retail stores in key locations across Canada. +South America and Central America +We currently merchandise, market and distribute product in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; and Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. We have retail stores in key locations such as Santiago, Panama City, Bogota and Lima. +Japan +We currently merchandise, market and distribute product in Japan through our wholly-owned subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. We have retail stores in key locations such as Osaka and Tokyo. +India +We currently merchandise, market and distribute product in through our wholly-owned subsidiary, Skechers South Asia Private Limited and Skechers Retail India Private Limited. We have retail stores in key locations such as Bangalore, Mumbai, and New Delhi. +12 +China and Hong Kong +We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong that operate and generate sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Shanghai, Beijing, Guangzhou, Hong Kong and Macau. These joint ventures are consolidated in our financial statements. +Malaysia, Singapore and Thailand +We have a 50% interest in a joint venture in Malaysia and Singapore, and a 51% interest in a joint venture in Thailand that operates and generates sales in those countries. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Singapore and Kuala Lumpur. These joint ventures are consolidated in our financial statements. +Israel +We have a 51% interest in Skechers Ltd. (Israel), which is a joint venture that operates and generates sales in Israel. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Jerusalem and Tel Aviv. This joint venture is consolidated in our financial statements. +South Korea +We have a 65% interest in Skechers Korea Co., Ltd., which is a joint venture that operates and generates sales in South Korea. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have retail stores in key locations such as Seoul and Busan. This joint venture is consolidated in our financial statements. +Mexico +We have a 60% interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”) , which is a joint venture that operates and generates sales in Mexico. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. We have over 80 retail stores in key locations such as Mexico City and Guadalajara. This joint venture is consolidated in our financial statements. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through an extensive network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2019, we also had agreements with 18 of these distributors and 50 licensees regarding 727 distributor-owned or licensed Skechers retail stores and 1,666 licensee-owned Skechers retail stores, respectively. Our distributors, licensees and franchisees own and operate the following retail stores in more than 175 countries around the world: +Number of Store Locations December 31, 2018 +Opened during 2019 +Closed during 2019 +Number of Store Locations December 31, 2019 +Distributor, licensee and franchise stores +Africa +46 +15 +(1 +) +60 +Asia +1,348 +464 +(118 +) +1,694 +Australasia +87 +22 +— +109 +Central America +9 +7 +— +16 +Europe +231 +79 +(7 +) +303 +Middle East +160 +11 +(7 +) +164 +North America +11 +(1) +1 +— +12 +South America +29 +6 +— +35 +Total distributor, licensee and franchise stores +1,921 +605 +(133 +) +2,393 +(1) +Includes the reclassification of 59 concept stores and 16 outlet stores from our licensed distributor in Mexico to joint venture stores. +13 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +For disclosure of financial information about geographic areas and segment information for our three reportable segments–domestic wholesale sales, international wholesale sales, and retail sales, see Note 20 – Segment and Geographic Reporting in the Consolidated Financial Statements included in this annual report. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We also believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +As of February 1, 2020, we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and travel accessories, and watches for adults and kids; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness, yoga and running accessories; consumer electronics; and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; and Skechers Work socks. We also have BOBS for DOGS pet accessories in Petco. We have international licensing agreements for the design and distribution of prescription and sunglass eyewear globally; men’s, women’s and kids’ apparel in the United Kingdom; socks and watches throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe and the Middle East; medical scrubs in the Middle East, Australia, and New Zealand; apparel, socks, headwear, bags, and backpacks in Indonesia; apparel, socks, and bags in Mexico; bags, backpacks, luggage, wallets, watches, medical scrubs and accessories in Latin America; apparel, bags, and backpacks, headwear, socks, and shoe care Turkey; and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 1.8 million square-foot distribution center located in Rancho Belago, California, (ii) to our approximate 1.3 million square-foot European Distribution Center (“EDC”) located in Liege, Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system (“EDI system”) which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +Our shipping methods at our factories reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recyclable materials and are 100% recyclable. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our trademarks in the United States. In addition, we have trademark registrations and trademark applications in approximately 142 foreign countries. We also have design patents and pending design and utility patent applications in both the United States and approximately 23 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +14 +We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce intellectual property rights in our logos, trade names and in the design of our products. In particular, we believe that our future success will largely depend on our ability to maintain and protect the Skechers trademark and other key trademarks. Despite our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that we will be successful in this regard. Furthermore, we cannot be certain that our trademarks, products and promotional materials or other intellectual property rights do not, or will not, violate the intellectual property rights of others, that our intellectual property would be upheld if challenged, or that we would, in such an event, not be prevented from using our trademarks or other intellectual property rights. Such claims, if proven, could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention and associated legal costs with litigation or other resolution of future claims concerning trademarks and other intellectual property rights could materially and adversely affect our business, financial condition and results of operations. We have sued and have been sued by third parties for infringement of intellectual property. It is our opinion that none of these claims filed against us has materially impaired our ability to utilize our intellectual property rights. +The laws of certain foreign countries do not protect intellectual property rights to the same extent, or in the same manner, as do the laws of the United States. Although we continue to implement protective measures and intend to defend our intellectual property rights vigorously, these efforts may not be successful, or the costs associated with protecting our rights in certain jurisdictions may be prohibitive. From time to time, we discover products in the marketplace that are counterfeit reproductions of our products or that otherwise infringe upon intellectual property rights held by us. Actions taken by us to establish and protect our trademarks and other intellectual property rights may not be adequate to prevent imitation of our products by others, or to prevent others from seeking to block sales of our products as violating trademarks and intellectual property rights. If we are unsuccessful in challenging a third party’s products on the basis of infringement of our intellectual property rights, continued sales of such products by that or any other third party could adversely impact the Skechers brand, result in the shift of consumer preferences away from our products, and generally have a material adverse effect on our business, financial condition, results of operations and cash flows. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our casual shoes and utility footwear compete with footwear offered by companies such as Columbia Sportswear Company, Converse by Nike, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., The Timberland Company, V.F. Corporation and Wolverine World Wide, Inc. Our athletic lifestyle and performance shoes compete with footwear offered by companies such as Nike, Inc., adidas AG, Reebok International Ltd., Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc. and Under Armour, Inc. The intense competition among these companies and the rapid changes in technology and consumer preferences in the markets for performance footwear, including the walking fitness category, constitute significant risk factors in our operations. Our children’s shoes compete with footwear offered by these companies and with other brands such as Stride Rite by Wolverine World Wide, Inc. In varying degrees, depending on the product category involved, we compete on the basis of style, price, quality, comfort and brand name prestige and recognition, among other factors. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We cannot be certain that we will be able to compete successfully against present or future competitors, or that competitive pressures will not have a material adverse effect on our business, financial condition, results of operations and cash flows. +EMPLOYEES +As of January 31, 2020, we employed approximately 13,100 persons, of whom approximately 4,000 were employed on a full-time basis and approximately 9,100 were employed on a part-time basis, primarily in our retail stores. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory. +15 \ No newline at end of file diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/item13.txt b/raw/filings/0001065837/2019/0001564590-20-007744/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..f8a668ca30b0f07bcad56e1d1dbdfff15eb6cd63 --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2019 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/item9a.txt b/raw/filings/0001065837/2019/0001564590-20-007744/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..8ec2a5b529206252add918d8099839d0682c60f0 --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/item9a.txt @@ -0,0 +1,41 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2019, excluded Manhattan SKMX, S. de R.L. de C.V., which was acquired by the Company in the second quarter of 2019. Total assets and total sales of Skechers Mexico each constituted less than 3% of the consolidated total assets and total sales as of and for the year ended December 31, 2019. Companies are allowed to exclude acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company under guidelines established by the SEC. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2019. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2019, which is set forth below. +77 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2019. The results of our evaluation are discussed above in Management’s Report on Internal Control over Financial Reporting. +78 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2020, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +As indicated in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Manhattan SKMX, S. De R.L. De C.V. (“Skechers Mexico”), which was acquired on April 1, 2019, and which is included in the consolidated balance sheet of the Company as of December 31, 2019 and the related consolidated statements of earnings, comprehensive income, equity and cash flows for the year then ended. Skechers Mexico constituted 2.6% of total assets as of December 31, 2019 and 1.7% of total sales for the year ended December 31, 2019. Management did not assess the effectiveness of internal control over financial reporting of Skechers Mexico because of the timing of the acquisition which was on April 1, 2019. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Skechers Mexico. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 28, 2020 +79 \ No newline at end of file diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/rp_note.txt b/raw/filings/0001065837/2019/0001564590-20-007744/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2019/0001564590-20-007744/rpt_disclosure.txt b/raw/filings/0001065837/2019/0001564590-20-007744/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..81121f46edfcb283b73d66a14d96adf4819b953c --- /dev/null +++ b/raw/filings/0001065837/2019/0001564590-20-007744/rpt_disclosure.txt @@ -0,0 +1,35 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in +our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the +avoidance of conflicts of interest (which is discussed in the section entitled “ Corporate Code of Conduct and Code of Ethics ”), (ii) past and proposed transactions between our company, on the one hand, and any of our +directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of +March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will +or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten +percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy +statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A or Class B Common Stock or +(c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as +transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related +Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, +ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an +unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or +approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at +least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since +January 1, 2020. Each of these transactions was reviewed, and approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +45 +Related Person Transactions +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our +Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg has agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for the third +time for an additional year with the same terms and conditions effective as of February 1, 2021. +On July 29, 2010, we formed +the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise +affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2020, we made contributions of +$2,250,000 to the Foundation. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of +Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $322,232, $3,395,951, $2,605,044 and $354,239, respectively, in 2020. +Jeffrey Greenberg was also a member of our Board of Directors in 2020, but did not earn any additional compensation for services provided as a director. +Andrew Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees +of Skechers, and they earned total compensation of $496,669 and $180,297, respectively, in 2020. \ No newline at end of file diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/filing.txt b/raw/filings/0001065837/2020/0001564590-21-009442/filing.txt new file mode 100644 index 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+us-gaap:ReserveForOffBalanceSheetActivitiesMember +2020-01-01 +2020-12-31 +0001065837 +skx:ReserveForObsolescenceMember +2020-01-01 +2020-12-31 +0001065837 +us-gaap:AllowanceForCreditLossMember +2020-12-31 +0001065837 +us-gaap:AllowanceForNotesReceivableMember +2020-12-31 +0001065837 +skx:LiabilityForSalesReturnsAndAllowancesMember +2020-12-31 +0001065837 +us-gaap:ReserveForOffBalanceSheetActivitiesMember +2020-12-31 +0001065837 +skx:ReserveForObsolescenceMember +2020-12-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2020 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2020, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 4.3 billion based upon the closing price of $31.38 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2021: 136,729,982 . +The number of shares of Class B Common Stock outstanding as of February 15, 2021: 21,016,133 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2021 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended DECEMBER 31, 2020 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +9 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +18 +ITEM 2. +PROPERTIES +18 +ITEM 3. +LEGAL PROCEEDINGS +19 +ITEM 4. +MINE SAFETY DISCLOSURES +20 +PART II +ITEM 5. +MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +21 +ITEM 6. +SELECTED FINANCIAL DATA +22 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +23 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +29 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +30 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +55 +ITEM 9A. +CONTROLS AND PROCEDURES +55 +ITEM 9B. +OTHER INFORMATION +58 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +58 +ITEM 11. +EXECUTIVE COMPENSATION +58 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +58 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +58 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +58 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +58 +ITEM 16. +FORM 10-K SUMMARY +58 +SIGNATURES +63 +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements with regards to future revenue, projected operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our future performance. Factors that might cause or contribute to such differences include: +• +the COVID-19 pandemic and its adverse impact on our business, our operations, and our sales and results of operations around the world; +• +global economic, political and market conditions, including the challenging consumer retail market; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to predict our revenues, which have varied significantly in the past and can be expected to fluctuate in the future due to a number of reasons, many of which are beyond our control; and +• +sales levels during the spring, back-to-school and holiday selling seasons. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and state securities laws. +1 +PART I +ITEM 1. +BUSINESS +Skechers U.S.A., Inc. was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under generally accepted accounting principles in the United States (“U.S.”). Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. We also design and market men’s and women’s Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and scrub manufacturers, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through department and specialty stores, athletic and independent retailers, boutiques and online retailers. In addition to wholesale distribution, our footwear is available on our direct-to-consumer websites and in our own retail stores. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are attracted to our relevant brand image, fashion-forward designs, affordable and comfortable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2020, the Skechers brand was supported by print, television, digital, radio and outdoor campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2020, our brand ambassadors included Sugar Ray Leonard, Tony Romo, Howie Long, and Brooke Burke, along with athletes Edward Cheserek, Meb Keflezighi, Matt Kuchar and Brooke Henderson. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. +Lifestyle Brands . Our lifestyle offering includes multiple categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Mark Nason, the charity-minded BOBS from Skechers collection, among others. Comfort, style and value are at the cornerstone of our vast lifestyle collections. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and retro fashion. Innovation is also important within our lifestyle offering and select styles across many lines include a patented Arch Fit insole design for podiatrist-certified arch support and Goodyear Performance Outsoles for enhanced traction, stability and durability. Also within our lifestyle collections are collaborations with known brands and properties—including street artists, influential boutiques and manga characters. +2 +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed with a focus on specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight ULTRA GO and HYPER BURST midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines of Skechers GOrun , Skechers GOwalk , Skechers GOtrain , Skechers GOtrail , and Skechers GO G olf . Additional features found in select styles across multiple categories include Arch Fit insoles, Goodyear Performance Outsoles, and Max Cushioning designs. +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection; Skechers Mega-Craft; S-Lights; SKECH-AIR; Foamies, Twinkle Toes; Z-Strap; Skechers Stretch Fit; and Skechers Street. Skechers Kids also includes shoes that are designed as “takedowns” of their adult counterparts, allowing younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. +Skechers Work. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear across a wide range of work environments. Skechers Work styles include safety features such as steel, composite and lightweight safety toes; puncture resistance; waterproofing and electrostatic-dissipative technology, as well as Skechers’ comfort technologies such as Relaxed Fit construction; Max Cushioning; Skechers Memory Foam insoles and Arch Fit insoles. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles for prolonged durability. +In addition, Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features the same Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear initiatives. The Skechers apparel collection is sold at Skechers retail stores, to our domestic wholesale accounts and select international partners. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our footwear is designed for active lifestyles and consumers needing comfort in their footwear from fashionable 18- to 34-year-olds, to a broader base of 5- to 50-year-olds, and even an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +3 +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia through staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website . We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +Sustainability. We believe that sustainability is an important responsibility in managing our business. We have worked to make our packaging more sustainable for the more-than-150 million pairs of Skechers that consumers purchase every year. Since 2016, we’ve reduced our products’ packaging plastics by 85% down to 10% of our foot forms, and have made remaining plastics completely recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging is also recyclable and printed with soy-or water-based ink. We are proud to have 99% of our shoes packaged in shoeboxes that meet the FSC® standard for responsible resources, and we are continually looking out for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. +Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recyclable materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including America’s largest LEED Gold certified distribution facility in Rancho Belago, California. Our new corporate headquarters in Manhattan Beach, California are also being designed and developed to qualify for LEED certification. +Product Styles. We closely monitor sales activity after initial introduction of a product in our concept stores and on-line to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales along with market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites are effective marketing tools to consumers. We have historically budgeted advertising as a percentage of projected sales. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: Domestic Wholesale, International Wholesale, and Direct-to-Consumer. In the U.S., our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors as well as through our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. +4 +In addition, 18 distributors and 51 licensees have opened and operate 799 distributor-owned or -licensed Skechers retail stores and 1,771 licensee-owned Skechers retail stores, respectively, as of December 31, 2020 . +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: big-box footwear stores, department stores, wholesale clubs, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. Skechers footwear is available in a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the U.S. from three principal sources: (i) sales to department stores and specialty retail stores through our joint ventures in Mexico, Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Asia; (ii) sales to international distributors who deliver our footwear to department stores, specialty retail stores and third-party-owned Skechers stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products abroad. +We believe that international distribution of our products represents a significant opportunity to increase sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global lifestyle and performance brand. +The following subsidiaries and joint ventures merchandise, market and distribute product to generate sales in their named countries, and we consolidate their results in our financial statements: +• +International Subsidiaries +Canada – We currently operate through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in California. We have company-owned retail stores in key locations across Canada. +Europe – We currently operate in Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; and Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.8 million square-foot distribution center in Liege, Belgium. +India – We currently operate through Skechers South Asia Private Limited and Skechers Retail India Private Limited. +Japan – We currently operate through our subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. +South America and Central America – We currently operate in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; and Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. +5 +• +International Joint Ventures +China and Hong Kong – We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. +Israel – We have a 51% interest in Skechers Ltd. (Israel). Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +Mexico – We have a 60% interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”) . Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +South Korea – We have a 65% interest in Skechers Korea Co., Ltd. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +Malaysia, Singapore and Thailand – We have a 50% interest in a joint venture in Malaysia and Singapore, and a 51% interest in a joint venture in Thailand. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2020, we also had agreements with 18 of these distributors and 51 licensees regarding 799 distributor-owned or licensed Skechers retail stores and 1,771 licensee-owned Skechers retail stores. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations at December 31, 2019 +Opened during 2020 +Closed during 2020 +Number of Store Locations at December 31, 2020 +Distributor, licensee and franchise stores +Africa +60 +8 +(1 +) +67 +Asia +1,694 +350 +(247 +) +1,797 +Australasia +109 +12 +— +121 +Central America +16 +3 +— +19 +Europe +303 +53 +(4 +) +352 +Middle East +164 +2 +(1 +) +165 +North America +12 +— +— +12 +South America +35 +2 +— +37 +Total distributor, licensee and franchise stores +2,393 +430 +(253 +) +2,570 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: e-commerce, concept stores, factory outlet and warehouse outlet stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E-commerce – Our company-owned e-commerce business enable consumers to shop, browse, find store locations, socially interact, post a shoe review, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which has improved our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the consumer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, and 34th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in +6 +Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Rue de Rivoli in Paris; Via del Corso in Rome; Kaufingerstraße in Munich; Toronto’s Eaton Centre; and the Shinsaibashi shopping district of Osaka, Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns. +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have concept stores ranging from 600 square feet to 14,300 square feet. When deciding where to open concept stores, we identify top geographic markets in larger metropolitan cities around the world. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 850 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores – Our free-standing and attached warehouse outlet stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory that would otherwise typically be sold to discounters at excessively low prices, which could compromise the Skechers brand image. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores ranging in size from approximately 4,000 to 30,600 square feet. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations at December 31, 2019 +Opened during 2020 +Closed during 2020 +Number of Store Locations at December 31, 2020 +Domestic stores +Concept +109 +3 +(7 +) +105 +Factory Outlet +171 +2 +(1 +) +172 +Warehouse Outlet +217 +31 +(2 +) +246 +Domestic stores total +497 +36 +(10 +) +523 +International stores +Concept +200 +21 +(1 +) +220 +Factory Outlet +93 +9 +(2 +) +100 +Warehouse Outlet +10 +1 +— +11 +International stores total +303 +31 +(3 +) +331 +Joint venture stores +China +157 +111 +(23 +) +245 +Hong Kong +47 +2 +(3 +) +46 +Israel +15 +2 +— +17 +Mexico +81 +4 +(1 +) +84 +South Korea +17 +— +(2 +) +15 +South East Asia +37 +23 +— +60 +Joint venture stores total +354 +142 +(29 +) +467 +Total domestic, international and joint venture stores +1,154 +209 +(42 +) +1,321 +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +7 +As of December 31, 2020 , we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and travel accessories, and watches for adults and kids ; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness and yoga accessories; headwear ; and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; Skechers Work socks and Skechers G o G olf apparel for men and women . We also have BOBS from Skechers pet accessories in Petco. We have international licensing agreements for the design and distribution of prescription and sunglass eyewear globally; men’s, women’s and kids’ apparel in the United Kingdom; kids’ apparel in Europe; socks and watches throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe Russia, Scandinavia and the Middle East; medical scrubs in the Middle East, United Kingdom, Australia, and New Zealand; apparel, socks, headwear, bags , and backpacks in Indonesia; apparel, socks, and bags in Mexico; bags, backpacks, luggage, wallets, watches, medical scrubs and accessories in Latin America; apparel, bags, and backpacks, headwear, socks, and shoe care Turkey; socks in Japan and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 2.8 million square-foot North American distribution center located in California, (ii) to our approximate 1.8 million square-foot European Distribution Center located in Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in approximately 155 foreign countries. We also have design patents and pending design and utility patent applications in both the U.S. and approximately 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our footwear competes with footwear offered by companies such as Columbia Sportswear Company, Nike, Inc., Crocs, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., V.F. Corporation, Adidas AG, Reebok International, Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc., Under Armor Inc. and Wolverine World Wide, Inc. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +EMPLOYEES +As of December 31, 2020, we employed approximately 11,700 persons, of whom approximately 5,900 were employed on a full-time basis and approximately 5,800 were employed on a part-time basis, primarily in our retail stores. As a family-focused brand, Skechers was founded on the philosophy of putting people first – offering comfort and care to its employees and customers, and supporting both with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of our company – from our factories to our suppliers. +8 +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Risks Related to COVID-19 +The COVID-19 Pandemic Has Had, And May Continue To Have, A Material Adverse Effect On Our Business And Results Of Operations. +Impact on Global Economy and on Our Business and Financial Performance +The COVID-19 pandemic has negatively impacted the global economy, disrupted consumer spending and global supply chains, and created significant volatility and disruption of financial markets. The COVID-19 pandemic has had, and may continue to have, a material adverse impact on our business and financial performance. The extent of this impact on our business and financial performance, including our ability to execute our near-term and long-term business strategies and initiatives in the expected time frame, is highly uncertain and cannot be predicted, as information is rapidly evolving with respect to the duration and severity of the pandemic. It will depend on future developments, including the duration and severity of the pandemic, related restrictions on travel, temporary store closure requirements and the related impact on consumer confidence and spending, and the extent of any recession resulting from the pandemic. At this time, we cannot reasonably estimate the duration and severity of the COVID-19 pandemic, or its overall impact on our business and financial performance. +Closures and Operational Restrictions of Our Retail Stores and Our Wholesale Customers’ Stores +As a result of the COVID-19 pandemic, and in response to government mandates or recommendations, as well as decisions we have made to protect the health and safety of our employees, consumers and communities, beginning in March 2020, we (including our joint ventures), and our distributors, licensees and franchisees, temporarily closed a significant number of our company- and joint venture-owned retail stores, and our distributor-, licensee- and franchisee-owned retail stores, respectively, around the world. While over 90% of our company- and joint venture-owned retail stores and over 90% of our third party-owned retail stores around the world have reopened (although many with temporarily reduced operating hours) as of the filing date of this report, collectively, we may face recurring store closure requirements and other operational restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among other factors, evolving or new increasingly stringent governmental restrictions including public health directives, quarantine policies or social distancing measures. In addition, many of our significant wholesale customers have closed many of their stores, which will adversely impact our revenues from these customers. As a result, our business and results of operations have been, and will continue to be, materially adversely impacted by store closures and operational restrictions. +Even as we and our wholesales customers reopen our stores, as the number of people affected by the COVID-19 pandemic continues to grow, consumer fear about becoming ill with the disease and recommendations and/or mandates from federal, state and local authorities to avoid large gatherings of people or self-quarantine may continue to increase, which has, and will continue to, adversely affect traffic to stores. Any significant reduction in consumer visits to, or spending at, our wholesale customers’ stores and our retail stores, caused by the COVID-19 pandemic, and any decreased spending at stores caused by decreased consumer confidence and spending during and following this pandemic, has resulted in, and will continue to result in, a loss of sales and profits and other material adverse effects on our business and results of operations. +Disruptions or Delays in Our Supply Chain +Although not a material issue as of the filing date of this report, the COVID-19 pandemic has also caused delays in shipments of our products and could once again have the potential to significantly impact our supply chain if the factories that manufacture our products, the distribution centers where we manage our inventory, or the operations of our logistics and other service providers are disrupted, temporarily closed or experience worker shortages. More specifically, the majority of our manufacturers are located primarily in China and Vietnam. To date, the Chinese and Vietnamese governments have imposed certain restrictions on business operations and the movement of people and goods, including the temporary closure of some factories and businesses in China and restrictions on others in Vietnam, to limit the spread of COVID-19. As a result, we have seen and may yet again see disruptions or delays in shipments, and we may experience negative impacts to pricing of our products due to changes in availability of inventory, which could materially adversely impact our business and results of operations. +Office Closures, Focus of Key Personnel and Productivity of Employees +As a result of the COVID-19 pandemic, including related governmental guidance or requirements, beginning in March 2020, we also temporarily closed many of our corporate offices and other facilities, including our corporate headquarters in Manhattan Beach, California, and implemented a policy for many of our corporate employees to work remotely. While we began to allow a limited number of personnel back to our corporate offices with added safety measures and staggered work schedules in June, these evolving work place arrangements may negatively impact productivity and cause other disruptions to our business. +9 +In addition, our management team is focused on mitigating the adverse effects of the COVID-19 pandemic, which has required and will continue to require a large investment of time and resources across the entire company, thereby diverting their attention from other priorities that existed prior to the outbreak of the pandemic. If these conditions worsen, or last for an extended period of time, our ability to manage our business may be impaired, and operational risks and other risks facing us even prior to the COVID-19 pandemic may be elevated. +The COVID-19 Pandemic Has Had A Negative Impact On The Global Economy, And Our Sales Are Influenced By Economic Conditions That Impact Consumer Spending And Consumer Confidence. +Footwear is a cyclical industry that is dependent upon the overall level of consumer spending and consumer confidence. Consumer purchases of discretionary items, including our products, generally decline during periods when disposable income is adversely affected, there is economic uncertainty or volatility or during recessionary periods. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by closing doors, reducing inventories, canceling orders or increasing promotional activity. Our retail stores are also affected by these conditions, which may lead to a decline in consumer traffic and spending in these stores as they reopen. As a result, factors that diminish consumer spending and confidence in any of the markets in which we compete, particularly deterioration in general economic conditions, consumer credit availability, consumer debt levels, inflation, the impact of foreign exchange fluctuations on tourism and tourist spending, volatility in investment returns, fear of unemployment, increases in energy costs or tax or interest rates, housing market downturns, fear about and impact of pandemic illness (such as the impact of the COVID-19 pandemic, including reduced store traffic and widespread temporary store closures), and other factors such as acts of war, natural disasters or terrorist or political events that impact consumer confidence, have reduced, and may continue to reduce (with respect to the COVID-19 pandemic), our sales and may continue to have a material adverse effect on our operations and financial condition through their negative impact on our wholesale customers as well as decreased spending in our retail stores and potentially via our e-commerce business. +Risks Related to Customers, Competition and Retail Operations +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has in large part been due to the strength of the Skechers brand. Maintaining, promoting and growing our brand name and image depends on sustained effort and commitment to, and significant investment in, both the successful development of high-quality, innovative, fashion forward products, and fresh and relevant marketing and advertising campaigns. Even if we are able to timely and appropriately respond to changing consumer preferences and trends with new high-quality products, our marketing and advertising campaigns may not resonate with consumers, or consumers may consider our brand to be outdated or associated with footwear styles that are no longer popular or relevant. Our brand name and image with consumers could also be negatively impacted if we or any of our products were to receive negative publicity, whether related to our products or otherwise. If we are unable to maintain, promote and grow our brand image, then our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our performance footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically, and in fashion and lifestyle categories generally. +In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever-changing nature of consumer preferences and market trends, a number of companies in the footwear industry, including ours, experience periods of both rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development of products that achieve market acceptance, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +10 +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and Those With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry. Our competitors’ product offerings, pricing, costs of production, and advertising and marketing expenditures are highly competitive areas in our business. If we do not adequately and timely anticipate and respond to our competitors, consumer demand for our products may decline significantly. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition in the footwear industry. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +We Depend Upon A Relatively Small Group Of Customers For A Large Portion Of Our Sales. +During the year ended December 31, 2020, our net sales to our five largest customers accounted for approximately 8.8% of total net sales, respectively. No one customer accounted for more than 10.0% of outstanding accounts receivable balance at December 31, 2020. Although we have long-term relationships with many of our customers, our customers do not have a contractual obligation to purchase our products and we cannot be certain that we will be able to retain our existing major customers. Store closures or re-closures, decreased foot traffic and economic recession resulting from the COVID-19 pandemic has, and will likely continue to, adversely affect our performance and could continue to adversely affect the financial condition of many of our customers. If any major existing customer ceases or decreases its purchases from us, cancels its orders, delays or defaults on its payment obligations to us, reduces the floor space, assortments, fixtures or advertising for our products or changes its manner of doing business with us for any reason, such as due to store closures, decreased foot traffic or recession resulting from the COVID-19 pandemic, such actions may adversely affect our business and financial condition. Furthermore, the retail industry regularly experiences consolidation, contractions and closings, which may result in our loss of customers or our inability to collect accounts receivable of major customers, and we have recently experienced delays in payments from some of our customers and others have gone bankrupt. If we lose a major customer, experience a significant decrease in sales to a major customer or are unable to collect the accounts receivable of a major customer due to any of the foregoing reasons, our business and financial condition could be harmed. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, some or a substantial number of new stores could be opened in regions of the U.S. in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those currently encountered in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, to the extent that any new store openings are in existing markets, we may experience reduced sales volumes in existing stores in those markets. If sales decline at our retail stores, whether through competition from online sites or other companies, we may decide to close stores, which could result in additional costs, expenses, asset impairments or asset write-downs. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory and personnel. We have also made substantial operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, a decline in sales or the closure or poor performance of individual or multiple stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to direct-to-consumer and mobile channels, and our ability to effectively develop our direct-to-consumer and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position and cash flows. +11 +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are located in shopping malls, and some of our factory outlet stores are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls, and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military events or otherwise, has and is likely to continue to adversely affect sales in our existing stores, particularly those with street locations. The effects of these factors could continue to reduce sales of particular existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +Risks Related to Inventory, Manufacturing and Distribution +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast product demand trends, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Sell Or Manufacture Our Products In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all of our sales during the year ended December 31, 2020, were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; changes in domestic and foreign governmental policies; and there may be circumstances in the future where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers, our gross profit will be negatively affected if we are unable to collect those charges. Apart from the aforementioned impacts of the COVID-19 pandemic, we have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the Communist Party of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate under the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. +12 +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During the year ended December 31, 2020, the top five manufacturers of our products produced approximately 42.1% of our total purchases. One manufacturer accounted for 21.0% of total purchases for the year ended December 31, 2020. +We compete with other footwear companies for production facilities, and we do not have long-term contracts with any of our contract manufacturers. Under our current arrangements with them, these manufacturers generally may unilaterally terminate their relationship with us at any time. If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our footwear is delayed or becomes more expensive, our business and financial condition would be harmed. +While not a material issue as of the filing date of this report, the COVID-19 pandemic previously led to the Chinese and Vietnamese governments imposing temporary closures of some of our factories in China and restrictions on others in Vietnam that caused delays in shipment of our products. We may encounter similar challenges yet again with these manufacturers, or new difficulties could arise with our manufacturers or any raw material suppliers on which our manufacturers rely, including prolonged manufacturing or transportation disruptions due to public health conditions, such as the recent COVID-19 pandemic, reductions in the availability of production capacity due to government imposed restrictions, failure to meet our quality control standards, failure to meet production deadlines or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries or demanding reductions in purchase prices, any of which could have a negative impact on our cash flow and harm our business and results of operations. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistics and distribution systems include computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all of our products are distributed from a few key locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the adverse effects that could be caused by significant disruptions affecting our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +Risks Related to Economic and External Factors +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +While global economic conditions have recently improved slightly, their uncertain state, including the challenging consumer retail market in the U.S., may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending that affect not only the ultimate consumer, but also retailers, who are our primary direct customers. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period of time or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +13 +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Significant Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +As of December 31, 2020, a substantial portion of our operations are located in California, including 110 of our retail stores, our headquarters in Manhattan Beach, and our U.S. distribution center in Rancho Belago. Because a significant portion of our sales is derived from sales in California, a decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake or wildfire affecting California, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Risks Related to Currency and Debt +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for us, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars in which the cost of those products will vary depending on the foreign currency exchange rates and will impact the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency exchange rates. Although we typically work to mitigate the impact of exchange rate fluctuations through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts, as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +We Have Debt And Interest Payment Requirements At Levels That May Restrict Our Future Operations. +As of December 31, 2020 , we had $735.0 million of debt and $250.0 million of additional borrowings available under our unsecured revolving credit facility. In March 2020, as a precautionary measure to maximize liquidity and to increase available cash on hand, we drew down on our unsecured revolving credit facility. Our debt requires us to dedicate cash flow from operations to the payment of interest and principal due under our debt. This dedicated use of cash could impact our ability to successfully compete by, for example: +• increasing our vulnerability to general adverse economic and industry conditions; +• limiting our flexibility in planning for or reacting to changes in our business and the general retail environment; and +• limiting our ability to obtain additional financing required to fund working capital and capital expenditures and for other general corporate purposes. +14 +Risks Related to Legal and Regulatory Matters +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All of our products manufactured overseas and imported into the U.S., the European Union and other countries are subject to customs duties collected by customs authorities. Customs information submitted by us is routinely subject to review by customs authorities. We are unable to predict whether there may be unfavorable changes in tax laws in the U.S. or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Changes to Trade Policy, including New Tariffs Imposed By The U.S. Government, Could Have A Material Adverse Effect On Our Results Of Operations. +Changes in social, political, regulatory and economic conditions or in laws and policies governing trade, manufacturing, development and investment in the countries from which we import our products, or conduct our business, as well as any negative sentiment toward the U.S. as a result of such changes, could adversely affect our business. The U.S. government has placed or proposed additional tariffs on certain goods imported from China and may enact new tariffs on additional goods imported from China, including footwear and other products that we import. China had imposed tariffs on a wide range of American products in retaliation and responded to the new proposed tariff by, among other things, adjusting the value of its currency. China and the U.S. have made progress and are in discussions to finalize a trade agreement, however there is no guarantee that any agreement between the countries will be reached. China could impose additional tariffs or take other actions if the countries are unable to come to an agreement. The majority of our products that we sell in the U.S. are manufactured in China. The U.S. government has also negotiated a replacement trade deal for NAFTA with Mexico and Canada, the U.S.-Mexico-Canada Agreement (the “USMCA”), which still needs to be ratified. There is also a concern that the imposition of additional tariffs by the U.S. could result in the adoption of additional tariffs by other countries as well. If the U.S. government does not reach a trade agreement with China or replaces NAFTA with USMCA, or if additional tariffs or trade restrictions are implemented by the U.S. or other countries in connection with a global trade war, the resulting escalation of trade tensions could have a significant, adverse effect on world trade and the world economy. While it is too early to predict whether or how the recent policy changes will impact our business, the imposition of tariffs on footwear, apparel or other items imported by us from China could require us to increase prices to our customers or, if unable to do so, result in lowering our gross margin on products sold. Tariffs on footwear imported from China could have a material adverse effect on our business and results of operations. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the U.S., it could result in adverse publicity for us, damage our reputation in the U.S., or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the +15 +outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +Risks Related to Management and Employees +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +We Have A Significant Work Force And Are Subject To Risks Related To Human Capital Management. +As of December 31, 2020, we employee over 11,500 employees worldwide. A significant portion of our operating expenses relate to compensation and benefits, and we spend significant time and effort managing these employees. We cannot ensure that we will be able to maintain a happy and productive workforce. Some of our employees may take actions that harm our business or we may face other issues with our employees, such as retention. Although we spend a significant amount of time and expense on human capital management, we cannot ensure that these efforts will be successful. +Risks Related to Intellectual Property and Information Technology +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all of our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers GOtrain ® , Skechers on-the-GO ® , ® , ® , ® , , Skechers Cali ® , Skecher Street ® , Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Skechers Max Cushioning™, Mark Nason ® , D’Lites ® , DLT-A ® , BOBS ® , Energy Lights ® , Glide Step™, Skech-Air ® , Twinkle Toes ® , Z-Strap ® , Mega-Flex ® , Luminators ® , Heart Lights ™ , Relaxed Fit ® , Arch Fit ™ , Ultra GO ® , Hyper Burst ® , Skechers Memory Foam ™ , and Air-cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and a limited number of utility patents covering components and features used in various shoes. We believe that our patents and trademarks are generally sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, each of which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the U.S. We cannot be assured that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of counterfeit products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +16 +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, in particular, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +Risks Related to Our Stock and Stock Price +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts, may and have canceled orders in the past, and may change delivery schedules or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In addition, sales of footwear products have historically been somewhat seasonal in nature, with the strongest domestic sales generally occurring in our second and third quarters for the back-to-school selling season. Domestic back-to-school sales typically ship in June, July and August, and delays in the timing, cancellation, or rescheduling of these customer orders and shipments by our wholesale customers could negatively impact our sales and results of operations for our second or third quarters. More specifically, the timing of when product ships is determined by the delivery schedules set by our wholesale customers, which could cause sales to shift between our second and third quarters. Because our expense levels are partially based on our expectations of future sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter, and it is highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in our annualized tax rate that may occur could have a material impact on our quarterly operating results. As a result of these specific and other general factors, our operating results will likely vary from quarter to quarter, and the results for any particular quarter may not be necessarily indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +One Principal Stockholder Is Able To Substantially Control All Matters Requiring Approval By Our Stockholders And Another Stockholder Is Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2020, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 86.5% of our outstanding Class B Common Stock, members of Mr. Greenberg’s immediate family beneficially owned an additional +17 +7.9% of our outstanding Class B Common Stock, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 29.8% of our outstanding Class B Common Stock. The holders of Class A Common Stock and Class B Common Stock have identical rights except that holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2020 , Mr. Greenberg beneficially owned 37.6% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 43.4% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 18.0% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A Common Stock . Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to substantially control or significantly influence, respectively, actions requiring stockholder approval, may result in the C ompany taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A Common Stock to the extent that investors or any potential future purchaser view the superior voting rights of our Class B Common Stock to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Manhattan Beach, California, which consist of an aggregate of approximately 204,000 square feet. We own and lease portions of our corporate headquarters. +Our North American distribution center occupies approximately 2.8 million square feet in southern California. The majority of this distribution center is leased from a joint venture, HF Logistics-SKX (the “JV”), that we formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility. The leases provide for terms expiring in November 2031 with a small portion set to expire in early 2026. The JV is consolidated in our financial statements. +Our European distribution center occupies approximately 1.8 million square feet in Liege, Belgium under operating leases. These leases provide for original terms of 10 to 15 years, commencing between January 2016 and June 2016, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +All of our domestic retail stores and showrooms are leased with terms expiring through January 2033. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. +We lease most of our international administrative offices, retail stores, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates through October 2033. +18 +ITEM 3. +LEGAL PROCEEDINGS +Converse, Inc. v. Skechers U.S.A., Inc. – On October 14, 2014, Converse filed an action against the Company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and deceptive practices arising out of our alleged use of certain design elements on footwear. The complaint seeks, among other things, injunctive relief, profits, actual damages, enhanced damages, punitive damages, costs and attorneys’ fees. On October 14, 2014, Converse also filed a complaint naming 27 respondents including the Company with the U.S. International Trade Commission (the “ITC” or “Commission”), Federal Register Doc. 2014‑24890, alleging violations of federal law in the importation into and the sale within the United States of certain footwear. Converse has requested that the Commission issue a general exclusion order, or in the alternative a limited exclusion order, and cease and desist orders. On December 8, 2014, the District Court stayed the proceedings before it. On December 19, 2014, Skechers responded to the ITC complaint, denying the material allegations and asserting affirmative defenses. A trial before an administrative law judge of the ITC was held in August 2015. On November 15, 2015, the ITC judge issued his Initial Determination finding that certain discontinued products (Daddy’$ Money and HyDee HyTops) infringed on Converse’s intellectual property, but that other, still active product lines (Twinkle Toes and Bobs Utopia) did not. On February 3, 2016, the ITC decided that it would review in part certain matters that were decided by the ITC judge. On June 28, 2016, the full ITC issued its Final Determination affirming that Skechers Twinkle Toes and Bobs Utopia shoes do not infringe Converse’s Chuck Taylor Midsole Trademark and affirming that Converse’s common law trademark was invalid. The full ITC also invalidated Converse’s registered trademark. Converse appealed this decision to the United States Court of Appeals for the Federal Circuit. On January 27, 2017, Converse filed its appellate brief but did not contest the portion of the decision that held that Skechers Twinkle Toes and Bobs Utopia shoes do not infringe. On June 26, 2017 we filed our responsive brief, on February 8, 2018 the court heard oral argument, and on June 7, 2018 the court requested supplemental briefing on certain issues. On October 30, 2018, the United States Court of Appeals for the Federal Circuit vacated portions of the ITC’s ruling and remanded the matter back to the ITC for further proceedings. Although Converse did not appeal the Commission’s non-infringement findings for Skechers Twinkle Toes and Bobs Utopia shoes to the Federal Circuit, Converse asked the Commission to reconsider its previous non-infringement findings on remand. On October 9, 2019, the ITC judge issued his Remand Initial Determination (the “RID”) finding that Converse did not have any rights in the subject intellectual property as to Skechers, and that Skechers Twinkle Toes, Bobs Utopia, and Hydee Hytop did not infringe Converse’s intellectual property but the discontinued Daddy’$ Money would infringe, but only if Converse had rights in the subject intellectual property as to Skechers (which the ITC judge found that Converse did not). On October 22, 2019, the parties filed petitions seeking review of the RID. Converse did not, however, seek review of the finding in the RID that Skechers Twinkle Toes and Bobs Utopia do not infringe. On February 7, 2020, the full Commission decided to review the RID and outlined the issues it wanted briefed. The parties subsequently filed briefs on those issues and, on September 9, 2020, the full Commission issued its decision. In that decision, the Commission found that, although Converse had demonstrated enforceable rights in its Chuck Taylor Midsole Trademark, it had not proven that the Skechers Twinkle Toes, Bobs Utopia or Hydee Hytops infringe those rights, or otherwise established a violation of the applicable federal statutes by Skechers. The time for Nike to appeal the Commission’s decision to the United States Court of Appeal for the Federal Circuit has expired and the ITC matter in now concluded. The federal court action that Nike filed in New York, which was stayed pending the outcome of the ITC proceedings, remains pending. While it is too early to predict the outcome of these legal proceedings or whether an adverse result in either or both of them would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend these legal matters vigorously. +Nike, Inc. v. Skechers USA, Inc. – On January 4, 2016, Nike filed an action against the Company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. In April and May 2016, we filed petitions with the United States Patent and Trademark Office’s Patent Trial and Appeal Board (the “PTAB”) for inter partes review of all eight design patents, seeking to invalidate those patents. In September and November 2016, the PTAB denied each of our petitions. On January 6, 2017, we filed several additional petitions for inter partes review with the PTAB, seeking to invalidate seven of the eight designs patents that Nike is asserting. In July 2017, we were notified that the PTAB granted our petitions and instituted inter partes review proceedings with respect to two of the seven design patents but denied our petitions as to the others. In June 2017, we filed a motion to transfer venue from the District of Oregon to the Central District of California based on a recent United States Supreme Court decision and the motion was granted on November 17, 2017. On June 28, 2018, the PTAB issued final decisions in the two inter partes review proceedings, rejecting the invalidity challenges made by the Company in those proceedings. On June 4, 2018, the court, over Nike’s opposition, granted our request for a claim construction hearing. On March 28, 2019, the court issued an order declining to issue a claim construction at this stage of the proceedings, but it did not foreclose the issue, instead observing that it might be appropriate to address claim construction at a later stage. The parties have now completed discovery and have filed summary judgement motions. Nike has also withdrawn its claim for treble or enhanced damages. The summary judgment motions were heard on February 18, 2020, and on October 27, 2020, the Court issued its ruling. The court granted Skechers’ motion for summary judgment of non-infringement as to three of the eight design patents at issue. The court, however, concluded that whether Skechers had infringed any of the five remaining design patents presented issues for a jury to resolve. The court also denied Nike’s motion for summary judgment of validity as to the five remaining design patents, holding that Skechers’ invalidity challenges had to be resolved by the jury. While it is too early to predict the outcome +19 +of the case or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc. v. Skechers USA, Inc. – On September 30, 2019, Nike filed an action against our company in the United States District Court for the Central District of California, Case No. 2:19-cv-08418, alleging that certain Skechers’ shoe designs (Skech-Air Atlas, Skech-Air 92, Skech-Air Stratus and Skech-Air Blast) infringe the claims of twelve design patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. Skechers has filed its answer and the case is in the early stages. While it is too early to predict the outcome of the case or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Nike, Inc. v. Skechers USA, Inc. – On October 28, 2019, Nike filed an action against the Company in the United States District Court for the Central District of California, Case No. 2:19-cv-09230, alleging that certain Skechers’ shoe designs (Skech-Air Jumpin’ Dots and Skech-Air Mega) infringe the claims of two utility patents. Nike seeks injunctive relief, disgorgement of Skechers’ profits, damages (including treble damages), pre-judgment and post-judgment interest, attorneys’ fees, and costs. Skechers has answered the complaint and the case is in the early stages. While it is too early to predict the outcome of the case or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this legal matter vigorously. +Ealeen Wilk v. Skechers U.S.A., Inc . – On September 10, 2018, Ealeen Wilk filed a putative class action lawsuit against the Company in the United States District Court for the Central District of California, Case No. 5:18-cv-01921, alleging violations of the California Labor Code, including unpaid overtime, unpaid wages due upon termination and unfair business practices. The complaint seeks actual, compensatory, special and general damages; penalties and liquidated damages; restitutionary and injunctive relief; attorneys’ fees and costs; and interest as permitted by law. On July 5, 2019, the court granted, in part, plaintiff’s motion for conditional certification of a Fair Labor Standards Act (FLSA) collective action. On July 22, 2019, the parties submitted to the court an agreed upon notice to be sent to members of the collective. The parties are delaying the mailing of the Belaire-West privacy opt out notice until after mediation. The parties have agreed to an informal stay of discovery and have stipulated to continue all relevant discovery and motion deadlines accordingly. The parties reached a settlement in principle as a result of a January 27, 2020 mediation but the details of the settlement still need to be worked out and the settlement has to be documented. In the event the settlement is not concluded successfully, it is too early to predict the outcome of the litigation or a reasonable range of potential losses and whether an adverse result would have a material adverse impact on our results of operations or financial position, we believe that we have meritorious defenses, vehemently deny the allegations, and intend to defend the case vigorously. +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against the Company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +20 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades under the symbol “SKX” on the New York Stock Exchange. +HOLDERS +As of February 15, 2021, there were 86 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 27 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +ISSUER PURCHASES OF EQUITY SECURITIES +No shares of our Class A Common Stock were repurchased during the three months ended December 31, 2020. Our $150.0 million share repurchase program expired on February 6, 2021. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2015 to December 31, 2020, relative to the performance of the Russell 2000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. The peer group index consists of six companies: Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +The graph assumes an investment of $100 on December 31, 2015 in each of our Class A Common Stock, the Russell 2000 Index and the customized peer group index. Each of the indices assumes that all dividends were reinvested. The stock performance of our Class A Common Stock shown on the graph is not necessarily indicative of future performance. We will neither make nor endorse any predictions as to our future stock performance. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +2015 +2016 +2017 +2018 +2019 +2020 +Skechers U.S.A., Inc. +100.00 +81.36 +125.26 +75.77 +142.97 +118.97 +Russell 2000 +100.00 +121.31 +139.08 +123.76 +155.35 +186.36 +Peer Group +100.00 +99.06 +125.55 +146.21 +209.01 +273.39 +21 +ITEM 6. +SELECTED FINANCIAL DATA +The following tables set forth the Company’s selected consolidated financial data as of and for each of the years in the five-year period ended December 31, 2020 and should be read in conjunction with our audited consolidated financial statements and notes thereto included under Part II, Item 8 of this annual report. +For the Year Ended December 31, +(in thousands, except per share data) +2020 +2019 +2018 +2017 +2016 +Sales (1) +$ +4,597,414 +$ +5,220,051 +$ +4,642,068 +$ +4,164,160 +$ +3,563,311 +Gross profit +2,189,781 +2,491,157 +2,223,605 +1,938,889 +1,634,596 +Earnings from operations +133,684 +518,443 +437,765 +382,880 +370,518 +Earnings before income taxes +154,729 +516,005 +431,884 +384,260 +359,484 +Net earnings attributable to Skechers U.S.A., Inc. +98,564 +346,560 +301,041 +179,190 +243,493 +Net earnings per share: +Basic +$ +0.64 +$ +2.26 +$ +1.93 +$ +1.15 +$ +1.58 +Diluted +$ +0.64 +$ +2.25 +$ +1.92 +$ +1.14 +$ +1.57 +Weighted-average shares: +Basic +154,184 +153,392 +155,815 +155,651 +154,169 +Diluted +154,894 +154,151 +156,450 +156,523 +155,084 +(1 ) +Results for reporting periods beginning after January 1, 2018 are presented under Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic revenue recognition methodology under ASC 605, Revenue Recognition. +As of December 31, +(in thousands) +2020 +2019 +2018 +2017 +2016 +Working capital +$ +2,131,645 +$ +1,581,360 +$ +1,621,918 +$ +1,507,676 +$ +1,206,036 +Total assets +5,812,369 +4,892,943 +3,228,255 +2,735,082 +2,393,670 +Long-term borrowings, excluding current installments +679,415 +49,183 +88,119 +71,103 +67,159 +Skechers U.S.A., Inc. equity +2,481,435 +2,314,665 +2,034,958 +1,829,064 +1,603,633 +22 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. +This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 201 9 filed with the SEC on February 28, 2020 . +OVERVIEW +The COVID-19 pandemic continues to impact various markets and business channels. After we temporarily closed our stores around the world and temporarily furloughed a meaningful portion of our hourly workforce in March 2020, we saw meaningful improvements during the second half of 2020 including a return to growth in many markets. Although the recovery has progressed at a different pace across countries, we remain confident in our actions and strength of the brand. Consumers have gravitated towards comfort in their lives as people are predominately working from home and increasingly focused on their well-being. We believe the actions we have taken and the strength of our brand positions Skechers well as the global recovery continues. +We continue to invest for growth, with a focus on our direct-to-consumer capabilities and global infrastructure. +• +To further enhance our consumer shopping experience, we began implementing a new point of sale system in our domestic retail locations, introduced a new website and mobile application suite, and made enhancements to our omnichannel capabilities, including introducing features like buy online pick up in store and buy online pick up curb-side. +• +We completed the expansion of our European distribution center in July 2020 and opened a new distribution center in Colombia. +• +Our new China distribution center remains on-track and we opened a new United Kingdom based distribution center. +• +Development continued on our North American distribution center expansion. +• +During 2020, we opened 67 company-owned stores, 142 joint venture stores and 430 third-party Skechers stores globally. +RESULTS OF OPERATIONS +We have three reportable segments – Domestic Wholesale, International Wholesale, and Direct-to-Consumer, which includes results from both our retail store and e-commerce channels. We evaluate segment performance based primarily on sales and gross margin. +The following table sets forth, for the periods indicated, selected information from our results of operations: +Year Ended December 31, +(in thousands) +2020 +2019 +Sales +$ +4,597,414 +$ +5,220,051 +Cost of sales +2,407,633 +2,728,894 +Gross profit +2,189,781 +47.6 +% +2,491,157 +47.7 +% +Royalty income +16,017 +22,493 +2,205,798 +2,513,650 +Operating expenses: +Selling +318,097 +369,901 +General and administrative +1,754,017 +1,625,306 +2,072,114 +1,995,207 +Earnings from operations +133,684 +518,443 +Interest income +5,912 +11,782 +Interest expense +(16,327 +) +(7,509 +) +Other, net +31,460 +(6,711 +) +Earnings before income tax expense +154,729 +516,005 +Income tax expense +8,502 +88,753 +Net earnings +146,227 +427,252 +Less: Net earnings attributable to noncontrolling interests +47,663 +80,692 +Net earnings attributable to Skechers U.S.A., Inc. +$ +98,564 +$ +346,560 +23 +Sales +Sales for 2020 were $4.6 billion, a decrease of $0.6 billion, or 11.9%, compared to sales of $5.2 billion for 2019 reflecting the impact of the global pandemic on our businesses worldwide. The decrease is a result of a 12.9% decrease in our domestic business and an 11.2% decrease internationally. Our Domestic Wholesale segment sales decreased 9.7%, International Wholesale segment sales decreased 8.3% and Direct-to-Consumer segment sales decreased 19.7%. +Gross profit +Gross profit for 2020 decreased $0.3 billion to $2.2 billion as compared to $2.5 billion for 2019 due to the decline in sales. Gross margin remained relatively flat with the prior year at 47.6% with increases of 160 basis points in Domestic Wholesale and 101 basis points in Direct-to-Consumer, offset by a decrease of 71 basis points in International Wholesale. +Selling expenses +Selling expenses decreased by $51.8 million, or 14.0%, to $318.1 million for 2020 from $369.9 million for 2019. As a percentage of sales, selling expenses were 6.9% and 7.1% for 2020 and 2019, respectively. The decrease in selling expenses was primarily due to lower worldwide spending on advertising and marketing, and trade shows of $48.4 million. +General and administrative expenses +General and administrative expenses increased by $128.7 million, or 7.9%, primarily driven by increased domestic and international warehouse and distribution expenses of $64.3 million, increased depreciation and amortization expense of $31.7 million from fixed asset additions and the Skechers Mexico acquisition, and increased stock compensation of $24.2 million which included a one-time $18.2 million non-cash, equity compensation charge associated with a legal settlement. +Other income (expense) +Interest income decreased $5.9 million to $5.9 million for 2020 as compared to $11.8 million for 2019. The decrease in interest income was due primarily due to lower average interest rates. Interest expense increased $8.8 million due to additional borrowings under our credit facility. Other income increased $38.2 million primarily due to purchase price adjustments from the acquisition of Skechers Mexico and foreign exchange gains. +Income taxes +Income tax expense and the effective tax rate were as follows: +Year Ended December 31, +(in thousands) +2020 +2019 +Income tax expense +$ +8,502 +$ +88,753 +Effective tax rate +5.5 +% +17.2 +% +Our provision for income tax expense and effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (losses) before income taxes. In the foreign jurisdictions in which we have operations, the applicable statutory rates range from 0.0% to 34.0%, which on average are generally significantly lower than the U.S. federal and state combined statutory rate of approximately 25%. The decrease in the effective tax rate in 2020 was primarily due to changes in the ownership structure of our international operations and related benefits provided by the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. +See Note 10 – Income Taxes of the Consolidated Financial Statements for additional information. +Noncontrolling interest in net income and loss of consolidated subsidiaries +Net earnings attributable to noncontrolling interest for 2020 decreased $33.0 million to $47.7 million as compared to $80.7 million for 2019 attributable to decreased profitability by our joint ventures due to the impacts of the COVID-19 pandemic. Noncontrolling interest represents the share of net earnings or loss that is attributable to our joint venture partners. +RESULTS OF SEGMENT OPERATIONS +Domestic Wholesale +Year Ended December 31, +(in thousands) +2020 +2019 +Sales +$ +1,126,564 +$ +1,247,550 +Gross profit +431,603 +457,944 +Gross margin +38.3 +% +36.7 +% +Domestic Wholesale sales decreased $0.1 billion, or 9.7%, to $1.1 billion for 2020 from $1.2 billion for 2019. Sales volume decrease was driven by a 12.4% reduction in the number of pairs sold, partially offset by a 1.0% increase in average price per pair. Sales volume decreased to 50.0 million pairs sold from 57.0 million. The average price per pair increased to $21.88 from $21.67. +24 +Domestic W holesale gross profit decrease d $ 26.3 million, or 5.8% , to $ 431.6 million for 2020 compared to $ 457.9 million for 2019 . Domestic W holesale gross margin increase d 160 basis points to 38.3% primarily driven by lower product costs and the aforementioned increase in average price per pair. +International Wholesale +Year Ended December 31, +(in thousands) +2020 +2019 +Sales +$ +2,257,846 +$ +2,462,632 +Gross profit +1,023,183 +1,133,573 +Gross margin +45.3 +% +46.0 +% +International Wholesale sales decreased $0.2 billion, or 8.3%, to $2.3 billion for 2020 compared to sales of $2.5 billion for 2019. Our distributor sales decreased to $239.1 million, a decrease of $176.3 million or 42.4% and direct sales by our foreign subsidiaries and joint ventures, were $2.0 billion, flat to the prior year. The number of units sold decreased 6.7% and the average selling price decreased by 1.8%. +International Wholesale gross profit decreased $0.1 billion, or 9.7%, to $1.0 billion for 2020 as compared to $1.1 billion for 2019. International Wholesale gross margin decreased 71 basis points to 45.3% as a result of higher promotional activity for our joint ventures as well as a non-cash, cost of goods purchase price adjustment related to the acquisition of Skechers Mexico. +Direct-to-Consumer +Year Ended December 31, +(in thousands) +2020 +2019 +Sales +$ +1,213,004 +$ +1,509,869 +Gross profit +734,995 +899,640 +Gross margin +60.6 +% +59.6 +% +Direct-to-Consumer sales decreased $0.3 billion, or 19.7%, to $1.2 billion for 2020 as compared to sales of $1.5 billion for 2019. Declines were driven by lower domestic and international retail sales during temporary store closures and reduced operating hours as a result of the COVID-19 pandemic, partially offset by a 211.9% increase in domestic e-commerce sales. Direct-to-Consumer comparable same store sales decreased 24.0% for 2020, including decreases of 20.3% domestically and 32.2% internationally. Volume decreased due to a 21.5% reduction in the number of units sold, partially offset by a 2.3% increase in the average selling price. +Direct-to-Consumer gross profit decreased $164.6 million, or 18.3%, to $735.0 million for 2020 as compared to $899.6 million for 2019. Direct-to-Consumer gross margin increased 101 basis points to 60.6% due to a favorable mix of e-commerce sales which have higher overall margins. +Comparable store sales mentioned above includes stores that have been opened for at least thirteen calendar months as well as sales on our company-owned websites. We did not make any adjustments for the effects of the COVID-19 pandemic and the related impacts of store closures and reduced operating hours. Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +LIQUIDITY AND CAPITAL RESOURCES +Liquidity outlook +Our liquidity remains ample and we believe we are well-positioned to endure the environment associated with the COVID-19 pandemic. We have taken actions to preserve our liquidity and manage our cash flow. As a precautionary measure, in March 2020, we borrowed against our unsecured revolving credit facility. At December 31, 2020, we have unused credit capacity of $8.8 million along with an additional $250.0 million available through an accordion feature on the unsecured revolving credit facility. We continue to partner with our vendors, landlords, and lenders to maximize our liquidity and mitigate cash flow risk. We believe that anticipated cash flows from operations, existing cash and investments balances, available borrowings under our credit agreement, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements for the next twelve months. +As of December 31, 2020, we had approximately $1.37 billion in cash and cash equivalents, of which $735.1 million, or 53.6%, was held outside the U.S. Of the $735.1 million held by its non-U.S. subsidiaries, approximately $405.2 million is available for repatriation to the U.S. without incurring U.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in the Company’s consolidated financial statements as of December 31, 2020. +25 +Cash Flows +Our working capital at December 31, 2020 was $2.1 billion, an increase of $0.5 billion from working capital of $1.6 billion at December 31, 2019. Our cash and cash equivalents at December 31, 2020 were $1.4 billion, compared to $824.9 million at December 31, 2019. Our primary sources of operating cash are collections from customers on wholesale and direct-to-consumer sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $331.5 million for 2020 and $426.6 million for 2019. On a comparative year‑to‑year basis, the $95.1 million decrease in cash flows from operating activities in 2020 primarily resulted from reduced net earnings of $281.0 million. +Investing Activities +Net cash used in investing activities was $312.5 million for 2020 as compared to $344.1 million for 2019. The $31.6 million decrease was primarily due to the 2019 acquisition of Skechers Mexico of $100.7 million partially offset by an increase in capital expenditures of $73.8 million . Capital expenditures for 2020 were approximately $309.9 million, which consisted of $122.0 million to support our worldwide distribution capabilities, $67.9 million was related to the acquisition of a corporate office building and new retail stores in China, and $59.8 million for retail stores and e-commerce investments worldwide, excluding China. Capital expenditures for 2019 were approximately $236.1 million, of which $72.6 million supported our worldwide distribution capabilities, $51.9 million related to retail stores worldwide, and $33.8 million to support our international wholesale operations. We expect our ongoing capital expenditures for 2021 to be approximately $275.0 million to $325.0 million, which is primarily related to the expansion of our worldwide distribution capabilities, continued investments in retail and e-commerce technologies and stores, and our new corporate offices in California. We expect to fund ongoing capital expenses through a combination of borrowings and available cash. +Financing Activities +Net cash provided by financing activities was $533.3 million during 2020 compared to $132.0 million net cash used during 2019. The change of $665.3 million is primarily net long-term borrowings of $616.6 million, which includes $452.5 million on our unsecured revolving credit facility. +Capital Resources and Prospective Capital Requirements +Financing Arrangements +As of December 31, 2020, outstanding short-term and long-term borrowings were $735.0 million, of which $452.5 million relates to our unsecured revolving credit facility, $229.2 million relates to loans for our domestic and China distribution centers, $48.7 million relates to our operations in China and the remainder relates to our international operations. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. See Note 6 – Financial Commitments of the Consolidated Financial Statements for additional information. +Disclosure about Contractual Obligations and Commercial Commitments +The following table summarizes our material contractual obligations and commercial commitments as of December 31, 2020: +(in thousands) +Total +Less than +One +Year +One to +Three +Years +Three to +Five +Years +More Than +Five +Years +Borrowings (1) +$ +737,680 +$ +56,638 +$ +64,615 +$ +616,427 +$ +— +Operating leases +1,437,927 +254,674 +429,356 +353,636 +400,261 +Purchase obligations (2) +1,359,414 +1,359,414 +— +— +— +Warehouse and equipment and corporate construction (3) +583,206 +239,000 +344,206 +— +— +Minimum payments related to other arrangements +43,180 +26,065 +17,115 +— +— +Total (4) +$ +4,161,407 +$ +1,935,791 +$ +855,292 +$ +970,063 +$ +400,261 +(1) +Borrowings include anticipated interest payments based on interest rates currently in effect. +(2) +Purchase obligations include the following: (i) accounts payable balances for the purchase of footwear of $210.1 million, (ii) outstanding letters of credit of $38.7 million and (iii) open purchase commitments with our foreign manufacturers for $1.1 billion. +( 3 ) +Obligations to support upgrades for our distribution centers and corporate facilities in Manhattan Beach, California. +( 4 ) +Our consolidated balance sheet, as of December 31, 2020, included $21.5 million in unrecognized tax benefits. Future payments related to these unrecognized tax benefits have not been presented in the table above, due to the uncertainty of the amounts, the potential timing of cash settlements with the tax authorities, and uncertainty whether any settlement would occur. +26 +OFF-BALANCE SHEET ARRANGEMENTS +We are required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the consolidated balance sheets. Outstanding letters of credit totaled approximately $38.7 million as of December 31, 2020. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements. +Revenue Recognition. We derive income primarily from the sale of footwear and royalties earned from licensing the Skechers brand. We recognize revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We recognize revenue on wholesale sales upon shipment. We generate direct-to-consumer revenues primarily from the sale of footwear to customers at retail locations or through our websites. For our in-store sales, we recognize revenue at the point of sale. For sales made through our websites, we recognize revenue upon shipment to the customer. Sales and value added taxes collected from direct-to-consumer customers are excluded from reported revenues. +We accrue a liability for product returns at the time of sale based on our historical experience. We also accrue amounts for goods expected to be returned in salable condition. +We earn royalty income from symbolic licensing arrangements based on third-party sales of Skechers-branded product. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to us or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. We calculate and accrue estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales. +Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and direct-to-consumer receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. +We reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory write-downs . Inventory is stated at the lower of cost or market (net realizable value). We review our inventory for excess and slow-moving inventory. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value is determined based on historical sales experience on a style-by-style basis. +Impairment of long-lived assets . When circumstances warrant, we test for recoverability of the asset groups’ carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. +If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. We base the useful lives and related amortization or depreciation expense on our estimate of the +27 +period that the assets will generate revenues or otherwise be used by us. We review all of our stores for impairment annually or more frequently if events or changes in circumstances require it. We prepare a summary of cash flows for each of our retail stores, to assess potential impairment of the fixed assets and leasehold improvements. Stores with negative cash flows which have been open in excess of twenty-four months are then reviewed in detail to determine whether impairment exists. Management reviews both quantitative and qualitative factors to assess whether a triggering event occurred. We did not record a material impairment charge f or the years ended December 31, 2020 , 2019 and 2018 . +Goodwill. The Company tests goodwill for impairment annually for each reporting unit in the fourth quarter of the fiscal year, and between annual tests if events occur or circumstances change which suggest that goodwill should be reevaluated. Such events or circumstances include significant changes in historical financial performance, macroeconomic and industry conditions and the legal and regulatory environment. The Domestic Wholesale, International Wholesale and Direct-to-Consumer segments each represent a reporting unit. The Company performed its annual impairment test using a qualitative approach to determine whether conditions existed to indicate that it was more likely than not that the fair value of goodwill was less than its carrying value. Based on this assessment, the Company concluded that it was more likely than not that the fair value of goodwill was greater than its carrying values, and therefore a quantitative analysis, involving the calculation of an estimated fair value of each reporting unit based on projected future cash flows and comparing the estimated fair values of the reporting units to their carrying amounts, was not required. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates and valuation of deferred income taxes . We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may impact our cost of goods in the future. During 2020 and 2019, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +28 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. Changes in interest rates and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2020, we have $55.5 million and $679.4 million of outstanding short-term and long-term borrowings, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by approximately $12.1 million for the year ended December 31, 2020. We do not expect changes in interest rates to have a material impact on our financial condition or results of operations or cash flows during the remainder of 2021. The interest rate charged on our unsecured revolving credit facility is based on LIBOR, our domestic distribution center loan is based on the one month LIBOR, and our China distribution center and China operational loans are based on a reference rate provided by the People’s Bank of China. Changes in these interest rates will have an effect on the interest charged on outstanding balances. +We may enter into derivative financial instruments such as interest rate swaps in order to limit our interest rate risk on our long-term debt. We had one derivative instrument in place as of December 31, 2020 to hedge the cash flows on our $129.5 million variable rate debt on our domestic distribution center. This instrument was a variable to fixed derivative with a notional amount of $129.5 million at December 31, 2020. Our receive rate was one-month LIBOR and the average pay rate was 0.795%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest payments. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have an impact on the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. +Assets and liabilities outside the U.S. are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation gain of $2.7 million and $1.5 million, for the years ended December 31, 2020 and 2019, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2020 would have reduced the values of our net investments by approximately $61.5 million. +29 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +31 +CONSOLIDATED BALANCE SHEETS +33 +CONSOLIDATED STATEMENTS OF EARNINGS +34 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +35 +CONSOLIDATED STATEMENTS OF EQUITY +36 +CONSOLIDATED STATEMENTS OF CASH FLOWS +37 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +38 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +59 +30 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 , in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 26, 2021 expressed an unqualified opinion thereon. +Change in Accounting Method Related to Leases +As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for leases during the year ended December 31, 2019 due to the adoption of the Accounting Standards Codification (“ASC”) 842, Leases (“ASC 842”). +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Accounting for Leases +As described in Note 3 to the Company’s consolidated financial statements, as of December 31, 2020, the Company’s operating lease right-of-use asset was $1,171.5 million and the operating lease liability was $1,269.4 million. The Company operates in the United States and various foreign countries and continues to expand its operations. The Company continues to execute new lease contracts and negotiate extensions and amendments of existing lease contracts. +We identified the accounting for leases under ASC 842 as a critical audit matter. The Company’s lease processes include the following: (i) ensuring the completeness of new leases, lease extensions and amendments, and (ii) assessment of incremental borrowing rates for each lease. Auditing these elements involved especially challenging auditor judgment and audit effort due to the +31 +significant number of leases that are disaggregated in various countries and the specialized skills and knowledge needed to assess the reasonableness of the incremental borrowing rates. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) the completeness and accuracy of newly executed lease contracts, extensions, and amendments to existing lease contracts, and (ii) the determination of the incremental borrowing rates. +• +Testing the appropriateness of the calculation of the right-of-use asset balance, operating lease liability and a corresponding amortization expense for a sample of new, extended or amended lease contracts. +• +Testing the completeness and accuracy of lease contracts included in the lease system module. +• +Utilizing personnel with specialized knowledge and skill in valuation to assist in assessing the reasonableness of the Company’s incremental borrowing rates.   +Accounting for Income Taxes +As described in Note 10 to the Company’s consolidated financial statements, the Company’s total tax expense for the fiscal year ended December 31, 2020 was $8.5 million, of which $32.3 million represented U.S. Federal tax benefit, $0.8 million represented U.S. State tax expense, and the remaining $40.0 million represented foreign tax expense. The Company operates in multiple jurisdictions worldwide through its wholly-owned subsidiaries and several joint ventures. During the current reporting period, the Company implemented changes in the ownership structure of its international operations. +We identified accounting for the Company’s income tax provision as a critical audit matter. The Company’s tax provision processes include the following: (i) reporting and data accumulation from multiple foreign jurisdictions, (ii) evaluation of potential impact of recent changes in regulations and tax laws in the United States and various foreign jurisdictions, (iii) evaluation of assumptions in the Company’s assessment of deferred tax assets and liabilities and related tax reserves, (iv) development of complex assumptions used in transfer pricing studies and related determinations, (v) assessment of repatriation of foreign earnings and cash balances, and (vi) implementation of changes in the ownership structure of its international operations. Auditing these elements involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) completeness and accuracy of reporting and data accumulation from multiple foreign jurisdictions, (ii) potential implications of recent changes in regulations and tax laws in various foreign jurisdictions, (iii) reasonableness of assumptions used in tax reserves, transfer pricing studies and repatriation of foreign earnings and cash balances, and (iv) implementation of changes in the ownership structure of its international operations. +• +Evaluating management’s computation of deferred tax assets and liabilities and assessing the reasonableness of assumptions used in the Company’s tax reserves for certain significant jurisdictions. +• +Testing mathematical accuracy and computation of the tax provision and agreeing to relevant source documents. +• +Utilizing personnel with specialized skill and knowledge in transfer pricing to assist in evaluating the reasonableness of the Company’s assumptions, inputs and overall conclusions reached related to transfer pricing studies over inter-company transactions. +• +Utilizing personnel with specialized skill and knowledge in domestic and foreign taxes to assist in i) evaluating the reasonableness of the Company’s assumptions, inputs and methods used to estimate certain tax reserves, (ii) evaluating the application of new and updated regulatory and legislative guidance and tax laws in various jurisdictions, (iii) assessing the implementation of changes in the ownership structure of its international operations, and (iv) assessing the appropriateness of conclusions reached related to foreign earnings repatriations. +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +February 26, 2021 +32 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +As of December 31, +(in thousands, except par values) +2020 +2019 +ASSETS +Current assets: +Cash and cash equivalents +$ +1,370,826 +$ +824,876 +Short-term investments +100,767 +112,037 +Trade accounts receivable, less allowances of $ 48,562 and $ 24,106 +619,800 +645,303 +Other receivables +69,222 +53,932 +Total receivables +689,022 +699,235 +Inventory +1,016,774 +1,069,863 +Prepaid expenses and other current assets +166,962 +113,580 +Total current assets ($ 862,954 and $ 752,965 related to VIEs) +3,344,351 +2,819,591 +Property, plant and equipment, net +935,441 +738,925 +Operating lease right-of-use assets +1,171,521 +1,073,660 +Deferred tax assets +63,884 +49,088 +Long-term investments +108,412 +94,589 +Goodwill +93,497 +71,412 +Other assets, net +95,263 +45,678 +Total non-current assets ($ 682,068 and $ 429,810 related to VIEs) +2,468,018 +2,073,352 +TOTAL ASSETS +$ +5,812,369 +$ +4,892,943 +LIABILITIES AND EQUITY +Current liabilities: +Current installments of long-term borrowings +$ +52,250 +$ +66,234 +Short-term borrowings +3,297 +5,789 +Accounts payable +744,077 +764,844 +Operating lease liabilities +204,370 +191,129 +Accrued expenses +208,712 +210,235 +Total current liabilities ($ 526,466 and $ 494,882 related to VIEs) +1,212,706 +1,238,231 +Long-term borrowings, excluding current installments +679,415 +49,183 +Long-term operating lease liabilities +1,065,069 +966,011 +Deferred tax liabilities +11,439 +322 +Other long-term liabilities +118,077 +103,089 +Total non-current liabilities ($ 365,235 and $ 136,912 related to VIEs) +1,874,000 +1,118,605 +Total liabilities +3,086,706 +2,356,836 +Commitments and contingencies (Note 7) +Stockholders’ equity: +Preferred Stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; +133,618 and 131,071 shares issued and outstanding +134 +131 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; +21,016 and 22,408 shares issued and outstanding +21 +22 +Additional paid-in capital +372,165 +306,669 +Accumulated other comprehensive loss +( 27,285 +) +( 29,993 +) +Retained earnings +2,136,400 +2,037,836 +Skechers U.S.A., Inc. equity +2,481,435 +2,314,665 +Noncontrolling interests +244,228 +221,442 +Total stockholders' equity +2,725,663 +2,536,107 +TOTAL LIABILITIES AND EQUITY +$ +5,812,369 +$ +4,892,943 +See accompanying notes to consolidated financial statements. +33 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +Year Ended December 31, +(in thousands, except per share data) +2020 +2019 +2018 +Sales +$ +4,597,414 +$ +5,220,051 +$ +4,642,068 +Cost of sales +2,407,633 +2,728,894 +2,418,463 +Gross profit +2,189,781 +2,491,157 +2,223,605 +Royalty income +16,017 +22,493 +20,582 +2,205,798 +2,513,650 +2,244,187 +Operating expenses: +Selling +318,097 +369,901 +350,435 +General and administrative +1,754,017 +1,625,306 +1,455,987 +Selling, general and administrative +2,072,114 +1,995,207 +1,806,422 +Earnings from operations +133,684 +518,443 +437,765 +Other income (expense): +Interest income +5,912 +11,782 +10,128 +Interest expense +( 16,327 +) +( 7,509 +) +( 5,847 +) +Other, net +31,460 +( 6,711 +) +( 10,162 +) +Total other income (expense) +21,045 +( 2,438 +) +( 5,881 +) +Earnings before income tax expense +154,729 +516,005 +431,884 +Income tax expense +8,502 +88,753 +60,611 +Net earnings +146,227 +427,252 +371,273 +Less: Net earnings attributable to noncontrolling interests +47,663 +80,692 +70,232 +Net earnings attributable to Skechers U.S.A., Inc. +$ +98,564 +$ +346,560 +$ +301,041 +Net earnings per share attributable to Skechers U.S.A., Inc.: +Basic +$ +0.64 +$ +2.26 +$ +1.93 +Diluted +$ +0.64 +$ +2.25 +$ +1.92 +Weighted-average shares used in calculating net earnings per share +attributable to Skechers U.S.A, Inc.: +Basic +154,184 +153,392 +155,815 +Diluted +154,894 +154,151 +156,450 +See accompanying notes to consolidated financial statements. +34 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Net earnings +$ +146,227 +$ +427,252 +$ +371,273 +Other comprehensive income: +Gain (loss) on foreign currency translation adjustment +11,540 +1,298 +( 24,806 +) +Comprehensive income +157,767 +428,550 +346,467 +Less: Comprehensive income attributable to noncontrolling interests +56,495 +80,495 +62,170 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +101,272 +$ +348,055 +$ +284,297 +See accompanying notes to consolidated financial statements. +35 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +NONCONTROLLING +(in thousands) +STOCK +STOCK +STOCK +STOCK +CAPITAL +INCOME (LOSS) +EARNINGS +EQUITY +INTERESTS +TOTAL +Balance at January 1, 2018 +131,784 +24,545 +$ +132 +$ +24 +$ +453,417 +$ +( 14,744 +) +$ +1,390,235 +$ +1,829,064 +$ +119,147 +$ +1,948,211 +Net earnings +— +— +— +— +— +— +301,041 +301,041 +70,232 +371,273 +Foreign currency translation adjustment +— +— +— +— +— +( 16,744 +) +— +( 16,744 +) +( 8,062 +) +( 24,806 +) +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 27,000 +) +( 27,000 +) +Stock compensation expense +— +— +— +— +30,468 +— +— +30,468 +— +30,468 +Proceeds from the employee stock purchase plan +222 +— +— +— +5,297 +— +— +5,297 +— +5,297 +Shares issued under the incentive award plan +1,018 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 405 +) +— +( 1 +) +— +( 14,190 +) +— +— +( 14,191 +) +— +( 14,191 +) +Conversion of Class B Common Stock into Class A +Common Stock +562 +( 562 +) +— +— +— +— +— +— +— +— +Repurchases of Class A Common Stock +( 3,656 +) +— +( 3 +) +— +( 99,974 +) +— +— +( 99,977 +) +— +( 99,977 +) +Balance at December 31, 2018 +129,525 +23,983 +$ +129 +$ +24 +$ +375,017 +$ +( 31,488 +) +$ +1,691,276 +$ +2,034,958 +$ +154,317 +$ +2,189,275 +Net earnings +— +— +— +— +— +— +346,560 +346,560 +80,692 +427,252 +Foreign currency translation adjustment +— +— +— +— +— +1,495 +— +1,495 +( 197 +) +1,298 +Contributions from noncontrolling interests +— +— +— +— +— +— +— +— +36,934 +36,934 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 38,675 +) +( 38,675 +) +Purchase of noncontrolling interest +— +— +— +— +( 71,265 +) +— +— +( 71,265 +) +( 11,629 +) +( 82,894 +) +Stock compensation expense +— +— +— +— +41,076 +— +— +41,076 +— +41,076 +Proceeds from the employee stock purchase plan +261 +— +— +— +6,173 +— +— +6,173 +— +6,173 +Shares issued under the incentive award plan +1,117 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 438 +) +— +— +— +( 14,313 +) +— +— +( 14,313 +) +— +( 14,313 +) +Conversion of Class B Common Stock into Class A +Common Stock +1,575 +( 1,575 +) +2 +( 2 +) +— +— +— +— +— +— +Repurchases of Class A Common Stock +( 969 +) +— +( 1 +) +— +( 30,018 +) +— +— +( 30,019 +) +— +( 30,019 +) +Balance at December 31, 2019 +131,071 +22,408 +$ +131 +$ +22 +$ +306,669 +$ +( 29,993 +) +$ +2,037,836 +$ +2,314,665 +$ +221,442 +$ +2,536,107 +Net earnings +— +— +— +— +— +— +98,564 +98,564 +47,663 +146,227 +Foreign currency translation adjustment +— +— +— +— +— +2,708 +— +2,708 +8,832 +11,540 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 81,105 +) +( 81,105 +) +Noncontrolling interests of acquired businesses +— +— +— +— +— +— +— +— +49,045 +49,045 +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 1,649 +) +( 1,649 +) +Stock compensation expense +— +— +— +— +65,240 +— +— +65,240 +— +65,240 +Proceeds from the employee stock purchase plan +233 +— +1 +— +5,915 +— +— +5,916 +— +5,916 +Shares issued under the incentive award plan +1,094 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 172 +) +— +— +— +( 5,658 +) +— +— +( 5,658 +) +— +( 5,658 +) +Conversion of Class B Common Stock into Class A +Common Stock +1,392 +( 1,392 +) +1 +( 1 +) +— +— +— +— +— +— +Balance at December 31, 2020 +133,618 +21,016 +$ +134 +$ +21 +$ +372,165 +$ +( 27,285 +) +$ +2,136,400 +$ +2,481,435 +$ +244,228 +$ +2,725,663 +See accompanying notes to consolidated financial statements +36 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Cash flows from operating activities: +Net earnings +$ +146,227 +$ +427,252 +$ +371,273 +Adjustments to reconcile net earnings to net cash provided by operating activities: +Depreciation and amortization +142,810 +111,515 +109,680 +Provision for bad debts and returns +50,696 +52,456 +35,730 +Stock compensation +65,240 +41,076 +30,468 +Deferred income taxes +( 19,568 +) +( 7,568 +) +( 9,767 +) +Net settlement gain +( 13,877 +) +— +— +Other items, net +— +334 +550 +Net foreign currency adjustments +( 13,854 +) +2,114 +10,072 +Changes in operating assets and liabilities: +Receivables +13,259 +( 118,390 +) +( 136,188 +) +Inventory +78,632 +( 171,903 +) +( 7,212 +) +Other assets +( 153,092 +) +( 69,234 +) +( 30,069 +) +Accounts payable +( 37,714 +) +154,464 +174,352 +Other liabilities +72,694 +4,436 +19,663 +Net cash provided by operating activities +331,453 +426,552 +568,552 +Cash flows from investing activities: +Capital expenditures +( 309,916 +) +( 236,111 +) +( 143,036 +) +Acquisitions, net of cash acquired +— +( 100,658 +) +— +Proceeds from sale of property, plant and equipment +— +5,547 +— +Purchases of investments +( 166,614 +) +( 189,624 +) +( 446,127 +) +Proceeds from sales and maturities of investments +164,062 +176,773 +269,749 +Net cash used in investing activities +( 312,468 +) +( 344,073 +) +( 319,414 +) +Cash flows from financing activities: +Net proceeds from the employee stock purchase plan +5,916 +6,173 +5,297 +Repayments on long-term borrowings +( 86,357 +) +( 4,108 +) +( 1,683 +) +Proceeds from long-term borrowings +702,998 +33,296 +18,626 +Repayments on short-term borrowings, net +( 2,492 +) +( 1,433 +) +( 787 +) +Payments for employee taxes related to stock compensation +( 5,658 +) +( 14,313 +) +( 14,191 +) +Repurchases of common stock +— +( 30,019 +) +( 99,977 +) +Purchase of noncontrolling interest +— +( 82,894 +) +— +Distributions to noncontrolling interests +( 81,105 +) +( 38,675 +) +( 27,000 +) +Net cash provided by (used in) financing activities +533,302 +( 131,973 +) +( 119,715 +) +Effect of exchange rates on cash and cash equivalents +( 6,337 +) +2,133 +6,383 +Net change in cash and cash equivalents +545,950 +( 47,361 +) +135,806 +Cash and cash equivalents at beginning of the period +824,876 +872,237 +736,431 +Cash and cash equivalents at end of the period +$ +1,370,826 +$ +824,876 +$ +872,237 +Supplemental disclosures of cash flow information: +Cash paid during the period for: +Interest +$ +15,987 +$ +7,140 +$ +5,568 +Income taxes, net +55,825 +88,753 +93,041 +Non-cash transactions: +Land and other assets contribution from noncontrolling interests +— +36,934 +— +Note payable contribution from noncontrolling interest +— +2,150 +— +Purchase price adjustment for Skechers Mexico +49,045 +— +— +See accompanying notes to consolidated financial statements. +37 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2020, 2019 and 2018 +(1) +SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +BASIS OF PRESENTATION +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the consolidated financial statements in prior years to conform to the current year presentation. +EFFECTS OF THE COVID-19 PANDEMIC ON THE COMPANY’S BUSINESS +In March 2020, the Company temporarily closed its stores around the world and temporarily furloughed a meaningful portion of its hourly employees. The Company began reopening its stores in April 2020, and as of December 31, 2020, over 90% of the Company-owned retail stores have reopened. The Company continues to monitor and react to the COVID-19 pandemic, including conforming to local governments and global health organizations’ guidance, implementing global travel restrictions, and implementing “work from home” measures for many of its employees. The Company is actively monitoring and assessing the rapidly emerging government policies and economic stimulus responses to the COVID-19 pandemic around the world. +Although the Company has reopened the majority of its worldwide retail stores, the economic impact of the COVID-19 pandemic continues to negatively affect the Company’s results of operations. Many of the reopened retail stores continue to have temporarily reduced operating hours and less foot traffic, which has resulted in lower sales. Additionally, the reopening of stores and corporate offices required the Company to implement safety protocols, facilitate social distancing, enhance cleaning and sanitation activities, and provide masks and gloves to all employees. These safety processes and procedures have increased our costs to operate for the foreseeable future. Given the unprecedented impact the COVID-19 pandemic has had, the Company is unable to forecast consumer demand and store productivity. Whether and how quickly customers may resume shopping, and the effect of the pandemic on consumer behavior and spending patterns remains highly uncertain. The Company expects customer demand to be suppressed in the near term. In addition, it is possible that there will be an increase in the number of COVID-19 cases in the future, which could require the Company’s stores to close again and negatively impact the Company’s sales. +As the COVID-19 pandemic is complex and rapidly evolving, the Company’s plans as described above may change. The Company expects that the ongoing impact of the COVID-19 pandemic and the resulting economic disruption may have a material adverse effect on its consolidated results of operations, financial position, and cash flows beyond fiscal year 2020. +USE OF ESTIMATES +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Significant areas requiring the use of estimates relate primarily to revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, goodwill, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +BUSINESS SEGMENT INFORMATION +The Company’s operations and segments are organized along its distribution channels and consist of the following: Domestic Wholesale, International Wholesale, and Direct-to-Consumer. Information regarding these segments is summarized in Note 13 – Segment and Geographic Information. +REVENUE RECOGNITION +The Company derives income from the sale of footwear and royalties earned from licensing the Skechers brand. The Company recognizes sales revenue, net of estimated returns and excluding sales and value added taxes. Revenue is recognized at point of sale or upon shipment, the point in time where control transfers to the customer. +For North America, goods are shipped free on board (“FOB”) shipping point directly from the Company’s U.S. distribution center. For international wholesale customers, product is shipped FOB shipping point: (i) directly from the Company’s European distribution center; (ii) to third-party distribution centers in Central America, South America and Asia; or (iii) directly from third-party manufacturers to other international customers. For distributor sales, product is generally delivered directly from independent factories to third-party distribution centers or to distributors’ freight forwarders on a free named carrier basis. Wholesale sales are recognized upon shipment. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a +38 +fulfillment cost. Direct-to-consumer revenues are primarily generated from sales to customers at the Company’s retail stores recognized at the point of sale and sales made through its websites recognized upon shipment. +The Company earns royalty income from symbolic licensing arrangements in which third parties sell product with the Company’s brand. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to the Company or on a straight-line basis over the term of the agreement). The Company applies the sales-based royalty exception for the royalty income based on sales and recognizes revenue only when subsequent sales occur. The Company calculates and accrues estimated royalties based on individual agreement terms and correspondence with its licensees regarding actual sales. +ALLOWANCE FOR BAD DEBTS, RETURNS, SALES ALLOWANCES AND CUSTOMER CHARGEBACKS +The Company provides a reserve, charged against revenue and its receivables, for estimated losses that may result from its customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and the Company’s experience with the customer’s account. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and its customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged against this reserve. Allowances for bad debts are recorded to general and administrative expenses. Direct-to-consumer receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. The Company typically extends credit terms to its wholesale customers based on their creditworthiness and generally does not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, the Company periodically decides to accept returns or provide customers with credits. +Sales and cost of sales are reduced by an estimate of customer merchandise returns, which is calculated based on historical experience. The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions and nature of the chargeback. +WAREHOUSE AND DISTRIBUTION COSTS +The Company’s distribution network-related costs are included in general and administrative expenses. Distribution expenses, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging product totaled $ 315.8 million, $ 276.4 million and $ 249.6 million for 2020, 2019 and 2018. +PRODUCT DESIGN AND DEVELOPMENT COSTS +The Company charges product design and development costs to general and administrative expenses. Aggregate product design and development costs were approximately $ 17.9 million, $ 16.8 million, and $ 18.5 million during the years ended December 31, 2020, 2019 and 2018. +ADVERTISING +Advertising costs are expensed in the period in which an advertisement first runs, or over the life of an endorsement contract. Advertising expense for the years ended December 31, 2020, 2019 and 2018 was approximately $ 248.7 million, $ 297.1 million and $ 278.4 million. Prepaid advertising costs were $ 3.8 million and $ 6.4 million at December 31, 2020 and 2019. Prepaid amounts represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run. +INCOME TAXES +The Company recognizes deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +CASH AND CASH EQUIVALENTS +Cash and cash equivalents include deposits with initial terms of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. +INVESTMENTS +Investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. +39 +INVENTORY +Inventory, principally finished goods, is stated at the lower of cost (based on the first-in, first-out method) or net realizable value. Cost includes shipping and handling fees and product cost, which are subsequently expensed to cost of sales. The Company provides for estimated losses from obsolete or slow-moving inventory and writes down the cost of inventory at the time such determinations are made. Reserves are estimated based on inventory on hand, historical sales activity, industry trends, the retail environment, and the expected net realizable value. The net realizable value is determined using estimated sales prices of similar inventory through off-price or discount store channels. +BUSINESS COMBINATIONS +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. Purchased intangible assets with finite lives are amortized over their estimated useful lives. The purchase price allocation is subject to adjustment until the Company has completed its analysis within the measurement period. +In the first quarter of 2019, we purchased the minority interest in our India joint-venture for $ 82.9 million, which made our India joint-venture entity a wholly-owned subsidiary. +On April 1, 2019, the Company purchased a 60 % interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”), for total cash consideration of $ 120.6 million, net of cash acquired. Skechers Mexico is a joint venture operating and generating sales in Mexico. As a result of this purchase, Skechers Mexico became a majority-owned subsidiary and its results are consolidated in the consolidated financial statements beginning April 1, 2019. The Company completed its purchase price allocation during the first quarter of 2020. The total purchase consideration was allocated to the assets acquired of $ 248.7 million and liabilities assumed of $ 47.3 million based on their estimated fair values. The change to the provisional amounts resulted in a $ 22.1 million increase to goodwill, a $ 49.1 million increase to intangible assets and a $ 17.1 million increase to deferred tax liabilities. Additionally, the change to the provisional amounts resulted in a $ 13.9 million gain on reacquired rights and an increase in amortization expense and accumulated amortization of $ 7.0 million, of which $ 5.2 million relates to the prior year and an $ 8.0 million increase in inventory, of which $ 6.0 million relates to the prior year . The prior year amounts were not material to amortization expense or cost of sales within the consolidated statements of earnings for the year ended December 31, 2019. Acquisition-related costs of $ 0.9 million, associated with the acquisition, were expensed as incurred and included in general and administrative expenses in the condensed consolidated statement of earnings. The pro forma and actual results of operations for this acquisition have not been presented because they are not material. +GOODWILL +As of December 31, 2020, the Company had $ 93.5 million of goodwill with $ 91.9 million allocated to International Wholesale and $ 1.6 million to Domestic Wholesale. Goodwill is not amortized but is tested at least annually in the fourth quarter for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. +INTANGIBLE ASSETS +The Company has amortizable intangible assets consisting of reacquired rights with a gross carrying value of $ 49.1 million and accumulated amortization of $ 12.1 million as of December 31, 2020. Purchased intangible assets with finite lives are amortized over their estimated useful lives. In addition to purchase price adjustments, amortization expense related to amortizable intangible assets was $ 6.9 million for the year ended December 31, 2020. Future amortization expense related to amortizable intangible assets will be approximately $ 6.9 million per year for the each of the years 2021 through 2025. The weighted-average amortization period for amortizable reacquired rights is 7 years. +NONCONTROLLING INTERESTS +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout Mexico, Asia and the Middle East or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”), and the Company is considered the primary beneficiary. This determination is based on the relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. Specifically, the Company has both of the following characteristics: (a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE, or the right to receive benefits from the entity that could potentially be significant to the VIE. The assets and liabilities and results of operations of these entities are included in the Company’s consolidated financial statements, even though the Company may not hold a majority equity interest. There have been no changes during 2020 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships quarterly. The assets of these joint ventures are restricted, as they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. +40 +FOREIGN CURRENCY TRANSLATION +The Company’s reporting currency is the U.S. dollar. Certain international operations use the respective local currency as their functional currency, while others use the U.S. dollar as their functional currency. Translation adjustments for subsidiaries with non-U.S. dollar functional currencies are included in other comprehensive income. Foreign currency transaction gains (losses), resulting from exchange rate fluctuations, on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated at the balance sheet date exchange rate. Net income (loss) and cash flow items are translated at the weighted-average exchange rates during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +FAIR VALUE OF FINANCIAL INSTRUMENTS +The fair value hierarchy as defined by applicable accounting standards prioritizes the use of inputs used in valuation techniques into the following three levels: +• +Level 1: Quoted market prices in active markets for identical assets or liabilities. +• +Level 2: Other observable market-based inputs or unobservable inputs that are corroborated by market data. +• +Level 3: Unobservable inputs that cannot be corroborated by market data that reflect the reporting entity’s own assumptions. +The Company’s Level 1 investments primarily include money market funds and U.S. Treasury securities; Level 2 investments primarily include corporate notes and bonds, asset-backed securities, U.S. Agency securities, and actively traded mutual funds; and the Company does not currently have any Level 3 assets or liabilities. The Company has one Level 2 derivative instrument which is an interest rate swap related to the refinancing of its U.S. distribution center (see Note 6 – Financial Commitments) classified as other long-term liabilities. The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements . +The carrying amount of receivables, payables and other amounts arising out of the normal course of business approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based on current rates and terms available to the Company for similar debt. +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company uses an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap, designated as a cash flow hedge, involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2020, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +RECENT ACCOUNTING PRONOUNCEMENTS +In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument,” (“ASU 2016-13”) which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments; including, trade and other receivables, loans and held-to-maturity debt securities, to record an allowance for credit risk based on expected losses rather than incurred losses. The Company adopted ASU 2016-03 on January 1, 2020 , and the adoption of this ASU did not have a material impact on its consolidated financial statements. +In August 2018, the FASB issued ASU 2018-13 Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, (“ASU 2018-13”) which modifies the disclosure requirements on fair value measurements, including the consideration of costs and benefits. The Company adopted ASU 2018-13 on January 1, 2020 , and the adoption of this ASU did not have a material impact on its consolidated financial statements . +In August 2018, the FASB issued ASU 2018-15 Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, (“ASU 2018-15”). ASU 2018-15 requires that issuers follow the internal-use software guidance in ASC 350-40 to determine which costs to capitalize as assets or expense as incurred. The guidance in ASC 350-40 requires that certain costs incurred during the application development stage be capitalized and other costs incurred during the preliminary project and post-implementation stages be expensed as they are incurred. The Company adopted ASU 2018-15 on January 1, 2020 , and the adoption of this ASU did not have a material impact on its consolidated financial statements . +41 +In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, (“ASU 2019-12”). ASU 2019-12 removes certain exceptions to the general income tax accounting methodology including an exception for the recognition of a deferred tax liability when a foreign subsidiary becomes an equity method investment and an exception for interim periods showing operating losses in excess of anticipated operating losses for the year. The amendment also reduces the complexity surrounding franchise tax recognition; the step up in the tax basis of goodwill in conjunction with business combinations; and the accounting for the effect of changes in tax laws enacted during interim periods. The amendments in this update are effective for the Company for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. +In March 2020, the FASB issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, as amended and supplemented by subsequent ASUs (collectively, “ASU 2020-04”), which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for borrowing instruments, which use LIBOR as a reference rate, and is effective immediately, but is only available through December 31, 2022. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. +(2) +CASH, CASH EQUIVALENTS, SHORT-TERM AND LONG-TERM INVESTMENTS +The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category: +As of December 31, 2020 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +946,961 +$ +946,961 +$ +946,961 +$ +— +$ +— +Level 1: +Money market funds +423,865 +423,865 +423,865 +— +— +U.S. Treasury securities +21,146 +21,146 +— +8,067 +13,079 +Total level 1 +445,011 +445,011 +423,865 +8,067 +13,079 +Level 2: +Corporate notes and bonds +117,253 +117,253 +— +83,521 +33,732 +Asset-backed securities +28,253 +28,253 +— +5,498 +22,755 +U.S. Agency securities +3,681 +3,681 +— +3,681 +— +Mutual funds +38,846 +38,846 +— +— +38,846 +Total level 2 +188,033 +188,033 +— +92,700 +95,333 +TOTAL +$ +1,580,005 +$ +1,580,005 +$ +1,370,826 +$ +100,767 +$ +108,412 +As of December 31, 2019 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +662,355 +$ +662,355 +$ +662,355 +$ +— +$ +— +Level 1: +Money market funds +162,521 +162,521 +162,521 +— +— +U.S. Treasury securities +9,686 +9,686 +— +1,679 +8,007 +Total level 1 +172,207 +172,207 +162,521 +1,679 +8,007 +Level 2: +Corporate notes and bonds +132,431 +132,431 +— +104,130 +28,301 +Asset-backed securities +23,614 +23,614 +— +263 +23,351 +U.S. Agency securities +12,352 +12,352 +— +5,965 +6,387 +Mutual funds +28,543 +28,543 +— +— +28,543 +Total level 2 +196,940 +196,940 +- +110,358 +86,582 +TOTAL +$ +1,031,502 +$ +1,031,502 +$ +824,876 +$ +112,037 +$ +94,589 +The Company’s investments consist of U.S. Treasury securities, corporate notes and bonds, asset-backed securities and U.S. Agency securities, which the Company has the intent and ability to hold to maturity and therefore are classified as held-to-maturity. The Company holds mutual funds in its deferred compensation plan which are classified as trading securities. +The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are typically +42 +less than two years . The Company minimizes the potential risk of principal loss by investing in highly-rated securities and limiting the amount of credit exposure to any one issuer. Fair values were determined for each individual security in the investment portfolio. +When evaluating an investment for its current expected credit losses, the Company reviews factors such as historical experience with defaults, losses, credit ratings, term, market sector and macroeconomic trends, including current conditions and forecasts to the extent they are reasonable and supportable. +(3) +LEASES +The Company regularly enters into non-cancellable operating leases for retail stores, distribution facilities, offices, showrooms and automobiles. Retail stores typically have initial terms ranging from 5 to 10 years and other real estate or facility leases may have initial lease terms of up to 20 years. In connection with the adoption of ASC 842, Leases , beginning with the first quarter of 2019, the Company’s leases are recorded as operating lease right-of-use (“ROU”) assets and operating leases liabilities. Operating lease liabilities are recognized based on the present value of the fixed portion of lease payments over the lease term at the commencement date. Net present value is calculated using an incremental borrowing rate based on a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. Many of the Company’s real estate leases include options to extend and are included in the lease obligations when considered reasonably certain. ROU assets are recognized based on operating lease liabilities reduced by lease incentives and initial direct costs incurred. Fixed lease cost is recognized on a straight-line basis over the lease term. +The Company’s real estate leases may also require additional payments for percentage rent, real estate taxes, or other occupancy-related costs. Percentage rent, a variable cost, is recognized in the consolidated financial statements when incurred and is based on the specific terms in the lease agreement. Real estate taxes and other occupancy-related costs are non-lease components. +Operating lease cost and other information: +Year Ended December 31, +(in thousands) +2020 +2019 +Fixed lease cost +$ +266,105 +$ +246,296 +Variable lease cost +3,455 +13,104 +Operating cash flows used for leases +257,775 +264,424 +ROU assets exchanged for lease liabilities upon adoption of ASC 842 +— +1,035,062 +ROU assets exchanged for lease liabilities +318,713 +122,078 +Weighted-average remaining lease term +4.31 years +4.66 years +Weighted-average discount rate +3.67 +% +4.20 +% +The following table presents future lease payments as of December 31, 2020: +Year (in thousands) +Operating Leases +2021 +$ +254,674 +2022 +226,841 +2023 +202,515 +2024 +186,135 +2025 +167,501 +Thereafter +400,261 +Total lease payments +$ +1,437,927 +Less: Imputed interest +( 168,488 +) +Operating lease liabilities +$ +1,269,439 +As of December 31, 2020, the Company has operating leases, primarily for new retail stores, that have not yet commenced which will generate additional ROU assets of $ 14.9 million. Rent expense for the year ended 2018 was $ 257.6 million. +43 +(4) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment is summarized as follows: +As of December 31, +(in thousands) +2020 +2019 +Land +$ +95,712 +$ +90,862 +Buildings and improvements +531,059 +349,066 +Furniture, fixtures and equipment +485,349 +454,837 +Leasehold improvements +506,459 +453,805 +Total property, plant and equipment +1,618,579 +1,348,570 +Less accumulated depreciation and amortization +683,138 +609,645 +Property, plant and equipment, net +$ +935,441 +$ +738,925 +Depreciation expense for the year ended December 31, 2020 was $ 115.5 million as calculated using the straight-line method, which is based on the following estimated useful lives: +Buildings +20 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Shorter of useful life or remaining lease term +The Company reviews all stores for impairment annually or when facts and circumstances indicate that the carrying values may be impaired. The Company performs an evaluation of recoverability by comparing the carrying values of the net assets to their related projected undiscounted future cash flows, in addition to other quantitative and qualitative analyses. The Company did not record material impairment charges during the years ended December 31, 2020, 2019 or 2018. +(5) +ACCRUED EXPENSES +Accrued expenses at December 31, 2020 and 2019 are summarized as follows: +As of December 31, +(in thousands) +2020 +2019 +Accrued payroll, taxes, and other +$ +104,004 +$ +92,264 +Return reserve liability +77,219 +69,048 +Accrued inventory purchases +27,489 +48,923 +Accrued expenses +$ +208,712 +$ +210,235 +(6) +FINANCIAL COMMITMENTS +The Company had $ 38.7 million and $ 3.8 million of outstanding letters of credit as of December 31, 2020 and December 31, 2019, and approximately $ 3.3 million and $ 5.8 million in short-term borrowings as of December 31, 2020 and December 31, 2019. +Long-term borrowings were as follows: +As of December 31, +(in thousands) +2020 +2019 +Revolving Credit Facility +$ +452,500 +$ +— +HF-T1 Distribution Center Loan +129,505 +63,692 +HF-T2 Distribution Center Construction Loan +22,169 +— +China Distribution Center Construction Loan +77,501 +48,791 +China Operational Loans +48,743 +2,541 +Other +1,247 +393 +Subtotal +731,665 +115,417 +Less: Current installments +( 52,250 +) +( 66,234 +) +Total long-term borrowings +$ +679,415 +$ +49,183 +Revolving Credit Facility +On November 21, 2019, the Company entered into a $ 500.0 million senior unsecured revolving credit facility, which matures on November 21, 2024 (the “2019 Credit Agreement”), with Bank of America, N.A., as administrative agent and joint lead arranger, +44 +HSBC Bank USA, N.A. and JPMorgan Chase Bank, N.A., as joint lead arrangers, and other lenders. The 2019 Credit Agreement may be increased by up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit and swingline loans up to a maximum of $ 100.0 million and $ 25.0 million. The Company may use the proceeds from the 2019 Credit Agreement for working capital and other lawful corporate purposes. Borrowings on the 2019 Credit Agreement’s revolving credit facility and letters of credit bear interest, at the Company’s option, at a rate equal to (a) LIBOR plus an applicable margin between 1.125 % and 1.625 % based upon the Company’s Total Adjusted Net Leverage Ratio (as defined in the 2019 Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate and (iii) LIBOR plus 1.00 %) plus an applicable margin between 0.125 % and 0.625 % based upon the Company’s Total Adjusted Net Leverage Ratio. The weighted-average annual interest rate on borrowings under the 2019 Credit Agreement was approximately 1.53 % during the year ended December 31, 2020. The 2019 Credit Agreement contains certain customary affirmative and negative covenants and events of default for credit facilities of this type. +The 2019 Credit Agreement requires the Company to maintain a maximum Total Adjusted Net Leverage Ratio of 3.75 :1, except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 :1 for the quarter in which such acquisition occurs and for the next three quarters thereafter. +As of December 31, 2020, there was $ 47.5 million available under the Company’s 2019 Credit Agreement. As of December 31, 2019, the entire $ 500 million was available, and the Company had not utilized the 2019 Credit Agreement for letters of credit. The Company was in compliance with the financial covenants under the 2019 Credit Agreement as of December 31, 2020. +HF-T1 Distribution Center Loan +On August 11, 2015, the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into an amended and restated construction loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (collectively, the “Amended Construction Loan Agreement”) . Under the Amended Construction Loan Agreement, the parties agreed that the lenders would loan $ 70 million to HF-T1 (the “2015 Loan”) at an interest rate per annum of LIBOR Daily Floating Rate (as defined therein) plus a margin of 2 %. On March 18, 2020, HF-T1 entered into an amendment to the 2015 Loan (the “2020 Amendment”) that increased the borrowings under the 2015 Loan to $ 129.5 million and extended the maturity date of the 2015 Loan to March 18, 2025 (the “HF-T1 2020 Loan”). The proceeds of the 2020 Amendment were used by the JV to (i) refinance all amounts owed on the 2015 Loan, (ii) pay $ 1.0 million in accrued interest, loan fees and other closing costs associated with the 2020 Amendment and (iii) make a distribution of $ 64.4 million to HF. Pursuant to the 2020 Amendment, the interest rate per annum on the HF-T1 2020 Loan is the LIBOR Daily Floating Rate (as defined therein) plus a margin of 1.75 %. +On August 11, 2015, HF-T1 and Bank of America, N.A. also entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. The Company’s objective in using the Swap Agreement is to stabilize interest expense and manage exposure to interest rate volatility. Pursuant to the Swap Agreement, on August 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) with Bank of America, N.A. The Interest Rate Swap had an effective date of August 12, 2015 and a maturity date of August 12, 2022 , subject to early termination at the option of HF-T1, commencing on August 1, 2020 . On March 18, 2020, HF-T1 and Bank of America, N.A. executed an amendment to the Swap Agreement (the “Swap Agreement Amendment”) to extend the maturity date of the Interest Rate Swap to March 18, 2025 . The Swap Agreement Amendment fixes the effective interest rate on the HF-T1 2020 Loan at 2.55 % per annum. The 2020 Amendment and the Swap Agreement Amendment are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Company’s 2019 Credit Agreement. +The Interest Rate Swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. As of December 31, 2020, the Interest Rate Swap had an aggregate notional amount of $ 129.5 million. Under the terms of the Swap Agreement Amendment, the Company will pay a weighted-average fixed rate of 0.795 % on the notional amount and receive payments from the counterparty based on the 30-day LIBOR rate, effectively modifying the Company’s exposure to interest rate risk by converting floating-rate debt to a fixed rate of 4.08 % . By using a derivative instrument, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. The Company continually assesses the creditworthiness of its counterparties. As of December 31, 2020, all counterparties to the Interest Rate Swap had performed in accordance with their contractual obligations. +HF-T2 Distribution Center Construction Loan +On April 3, 2020, the JV, through HF Logistics-SKX T2, LLC, a wholly-owned subsidiary of the JV (“HF-T2”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and lender (collectively, the “2020 Construction Loan Agreement”), pursuant to which the JV obtained a loan of up to $ 73.0 million used to expand the U.S. distribution center (the “HF-T2 2020 Construction Loan”). Under the 2020 Construction Loan Agreement, the interest rate per annum on the HF-T2 2020 Construction Loan is LIBOR Daily Floating Rate (as defined therein) plus a margin of 190 basis points, reducing to 175 basis points +45 +upon substantial completion of the construction and certain other conditions being satisfied. The weighted-average annual interest rate on borrowings under the 2020 Construction Loan Agreement was approximately 2.05 % during the year ended December 31, 2020. The maturity date of the HF-T2 2020 Construction Loan is April 3, 2025 . The obligations of the JV under the 2020 Construction Loan Agreement are guaranteed by TGD Holdings I, LLC, which is an affiliate of HF . +China Distribution Center Construction Loan +On September 29, 2018, through its Taicang subsidiary (“TC Subsidiary”), the Company entered into a 700 million yuan loan agreement with China Construction Bank Corporation (“the China DC Loan”) to finance the construction of the Company’s distribution center in China. Interest is paid quarterly. The interest rate floats and is calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2020 was 4.28 % and may increase or decrease over the life of the loan, and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan. The China DC Loan contains customary affirmative and negative covenants for secured credit facilities of this type. The China DC Loan matures on September 28, 2023 . The obligations of the TC Subsidiary under the China DC Loan are jointly and severally guaranteed by the Company’s Chinese joint venture. +China Operational Loans +The Company has entered certain secured credit facilities to support the operations of its Chinese joint venture. The balance of working capital loans at December 31, 2020 was approximately $ 30.1 million with interest rates ranging from 1.75 % to 3.92 % per annum, payable at terms agreed by the lender. The balance of loans related to a corporate office building in Shanghai was approximately $ 18.6 million with interest at 4.28 % per annum, payable at terms agreed by the lender. There was no amount outstanding on these credit facilities at December 31, 2019. +The following table presents the future principal payments required under the Company’s debt obligations, discussed above: +Year (in thousands) +Maturities +2021 +$ +52,250 +2022 +29,026 +2023 +33,962 +2024 +452,500 +2025 +163,927 +$ +731,665 +( 7 ) +COMMITMENTS AND CONTINGENCIES +PRODUCT AND OTHER FINANCING +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.4 % for 30- to 60-day financing. The amounts included in accounts payable and outstanding under these arrangements were $ 210.1 million and $ 214.7 million at December 31, 2020 and 2019. Interest expense incurred by the Company under these arrangements totaled $ 7.4 million in 2020, $ 7.9 million in 2019, and $ 3.3 million in 2018. The Company has open purchase commitments with its foreign manufacturers of $ 1.1 billion and warehouse and equipment and corporate construction contracts of $ 583.2 million for the expansion of its distribution centers and corporate headquarters, which are not included in the consolidated balance sheets at December 31, 2020. +LITIGATION +The Company recognizes legal expense in connection with loss contingencies as incurred. +In accordance with GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2020, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. +46 +( 8 ) +STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION +COMMON STOCK +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10 million shares of Preferred Stock, par value $ 0.001 per share. +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share (EPS). Basic and diluted net EPS of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +During the years ended December 31, 2020, 2019 and 2018 certain Class B stockholders converted 1,391,670 , 1,575,509 and 561,876 shares, respectively, of Class B Common Stock to Class A Common Stock. +SHARE REPURCHASE PROGRAM +On February 6, 2018, the Company’s Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company could purchase shares of its Class A Common Stock, for an aggregate repurchase price not to exceed $ 150.0 million. The Share Repurchase Program expired on February 6, 2021 at which time share repurchase authorizations of $ 20.0 million had not been executed. +The following table provides a summary of the Company’s Class A Common Stock repurchase activities: +Year Ended December 31, +2020 +2019 +2018 +Shares repurchased +— +968,724 +3,656,277 +Average cost per share +$ +— +$ +30.99 +$ +27.34 +Total cost of shares repurchased (in thousands): +$ +— +$ +30,019 +$ +99,977 +INCENTIVE AWARD PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2017 Incentive Award Plan (the “2017 Plan”), replaced and superseded the 2007 Incentive Award Plan adopted on May 24, 2007 (the “2007 Plan,” together with the 2017 Plan, the “Plans”). A total of 10,000,000 shares of Class A Common Stock were reserved for issuance under the 2017 Plan, which provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the plan to the employees, consultants and directors of the Company. The 2017 Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. As of December 31, 2020, a total of 5,737,050 shares remain available for grant as equity awards under the 2017 Plan. +47 +A summary of the status and changes of nonvested shares related to the Plans is presented below: +Shares +Weighted-Average Grant-Date Fair Value +Unvested at January 1, 2018 +2,303,557 +26.25 +Granted +1,811,000 +38.05 +Vested/Released +( 1,018,283 +) +21.91 +Cancelled +( 127,333 +) +29.71 +Unvested at December 31, 2018 +2,968,941 +34.79 +Granted +1,603,000 +28.45 +Vested/Released +( 1,116,868 +) +32.46 +Cancelled +( 28,250 +) +39.40 +Unvested at December 31, 2019 +3,426,823 +32.55 +Granted +1,569,300 +37.45 +Vested/Released +( 1,093,500 +) +32.64 +Cancelled +( 790,600 +) +32.23 +Unvested at December 31, 2020 +3,112,023 +35.06 +The Company recognized, as part of general and administrative, compensation expense of $ 65.2 million, $ 41.1 million and $ 30.5 million for grants under the Plans for the years ended December 31, 2020, 2019, and 2018. Related excess income tax benefits (expenses), recorded in the consolidated statements of earnings, for the years ended December 31, 2020, 2019 and 2018, were $( 0.7 ) million, $ 0.3 million, and $ 1.6 million. Included in compensation expense recognized in 2020 is an $ 18.2 million non-cash charge related to the cancellation of 750,000 unvested shares as a result of a legal settlement. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. For grants that have a service requirement, the Company accounts for forfeitures upon occurrence, rather than estimating the probability of forfeiture at the date of grant. Accordingly, the Company recognizes the full grant-date fair value of these awards on a straight-line basis throughout the requisite service period, reversing any expense if, and only if, there is a forfeiture . There was $ 75.6 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2020, which is expected to be recognized over a weighted-average period of 1.9 years. The total fair value of shares vested during the years ended December 31, 2020, 2019 and 2018 was $ 41.6 million, $ 36.3 million and $ 22.3 million. +The Company determines the fair value of restricted stock awards and any performance-related components based on the closing market price of the Company’s common stock on the date of grant. For share-based awards that have a performance-based vesting requirement, the Company evaluates the probability of achieving the performance criteria throughout the performance period and will adjust share-based compensation expense if it estimates that the achievement of the performance criteria is not probable. Certain performance-based awards contain market condition components which are valued on the date of grant using a Monte Carlo simulation model. The fair value of such awards is expensed ratably over the performance period and is not adjusted for actual achievement. Included in the table above are two tranches of performance-based awards granted on December 30, 2020 which vest at the end of a three-year performance period. The first tranche includes 125,000 shares with a market condition tied to the Company’s total shareholder return in relation to its peer companies, valued at $ 49.78 per share, and the second tranche includes 125,000 shares with a performance condition tied to annual EPS growth, valued at $ 36.02 per share. The ultimate payout of performance awards is determined at the end of the performance period and can vary from zero to 200 % based on actual results. +STOCK PURCHASE PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2018 Employee Stock Purchase Plan (the “2018 ESPP”), replaced the Company’s previous employee stock purchase plan, the Skechers U.S.A., Inc. 2008 Employee Stock Purchase Plan (the “2008 ESPP”), which expired pursuant to its terms on January 1, 2018. A total of 5,000,000 shares of Class A Common Stock are available for sale under the 2018 ESPP. The 2018 ESPP provides eligible employees of the Company and its subsidiaries the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the fair market value on the first trading day or last trading day of each purchase period, whichever is lower. Eligible employees can invest up to 15 % of their compensation through payroll deductions during each purchase period. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense, which is computed using the Black-Scholes valuation model. +Under the 2018 ESPP, the Company received approximately $ 5.9 million, $ 6.2 million and $ 5.3 million, and issued 232,904 , 260,630 and 221,889 shares, respectively, for the years ended December 31, 2020, 2019 and 2018. +48 +( 9 ) +EARNINGS PER SHARE +Basic EPS and diluted EPS are calculated by dividing net earnings by the following: for basic EPS, the weighted-average number of common shares outstanding for the period; and for diluted EPS, the sum of the weighted-average number of both outstanding common shares and potentially dilutive common shares using the treasury stock method. +The calculation of EPS is as follows: +Year Ended December 31, +(in thousands, except per share data) +2020 +2019 +2018 +Net earnings attributable to Skechers U.S.A., Inc. +$ +98,564 +$ +346,560 +$ +301,041 +Weighted-average common shares outstanding, basic +154,184 +153,392 +155,815 +Dilutive effect of nonvested shares +710 +759 +635 +Weighted-average common shares outstanding, diluted +154,894 +154,151 +156,450 +Anti-dilutive common shares excluded above +69,060 +10,838 +352,169 +Net earnings attributable to Skechers U.S.A., Inc. per common share: +Basic +$ +0.64 +$ +2.26 +$ +1.93 +Diluted +$ +0.64 +$ +2.25 +$ +1.92 +( 1 0 ) +INCOME TAXES +The Company’s earnings (loss) before income tax expense consists of the following: +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +U.S. operations +( 112,671 +) +4,999 +16,597 +Foreign operations +267,400 +511,006 +415,287 +Earnings before income taxes +154,729 +516,005 +431,884 +The provision for income tax consists of the following: +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Federal: +Current +$ +( 30,094 +) +$ +22,899 +$ +11,379 +Deferred +( 2,208 +) +( 3,583 +) +( 3,971 +) +Total federal +( 32,302 +) +19,316 +7,408 +State: +Current +3,841 +6,384 +5,408 +Deferred +( 3,070 +) +( 813 +) +( 1,316 +) +Total state +771 +5,571 +4,092 +Foreign: +Current +56,530 +66,656 +53,071 +Deferred +( 16,497 +) +( 2,790 +) +( 3,960 +) +Total foreign +40,033 +63,866 +49,111 +Total income tax expense +$ +8,502 +$ +88,753 +$ +60,611 +49 +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows: +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Expected income tax expense +$ +32,493 +$ +108,361 +$ +90,696 +State income tax, net of federal benefit +( 2,394 +) +1,278 +3,051 +Rate differential on foreign income +( 27,426 +) +( 43,327 +) +( 40,065 +) +Change in unrecognized tax benefits +6,084 +2,739 +820 +Non-deductible compensation +7,119 +7,126 +6,269 +Tax credits +( 6,312 +) +( 3,264 +) +( 2,539 +) +Excess tax (benefit) on stock compensation +703 +( 251 +) +( 1,557 +) +Benefits provided by the CARES Act +( 15,863 +) +— +— +Non-deductible share cancellation +4,048 +— +— +U.S. transition tax +— +— +( 10,963 +) +U.S. tax on foreign earnings +— +9,786 +9,956 +Other +( 463 +) +3,440 +2,077 +Change in valuation allowance +10,513 +2,865 +2,866 +Income tax expense +$ +8,502 +$ +88,753 +$ +60,611 +Effective tax rate +5.5 +% +17.2 +% +14.0 +% +The Company’s provision for income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0.0 % to 34.0 %. The Company’s provision for income tax expense (benefit) was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) with application of transfer pricing considerations in each jurisdiction, while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. For 2020, the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25 %, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. Additionally, the 2020 effective tax rate reflects the favorable impact of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, enacted on March 27, 2020. Due to changes in the ownership structure of the Company’s international operations that took effect in December 2020, the Company realized a $ 15.9 million tax benefit related to the net operating loss carryback provisions of the CARES Act. The Company also received a $ 4.8 million reduction in payroll taxes as a result of the Employee Retention Credit provisions of the CARES Act. +The Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI taxes foreign income in excess of a deemed return on tangible assets of foreign corporations and is treated as a period cost. +The tax effects of temporary differences giving rise to deferred tax assets and liabilities are presented below: +As of December 31, +(in thousands) +2020 +2019 +Deferred tax assets: +Inventory adjustments +$ +5,788 +$ +6,954 +Accrued expenses +59,266 +50,847 +Allowances for bad debts and chargebacks +5,820 +4,809 +Loss carryforwards +34,396 +28,605 +Business credit carryforward +13,130 +8,262 +Share-based compensation +5,194 +4,521 +Operating lease liabilities +305,261 +261,984 +Valuation allowance +( 43,557 +) +( 33,044 +) +Total deferred tax assets +385,298 +332,938 +Deferred tax liabilities: +Prepaid expenses +8,076 +5,586 +Right-of-use assets +305,231 +261,984 +Depreciation on property, plant and equipment +19,546 +16,602 +Total deferred tax liabilities +332,853 +284,172 +Net deferred tax assets +$ +52,445 +$ +48,766 +At December 31, 2020, combined foreign net operating loss carry-forwards were approximately $ 109.5 million, of which $ 0.1 million expire in 2021 and $ 27.4 million can be carried forward indefinitely. A valuation allowance of $ 26.5 million is recorded for the amount which is not likely to be fully utilized. The $ 10.5 million increase in the valuation allowance primarily relates to increases in deferred tax assets in certain foreign non-benefited loss jurisdictions. +50 +State tax credit and net operating loss carry-forwards at December 31, 2020 were $ 10.8 million and $ 53.4 million. These tax credit and net operating loss carry-forward amounts begin to expire in 2024 and 2026 . No valuation allowance has been recorded, as the Company believes they will be fully utilized. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +As of December 31, +(in thousands) +2020 +2019 +Beginning balance +$ +10,566 +$ +7,975 +Additions for current year tax positions +9,804 +1,795 +Additions for prior year tax positions +2,735 +1,638 +Reductions related to lapse of statute of limitations +( 1,594 +) +( 842 +) +Ending balance +$ +21,511 +$ +10,566 +Current unrecognized tax benefits are recorded as a reduction in prepaid expense and included in tax expense when recorded. Long-term unrecognized tax benefits are recorded as an increase in long-term taxes payable with a portion included in tax expense and a portion recorded as a reduction in deferred tax liabilities when recorded. If recognized, $ 17.9 million of unrecognized tax benefits would be recorded as a reduction in income tax expense, and $ 3.6 million would be recorded as an increase in deferred tax liabilities. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +The Company estimates interest and penalties related to income tax matters which are included in income tax expense. Amounts were $ 0.3 million, $ 0.4 million, and $ 0.2 million for the years ended December 31, 2020, 2019, and 2018. Accrued interest and penalties were $ 2.4 million and $ 2.1 million as of December 31, 2020 and 2019. +As of December 31, 2020, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2016, and in several Asian and European tax jurisdictions for years ending on or after December 31, 2010. During the year, the Company reduced the balance of unrecognized tax benefits by $ 1.6 million as a result of expiring statutes and there was no reduction in the balance of unrecognized tax benefits from the settlement of domestic and foreign audits. It is reasonably possible that certain domestic and foreign statutes will expire, and certain domestic and foreign audits will be settled during the next twelve months which would reduce the balance of 2020 and prior year unrecognized tax benefits by $ 1.3 million and $ 2.6 million. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2020. The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. In addition to certain tax restrictions, our joint venture in China has limitations on its distribution of earnings, as local law currently requires it to maintain $ 18.8 million of its earnings in a statutory reserve. +(1 1 ) +EMPLOYEE BENEFIT PLANS +The Company has a 401(k) profit sharing plan covering employees who are 21 years of age and have completed six months of service. Company contributions to the plan are discretionary and vest over a six year period. The Company made contributions of $ 2.8 million, $ 2.4 million, and $ 2.3 million to the plan for the years ended December 31, 2020, 2019, and 2018. +The Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”) allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees as determined by the Company’s Compensation Committee. Contributions were $ 0.3 million for the year ended December 31, 2020, and $ 0.1 million for each of the years ended December 31, 2019 and 2018. Deferred compensation is recognized based on the fair value of the participants’ accounts. +51 +(1 2 ) +RELATED PARTY TRANSACTIONS +The Skechers Foundation (the “Foundation”) is a 501(c)(3) non-profit entity and not a subsidiary or otherwise affiliated with the Company. The Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are also officers and directors of the Foundation. During the years ended December 31, 2020, 2019, and 2018, the Company made contributions of $ 2.3 million, $ 1.0 million, and $ 1.0 million to the Foundation in each year. +The Company had receivables from officers and employees of $ 1.0 million and $ 0.8 million at December 31, 2020 and 2019. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +( 1 3 ) +SEGMENT AND GEOGRAPHIC INFORMATION +The Company has three reportable segments – Domestic Wholesale, International Wholesale and Direct-to-Consumer. Management evaluates segment performance based primarily on sales and gross margin. All other costs and expenses of the Company are analyzed on an aggregate basis and not allocated to the segments. Sales, gross profit and identifiable assets for the Company’s segments were as follows: +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Sales +Domestic Wholesale +$ +1,126,564 +$ +1,247,550 +$ +1,259,615 +International Wholesale +2,257,846 +2,462,632 +2,054,770 +Direct-to-Consumer +1,213,004 +1,509,869 +1,327,683 +Total +$ +4,597,414 +$ +5,220,051 +$ +4,642,068 +Gross profit +Domestic Wholesale +$ +431,603 +$ +457,944 +$ +468,340 +International Wholesale +1,023,183 +1,133,573 +976,739 +Direct-to-Consumer +734,995 +899,640 +778,526 +Total +$ +2,189,781 +$ +2,491,157 +$ +2,223,605 +Additions to property, plant and equipment +Domestic Wholesale +$ +129,165 +$ +75,037 +$ +29,717 +International Wholesale +120,983 +109,205 +63,316 +Direct-to-Consumer +59,768 +51,869 +50,003 +Total +$ +309,916 +$ +236,111 +$ +143,036 +As of December 31, +(in thousands) +2020 +2019 +Identifiable assets +Domestic Wholesale +$ +1,945,681 +$ +1,472,323 +International Wholesale +2,436,568 +2,100,042 +Direct-to-Consumer +1,430,120 +1,320,578 +Total +$ +5,812,369 +$ +4,892,943 +The following summarizes the Company’s operations in different geographic areas: +Year Ended December 31, +(in thousands) +2020 +2019 +2018 +Sales (1) +United States +$ +1,913,409 +$ +2,197,391 +$ +2,128,100 +International +2,684,005 +3,022,660 +2,513,968 +Total +$ +4,597,414 +$ +5,220,051 +$ +4,642,068 +52 +As of December 31, +(in thousands) +2020 +2019 +Property, plant and equipment, net (1) +United States +$ +535,648 +$ +439,132 +International +399,793 +299,793 +Total +$ +935,441 +$ +738,925 +(1) +During the years ended December 31, 2020, 2019 and 2018, s ales in China were $ 924.5 million, $ 850.0 million and $ 744.0 million. Property, plant and equipment, net in China was $ 241.6 million and $ 146.1 million at December 31, 2020 and 2019 . +During the years ended December 31, 2020, 2019 and 2018, sales to the five largest customers were approximately 8.8 %, 9.6 % and 10.4 %. +The majority of the Company’s products are produced in China and Vietnam. The Company diversifies manufacturing among various factories to reduce risk. +The Company’s top five manufacturers produced the following: +Percentage of Total Production +Year Ended December 31, +2020 +2019 +2018 +Manufacturer #1 +21.0 +% +16.0 +% +12.8 +% +Manufacturer #2 +6.2 +% +7.3 +% +10.1 +% +Manufacturer #3 +5.8 +% +7.2 +% +8.6 +% +Manufacturer #4 +4.9 +% +5.1 +% +5.4 +% +Manufacturer #5 +4.2 +% +5.0 +% +5.0 +% +42.1 +% +40.6 +% +41.9 +% +Assets located outside the U.S. consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and operating lease ROU assets. Net assets held outside the U.S. were $ 3.1 billion and $ 2.6 billion at December 31, 2020 and 2019, respectively. +The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable generally do not require collateral. Foreign accounts receivable are generally collateralized by letters of credit. The Company’s credit losses charged to expense for the years ended December 31, 2020, 2019 and 2018 were $ 19.0 million, $ 31.6 million and $ 8.0 million. +The Company’s accounts receivables, excluding the allowance for bad debts, sales returns and chargebacks, in different geographic areas are summarized as follows: +As of December 31, +(in thousands) +2020 +2019 +Domestic Accounts Receivable +$ +230,546 +$ +228,533 +Foreign Accounts Receivable +437,816 +440,876 +( 1 4 ) +SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) +The operating results for any quarter are not necessarily indicative of results for any future period. Summarized financial data are as follows: +Year Ended December 31, 2020 +First +Second +Third +Fourth +(in thousands, except per share data) +Quarter +Quarter +Quarter +Quarter +Sales +$ +1,242,345 +$ +729,472 +$ +1,300,886 +$ +1,324,711 +Gross profit +547,668 +368,566 +625,121 +648,426 +Net earnings (loss) +41,160 +( 55,217 +) +82,110 +78,172 +Net earnings (loss) attributable to Skechers U.S.A., Inc. +49,101 +( 68,097 +) +64,278 +53,282 +Net earnings (loss) per share: +Basic +$ +0.32 +$ +( 0.44 +) +$ +0.42 +$ +0.34 +Diluted +$ +0.32 +$ +( 0.44 +) +$ +0.41 +$ +0.34 +53 +Year Ended December 31, 2019 +First +Second +Third +Fourth +(in thousands, except per share data) +Quarter +Quarter +Quarter +Quarter +Sales +$ +1,276,756 +$ +1,258,565 +$ +1,353,998 +$ +1,330,732 +Gross profit +590,509 +609,835 +653,064 +637,748 +Net earnings +131,019 +91,998 +121,734 +82,501 +Net earnings attributable to Skechers U.S.A., Inc. +108,758 +75,180 +103,090 +59,532 +Net earnings per share: +Basic +$ +0.71 +$ +0.49 +$ +0.67 +$ +0.39 +Diluted +$ +0.71 +$ +0.49 +$ +0.67 +$ +0.39 +54 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2020. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2020, which is set forth below. +55 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2020. +56 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 26, 2021, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 26, 2021 +57 +ITEM 9B. +OTHER INFORMATION +None. +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 30 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 59 of this annual report on Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +58 +SCHEDULE II +SKECHERS U.S.A., INC. AND SUBSIDIARIES +VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Balance at +Beginning of Year +Costs +Charged to +Expenses +Deductions +and +Write-offs +Balance at +End of Year +Year-ended December 31, 2018 +Allowance for chargebacks +$ +12,807 +$ +12,629 +$ +( 6,663 +) +$ +18,773 +Allowance for doubtful accounts +7,709 +2,856 +( 3,722 +) +6,843 +Liability for sales returns and allowances +30,664 +20,245 +( 2,443 +) +48,466 +Reserve for shrinkage +1,737 +5,771 +( 5,891 +) +1,617 +Reserve for obsolescence +7,019 +6,461 +( 2,344 +) +11,136 +Year-ended December 31, 2019 +Allowance for chargebacks +$ +18,773 +$ +3,931 +$ +( 5,291 +) +$ +17,413 +Allowance for doubtful accounts +6,843 +2,471 +( 2,621 +) +6,693 +Liability for sales returns and allowances +48,466 +46,054 +( 25,472 +) +69,048 +Reserve for shrinkage +1,617 +5,149 +( 5,802 +) +964 +Reserve for obsolescence +11,136 +9,444 +( 14,816 +) +5,764 +Year-ended December 31, 2020 +Allowance for chargebacks +$ +17,413 +$ +12,734 +$ +( 3,473 +) +$ +26,674 +Allowance for doubtful accounts +6,693 +19,940 +( 4,745 +) +21,888 +Liability for sales returns and allowances +69,048 +18,023 +( 9,852 +) +77,219 +Reserve for shrinkage +964 +5,348 +( 5,217 +) +1,095 +Reserve for obsolescence +5,764 +10,572 +( 9,211 +) +7,125 +See accompanying report of independent registered public accounting firm +59 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 20, 2007). +3.2(c) +Third Amendment to Bylaws dated as of May 15, 2019 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on May 17, 2019). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed on May 12, 1999). +4.20 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 3, 2013). +10.1(a)* +First Amendment to the Skechers U.S.A., Inc. Deferred Compensation Plan +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.3* +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2007). +10.4* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.5* +Form of Restricted Stock Agreement (Time-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.6* +Form of Restricted Stock Agreement (Performance-based Vesting) under 2017 Incentive Award Plan . +10.7* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.8 +Form of Indemnification Agreement between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.9 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.10* +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.11* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2019). +10.12 +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.2 of the Registrant’s Form 8-K filed on May 24, 2019). +60 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.13 +Credit Agreement dated June 30, 2015, by and among the Registrant, certain of its subsidiaries who are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and Bank of America, N.A., MUFG Union Bank, N.A. and HSBC Bank USA, National Association (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on July 7, 2015). +10.14 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.14(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on August 17, 2015). +10.14(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018). +10.14(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(c) of the Registrant’s Form 10-K for the year ended December 31, 2019). +10.15 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed on August 17, 2015). +10.15(a)** +First Amendment to Amended and Restated Loan Agreement dated as of March 18, 2020, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders. (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on March 24, 2020). +10.16 +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.17 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.18** +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.19 +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +61 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.20 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.21 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data file - the cover page from the Company's Annual Report on Form 10-K for the year ended December 31, 2020 has been formatted in Inline XBRL. +* +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** +C onfidential treatment has been granted by the SEC with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +62 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 26th day of February 2021. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 26, 2021 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 26, 2021 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 26, 2021 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 26, 2021 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Katherine Blair +Director +February 26, 2021 +Katherine Blair +/s/ Morton D. Erlich +Director +February 26, 2021 +Morton D. Erlich +/s/ Jeffrey Greenberg +Director +February 26, 2021 +Jeffrey Greenberg +/s/ Geyer Kosinski +Director +February 26, 2021 +Geyer Kosinski +/s/ Richard Rappaport +Director +February 26, 2021 +Richard Rappaport +/s/ Richard Siskind +Director +February 26, 2021 +Richard Siskind +/s/ Thomas Walsh +Director +February 26, 2021 +Thomas Walsh +63 \ No newline at end of file diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/filing_metadata.csv b/raw/filings/0001065837/2020/0001564590-21-009442/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1407591a6943f4b6f8c931926e86d21eff67761b --- /dev/null +++ b/raw/filings/0001065837/2020/0001564590-21-009442/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2021-02-26,2020-12-31,2021-02-26T21:20:18.000Z,0001564590-21-009442,skx-10k_20201231.htm,10-K,15533584,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000156459021009442/skx-10k_20201231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459021009442/,2020,2020,1 diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/item1.txt b/raw/filings/0001065837/2020/0001564590-21-009442/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..58f9c8853920e40cfef8930c0de8af1100ea0bd7 --- /dev/null +++ b/raw/filings/0001065837/2020/0001564590-21-009442/item1.txt @@ -0,0 +1,241 @@ +ITEM 1. +BUSINESS +Skechers U.S.A., Inc. was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under generally accepted accounting principles in the United States (“U.S.”). Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. We also design and market men’s and women’s Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and scrub manufacturers, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through department and specialty stores, athletic and independent retailers, boutiques and online retailers. In addition to wholesale distribution, our footwear is available on our direct-to-consumer websites and in our own retail stores. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and diversified distribution channels. +We seek to offer consumers a vast array of footwear that satisfies their active, casual, dress casual and athletic footwear needs. Our core consumers are attracted to our relevant brand image, fashion-forward designs, affordable and comfortable product, as well as athletes and fitness enthusiasts attracted to our performance footwear. Many of our best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Further, we offer children a unique collection of footwear designed just for them, including those with innovative light technology. +We believe that brand recognition is an important element for success in the footwear business. We have aggressively marketed our brands through comprehensive marketing campaigns for men, women and children. During 2020, the Skechers brand was supported by print, television, digital, radio and outdoor campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we have enlisted numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2020, our brand ambassadors included Sugar Ray Leonard, Tony Romo, Howie Long, and Brooke Burke, along with athletes Edward Cheserek, Meb Keflezighi, Matt Kuchar and Brooke Henderson. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines for men, women and children, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. +Lifestyle Brands . Our lifestyle offering includes multiple categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Mark Nason, the charity-minded BOBS from Skechers collection, among others. Comfort, style and value are at the cornerstone of our vast lifestyle collections. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and retro fashion. Innovation is also important within our lifestyle offering and select styles across many lines include a patented Arch Fit insole design for podiatrist-certified arch support and Goodyear Performance Outsoles for enhanced traction, stability and durability. Also within our lifestyle collections are collaborations with known brands and properties—including street artists, influential boutiques and manga characters. +2 +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed with a focus on specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight ULTRA GO and HYPER BURST midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines of Skechers GOrun , Skechers GOwalk , Skechers GOtrain , Skechers GOtrail , and Skechers GO G olf . Additional features found in select styles across multiple categories include Arch Fit insoles, Goodyear Performance Outsoles, and Max Cushioning designs. +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection; Skechers Mega-Craft; S-Lights; SKECH-AIR; Foamies, Twinkle Toes; Z-Strap; Skechers Stretch Fit; and Skechers Street. Skechers Kids also includes shoes that are designed as “takedowns” of their adult counterparts, allowing younger consumers the opportunity to wear the same popular styles as their older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by offering premium leathers, hardware and outsoles without the costs involved in designing and developing new products. In addition, we adapt current fashions from our men’s and women’s lines by modifying designs and choosing colors and materials that are more suitable for the playful image that we have established in the children’s footwear market. +Skechers Work. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear across a wide range of work environments. Skechers Work styles include safety features such as steel, composite and lightweight safety toes; puncture resistance; waterproofing and electrostatic-dissipative technology, as well as Skechers’ comfort technologies such as Relaxed Fit construction; Max Cushioning; Skechers Memory Foam insoles and Arch Fit insoles. Designed for men and women working in jobs with certain safety requirements, these durable styles are constructed on high-abrasion, long-wearing soles for prolonged durability. +In addition, Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features the same Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear initiatives. The Skechers apparel collection is sold at Skechers retail stores, to our domestic wholesale accounts and select international partners. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our footwear is designed for active lifestyles and consumers needing comfort in their footwear from fashionable 18- to 34-year-olds, to a broader base of 5- to 50-year-olds, and even an exclusive selection for infants and toddlers. Designed by the Skechers Performance Division, our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; traveling to domestic and international fashion markets to identify and confirm current trends; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and develop our successful styles in our brands’ images. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +3 +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia through staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website . We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe that quality control is an important and effective means of maintaining the quality and reputation of our products. Our quality control program is designed to ensure that not only finished goods meet our established design specifications, but also that all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +Sustainability. We believe that sustainability is an important responsibility in managing our business. We have worked to make our packaging more sustainable for the more-than-150 million pairs of Skechers that consumers purchase every year. Since 2016, we’ve reduced our products’ packaging plastics by 85% down to 10% of our foot forms, and have made remaining plastics completely recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging is also recyclable and printed with soy-or water-based ink. We are proud to have 99% of our shoes packaged in shoeboxes that meet the FSC® standard for responsible resources, and we are continually looking out for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. +Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recyclable materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including America’s largest LEED Gold certified distribution facility in Rancho Belago, California. Our new corporate headquarters in Manhattan Beach, California are also being designed and developed to qualify for LEED certification. +Product Styles. We closely monitor sales activity after initial introduction of a product in our concept stores and on-line to determine whether there is substantial demand for a style, thereby aiding us in our sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming collections or offered as part of our periodic style offerings, while less popular styles can be discontinued after a limited production run. We believe that sales in our concept stores can also help forecast sales in national retail stores, and we share this sales information with our wholesale customers. Sales, merchandising, production and allocations management analyze historical and current sales along with market data from our wholesale account base and our own retail stores to develop an internal product quantity forecast that allows us to manage our future production and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock position to minimize the time necessary to fill customer orders by placing orders with our manufacturers prior to the time we receive customers’ orders for such footwear. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity endorsers in some of our advertisements. We also believe our websites are effective marketing tools to consumers. We have historically budgeted advertising as a percentage of projected sales. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: Domestic Wholesale, International Wholesale, and Direct-to-Consumer. In the U.S., our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and online retailers. Internationally, our products are available through wholesale customers in more than 170 countries and territories via our global network of distributors as well as through our subsidiaries in Asia, Europe, Canada, Central America and South America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and warehouse outlet stores. Each of these channels serves an integral function in the global distribution of our products. +4 +In addition, 18 distributors and 51 licensees have opened and operate 799 distributor-owned or -licensed Skechers retail stores and 1,771 licensee-owned Skechers retail stores, respectively, as of December 31, 2020 . +Domestic Wholesale. We distribute our footwear through the following domestic wholesale distribution channels: big-box footwear stores, department stores, wholesale clubs, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. Skechers footwear is available in a variety of wholesale customers, many of whom may operate stores within the same retail location due to our distinct product lines, variety of styles and the price criteria of their specific customers. Management has a clearly defined growth strategy for each of our channels of distribution. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +In an effort to provide knowledgeable and personalized service to our wholesale customers, the sales force is segregated by product line, each of which is headed by a vice president or national sales manager. Reporting to each sales manager are knowledgeable account executives and territory managers. The vice presidents and national sales managers report to our senior vice president of sales. All of our vice presidents and national sales managers are compensated on a salary basis, while our account executives and territory managers are compensated on a commission basis. None of our domestic sales personnel sells competing products. +International Wholesale. Our products are sold in more than 170 countries and territories throughout the world. We generate revenues from outside the U.S. from three principal sources: (i) sales to department stores and specialty retail stores through our joint ventures in Mexico, Asia and the Middle East, as well as through our subsidiaries in the Americas, Europe, and Asia; (ii) sales to international distributors who deliver our footwear to department stores, specialty retail stores and third-party-owned Skechers stores in select countries and territories across Asia, South America, Africa, the Middle East and Australia; and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our non-footwear products abroad. +We believe that international distribution of our products represents a significant opportunity to increase sales and profits. We intend to further increase our share of the international footwear market by heightening our marketing in those countries in which we currently have a presence through our international advertising campaigns, which are designed to establish Skechers as a global lifestyle and performance brand. +The following subsidiaries and joint ventures merchandise, market and distribute product to generate sales in their named countries, and we consolidate their results in our financial statements: +• +International Subsidiaries +Canada – We currently operate through Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in Mississauga, Ontario. Product sold in Canada is primarily sourced from our U.S. distribution center in California. We have company-owned retail stores in key locations across Canada. +Europe – We currently operate in Europe through the following subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England; Skechers S.a.r.l., with its offices in Lausanne, Switzerland; Skechers USA France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L., with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its offices and showrooms in Waalwijk, the Netherlands; Skechers USA Italia S.r.l., with its offices and showrooms in Milan, Italy; and Skechers CEE, Kft. with its offices and showrooms in Budapest, Hungary as well as regional showrooms in Albania, Bosnia-Herzegovina, Bulgaria, Croatia, the Czech Republic, Kosovo, Macedonia, Moldova, Montenegro, Romania, Serbia, Slovakia and Slovenia. To accommodate our European subsidiaries’ operations, we operate a 1.8 million square-foot distribution center in Liege, Belgium. +India – We currently operate through Skechers South Asia Private Limited and Skechers Retail India Private Limited. +Japan – We currently operate through our subsidiary, Skechers Japan GK, with its offices and showrooms located in Tokyo, Japan. Product sold in Japan is primarily shipped directly from our contract manufacturers’ factories in China. +South America and Central America – We currently operate in South America and Central America through the following subsidiaries: Skechers Do Brasil Calcados LTDA, with its offices and showrooms located in Sao Paulo, Brazil; Comercializadora Skechers Chile Limitada, with its offices and showrooms located in Santiago, Chile; and Skechers Latin America LLC, with its offices and showrooms in Panama City, Panama as well as regional showrooms in Panama, Peru, Colombia and Costa Rica. Our Latin America subsidiary also distributes products in the Caribbean, Ecuador, Guatemala, El Salvador, Honduras and Nicaragua. Product sold in South America and Central America is primarily shipped directly from our contract manufacturers’ factories in China and Vietnam. +5 +• +International Joint Ventures +China and Hong Kong – We have a 50% interest in a joint venture in China and a minority interest in a joint venture in Hong Kong. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. +Israel – We have a 51% interest in Skechers Ltd. (Israel). Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +Mexico – We have a 60% interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”) . Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +South Korea – We have a 65% interest in Skechers Korea Co., Ltd. Under the joint venture agreement, the joint venture partners contribute capital in proportion to their respective ownership interests. +Malaysia, Singapore and Thailand – We have a 50% interest in a joint venture in Malaysia and Singapore, and a 51% interest in a joint venture in Thailand. Under the joint venture agreements, the joint venture partners contribute capital in proportion to their respective ownership interests. +• +Distributors and Licensees +Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of more than 23 distributors who sell our products to department, athletic and specialty stores. As of December 31, 2020, we also had agreements with 18 of these distributors and 51 licensees regarding 799 distributor-owned or licensed Skechers retail stores and 1,771 licensee-owned Skechers retail stores. Our distributors, licensees and franchisees own and operate the following retail stores in more than 170 countries around the world: +Number of Store Locations at December 31, 2019 +Opened during 2020 +Closed during 2020 +Number of Store Locations at December 31, 2020 +Distributor, licensee and franchise stores +Africa +60 +8 +(1 +) +67 +Asia +1,694 +350 +(247 +) +1,797 +Australasia +109 +12 +— +121 +Central America +16 +3 +— +19 +Europe +303 +53 +(4 +) +352 +Middle East +164 +2 +(1 +) +165 +North America +12 +— +— +12 +South America +35 +2 +— +37 +Total distributor, licensee and franchise stores +2,393 +430 +(253 +) +2,570 +Distributors and licensees are responsible for their respective stores’ operations, have ownership of their respective stores’ assets, and select the broad collection of our products to sell to consumers in their regions. In order to maintain a globally consistent image, we provide architectural, graphic and visual guidance and materials for the design of the stores, and we train the local staff on our products and corporate culture. We intend to expand our international presence and global recognition of the Skechers brand name by continuing to sell our footwear to foreign distributors and by opening retail stores with distributors that have local market expertise. +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: e-commerce, concept stores, factory outlet and warehouse outlet stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E-commerce – Our company-owned e-commerce business enable consumers to shop, browse, find store locations, socially interact, post a shoe review, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which has improved our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores have a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offering for the current season, as we estimate that our average wholesale customer carries no more than 5% of the complete Skechers line in any one location. Our concept stores showcase our products in an attractive, easy-to-shop open-floor setting, providing the consumer with the complete Skechers story. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. Domestic locations include concept stores at Times Square, and 34th Street, in New York; Powell Street in San Francisco: Santa Monica’s Third Street Promenade; Ala Moana Center in +6 +Hawaii; South Beach Miami’s Lincoln Road and Las Vegas’ Grand Canal Shoppes at the Venetian. International locations include Oxford Street and Covent Garden in London; Rue de Rivoli in Paris; Via del Corso in Rome; Kaufingerstraße in Munich; Toronto’s Eaton Centre; and the Shinsaibashi shopping district of Osaka, Harajuku and Shibuya in Tokyo. The stores are typically designed to create a distinctive Skechers look and feel, and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues. We believe that product sell-through information and rapid customer feedback derived from our concept stores enables our design, sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns. +The typical Skechers concept store is approximately 3,000 square feet, although in certain markets we have concept stores ranging from 600 square feet to 14,300 square feet. When deciding where to open concept stores, we identify top geographic markets in larger metropolitan cities around the world. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image. Skechers’ factory outlet stores range in size from approximately 850 to 24,100 square feet. Unlike our warehouse outlet stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Warehouse Outlet Stores – Our free-standing and attached warehouse outlet stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory that would otherwise typically be sold to discounters at excessively low prices, which could compromise the Skechers brand image. Skechers’ warehouse outlet stores are typically larger than our factory outlet stores ranging in size from approximately 4,000 to 30,600 square feet. We seek to open our warehouse outlet stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations at December 31, 2019 +Opened during 2020 +Closed during 2020 +Number of Store Locations at December 31, 2020 +Domestic stores +Concept +109 +3 +(7 +) +105 +Factory Outlet +171 +2 +(1 +) +172 +Warehouse Outlet +217 +31 +(2 +) +246 +Domestic stores total +497 +36 +(10 +) +523 +International stores +Concept +200 +21 +(1 +) +220 +Factory Outlet +93 +9 +(2 +) +100 +Warehouse Outlet +10 +1 +— +11 +International stores total +303 +31 +(3 +) +331 +Joint venture stores +China +157 +111 +(23 +) +245 +Hong Kong +47 +2 +(3 +) +46 +Israel +15 +2 +— +17 +Mexico +81 +4 +(1 +) +84 +South Korea +17 +— +(2 +) +15 +South East Asia +37 +23 +— +60 +Joint venture stores total +354 +142 +(29 +) +467 +Total domestic, international and joint venture stores +1,154 +209 +(42 +) +1,321 +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers may broaden and enhance the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms with licensees that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. We believe that the reputation of Skechers and its history in launching brands has also enabled us to partner with reputable non-footwear brands to design and market their footwear. +7 +As of December 31, 2020 , we had 23 active domestic and international licensing agreements in which we are the licensor. These include Skechers-branded kids’ apparel; bags, backpacks and lunch boxes; belts, wallets and travel accessories, and watches for adults and kids ; headwear, socks and shoe care; prescription and sunglass eyewear; outerwear, swimwear, underwear, sleepwear and medical scrubs; fitness and yoga accessories; headwear ; and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; Skechers Work socks and Skechers G o G olf apparel for men and women . We also have BOBS from Skechers pet accessories in Petco. We have international licensing agreements for the design and distribution of prescription and sunglass eyewear globally; men’s, women’s and kids’ apparel in the United Kingdom; kids’ apparel in Europe; socks and watches throughout Europe; bags and backpacks in the Philippines, Taiwan, Australia, New Zealand, Europe Russia, Scandinavia and the Middle East; medical scrubs in the Middle East, United Kingdom, Australia, and New Zealand; apparel, socks, headwear, bags , and backpacks in Indonesia; apparel, socks, and bags in Mexico; bags, backpacks, luggage, wallets, watches, medical scrubs and accessories in Latin America; apparel, bags, and backpacks, headwear, socks, and shoe care Turkey; socks in Japan and watches in the Philippines. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Once manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either: (i) to our approximate 2.8 million square-foot North American distribution center located in California, (ii) to our approximate 1.8 million square-foot European Distribution Center located in Belgium, (iii) to our company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, or (vi) directly from third-party manufacturers to our other international customers and other international third-party distribution centers. Upon receipt at either of the distribution centers, merchandise is inspected and recorded in our management information system and packaged according to customers’ orders for delivery. Merchandise is shipped to customers by whatever means each customer requests, which is usually by common carrier. The distribution centers have multi-access docks, enabling us to receive and ship simultaneously, and to pack separate trailers for shipments to different customers at the same time. We have an electronic data interchange system which is linked to some of our larger customers. This system allows these customers to automatically place orders with us, thereby eliminating the time involved in transmitting and inputting orders, and it includes direct billing and shipping information. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in approximately 155 foreign countries. We also have design patents and pending design and utility patent applications in both the U.S. and approximately 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets, and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. Our footwear competes with footwear offered by companies such as Columbia Sportswear Company, Nike, Inc., Crocs, Inc., Deckers Outdoor Corporation, Kenneth Cole Productions Inc., Steven Madden, Ltd., V.F. Corporation, Adidas AG, Reebok International, Puma SE, ASICS America Corporation, New Balance Athletic Shoe, Inc., Under Armor Inc. and Wolverine World Wide, Inc. These and other competitors pose challenges to our market share in domestic and international markets. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +EMPLOYEES +As of December 31, 2020, we employed approximately 11,700 persons, of whom approximately 5,900 were employed on a full-time basis and approximately 5,800 were employed on a part-time basis, primarily in our retail stores. As a family-focused brand, Skechers was founded on the philosophy of putting people first – offering comfort and care to its employees and customers, and supporting both with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of our company – from our factories to our suppliers. +8 \ No newline at end of file diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/item13.txt b/raw/filings/0001065837/2020/0001564590-21-009442/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..be96ca54f5bc2c90c0ccace7297f365f6c649535 --- /dev/null +++ b/raw/filings/0001065837/2020/0001564590-21-009442/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2020 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/item9a.txt b/raw/filings/0001065837/2020/0001564590-21-009442/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..5cc7471c30aed3d00b3286c5fac431b6a5bd70a7 --- /dev/null +++ b/raw/filings/0001065837/2020/0001564590-21-009442/item9a.txt @@ -0,0 +1,39 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2020. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2020, which is set forth below. +55 +Inherent Limitations on Effectiveness of Controls +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2020. +56 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 26, 2021, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 26, 2021 +57 \ No newline at end of file diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/rp_note.txt b/raw/filings/0001065837/2020/0001564590-21-009442/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2020/0001564590-21-009442/rpt_disclosure.txt b/raw/filings/0001065837/2020/0001564590-21-009442/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..33ac7681add8875f8258f986b37c54e42c899337 --- /dev/null +++ b/raw/filings/0001065837/2020/0001564590-21-009442/rpt_disclosure.txt @@ -0,0 +1,14 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in the section entitled “ Corporate Code of Conduct and Code of Ethic s ”), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A Common Stock or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2021. Each of these transactions was reviewed, and approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +Related Person Transactions +On November 12, 2021, we paid $200,000 to The Beach Life Festival for Skechers marketing and sponsorship. The Beach Life Festival is owned and operated by Beach Life Festival, LLC, of which Michael Greenberg owned an 8% beneficial ownership interest. Skechers had no outstanding accounts receivable or payable with The Beach Life Festival or Beach Life Festival, LLC as of December 31, 2021. +On March 31, 2021, we purchased two properties for $2.7 million, from an entity controlled by Michael Greenberg, to facilitate future expansion of our corporate office buildings in Manhattan Beach, California. The terms of the sale were no less favorable than could be obtained from an unrelated third party. +43 +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg has agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for the fourth time for an additional year with the same terms and conditions effective as of February 1, 202 2 . +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2021, we made contributions of $3,000,000 to the Foundation. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $319,738, $4,146,195, $3,407,625 and $338,830, respectively, in 2021. 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+2021-12-31 +0001065837 +us-gaap:InventoryValuationReserveMember +2021-01-01 +2021-12-31 +0001065837 +us-gaap:AllowanceForCreditLossMember +2021-12-31 +0001065837 +us-gaap:AllowanceForNotesReceivableMember +2021-12-31 +0001065837 +skx:ReturnReserveLiabilityMember +2021-12-31 +0001065837 +us-gaap:InventoryValuationReserveMember +2021-12-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2021 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2021, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 6.9 billion based upon the closing price of $49.83 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2022: 135,107,264 . +The number of shares of Class B Common Stock outstanding as of February 15, 2022: 20,938,571 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2022 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +table of contents TO ANNUAL REPORT ON form 10-k +for the year ended DECEMBER 31, 2021 +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +6 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +14 +ITEM 2. +PROPERTIES +14 +ITEM 3. +LEGAL PROCEEDINGS +15 +ITEM 4. +MINE SAFETY DISCLOSURES +15 +PART II +ITEM 5. +MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +16 +ITEM 6. +[RESERVED] +16 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +17 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +22 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +23 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +46 +ITEM 9A. +CONTROLS AND PROCEDURES +46 +ITEM 9B. +OTHER INFORMATION +48 +ITEM 9C. +DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +48 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +49 +ITEM 11. +EXECUTIVE COMPENSATION +49 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +49 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +49 +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +49 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +50 +ITEM 16. +FORM 10-K SUMMARY +50 +SIGNATURES +55 +i +SPECIAL NOTE ON Forward-looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 , including statements with regards to future revenue, projected operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our future performance. Factors that might cause or contribute to such differences include: +• +the COVID-19 pandemic and its adverse impact on our business, our operations, and our sales and results of operations around the world; +• +our ability to manage the impact from delays and disruptions in our supply chain; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; and +• +global economic, political and market conditions, including the challenging consumer retail market in the United States (“U.S.”). +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and state securities laws. +1 +PART I +ITEM 1. +BUSINESS +Skechers U.S.A., Inc., The Comfort Technology Company TM , was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under U.S. generally accepted accounting principles. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, performance footwear for men and women under the Skechers Performance brand name, and work footwear for men and women under Skechers Work brand name. We design and market Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and medical scrubs, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through wholesale distribution to department and specialty stores, athletic and independent retailers, and e-commerce retailers and directly to consumers through retail stores and digital sales. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and various distribution channels. +We believe that brand recognition is an important element for success in the footwear business. We aggressively market our brands through comprehensive marketing campaigns for men, women and children. The Skechers brand is supported by print, television, digital, radio, outdoor and press campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we enlist numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2021 , our brand ambassadors included Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Rusty Wallace and Brooke Burke, along with athletes Clayton Kershaw, Edward Cheserek, Meb Keflezighi, Colin Montgomerie and Brooke Henderson. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account and customer base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. +Lifestyle Brands . Our lifestyle offering includes categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Foamies, Mark Nason, the charity-minded BOBS from Skechers collection, among others. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and fashion. Innovation is also important within our lifestyle offering and select styles include patented designs including podiatrist-certified arch support and outsoles for enhanced traction, stability and durability. Within our lifestyle collections are collaborations with known brands and properties—including street artists, designers and well-known animated characters. +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed for specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight ULTRA GO and HYPER BURST midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines of Skechers GOrun, Skechers GOwalk, Skechers GOtrain, Skechers GOtrail, and Skechers GO Golf. +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection; Skechers Mega-Craft, S-Lights, SKECH-AIR, Foamies, Twinkle Toes, Skechers Stretch Fit, and Skechers Street. +Skechers Work. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers +2 +comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology . +Skechers Apparel. Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear products. The Skechers apparel collection is sold at Skechers retail stores, on our websites and through wholesale customers. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. Our occupational footwear is designed to meet the specifications and demands of the service, medical and construction industries while also meeting testing specifications in the markets where the product is sold. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and improve our most successful styles. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +Sustainability. We believe sustainability is an important responsibility in managing our business. We recently launched Our Planet Matters, a collection of sustainable products utilizing recycled materials. We partnered with a global conservation organization to help fund their organization’s global efforts which align with our core values and commitment to reduce tree harvesting and emissions through packaging. +We worked to make our packaging more sustainable for the more-than-200 million units of Skechers that consumers purchased in 2021. Since 2016, we’ve reduced our products’ packaging plastics by 99% down to less than 1%; all of which are recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging are recyclable and printed with soy-or water-based ink. Further, 99% of our shoeboxes meet the FSC® standard for responsible resources, and we continually look for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed +3 +with soy-or-water-based ink and are 100% recyclable, and at the distribution center s managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recycl ed materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our expanding corporate offices in Los Angeles, California are being designed and developed to qualify for LEED certification. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity endorsers in some of our advertisements. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: Domestic Wholesale, International Wholesale, and Direct-to-Consumer. In the U.S., our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and e-commerce retailers. Internationally, our products are available through wholesale customers in more than 180 countries and territories via our global network of distributors as well as through our subsidiaries in Asia, Europe, Canada, and Latin America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and big box stores. Each of these channels serves an integral function in the global distribution of our products. +Domestic Wholesale. We distribute our footwear domestically to department stores, wholesale clubs, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. Skechers footwear is available through a variety of wholesale customers, many of whom operate stores within the same retail locations due to our distinct product lines, variety of styles and the price criteria of their specific customers. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +International Wholesale. Our products are sold in more than 180 countries and territories throughout the world. We generate revenues from outside the U.S. from sales to department stores, specialty, independent and internet retailers. To support our global operations, we have offices and showrooms in over 20 countries. +Our subsidiaries and joint ventures merchandise, market and distribute Skechers product to generate sales in their countries, and we consolidate their results in our financial statements. Our joint venture interests include: China, Malaysia and Singapore (50%), Thailand and Israel (51%), Mexico (60%), and South Korea (65%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores. Our distributors, licensees and franchisees own and operate the following retail stores around the world: +Number of Store Locations at December 31, 2020 +Opened during 2021 +Closed during 2021 +Number of Store Locations at December 31, 2021 +Distributor, licensee and franchise stores +Africa +67 +1 +— +68 +Asia +1,797 +545 +(278 +) +2,064 +Australasia +121 +28 +— +149 +Central America +19 +10 +— +29 +Europe +352 +57 +(2 +) +407 +Middle East +165 +13 +— +178 +North America +12 +1 +— +13 +South America +37 +2 +(1 +) +38 +Total distributor, licensee and franchise stores +2,570 +657 +(281 +) +2,946 +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: e-commerce, concept stores, factory outlet and big box stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E-commerce – Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which has improved our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are +4 +generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as marketing and product testing venues. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise. Unlike our big box stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Big Box Stores – Our free-standing and attached big box stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory. We seek to open our big box stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations at December 31, 2020 +Opened during 2021 +Closed during 2021 +Number of Store Locations at December 31, 2021 +Domestic stores +523 +18 +(26 +) +515 +International stores +331 +33 +(6 +) +358 +Joint venture stores +467 +128 +(108 +) +487 +Total domestic, international and joint venture stores +1,321 +179 +(140 +) +1,360 +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers broadens and enhances the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. +As of December 31, 2021 , we had 25 active licensing agreements in which we are the licensor. These include a variety of Skechers-branded products including apparel, accessories, socks and eyewear; medical scrubs; fitness and yoga accessories, and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; BOBS from Skechers socks and backpacks; and Skechers Work socks. We also have BOBS from Skechers pet accessories in Petco. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Our distribution network includes (i) an approximately 2.8 million square-foot North American distribution center located in California, (ii) an approximately 2.2 million square-foot European distribution center located in Belgium, (iii) an approximately 1.6 million square foot China distribution center, (iv) an approximately 0.3 million square foot United Kingdom distribution center, (v) company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, and (vi) third-party manufacturers and other international third-party distribution centers. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in approximately 155 foreign countries. We have design patents and pending design and utility patent applications in both the U.S. and approximately 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +5 +HUMAN CAPITAL +As of December 31, 2021 , we employed approximately 11,700 persons, of whom approximately 6,200 were employed on a full-time basis and approximately 5,500 were employed on a part-time basis, primarily in our retail stores. +Social Responsibility. As a family-focused brand, Skechers was founded on inclusivity, diversity, respect and entrepreneurial spirit with the philosophy of putting people first – offering comfort and care to our employees and customers. In conjunction with our policy against discrimination, Skechers emphasizes that every employee, applicant, contractor and customer is entitled to be treated with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of our company – including our factories and suppliers. All full-time and part-time corporate employees in the U.S. undergo harassment and diversity training, and employees of our wholly-owned operations in other countries comply with their local laws regarding human rights, harassment and diversity training in the workplace. As it relates to our factories and suppliers specifically, we provide employee and management training to ensure that employees and companies who oversee our production and manufacturer auditing know the most current issues regarding human rights. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify these values and our commitment to diversity, equity and inclusion. +Skechers is also focused on reducing its carbon footprint. We have made environmental advancements a top priority at our corporate facilities. Now under construction, our expanding corporate offices remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four buildings are being designed to receive LEED Gold certification upon completion, and include solar panels. +Community. Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2021, the Company donated over 50,000 pairs of new shoes to those in need, $1.0 million in support of earthquake relief efforts in Haiti, and we formed a partnership with a global conservation organization to contribute to their efforts to protect the world’s lands and waters. +Health and Safety. Skechers’ lifestyle and performance product offering has shaped our culture with a focus on wellness, and a commitment to providing a safe and healthful work environment for all employees. The Company offers healthy lunch options, an in-house fitness consultant and corporate exercise programs. We offer paid time off to get the COVID-19 vaccine and provided on-site vaccination clinics for our corporate employees and our domestic distribution center employees. We made changes to our corporate facilities, increasing cleaning protocols and distributing personal protective equipment and cleaning supplies to employees; instituting temperature screenings; installing touchless doors and faucets in common areas; limiting building occupancy; and staggering work schedules. +Talent. We offer competitive benefits in a casual, creative atmosphere and a fun, fast-paced environment where employees can always learn and grow. Employee benefits are designed to help employees and their families stay healthy, meet their financial goals, and help them balance their work and personal lives. Benefits include health and wellness programs, training and development programs, an employee stock purchase program, a childcare incentive program, on-site electric vehicle charging stations, and product discounts. +Item 1A. +RISK FACTORS +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +Risks Related to COVID-19 +The COVID-19 Pandemic Has Had, And May Continue To Have, A Material Adverse Effect On Our Business And Results Of Operations. +Impact on Global Economy and on Our Business and Financial Performance +The COVID-19 pandemic has negatively impacted the global economy, disrupted consumer spending and global supply chains, and created significant volatility and disruption of financial markets. As a result, the COVID-19 pandemic has had, and may continue to have, a material adverse impact on our business and financial performance. The extent of this impact will depend on future developments, including the duration and severity of the pandemic, restrictions on travel, temporary store closure requirements, changes in consumer confidence and spending, and the extent of any recession resulting from the pandemic. At this time, we cannot reasonably estimate the duration and severity of the COVID-19 pandemic, or its overall impact on our business and financial performance. +Closures and Operational Restrictions of Our Retail Stores and Our Wholesale Customers’ Stores +We may face recurring store closure requirements and other operational restrictions with respect to some or all our physical locations because of evolving or new governmental restrictions, quarantine policies, or social distancing measures related to the COVID-19 pandemic. Our business and results of operations have been, and may continue to be, materially adversely impacted by store closures and operational restrictions. +6 +Consumer fear about becoming ill with COVID-19 and recommendations and/or mandates from governmental authorities has had, and may continue to have, an adverse effect on traffic to stores. Any significant reduction in consumer visits to, or spending at, our wholesale customers’ stores and our retail stores during and following this pandemic has resulted in, and may continue to result in, a loss of sales and profits and other material adverse effects on our business and results of operations. +Disruptions or Delays in Our Supply Chain +The COVID-19 pandemic and related governmental and port facility actions have caused delays in shipments of our products and could significantly impact our supply chain if the factories that manufacture our products, the distribution centers where we manage our inventory, or the operations of our logistics and other service providers are further disrupted, temporarily closed or experience worker shortages. More specifically, most of our manufacturers are in China and Vietnam. To date, the Chinese and Vietnamese governments have imposed certain restrictions on business operations and the movement of people and goods to limit the spread of COVID-19, including the temporary closure of some factories and businesses in China and restrictions on others in Vietnam. Further, product that is sent from third-party manufacturers to our domestic distribution center arrives via cargo ships at the ports in Los Angeles and Long Beach where operations have been disrupted. Any prolonged or subsequent disruptions or delays in shipments could result in additional negative impacts to the pricing of our products due to changes in the availability of inventory, increased shipping costs, or missed sales that may materially adversely impact our business and results of operations. +Office Closures, Focus of Key Personnel and Productivity of Employees +Beginning in early 2020, we temporarily closed many of our corporate offices and other facilities, including our corporate headquarters in Manhattan Beach, California, and implemented a policy for many of our corporate employees to work remotely. While we began to allow a limited number of personnel back to our corporate offices with added safety measures and staggered work schedules in June 2020, these evolving workplace arrangements may negatively impact productivity and cause other disruptions to our business. +In addition, our management team has focused on mitigating the adverse effects of the COVID-19 pandemic, which has required and may continue to require a large investment of time and resources, diverting their attention from other priorities that existed prior to the pandemic. If these conditions worsen or last for an extended period, our ability to manage our business may be impaired and operational risks may be elevated. +The COVID-19 Pandemic Has Had A Negative Impact On The Global Economy, And Our Sales Are Influenced By Economic Conditions That Impact Consumer Spending And Consumer Confidence. +Consumer confidence and spending on discretionary items generally declines during periods of economic uncertainty or recession. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and/or increasing promotional activity. Our retail stores are also affected by these conditions and may experience declines in consumer traffic and spending. As a result, factors that diminish consumer confidence and spending, particularly deterioration in general economic conditions, consumer credit availability, consumer debt levels, inflation, the impact of foreign exchange fluctuations on tourism and tourist spending, volatility in investment returns, fear of unemployment, increases in energy costs or taxes or interest rates, housing market downturns, fear about and impact of pandemic illness (such as the impact of the COVID-19 pandemic, including reduced store traffic and widespread temporary store closures), and other factors such as acts of war, natural disasters or terrorist or political events that impact consumer confidence, have had, and may continue to have (with respect to the COVID-19 pandemic), a material adverse effect on our operations and financial condition through their negative impact on our wholesale customers as well as decreased spending in our retail stores and potentially via our e-commerce business. +Risks Related to Our Business and Industry +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has largely been due to the strength of the Skechers brand. Maintaining, promoting, and growing our brand depends on our ability to develop high-quality, innovative, and fashion forward products, as well as our ability to create fresh and relevant marketing and advertising campaigns. The inability to execute or adverse developments in these areas could negatively impact our brand. Our brand could also be negatively impacted if we or any of our products were to receive negative publicity of any kind. If we are unable to maintain, promote and grow our brand, then our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear requires us to accurately identify changing consumer preferences and effectively respond in a timely manner. Demand for and market acceptance of existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +7 +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends. +We are often required to make decisions about product designs and marketing expenditures several months in advance of when consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences with new products that achieve market acceptance. If we fail to identify and effectively respond to changing consumer preferences, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry in the areas of product offerings, pricing, costs of production, and advertising and marketing expenditures. Consumer demand for our products may decline significantly if we do not adequately and timely anticipate and respond to our competitors. Some of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on price and production, more effectively keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, new stores could be opened in regions in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those we encounter in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, any new store openings in existing markets could result in reduced sales in existing stores in those markets. We may decide to close stores that experience sales declines, which could result in additional costs, expenses, asset impairments or asset write-downs. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory, and personnel. We have also made significant operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, the poor performance or closure of stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to direct-to-consumer and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position, and cash flows. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are in shopping malls and some of our factory outlet stores are in manufacturers’ outlet malls. We depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. The overall success of the malls can be negatively impacted by factors outside of our control, such as store closures by other retailers. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Tourism can be adversely affected by external factors such as an economic slowdown or social or political events. Any substantial decrease customer traffic generated by malls or tourism has, and may continue to have, an adverse effect on sales in our existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +8 +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +We Have A Significant Work Force And Are Subject To Risks Related To Human Capital Management. +We employ approximately 11,700 employees worldwide and a significant portion of our operating expenses relate to compensation and benefits. Although we spend a significant amount of time and expense on human capital management, we cannot ensure that we will be able to maintain a happy and productive workforce. Some of our employees may leave or take other actions that harm our business. +Risks Related to Supply Chain +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders, and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast demand, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels exceeding customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply products when we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Manufacture Or Sell Our Products, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all our sales during the year ended December 31, 2021 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; changes in domestic and foreign governmental policies; and the potential for circumstances where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers and we are not able to collect those charges, our gross profit will be negatively affected. Apart from the impacts of the COVID-19 pandemic, including supply chain constraints, we have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the People’s Republic of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate under the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PRC government could adversely affect our interests +9 +by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During the year ended December 31, 2021, the top five manufacturers of our products produced approximately 37.1% of our total purchases. One manufacturer accounted for 18.0% of total purchases for the year ended December 31, 2021. +We compete with other footwear companies for production facilities, and we do not have long-term contracts with any of our contract manufacturers. Under our current arrangements with them, these manufacturers generally may unilaterally terminate their relationship with us at any time. If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our footwear is delayed or becomes more expensive, our business and financial condition would be harmed. +While not a material issue as of the filing date of this report, the COVID-19 pandemic previously led to the Chinese and Vietnamese governments imposing temporary closures of some of our factories in China and restrictions on others in Vietnam that caused delays in shipment of our products. We may encounter similar challenges yet again with these manufacturers, or new difficulties could arise with our manufacturers or any raw material suppliers on which our manufacturers rely, including prolonged manufacturing or transportation disruptions due to public health conditions, such as the recent COVID-19 pandemic, reductions in the availability of production capacity due to government imposed restrictions, failure to meet our quality control standards, failure to meet production deadlines or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries or demanding reductions in purchase prices, any of which could have a negative impact on our cash flows and harm our business and results of operations. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistics and distribution systems include computer-controlled and automated equipment, which may be subject to risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all our products are distributed from a few locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the potential adverse effects of significant disruptions to our distribution system, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales, and achieve operating efficiencies could be materially adversely affected. +Risks Related to Economic and External Factors +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +The uncertain state of global economic conditions, including the challenging consumer retail market, may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. If the uncertain global market conditions continue for a significant period or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +10 +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Our Customers Due To Global Economic Conditions. +The global financial crisis affected the banking system and financial markets and resulted in a tightening in the credit markets, more stringent lending standards and terms, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +A substantial portion of our operations are in California, including 98 of our retail stores, our headquarters in Manhattan Beach, and our North America distribution center in Rancho Belago. A decline in the economic conditions in California could have a material adverse impact on our business. Furthermore, a natural disaster or other catastrophic event in California, such as an earthquake or wildfire, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Risks Related to Currency +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for us, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars, which causes the cost of those products to vary depending on the foreign currency exchange rates and impacts the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency exchange rates. Although we typically work to mitigate the impact of exchange rate fluctuations through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts, as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +Risks Related to Legal and Regulatory Matters +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All our products manufactured overseas and imported into the U.S., the European Union and other countries are subject to customs duties. We are unable to predict whether there may be unfavorable changes in tax laws in the U.S. or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on the sales and profitability of Skechers. +Changes to Trade Policy, Including New Tariffs Imposed By The U.S. Government, Could Have A Material Adverse Effect On Our Results Of Operations. +Changes in social, political, regulatory and economic conditions or in laws and policies governing trade, manufacturing, development and investment in the countries from which we import our products, or conduct our business, as well as any negative sentiment toward the U.S. as a result of such changes, could adversely affect our business. The U.S. government has placed or proposed additional tariffs on certain goods imported from China and may enact new tariffs on additional goods imported from China, including footwear and other products that we import. China had imposed tariffs on a wide range of American products in retaliation and responded to the new proposed tariff by, among other things, adjusting the value of its currency. China and the U.S. have made progress and are in discussions to finalize a trade agreement, however there is no guarantee that any agreement between the countries will be reached. China could impose additional tariffs or take other actions if the countries are unable to come to an agreement. Most of our products that we +11 +sell in the U.S. are manufactured in China. The U.S. government has also negotiated a replacement trade deal for NAFTA with Mexico and Canada, the U.S. -Mexico-Canada Agreement (the “USMCA”). There is also a concern that the imposition of additional tariffs by the U.S. could result in the adoption of additional tariffs by other countries as well. If the U.S. government does not reach a trade agreement with China or replaces NAFTA with USMCA, or if additional tariffs or trade restrictions are implemented by the U.S. or other countries in connection with a global trade war, the resulting escalation of trade tensions could have a significant, adverse effect on world trade and the world economy. While it is too early to predict whether or how the recent policy changes will impact our business, the imposition of tariffs on footwear, apparel or other items imported by us from China could require us to increase prices to our customers or, if unable to do so, result in lowering our gross margin on products sold. Tariffs on footwear imported from China could have a material adverse effect on our business and results of operations. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the U.S., it could result in adverse publicity for us, damage our reputation in the U.S., or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers GOtrain ® , Skechers on-the-GO ® , ® , ® , ® , , Skechers Cali ® , Skecher Street ® , Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Skechers Max Cushioning™, Mark Nason ® , D’Lites ® , DLT-A ® , BOBS ® , Energy Lights ® , Glide Step™, Skech-Air ® , Twinkle Toes ® , Z-Strap ® , Mega-Flex ® , Luminators ® , Heart Lights ™ , Relaxed Fit ® , Arch Fit ™ , Ultra GO ® , Hyper Burst ® , Skechers Memory Foam ™ , and Air-cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and utility patents covering components and features used in various shoes. We believe that our patents and trademarks are sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims +12 +made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the U.S. We cannot be assured that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of counterfeit products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur due to non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +Risks Related to Our Stock and Stock Price +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts and from time to time cancel orders, change delivery schedules, or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. Furthermore, our expenses are partially based on our expectations of future sales, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts. As a result, our expenses may be disproportionately large relative to our revenues, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter. Any quarterly fluctuations in our annualized tax rate could have a material impact on our quarterly operating results and the results for any one quarter may not be indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +13 +One Principal Stockholder Is Able To Substantially Control All Matters Requiring Approval By Our Stockholders And Another Stockholder Is Able To Exert Significant Influence Over All Matters Requiring A Vote Of Our Stockholders, And Their Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2021, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 86.8% of our outstanding Class B Common Stock, members of Mr. Greenberg’s immediate family beneficially owned an additional 8.2% of our outstanding Class B Common Stock, and Gil Schwartzberg, trustee of several trusts formed by Mr. Greenberg and his wife for estate planning purposes, beneficially owned 29.9% of our outstanding Class B Common Stock. The holders of Class A Common Stock and Class B Common Stock have identical rights except that holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2021, Mr. Greenberg beneficially owned 37.4% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 42.9% of the aggregate number of votes eligible to be cast by our stockholders, and Mr. Schwartzberg beneficially owned 18.0% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Messrs. Greenberg and Schwartzberg are each able to exert significant influence over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Messrs. Greenberg and Schwartzberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A Common Stock. Because Messrs. Greenberg’s and Schwartzberg’s interests may differ from the interests of the other stockholders, their ability to substantially control or significantly influence, respectively, actions requiring stockholder approval, may result in the Company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A Common Stock to the extent that investors or any potential future purchaser view the superior voting rights of our Class B Common Stock to have value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +ITEM 1B. +UNRESOLVED STAFF COMMENTS +None. +ITEM 2. +PROPERTIES +Our corporate headquarters are located at several properties in or near Los Angeles, California, which consist of an aggregate of approximately 213,000 square feet. We own and lease portions of our corporate headquarters. +Our North America distribution center occupies approximately 1.8 million square feet on its main campus in southern California, which is leased from a joint venture, HF Logistics-SKX (the “JV”). The JV was formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility and is consolidated in our financial statements. An additional 1.0 million square feet of distribution center space is leased from third parties. The main campus lease is set to expire in November 2031, and the remaining space is set to expire in early 2026. +Our European distribution center occupies approximately 2.2 million square feet in Liege, Belgium under operating leases. These leases provide for original terms of 10 to 15 years, commencing between January 2016 and July 2020, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +Our China distribution center occupies approximately 1.6 million square feet in Taicang, China. +Substantially all of our retail stores and showrooms are leased with terms expiring through January 2036. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. +We lease most of our international administrative offices, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire at various dates through January 2035. +14 +ITEM 3. +LEGAL PROCEEDINGS +Converse, Inc. v. Skechers U.S.A., Inc. – On October 14, 2014, Converse filed an action against the Company in the United States District Court for the Eastern District of New York, Brooklyn Division, Case 1:14-cv-05977-DLI-MDG, alleging trademark infringement, false designation of origin, unfair competition, trademark dilution and unlawful deceptive practices arising out of our alleged use of certain design elements on our footwear. This matter was previously disclosed in greater detail in the Company’s prior periodic reports filed with the SEC including in its most recently filed quarterly report on Form 10-Q. On November 30, 2021, Skechers and Converse entered into a confidential settlement resolving this matter. Pursuant to the settlement, the federal court action has now been dismissed. +Nike, Inc. v. Skechers USA, Inc. – On November 30, 2021, Skechers and Nike entered into a confidential settlement resolving the following three previously disclosed matters: +1. +On January 4, 2016, Nike filed an action against the Company in the United States District Court for the District of Oregon, Case No. 3:16-cv-0007, alleging that certain Skechers shoe designs (Men’s Burst, Women’s Burst, Women’s Flex Appeal, Men’s Flex Advantage, Girls’ Skech Appeal, and Boys’ Flex Advantage) infringe the claims of eight design patents. Nike sought injunctive relief, disgorgement of Skechers’ profits, trebling of such damages due to purported willful infringement, pre-judgment and post-judgment interest, attorneys’ fees, and costs. In June 2017, we filed a motion to transfer venue from the District of Oregon to the Central District of California based on a recent United States Supreme Court decision and the motion was granted on November 17, 2017. After transfer, the case was renumbered as Case No. 2:17-cv-08509. +2. +On September 30, 2019, Nike filed an action against the Company in the United States District Court for the Central District of California, Case No. 2:19-cv-08418, alleging that certain Skechers’ shoe designs (Skech-Air Atlas, Skech-Air 92, Skech-Air Stratus and Skech-Air Blast) infringe the claims of twelve design patents. Nike sought injunctive relief, damages in the form of either lost profits, reasonable royalty, or disgorgement of Skechers’ profits, trebling of such damages due to purported willful infringement, pre-judgment and post-judgment interest, attorneys’ fees, and costs. +3. +On October 28, 2019, Nike filed an action against the Company in the United States District Court for the Central District of California, Case No. 2:19-cv-09230, alleging that certain Skechers’ shoe designs (Skech-Air Jumpin’ Dots and Skech-Air Mega) infringe the claims of two utility patents. Nike sought injunctive relief, damages in the form of a reasonable royalty, trebling of such damages due to purported willful infringement, pre-judgment and post-judgment interest, attorneys’ fees, and costs. +Pursuant to the settlement, the federal court actions have now been dismissed, and the inter partes review proceedings terminated. +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against the Company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +ITEM 4. +MINE SAFETY DISCLOSURES +Not applicable. +15 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Our Class A Common Stock trades under the symbol “SKX” on the New York Stock Exchange. +HOLDERS +As of February 15, 2022, there were 86 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 38 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +COMPANY PURCHASES OF EQUITY SECURITIES +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2016 to December 31, 2021, relative to the performance of the Russell 2000 Index, which previously included our Class A Common Stock, the Russell 1000 Index, which includes our Class A Common Stock, and the peer group index, which is believed to include companies engaged in businesses similar to ours. As of fiscal year 2021, we believe the Russell 1000 is a more accurate representation of stock performance for a broad market index whose securities have a market capitalization comparable to ours. The peer group index consists of Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS +(in dollars) +2016 +2017 +2018 +2019 +2020 +2021 +Skechers U.S.A., Inc. +100.00 +153.95 +93.12 +175.71 +146.22 +176.57 +Russell 1000 +100.00 +121.69 +115.87 +152.28 +184.20 +232.93 +Russell 2000 +100.00 +114.65 +102.02 +128.06 +153.62 +176.39 +Peer Group +100.00 +126.34 +147.52 +209.65 +277.09 +307.41 +ITEM 6. +[RESERVED] +16 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. We intend for this discussion to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of our company as a whole. +This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 2020 filed with the SEC on February 26, 2021 . +OVERVIEW +We design and market Skechers-branded comfort footwear for men, women and children, performance footwear for men and women under the Skechers Performance brand name, and work footwear for men and women under Skechers Work brand name. We design and market Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and medical scrubs, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through wholesale distribution to department and specialty stores, athletic and independent retailers, and e-commerce retailers and directly to consumers through retail stores and digital sales. +Our objective is to profitably grow our operations worldwide by leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and various distribution channels. We are committed to achieving our objective by investing in our growth. Our current global infrastructure investments and technology projects include: +• +We upgraded our point of sale systems in North America and the United Kingdom, with Japan and Europe to follow. +• +We continued efforts to expand our e-commerce presence internationally. +• +Our new China and United Kingdom distribution centers are complete and fully operational. +• +We continued development on our North American LEED Gold Certified distribution center expansion, which we expect to be completed in 2022. +• +We opened 415, net company-owned and third-party Skechers stores globally this year, including our first stores in the Dominican Republic and Slovakia. +COVID-19 UPDATE +We continued to be impacted by COVID-19 related operating restrictions, store closures and supply chain disruptions throughout fiscal year 2021. Most notably, manufacturing delays, shipping container shortages, extended transit times, port congestion, and elevated freight rates contributed to a year-over-year increase of $325.1 million in inventory in-transit. Although we started to see supply chain improvements in December 2021 with more goods moving through our distribution centers than in previous months, we expect supply chain challenges to remain through at least the first half of fiscal year 2022. +Despite these challenges, we achieved record sales of $6.3 billion for fiscal year 2021, reflecting the continued global demand for our product. Sales increased across all segments compared to 2020 and surpassed pre-COVID-19 pandemic levels with growth of over 20% compared to 2019. Our core product philosophy of comfort, style, innovation, and quality at the right price continued to resonate with consumers during the pandemic, and we remain focused on delivering our products as quickly as possible to meet the consumer demand. +17 +RESULTS OF OPERATIONS +Selected information from our results of operations follows: +Year Ended December 31, +Change +(in thousands) +2021 +2020 +$ +% +Sales +$ +6,285,029 +$ +4,597,414 +$ +1,687,615 +36.7 +Cost of sales +3,185,817 +2,407,633 +778,184 +32.3 +Gross profit +3,099,212 +2,189,781 +909,431 +41.5 +Gross margin +49.3 +% +47.6 +% +170 +bps +Royalty income +25,159 +16,017 +9,142 +57.1 +3,124,371 +2,205,798 +918,573 +41.6 +Operating expenses: +Selling +459,599 +318,097 +141,502 +44.5 +General and administrative +2,066,585 +1,754,017 +312,568 +17.8 +Total operating expenses +2,526,184 +2,072,114 +454,070 +21.9 +As a % of sales +40.2 +% +45.1 +% +(490 +) bps +Earnings from operations +598,187 +133,684 +464,503 +347.5 +Operating margin +9.5 +% +2.9 +% +660 +bps +Other income (expense) +(28,430 +) +21,045 +(49,475 +) +n/m +Earnings before income taxes +569,757 +154,729 +415,028 +268.2 +Income tax expense (benefit) +(245,875 +) +8,502 +(254,377 +) +n/m +Net earnings +815,632 +146,227 +669,405 +457.8 +Net earnings attributable to noncontrolling interest +74,129 +47,663 +26,466 +55.5 +Net earnings attributable to Skechers U.S.A. Inc. +$ +741,503 +$ +98,564 +$ +642,939 +652.3 +Sales +Sales increased $1.7 billion, or 36.7% to $6.3 billion as compared to $4.6 billion, reflecting a 33.4% domestic increase and a 39.0% increase internationally, with the largest contribution derived from International Wholesale growth. Sales grew across all segments with increases to Domestic Wholesale of 27.6%, International Wholesale of 34.0% and Direct-to-Consumer of 50.2%. Sales increased overall due to improved sales volume, higher average selling prices and less significant impacts of the COVID-19 pandemic. +Gross margin +Gross margin increased 170 basis points to 49.3% driven by higher average selling prices in Direct-to-Consumer, partially offset by declines in Domestic Wholesale and International Wholesale, due to higher average costs per unit. +Operating expenses +Selling expenses increased by $141.5 million, or 44.5%, to $459.6 million from $318.1 million primarily due to higher demand creation expenditures. Worldwide spending on advertising and marketing was lower in the prior year due to pandemic-related store and market closures. General and administrative expenses increased by $312.6 million, or 17.8%, primarily driven by higher labor costs of $77.0 million, volume-driven global distribution expenses of $76.7 million, incentive compensation of $50.2 million, and rent of $34.8 million. As a percentage of sales, operating expenses improved 490 basis points to 40.2% compared to 45.1%. +Other income (expense) +Other income (expense) changed $49.5 million to $28.4 million expense from $21.0 income primarily as a result of foreign currency losses in the current year and a $13.9 million gain related to the acquisition of our Mexico joint venture in the prior year . +Income taxes +Income tax expense (benefit) and the effective tax rate were as follows: +Year Ended December 31, +(in thousands) +2021 +2020 +Income tax expense (benefit) +$ +(245,875 +) +$ +8,502 +Effective tax rate +(43.2 +)% +5.5 +% +Income tax benefit was $245.9 million as compared to an income tax expense of $8.5 million due to the establishment of deferred tax assets from an intra-entity transfer of certain intellectual property rights of $346.8 million in 2021. Our effective tax rate was negative 43.2%, which included a 60.9% impact from the intellectual property rights transfer. +18 +Our income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (losses) before income taxes. In the foreign jurisdictions in which we have operations, the applicable statutory rates range from 0.0% to 34 .0% , which on average are generally significantly lower than the U.S. federal and state combined statutory rate of approximately 2 5 % . +See Note 10 – Income Taxes of the Consolidated Financial Statements for additional information. +Noncontrolling interest in net earnings of consolidated subsidiaries +Noncontrolling interest represents the share of net earnings or loss that is attributable to our joint venture partners. Net earnings attributable to noncontrolling interest increased $26.5 million to $74.1 million as compared to $47.7 million, primarily due to increased profitability by our joint ventures, predominantly China, due to reduced impacts related to the COVID-19 pandemic. +RESULTS OF SEGMENT OPERATIONS +Domestic Wholesale +Year Ended December 31, +Change +(in thousands) +2021 +2020 +$ +% +Sales +$ +1,438,038 +$ +1,126,564 +$ +311,474 +27.6 +Gross profit +523,165 +431,603 +91,562 +21.2 +Gross margin +36.4 +% +38.3 +% +(190 +) bps +Domestic Wholesale sales increased $0.3 billion, or 27.6%, to $1.4 billion due to a 26.3% increase in the number of units sold and 1.1% increase in average selling price per unit. +Domestic Wholesale gross margin decreased 190 basis points to 36.4% due to higher average cost per unit, partially offset by the increase in the average selling price per unit. +International Wholesale +Year Ended December 31, +Change +(in thousands) +2021 +2020 +$ +% +Sales +$ +3,025,479 +$ +2,257,846 +$ +767,633 +34.0 +Gross profit +1,364,347 +1,023,183 +341,164 +33.3 +Gross margin +45.1 +% +45.3 +% +(20 +) bps +International Wholesale sales increased $0.8 billion, or 34.0%, to $3.0 billion primarily driven by growth in China of 35%, Europe of 23.6% and distributor sales of 62.0%. Volume increased 27.9% in the number of units sold and the average selling price per unit increased 4.8%. +International Wholesale gross margin decreased 20 basis points to 45.1%, primarily due to higher average cost per unit and a higher proportion of distributor sales which were offset by the increase in the average selling price per unit. +Direct-to-Consumer +Year Ended December 31, +Change +(in thousands) +2021 +2020 +$ +% +Sales +$ +1,821,512 +$ +1,213,004 +$ +608,508 +50.2 +Gross profit +1,211,700 +734,995 +476,705 +64.9 +Gross margin +66.5 +% +60.6 +% +590 +bps +Direct-to-Consumer sales increased $0.6 billion, or 50.2%, to $1.8 billion as compared to sales of $1.2 billion primarily driven by growth in domestic and international retail store sales of 50.7%. Direct-to-Consumer comparable store sales increased 38.0% driven by an increase of 39.5% domestically and 34.1% internationally. Average selling price per unit increased 19.1% and volume increased 26.0% in the number of units sold. +Direct-to-Consumer gross margin increased 590 basis points to 66.5%, primarily driven by reduced promotional activity and the increase in average selling price per unit. +Comparable store sales mentioned above includes stores that have been opened for at least thirteen calendar months as well as sales on our company-owned websites. We did not make any adjustments for the effects of the COVID-19 pandemic and the related impacts of store closures and reduced operating hours. Definitions and calculations of comparable store sales differ among companies in the retail industry, and therefore comparable store sales disclosed by us may not be comparable to the metrics disclosed by other companies. +19 +LIQUIDITY AND CAPITAL RESOURCES +Liquidity outlook +Our liquidity remains strong with $796.3 million of cash and cash equivalents at December 31, 2021. Amounts held outside the U.S. were $638.7 million, or 80.2%, and approximately $241.9 million was available for repatriation to the U.S. as of December 31, 2021 without incurring additional U.S. federal income taxes and applicable non-U.S. income and withholding taxes. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers. However, we have long-standing relationships with many of our contract manufacturers and believe our relationships to be good. +We fully repaid the $452.5 million balance on our revolving credit facility in the second quarter and amended the agreement in the fourth quarter of 2021 to expand our c redit capacity to $750.0 million with an additional $250.0 million available through an accordion feature. We believe that anticipated cash flows from operations, existing cash and investments balances, available borrowings under our revolving credit facility, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements for the next twelve months. +Cash Flows +Our working capital at December 31, 2021 was $1.9 billion, a decrease of $0.2 billion from working capital of $2.1 billion at December 31, 2020. Our cash and cash equivalents at December 31, 2021 were $0.8 billion, compared to $1.4 billion at December 31, 2020. Our primary source of operating cash is collections from customers. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $212.2 million for 2021 and $331.5 million for 2020. The $119.3 million decrease in cash flows from operating activities in 2021 resulted from increased inventory and merchandise in-transit, offset by increased earnings. +Investing Activities +Net cash used in investing activities was $344.7 million for 2021 as compared to $312.5 million for 2020. The $32.2 million increase was due to increased net investment activity of $32.4 million. +Our capital investments remain focused on supporting our strategic growth priorities, growing our Direct-to-Consumer business, as well as expanding the presence of our brand internationally. Capital expenditures for the year ended December 31, 2021 were approximately $309.7 million, which included $110.9 million for the expansion of our joint-venture owned domestic distribution center, $75.7 million for investments in our new corporate offices and other real estate, and $56.5 million of investments in our direct-to-consumer technology and retail stores. We expect our capital expenditures for 2022 to be approximately $250.0 million to $300.0 million, which is primarily related to the expansion of our worldwide distribution capabilities, continued investments in retail and e-commerce technologies and stores, and our new corporate offices in Southern California. We expect to fund ongoing capital expenses through a combination of borrowings and available cash . +Financing Activities +Net cash used in financing activities was $433.9 million during 2021 compared to $533.3 million in net cash provided by financing activities during 2020. The change is primarily the result of repaying $452.5 on our revolving credit facility in the current year and receiving $490.0 million in proceeds from our revolving credit facility in the prior year. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +20 +Financing Arrangements +As of December 31, 2021, outstanding short-term and long-term borrowings were $341.6 million, of which, $262.4 million relates to loans for our domestic and China distribution centers, $69.8 million relates to our operations in China and the remainder relates to our international operations. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. See Note 6 – Financial Commitments of the Consolidated Financial Statements for additional information. +Commitments +Our material cash requirements as of December 31, 2021 which are not reflected as liabilities in the consolidated balance sheets include open purchase commitments with our foreign manufacturers of approximately $2.0 billion, and a building purchase commitment in India of approximately $20 million. +We are required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the consolidated balance sheets. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +The preparation of our financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements. +Reserves for returns and chargebacks. Revenue is recorded net of estimates for returns from our customers and potential disputed amounts or chargebacks. We accrue a liability for product returns at the time of sale based on our historical experience. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. +Allowance for bad debts. Accounts receivable is recorded net of estimated losses from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for bad debts are recorded to general and administrative expenses. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory write-downs . Inventory is stated at the lower of cost or market (net realizable value). Inventory reserves are recorded for excess and slow-moving inventory. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value is determined based on historical sales experience on a style-by-style basis. The valuation of inventory could be impacted by changes in public and consumer preferences, demand for product, changes in the buying patterns of both retailers and consumers and inventory management of customers. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +21 +Tax estimates . The establishment of deferred tax assets from intra-entity transfers of certain intellectual property rights requires management to make significant estimates and assumptions to determine the fair value of such intellectual property rights. The valuation of deferred tax assets requires significant estimates and assumptions including, but not limited to, future revenue growth, discount rates and the expected life of the assets, which by their nature are inherently uncertain and may ultimately differ materially from our actual results. We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may impact our cost of goods in the future. During 2021 and 2020, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. Changes in interest rates and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2021, we have $78.2 million and $263.4 million of outstanding current and long-term borrowings, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by approximately $4.1 million for the year ended December 31, 2021. We do not expect changes in interest rates to have a material impact on our financial condition or results of operations or cash flows during the remainder of 2022. The interest rate charged on our unsecured revolving credit facility is based on SOFR, our North America distribution center construction loan is based on the one-month LIBOR, and our China distribution center and China operational loans are based on a reference rate provided by the People’s Bank of China. Changes in these interest rates will have an effect on the interest charged on outstanding balances. +We may enter into derivative financial instruments such as interest rate swaps in order to limit our interest rate risk on our long-term debt. We had one derivative instrument in place as of December 31, 2021 to hedge the cash flows on our $129.5 million variable rate debt on our North America distribution center. This instrument was a variable to fixed derivative with a notional amount of $129.5 million at December 31, 2021. Our receive rate was one-month LIBOR and the average pay rate was 0.795%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest payments. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have an impact on the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. +Assets and liabilities outside the U.S. are located in regions where we have subsidiaries or joint ventures: Asia, Central America, Europe, Middle East, North America, and South America. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation loss of $21.0 million and gain of $2.7 million, for the years ended December 31, 2021 and 2020, that are deferred and recorded as a component of accumulated other comprehensive income in stockholders’ equity. A 200 basis point reduction in each of these exchange rates at December 31, 2021 would have reduced the values of our net investments by approximately $75.8 million. +22 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +index to CONSOLIDATED FINANCIAL STATEMENTS and Financial statement schedule +Page +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (BDO USA, LLP; LOS ANGELES, CALIFORNIA; PCAOB ID # 243 ) +24 +CONSOLIDATED BALANCE SHEETS +26 +CONSOLIDATED STATEMENTS OF EARNINGS +27 +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +28 +CONSOLIDATED STATEMENTS OF EQUITY +29 +CONSOLIDATED STATEMENTS OF CASH FLOWS +30 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +31 +SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS +51 +23 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A, Inc. (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 , in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 25, 2022 expressed an unqualified opinion thereon. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Accounting for Leases +As described in Note 3 to the Company’s consolidated financial statements, as of December 31, 2021, the Company’s operating lease right-of-use asset was $1,224.6 million and the operating lease liability was $1,320.4 million. The Company operates in the United States and various foreign countries and continues to expand its operations. The Company continues to execute new lease contracts and negotiate extensions and amendments of existing lease contracts. +We identified the accounting for leases as a critical audit matter. The Company’s lease processes include the following: (i) ensuring the completeness of new leases, lease extensions and amendments, and (ii) assessment of incremental borrowing rates. Auditing these elements involved especially challenging auditor judgment and audit effort due to the significant number of leases that are executed in various countries and the specialized skills and knowledge needed to assess the reasonableness of the incremental borrowing rates. +24 +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) the completeness and accuracy of newly executed lease contracts, extensions, and amendments to existing lease contracts, and (ii) the determination of the incremental borrowing rates. +• +Testing the appropriateness of the calculation of the right-of-use asset balance, operating lease liability and a corresponding amortization expense for a sample of new, extended or amended lease contracts. +• +Testing the completeness and accuracy of lease contracts included in the lease system module. +• +Utilizing personnel with specialized knowledge and skill in valuation to assist in assessing the reasonableness of the Company’s incremental borrowing rates.   +Accounting for Income Taxes +As described in Note 10 to the Company’s consolidated financial statements, the Company’s total tax benefit for the fiscal year ended December 31, 2021 was $245.9 million. In December 2021, the Company completed an intra-entity transfer of certain intellectual property rights to Switzerland and as a result, recorded a tax benefit of $346.8 million, net of uncertain tax positions of $25.2 million. The Company operates in multiple jurisdictions worldwide through its wholly-owned subsidiaries and several joint ventures. +We identified accounting for the Company’s income tax provision as a critical audit matter. The Company’s tax provision processes include the following: (i) reporting and data accumulation from multiple foreign jurisdictions, (ii) evaluation of assumptions in the Company’s assessment of deferred tax assets and liabilities and related tax reserves, (iii) development of complex assumptions used in transfer pricing studies and related determinations, (iv) assessment of repatriation of foreign earnings and cash balances, and (v) assessment of the intra-entity transfer of certain intellectual property rights. Auditing these elements involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed. +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain controls relating to management’s assessment of: (i) completeness and accuracy of reporting and data accumulation from multiple foreign jurisdictions, (ii) reasonableness of assumptions used in tax reserves, transfer pricing studies and repatriation of foreign earnings and cash balances, and (iii) reasonableness of the assessment of the intra-entity transfer of certain intellectual property rights. +• +Evaluating management’s computation of deferred tax assets and liabilities and assessing the reasonableness of assumptions used in the Company’s tax reserves for certain significant jurisdictions. +• +Testing mathematical accuracy and computation of the tax provision and agreeing to relevant source documents. +• +Utilizing personnel with specialized skill and knowledge in transfer pricing to assist in evaluating the reasonableness of the Company’s assumptions, inputs and overall conclusions reached related to transfer pricing studies over inter-company transactions. +• +Utilizing personnel with specialized skill and knowledge in domestic and foreign taxes to assist in (i) evaluating the reasonableness of the Company’s assumptions, inputs and methods used to estimate certain tax reserves and (ii) assessing the appropriateness of conclusions reached related to foreign earnings and cash balances and (iii) assessing the appropriateness of conclusions reached related to an intra-entity transfer of certain intellectual property rights. +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +February 25, 2022 +25 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +As of December 31, +(in thousands, except par values) +2021 +2020 +ASSETS +Current assets +Cash and cash equivalents +$ +796,283 +$ +1,370,826 +Short-term investments +98,580 +100,767 +Trade accounts receivable, less allowances of $ 62,684 and $ 48,562 +732,793 +619,800 +Other receivables +80,043 +69,222 +Inventory +1,470,994 +1,016,774 +Prepaid expenses and other current assets +193,547 +166,962 +Total current assets ($ 1,040,765 and $ 862,954 related to VIEs) +3,372,240 +3,344,351 +Property, plant and equipment, net +1,128,909 +935,441 +Operating lease right-of-use assets +1,224,580 +1,171,521 +Deferred tax assets +451,355 +63,884 +Long-term investments +145,590 +108,412 +Goodwill +93,497 +93,497 +Other assets, net +75,109 +95,263 +Total non-current assets ($ 608,607 and $ 682,068 related to VIEs) +3,119,040 +2,468,018 +TOTAL ASSETS +$ +6,491,280 +$ +5,812,369 +LIABILITIES AND EQUITY +Current liabilities +Accounts payable +$ +876,342 +$ +744,077 +Operating lease liabilities +225,658 +204,370 +Accrued expenses +265,420 +208,712 +Current installments of long-term borrowings +76,967 +52,250 +Short-term borrowings +1,195 +3,297 +Total current liabilities ($ 601,929 and $ 526,466 related to VIEs) +1,445,582 +1,212,706 +Long-term borrowings +263,445 +679,415 +Long-term operating lease liabilities +1,094,748 +1,065,069 +Deferred tax liabilities +11,820 +11,439 +Other long-term liabilities +133,613 +118,077 +Total non-current liabilities ($ 368,994 and $ 365,235 related to VIEs) +1,503,626 +1,874,000 +Total liabilities +2,949,208 +3,086,706 +Commitments and contingencies (Note 7) +Stockholders’ equity +Preferred Stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; +135,107 and 133,618 shares issued and outstanding +135 +134 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; +20,939 and 21,016 shares issued and outstanding +21 +21 +Additional paid-in capital +429,608 +372,165 +Accumulated other comprehensive loss +( 48,323 +) +( 27,285 +) +Retained earnings +2,877,903 +2,136,400 +Skechers U.S.A., Inc. equity +3,259,344 +2,481,435 +Noncontrolling interests +282,728 +244,228 +Total stockholders' equity +3,542,072 +2,725,663 +TOTAL LIABILITIES AND EQUITY +$ +6,491,280 +$ +5,812,369 +See accompanying notes to consolidated financial statements. +26 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EARNINGS +Year Ended December 31, +(in thousands, except per share data) +2021 +2020 +2019 +Sales +$ +6,285,029 +$ +4,597,414 +$ +5,220,051 +Cost of sales +3,185,817 +2,407,633 +2,728,894 +Gross profit +3,099,212 +2,189,781 +2,491,157 +Royalty income +25,159 +16,017 +22,493 +3,124,371 +2,205,798 +2,513,650 +Operating expenses +Selling +459,599 +318,097 +369,901 +General and administrative +2,066,585 +1,754,017 +1,625,306 +Total operating expenses +2,526,184 +2,072,114 +1,995,207 +Earnings from operations +598,187 +133,684 +518,443 +Other income (expense) +( 28,430 +) +21,045 +( 2,438 +) +Earnings before income taxes +569,757 +154,729 +516,005 +Income tax expense (benefit) +( 245,875 +) +8,502 +88,753 +Net earnings +815,632 +146,227 +427,252 +Less: Net earnings attributable to noncontrolling interest +74,129 +47,663 +80,692 +Net earnings attributable to Skechers U.S.A. Inc. +$ +741,503 +$ +98,564 +$ +346,560 +Net earnings per share attributable to Skechers U.S.A. Inc. +Basic +$ +4.77 +$ +0.64 +$ +2.26 +Diluted +$ +4.73 +$ +0.64 +$ +2.25 +Weighted-average shares used in calculating net earnings per share attributable to Skechers U.S.A. Inc. +Basic +155,539 +154,184 +153,392 +Diluted +156,794 +154,894 +154,151 +See accompanying notes to consolidated financial statements. +27 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Net earnings +$ +815,632 +$ +146,227 +$ +427,252 +Other comprehensive income, net of tax +Gain (loss) on foreign currency translation adjustment +( 22,141 +) +11,540 +1,298 +Comprehensive income +793,491 +157,767 +428,550 +Less: Comprehensive income attributable to noncontrolling interests +73,026 +56,495 +80,495 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +720,465 +$ +101,272 +$ +348,055 +See accompanying notes to consolidated financial statements. +28 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF EQUITY +SHARES +AMOUNT +ACCUMULATED +CLASS A +CLASS B +CLASS A +CLASS B +ADDITIONAL +OTHER +SKECHERS +TOTAL +COMMON +COMMON +COMMON +COMMON +PAID-IN +COMPREHENSIVE +RETAINED +U.S.A., INC. +NONCONTROLLING +STOCKHOLDERS' +(in thousands) +STOCK +STOCK +STOCK +STOCK +CAPITAL +INCOME (LOSS) +EARNINGS +EQUITY +INTERESTS +EQUITY +Balance at December 31, 2018 +129,525 +23,983 +$ +129 +$ +24 +$ +375,017 +$ +( 31,488 +) +$ +1,691,276 +$ +2,034,958 +$ +154,317 +$ +2,189,275 +Net earnings +— +— +— +— +— +— +346,560 +346,560 +80,692 +427,252 +Foreign currency translation adjustment +— +— +— +— +— +1,495 +— +1,495 +( 197 +) +1,298 +Contributions from noncontrolling interests +— +— +— +— +— +— +— +— +36,934 +36,934 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 38,675 +) +( 38,675 +) +Purchase of noncontrolling interest +— +— +— +— +( 71,265 +) +— +— +( 71,265 +) +( 11,629 +) +( 82,894 +) +Stock compensation expense +— +— +— +— +41,076 +— +— +41,076 +— +41,076 +Proceeds from the employee stock purchase plan +261 +— +— +— +6,173 +— +— +6,173 +— +6,173 +Shares issued under the incentive award plan +1,117 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 438 +) +— +— +— +( 14,313 +) +— +— +( 14,313 +) +— +( 14,313 +) +Conversion of Class B Common Stock into Class A +Common Stock +1,575 +( 1,575 +) +2 +( 2 +) +— +— +— +— +— +— +Repurchases of Class A Common Stock +( 969 +) +— +( 1 +) +— +( 30,018 +) +— +— +( 30,019 +) +— +( 30,019 +) +Balance at December 31, 2019 +131,071 +22,408 +$ +131 +$ +22 +$ +306,669 +$ +( 29,993 +) +$ +2,037,836 +$ +2,314,665 +$ +221,442 +$ +2,536,107 +Net earnings +— +— +— +— +— +— +98,564 +98,564 +47,663 +146,227 +Foreign currency translation adjustment +— +— +— +— +— +2,708 +— +2,708 +8,832 +11,540 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 81,105 +) +( 81,105 +) +Noncontrolling interest of acquired businesses +— +— +— +— +— +— +— +— +49,045 +49,045 +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 1,649 +) +( 1,649 +) +Stock compensation expense +— +— +— +— +65,240 +— +— +65,240 +— +65,240 +Proceeds from the employee stock purchase plan +233 +— +1 +— +5,915 +— +— +5,916 +— +5,916 +Shares issued under the incentive award plan +1,094 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 172 +) +— +— +— +( 5,658 +) +— +— +( 5,658 +) +— +( 5,658 +) +Conversion of Class B Common Stock into Class A +Common Stock +1,392 +( 1,392 +) +1 +( 1 +) +— +— +— +— +— +— +Balance at December 31, 2020 +133,618 +21,016 +$ +134 +$ +21 +$ +372,165 +$ +( 27,285 +) +$ +2,136,400 +$ +2,481,435 +$ +244,228 +$ +2,725,663 +Net earnings +— +— +— +— +— +— +741,503 +741,503 +74,129 +815,632 +Foreign currency translation adjustment +— +— +— +— +— +( 21,038 +) +— +( 21,038 +) +( 1,103 +) +( 22,141 +) +Contributions from noncontrolling interests +— +— +— +— +— +— +— +— +6,731 +6,731 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 41,557 +) +( 41,557 +) +Purchase of noncontrolling interest +— +— +— +— +( 6,856 +) +— +— +( 6,856 +) +( 3,072 +) +( 9,928 +) +Net unrealized gain on derivative contract +— +— +— +— +— +— +— +— +3,372 +3,372 +Stock compensation expense +— +— +— +— +60,108 +— +— +60,108 +— +60,108 +Proceeds from the employee stock purchase plan +226 +— +— +— +7,276 +— +— +7,276 +— +7,276 +Shares issued under the incentive award plan +1,252 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 66 +) +— +— +— +( 3,084 +) +— +— +( 3,084 +) +— +( 3,084 +) +Conversion of Class B Common Stock into Class A +Common Stock +77 +( 77 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2021 +135,107 +20,939 +$ +135 +$ +21 +$ +429,608 +$ +( 48,323 +) +$ +2,877,903 +$ +3,259,344 +$ +282,728 +$ +3,542,072 +See accompanying notes to consolidated financial statements +29 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Cash flows from operating activities +Net earnings +$ +815,632 +$ +146,227 +$ +427,252 +Adjustments to reconcile net earnings to net cash provided by operating activities +Depreciation and amortization +139,577 +142,810 +111,515 +Provision for bad debts and returns +62,771 +50,696 +52,456 +Stock compensation +60,108 +65,240 +41,076 +Deferred income taxes +( 387,250 +) +( 19,568 +) +( 7,568 +) +Net settlement gain +— +( 13,877 +) +— +Net foreign currency adjustments +2,154 +( 13,854 +) +2,114 +Other items, net +— +— +334 +Changes in operating assets and liabilities +Receivables +( 154,248 +) +13,259 +( 118,390 +) +Inventory +( 458,002 +) +78,632 +( 171,903 +) +Other assets +( 110,464 +) +( 153,092 +) +( 69,234 +) +Accounts payable +135,140 +( 37,714 +) +154,464 +Other liabilities +106,734 +72,694 +4,436 +Net cash provided by operating activities +212,152 +331,453 +426,552 +Cash flows from investing activities +Capital expenditures +( 309,674 +) +( 309,916 +) +( 236,111 +) +Acquisitions, net of cash acquired +— +— +( 100,658 +) +Proceeds from sale of property, plant and equipment +— +— +5,547 +Purchases of investments +( 215,164 +) +( 166,614 +) +( 189,624 +) +Proceeds from sales and maturities of investments +180,172 +164,062 +176,773 +Net cash used in investing activities +( 344,666 +) +( 312,468 +) +( 344,073 +) +Cash flows from financing activities +Net proceeds from the employee stock purchase plan +7,276 +5,916 +6,173 +Repayments on long-term borrowings +( 487,441 +) +( 86,357 +) +( 4,108 +) +Proceeds from long-term borrowings +96,187 +702,998 +33,296 +Net repayments on short-term borrowings +( 2,102 +) +( 2,492 +) +( 1,433 +) +Payments for employee taxes related to stock compensation +( 3,084 +) +( 5,658 +) +( 14,313 +) +Repurchases of common stock +— +— +( 30,019 +) +Purchase of noncontrolling interest +( 9,928 +) +— +( 82,894 +) +Contributions from noncontrolling interests +6,731 +— +— +Distributions to noncontrolling interests +( 41,557 +) +( 81,105 +) +( 38,675 +) +Net cash provided by (used in) financing activities +( 433,918 +) +533,302 +( 131,973 +) +Effect of exchange rates on cash and cash equivalents +( 8,111 +) +( 6,337 +) +2,133 +Net change in cash and cash equivalents +( 574,543 +) +545,950 +( 47,361 +) +Cash and cash equivalents at beginning of the period +1,370,826 +824,876 +872,237 +Cash and cash equivalents at end of the period +$ +796,283 +$ +1,370,826 +$ +824,876 +Supplemental disclosures of cash flow information +Cash paid during the period for: +Interest +$ +14,579 +$ +15,987 +$ +7,140 +Income taxes, net +125,082 +55,825 +88,753 +Non-cash transactions: +Land and other assets contribution from noncontrolling interests +— +— +36,934 +Note payable contribution from noncontrolling interest +— +— +2,150 +Purchase price adjustment for Skechers Mexico +— +49,045 +— +ROU assets exchanged for lease liabilities +356,855 +318,713 +122,078 +See accompanying notes to consolidated financial statements. +30 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +(1) +SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +BASIS OF PRESENTATION +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the consolidated financial statements in prior years to conform to the current year presentation. +USE OF ESTIMATES +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Significant areas requiring the use of estimates relate primarily to allowances for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +REVENUE RECOGNITION +The Company derives income from the sale of footwear and apparel and royalties earned from licensing the Skechers brand. The Company recognizes sales revenue, net of estimated returns and excluding sales and value added taxes. Revenue is recognized at point of sale or upon shipment, the point in time where control transfers to the customer. +Wholesale sales are recognized upon shipment. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost. Direct-to-consumer revenues are recognized at the point of sale for transactions with customers at the Company’s retail stores recognized at the point of sale and recognized upon shipment for sales made through its websites. +Sales are reduced by an estimate of customer merchandise returns, which is calculated based on historical experience. The Company also reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions and nature of the chargeback. +The Company earns royalty income from symbolic licensing arrangements in which third parties sell product with the Company’s brand. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized based on sales of licensed product when the Company expects royalties to exceed the minimum guarantee. For those arrangements in which the Company does not expect royalties to exceed the minimum guarantee, an estimate of the royalties expected to be recouped is recognized on a straight-line basis over the license term. +ALLOWANCE FOR BAD DEBTS +The Company provides a reserve for estimated losses that may result from its customers’ inability to pay. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and its customers’ credit-worthiness. Allowances for bad debts are recorded to general and administrative expenses. +WAREHOUSE AND DISTRIBUTION COSTS +The Company’s distribution network-related costs are included in general and administrative expenses. Distribution expenses, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging product totaled $ 376.5 million, $ 315.8 million and $ 276.4 million for 2021, 2020 and 2019. +PRODUCT DESIGN AND DEVELOPMENT COSTS +The Company charges product design and development costs to general and administrative expenses. Aggregate product design and development costs were approximately $ 24.6 million, $ 17.9 million, and $ 16.8 million during the years ended December 31, 2021, 2020 and 2019. +ADVERTISING +Advertising costs are expensed in the period in which an advertisement first runs, or over the life of an endorsement contract. Advertising expense for the years ended December 31, 2021, 2020 and 2019 was approximately $ 375.0 million, $ 248.7 million and $ 297.1 million. Prepaid advertising costs were $ 9.7 million and $ 3.8 million at December 31, 2021 and 2020. Prepaid amounts represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run. +31 +INCOME TAXES +The Company recognizes deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +CASH AND CASH EQUIVALENTS +Cash and cash equivalents include short-term investments, which are highly liquid investments with maturities of three months or less when purchased. +INVENTORY +Inventory is stated at the lower of cost (based on the first-in, first-out method) or net realizable value. Cost of product includes shipping and handling fees. The Company reserves for estimated losses from obsolete or slow-moving inventory and writes down the cost of inventory at the time such determinations are made. Expense associated with inventory reserves is recognized in cost of sales. +BUSINESS COMBINATIONS +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. +In the first quarter of 2019, we purchased the minority interest in our India joint-venture for $ 82.9 million, which made our India joint-venture entity a wholly-owned subsidiary. +On April 1, 2019, the Company purchased a 60 % interest in Manhattan SKMX, S. de R.L. de C.V. (“Skechers Mexico”), for total cash consideration of $ 120.6 million, net of cash acquired. Skechers Mexico is a joint venture operating and generating sales in Mexico. As a result of this purchase, Skechers Mexico became a majority-owned subsidiary and its results are consolidated in the consolidated financial statements beginning April 1, 2019. +GOODWILL +As of December 31, 2021, the Company had $ 93.5 million of goodwill with $64.1 million allocated to Direct-to-Consumer, $ 27.8 million allocated to International Wholesale and $ 1.6 million to Domestic Wholesale. Goodwill is not amortized but is tested at least annually in the fourth quarter for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. +INTANGIBLE ASSETS +Within other assets, the Company has amortizable intangible assets consisting of reacquired rights with a gross carrying value of $ 49.1 million and accumulated amortization of $ 19.0 million and $ 12.1 million as of December 31, 2021 and 2020. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Amortization expense related to amortizable intangible assets was $ 6.9 million for both of the years ended December 31, 2021 and 2020. Future amortization expense related to amortizable intangible assets will be approximately $ 6.9 million per year for the each of the years 2022 through 2025 and $ 1.9 million for 2026. The weighted-average amortization period for amortizable reacquired rights is 7 years. +NONCONTROLLING INTERESTS +The Company established several joint ventures either to distribute the Company’s products or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”), and the Company is considered the primary beneficiary. This determination is based on the relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. Specifically, the Company has both of the following characteristics: (a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE, or the right to receive benefits from the entity that could potentially be significant to the VIE. The assets and liabilities and results of operations of these entities are included in the Company’s consolidated financial statements, even though the Company may not hold a majority equity interest. +In March 2021, the minority interest related to the Hong Kong joint venture was purchased for $ 10.0 million. Other than the change in the Company’s ownership of the Hong Kong entity, which continues to be included in the Company’s consolidated financial statements, there have been no changes during 2021 in the accounting treatment or characterization of any previously identified VIE. The Company continues to reassess these relationships based on events and circumstances. The assets of these joint ventures are restricted, as they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. +32 +FOREIGN CURRENCY TRANSLATION +The Company’s reporting currency is the U.S. dollar. Certain international operations use the respective local currency as their functional currency, while others use the U.S. dollar as their functional currency. Translation adjustments for subsidiaries with non-U.S. dollar functional currencies are included in other comprehensive income. Foreign currency transaction gains (losses), resulting from exchange rate fluctuations, on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated at the balance sheet date exchange rate. Net earnings and cash flow items are translated at the weighted-average exchange rates during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +FAIR VALUE OF FINANCIAL INSTRUMENTS +The fair value hierarchy as defined by applicable accounting standards prioritizes the use of inputs used in valuation techniques into the following three levels: +• +Level 1: Quoted market prices in active markets for identical assets or liabilities. +• +Level 2: Other observable market-based inputs or unobservable inputs that are corroborated by market data. +• +Level 3: Unobservable inputs that cannot be corroborated by market data that reflect the reporting entity’s own assumptions. +The Company’s Level 1 investments primarily include money market funds and U.S. Treasury securities; Level 2 investments primarily include corporate notes and bonds, asset-backed securities, and actively traded mutual funds; and the Company does not currently have any Level 3 assets or liabilities. The Company has one Level 2 derivative instrument which is an interest rate swap related to the refinancing of its North America distribution center (see Note 6 – Financial Commitments) classified as other assets at December 31, 2021 and other long-term liabilities at December 31, 2020. The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements . +The carrying amount of receivables, payables and other amounts arising out of the normal course of business approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based on current rates and terms available to the Company for similar debt. +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company uses an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap, designated as a cash flow hedge, involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. As of December 31, 2021, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +RECENT ACCOUNTING PRONOUNCEMENTS +In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, (“ASU 2019-12”). ASU 2019-12 removes certain exceptions to the general income tax accounting methodology including an exception for the recognition of a deferred tax liability when a foreign subsidiary becomes an equity method investment and an exception for interim periods showing operating loss in excess of anticipated operating loss for the year. The amendment also reduces the complexity surrounding franchise tax recognition; the step up in the tax basis of goodwill in conjunction with business combinations; and the accounting for the effect of changes in tax laws enacted during interim periods. The Company adopted ASU 2019-12 on January 1, 2021 , and the adoption did not have a material impact on its consolidated financial statements. +In March 2020, the FASB issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, as amended and supplemented by subsequent ASUs (collectively, “ASU 2020-04”), which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for borrowing instruments, which use LIBOR as a reference rate, and is effective immediately, but is only available through December 31, 2022. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. +33 +(2) +CASH, CASH EQUIVALENTS, SHORT-TERM AND LONG-TERM INVESTMENTS +The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category: +As of December 31, 2021 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +664,220 +$ +664,220 +$ +664,220 +$ +— +$ +— +Level 1 +Money market funds +132,063 +132,063 +132,063 +— +— +U.S. Treasury securities +25,437 +25,437 +— +8,896 +16,541 +Total level 1 +157,500 +157,500 +132,063 +8,896 +16,541 +Level 2 +Corporate notes and bonds +148,373 +148,373 +— +84,783 +63,590 +Asset-backed securities +17,180 +17,180 +— +4,901 +12,279 +Mutual funds +53,180 +53,180 +— +— +53,180 +Total level 2 +218,733 +218,733 +— +89,684 +129,049 +Total +$ +1,040,453 +$ +1,040,453 +$ +796,283 +$ +98,580 +$ +145,590 +As of December 31, 2020 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +946,961 +$ +946,961 +$ +946,961 +$ +— +$ +— +Level 1 +Money market funds +423,865 +423,865 +423,865 +— +— +U.S. Treasury securities +21,146 +21,146 +— +8,067 +13,079 +Total level 1 +445,011 +445,011 +423,865 +8,067 +13,079 +Level 2 +Corporate notes and bonds +117,253 +117,253 +— +83,521 +33,732 +Asset-backed securities +28,253 +28,253 +— +5,498 +22,755 +U.S. Agency securities +3,681 +3,681 +— +3,681 +— +Mutual funds +38,846 +38,846 +— +— +38,846 +Total level 2 +188,033 +188,033 +— +92,700 +95,333 +Total +$ +1,580,005 +$ +1,580,005 +$ +1,370,826 +$ +100,767 +$ +108,412 +The Company’s investments consist of U.S. Treasury securities, corporate notes and bonds, asset-backed securities and U.S. Agency securities, which the Company has the intent and ability to hold to maturity and therefore are classified as held-to-maturity. The Company holds mutual funds in its deferred compensation plan which are classified as trading securities. The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are less than two years . The Company minimizes the potential risk of principal loss by investing in highly-rated securities and limiting the amount of credit exposure to any one issuer. Fair values were determined for each individual security in the investment portfolio. Interest income was $ 3.3 million, $ 5.9 million and $ 11.8 million for the years ended December 31, 2021, 2020 and 2019. +When evaluating an investment for its current expected credit losses, the Company reviews factors such as historical experience with defaults, losses, credit ratings, term, market sector and macroeconomic trends, including current conditions and forecasts to the extent they are reasonable and supportable. +(3) +LEASES +The Company regularly enters into non-cancellable operating leases for retail stores, distribution facilities, offices, showrooms and automobiles. Retail stores typically have initial terms ranging from 5 to 10 years and other real estate or facility leases may have initial lease terms of up to 20 years. The Company’s leases are recorded as operating lease right-of-use (“ROU”) assets and operating leases liabilities. Operating lease liabilities are recognized based on the present value of the fixed portion of lease payments over the lease term at the commencement date. Net present value is calculated using an incremental borrowing rate based on a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. Many of the Company’s real estate leases include options to extend and are included in the lease obligations when considered reasonably certain. ROU assets are recognized based on operating lease liabilities reduced by lease incentives and initial direct costs incurred. Fixed lease cost is recognized on a straight-line basis over the lease term. +The Company’s real estate leases may require additional payments for percentage rent, real estate taxes, or other occupancy-related costs. Percentage rent, a variable cost, is recognized in the consolidated financial statements when incurred and is based on the specific terms in the lease agreement. Real estate taxes and other occupancy-related costs are non-lease components. +34 +Operating lease cost and other information: +Year Ended December 31, +(in thousands) +2021 +2020 +Fixed lease cost +$ +290,509 +$ +266,105 +Variable lease cost +5,354 +3,455 +Operating cash flows used for leases +286,411 +257,775 +Weighted-average remaining lease term +5.95 years +4.31 years +Weighted-average discount rate +3.07 +% +3.67 +% +The following table presents future lease payments as of December 31, 2021: +Year (in thousands) +Operating Leases +2022 +$ +266,959 +2023 +245,011 +2024 +223,303 +2025 +198,589 +2026 +155,008 +Thereafter +378,638 +Total lease payments +$ +1,467,508 +Less: Imputed interest +147,102 +Operating lease liabilities +$ +1,320,406 +As of December 31, 2021, the Company has operating leases, primarily for new retail stores, that have not yet commenced which will generate additional ROU assets of $ 32.9 million. +(4) +PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment is summarized as follows: +As of December 31, +(in thousands) +2021 +2020 +Land +$ +111,212 +$ +95,712 +Buildings and improvements +658,910 +531,059 +Furniture, fixtures and equipment +584,059 +485,349 +Leasehold improvements +497,646 +506,459 +Total property, plant and equipment +1,851,827 +1,618,579 +Less: Accumulated depreciation and amortization +722,918 +683,138 +Property, plant and equipment, net +$ +1,128,909 +$ +935,441 +Depreciation expense was $ 122.2 million, $ 115.5 million and $ 101.1 million for the years ended December 31, 2021, 2020 and 2019 as calculated using the straight-line method, which is based on the following estimated useful lives: +Buildings +20 to 40 years +Building improvements +10 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Shorter of useful life or remaining lease term +The Company reviews all stores for impairment annually or when facts and circumstances indicate that the carrying values may be impaired. The Company performs an evaluation of recoverability by comparing the carrying values of the net assets to their related projected undiscounted future cash flows, in addition to other quantitative and qualitative analyses. The Company did not record material impairment charges during the years ended December 31, 2021, 2020 or 2019. +35 +(5) +ACCRUED EXPENSES +Accrued expenses at December 31, 2021 and 2020 are summarized as follows: +As of December 31, +(in thousands) +2021 +2020 +Accrued payroll, taxes, and other +$ +143,295 +$ +104,004 +Return reserve liability +68,944 +77,219 +Accrued inventory purchases +53,181 +27,489 +Accrued expenses +$ +265,420 +$ +208,712 +(6) +FINANCIAL COMMITMENTS +The Company had $ 17.2 million and $ 38.7 million of outstanding letters of credit as of December 31, 2021 and December 31, 2020, and approximately $ 1.2 million and $ 3.3 million in short-term borrowings as of December 31, 2021 and December 31, 2020. Interest expense for the years ended December 31, 2021, 2020 and 2019 was $ 14.9 million, $ 16.3 million and $ 7.5 million. +Long-term borrowings were as follows: +As of December 31, +(in thousands) +2021 +2020 +Revolving Credit Facility +$ +— +$ +452,500 +HF-T1 Distribution Center Loan +129,505 +129,505 +HF-T2 Distribution Center Construction Loan +57,227 +22,169 +China Distribution Center Construction Loan +75,621 +77,501 +China Operational Loans +69,796 +48,743 +Other +8,263 +1,247 +Subtotal +340,412 +731,665 +Less: Current installments +76,967 +52,250 +Total long-term borrowings +$ +263,445 +$ +679,415 +Revolving Credit Facility +The Company maintains a revolving credit facility to manage liquidity; including working capital and capital expenditures. On December 15, 2021, the Company amended its $ 500.0 million senior, unsecured revolving credit agreement dated November 21, 2019 (the “Amended Credit Agreement”), with Bank of America, N.A., as administrative agent and joint lead arranger, HSBC Bank USA, N.A. and JPMorgan Chase Bank, N.A., as joint lead arrangers, and other lenders. The Amended Credit Agreement expands its senior, unsecured credit facility to $ 750.0 million, which may be increased by up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $ 100.0 million and swingline loans up to a maximum of $ 50.0 million. The Amended Credit Agreement extends the maturity date of the credit agreement, which was due to expire on November 21, 2024 , to December 15, 2026 . The Company may use the proceeds from the Amended Credit Agreement for working capital and other lawful corporate purposes. Borrowings on the Amended Credit Agreement’s revolving credit facility and letters of credit bear interest, at the Company’s option, at a rate equal to (a) Term SOFR plus an applicable margin between 1.000 % and 1.500 % based upon the Company’s Total Adjusted Net Leverage Ratio (as defined in the Amended Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate, (iii) Term SOFR plus 1.00 %, and (iv) 1.00%) plus an applicable margin between 0 % and 0.500 % based upon the Company’s Total Adjusted Net Leverage Ratio. The weighted-average annual interest rate on borrowings under the revolving credit facility was approximately 1.37 % during the year ended December 31, 2021. The Amended Credit Agreement contains certain customary affirmative and negative covenants and events of default for credit facilities of this type. +The Amended Credit Agreement requires the Company to maintain a maximum Total Adjusted Net Leverage Ratio of 3.75 :1, except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 :1 for the quarter in which such acquisition occurs and for the next three quarters thereafter. +As of December 31, 2021, there was $ 732.8 million available under the Company’s Amended Credit Agreement. As of December 31, 2020, the unused credit capacity of the revolving credit facility was $ 8.8 million. The Company was in compliance with the financial covenants under the Amended Credit Agreement as of December 31, 2021. +HF-T1 Distribution Center Loan +To finance construction and improvements to the Company’s North American distribution center, the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered +36 +into an amended and restated construction loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (collectively, the “Amended Construction Loan Agreement”) . Under the Amended Construction Loan Agreement, the parties agreed that the lenders would loan $ 70 million to HF-T1 (the “2015 Loan ”) at an interest rate per annum of LIBOR Daily Floating Rate (as defined therein) plus a margin of 2 %. On March 18, 2020, HF-T1 entered into an amendment to the 2015 Loan (the “2020 Amendment”) that increased the borrowings under the 2015 Loan to $ 129.5 million and extended the maturity date of the 2015 Loan to March 18, 2025 (the “ HF-T1 2020 Loan”). The proceeds of the 2020 Amendment were used by the JV to (i) refinance all amounts owed on the 2015 Loan, (ii) pay $ 1.0 million in accrued interest, loan fees and other closing costs associated with the 2020 Amendment and (iii) make a distribution of $ 64.4 million to HF. Pursuant to the 2020 Amendment, the interest rate per annum on the HF-T1 2020 Loan is the LIBOR Daily Floating Rate (as defined therein) plus a margin of 1.75 %. +HF-T1 also entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) with Bank of America, N.A. to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) as amended (the “Swap Agreement Amendment”) on March 18, 2020 with Bank of America, N.A with a maturity date of March 18, 2025 . The Swap Agreement Amendment fixes the effective interest rate on the HF-T1 2020 Loan at 2.55 % per annum. The HF-T1 2020 Loan and Swap Agreement Amendment are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Company’s revolving credit facility. +As of December 31, 2021 , the Interest Rate Swap had an aggregate notional amount of $ 129.5 million. Under the terms of the Swap Agreement Amendment, the Company will pay a weighted-average fixed rate of 0.795 % on the notional amount and receive payments from the counterparty based on the 30-day LIBOR rate, effectively modifying the Company’s exposure to interest rate risk by converting floating-rate debt to a fixed rate of 4.08 % . The Company continually assesses the creditworthiness of its counterparties. +HF-T2 Distribution Center Construction Loan +On April 3, 2020, the JV, through HF Logistics-SKX T2, LLC, a wholly-owned subsidiary of the JV (“HF-T2”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and lender (collectively, the “2020 Construction Loan Agreement”), pursuant to which the JV obtained a loan of up to $ 73.0 million used to expand the North American distribution center (the “HF-T2 2020 Construction Loan”). Under the 2020 Construction Loan Agreement, the interest rate per annum on the HF-T2 2020 Construction Loan is LIBOR Daily Floating Rate (as defined therein) plus a margin of 190 basis points, reducing to 175 basis points upon substantial completion of the construction and certain other conditions being satisfied. The weighted-average annual interest rate on borrowings under the 2020 Construction Loan Agreement was approximately 2.00 % during the year ended December 31, 2021 . The maturity date of the HF-T2 2020 Construction Loan is April 3, 2025 . The obligations of the JV under the 2020 Construction Loan Agreement are guaranteed by TGD Holdings I, LLC, which is an affiliate of HF . +China Distribution Center Construction Loan +On September 29, 2018, through its Taicang subsidiary (“TC Subsidiary”), the Company entered into a 700.0 million yuan loan agreement with China Construction Bank Corporation (“the China DC Loan”) to finance the construction of the Company’s distribution center in China. Interest is paid quarterly. The interest rate floats and is calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2021 was 4.15 % and may increase or decrease over the life of the loan, and will be evaluated every 12 months. Beginning in 2021, the principal of the loan is repaid in semi-annual installments of variable amounts. The China DC Loan contains customary affirmative and negative covenants for secured credit facilities of this type. The China DC Loan matures on September 28, 2023 . The obligations of the TC Subsidiary under the China DC Loan are jointly and severally guaranteed by the Company’s China joint venture. As of December 31, 2021 , the outstanding balance under this loan included approximately $ 28.2 million classified as current borrowings in the Company’s consolidated balance sheets. +China Operational Loans +The Company has entered certain secured credit facilities to support the operations of its China joint venture. The balance of working capital loans at December 31, 2021 was approximately $ 52.6 million with interest rates ranging from 1.00% to 3.70% per annum, payable at terms agreed by the lender. The balance of working capital loans as of December 31, 2020 was approximately $ 30.1 million with interest rates ranging from 1.75 % to 3.92 % per annum. The balance of loans related to a corporate office building in Shanghai was approximately $ 17.2 million and $ 18.6 million as of December 31, 2021 and December 31, 2020 with interest at 4.28 % per annum, for both periods, payable at terms agreed by the lender. A s of December 31, 2021, the outstanding balances classified as current borrowings in the Company’s consolidated balance sheets included $ 37.6 million related to the working capital loans and $ 4.0 million related to the office building loans. +37 +The following table presents the future principal payments required under the Company’s debt obligations, discussed above: +Year (in thousands) +Maturities +2022 +$ +76,967 +2023 +47,375 +2024 +15,000 +2025 +201,070 +$ +340,412 +( 7 ) +COMMITMENTS AND CONTINGENCIES +PRODUCT AND OTHER FINANCING +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.4 % for 30- to 60 -day financing. The amounts included in accounts payable and outstanding under these arrangements were $ 337.0 million and $ 210.1 million at December 31, 2021 and 2020. Interest expense incurred by the Company under these arrangements totaled $ 6.5 million in 2021, $ 7.4 million in 2020, and $ 7.9 million in 2019. The Company has open purchase commitments with its foreign manufacturers of $ 2.0 billion and warehouse and equipment and corporate construction contracts of $ 310.6 million for the expansion of its distribution centers and corporate headquarters, which are not included in the consolidated balance sheets at December 31, 2021. +LITIGATION +In accordance with GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2021, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. The Company recognizes legal expense in connection with loss contingencies as incurred. +( 8 ) +STOCKHOLDERS’ EQUITY AND STOCK COMPENSATION +COMMON STOCK +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10 million shares of Preferred Stock, par value $ 0.001 per share. +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share (EPS). Basic and diluted net EPS of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +During the years ended December 31, 2021, 2020 and 2019 certain Class B stockholders converted 77,562 , 1,391,670 and 1,575,509 shares, respectively, of Class B Common Stock to Class A Common Stock. +SHARE REPURCHASE PROGRAM +On February 6, 2018, the Company’s Board of Directors authorized a share repurchase program (the “2018 Share Repurchase Program”), pursuant to which the Company could purchase shares of its Class A Common Stock, for an aggregate repurchase price not to exceed $ 150.0 million. The 2018 Share Repurchase Program expired on February 6, 2021 at which time share repurchase authorizations of $ 20.0 million had not been executed. For the year ended December 31, 2019, the Company repurchased 968,724 shares at an average cost per share of $ 30.99 totaling $ 30.0 million. +38 +On January 31, 2022, the Company's Board of Directors authorized a new share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A common stock, for an aggregate repurchase price not to exceed $ 500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +INCENTIVE AWARD PLAN +A total of 10,000,000 shares of Class A Common Stock were reserved for issuance under 2017 Incentive Award Plan (the “2017 Plan”) which replaced and superseded the 2007 Incentive Award Plan (the “2007 Plan,” together with the 2017 Plan, the “Plans”). The 2017 Plan provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the 2017 Plan to employees, consultants and directors of the Company. The 2017 Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. +For the year ended December 31, 2021, the Company granted restricted stock with time-based vesting as well as performance-based awards. The performance-based awards include a market condition tied to the Company’s total shareholder return in relation to its peer companies as well as a financial performance condition tied to annual EPS growth. The vesting and ultimate payout of performance awards is determined at the end of the three-year performance period and can vary from zero to 200 % based on actual results. As of December 31, 2021, a total of 4,343,649 shares remain available for grant as equity awards under the 2017 Plan if target levels are achieved for performance-based awards and 3,876,149 available if maximum levels are achieved. +The Company issued the following stock-based instruments: +Year Ended December 31, +2021 +2020 +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Restricted stock +1,201,600 +$ +42.88 +1,319,300 +$ +36.42 +Performance-based restricted stock +108,750 +$ +38.95 +125,000 +$ +36.02 +Market-based restricted stock +108,750 +$ +54.34 +125,000 +$ +49.78 +A summary of the status and changes of the Company’s unvested shares related to the Plans is presented below: +Shares +Weighted-Average Grant-Date Fair Value +Unvested at January 1, 2019 +2,968,941 +$ +34.79 +Granted +1,603,000 +28.45 +Vested/Released +( 1,116,868 +) +32.46 +Cancelled +( 28,250 +) +39.40 +Unvested at December 31, 2019 +3,426,823 +32.55 +Granted +1,569,300 +37.45 +Vested/Released +( 1,093,500 +) +32.64 +Cancelled +( 790,600 +) +32.23 +Unvested at December 31, 2020 +3,112,023 +35.06 +Granted +1,419,100 +43.46 +Vested/Released +( 1,252,108 +) +34.36 +Cancelled +( 25,699 +) +39.01 +Unvested at December 31, 2021 +3,253,316 +$ +38.97 +The Company determines the fair value of restricted stock awards and any performance-related components based on the closing market price of the Company’s common stock on the date of grant. For share-based awards with a performance-based vesting requirement, the Company evaluates the probability of achieving the performance criteria throughout the performance period and will adjust stock compensation expense up or down based on its estimated probable outcome. Certain performance-based awards contain market condition components which are valued on the date of grant using a Monte Carlo simulation model. The fair value of such awards is expensed ratably over the performance period and is not adjusted for actual achievement. +The Company recognized, as part of general and administrative, compensation expense of $ 60.1 million, $ 65.2 million and $ 41.1 million for grants under the Plans for the years ended December 31, 2021, 2020, and 2019. Related excess income tax benefits (expenses), recorded in the consolidated statements of earnings, for the years ended December 31, 2021, 2020 and 2019, were $( 1.0 ) million, $( 0.7 ) million, and $ 0.3 million. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. For grants that have a service requirement, the Company accounts for forfeitures upon occurrence, rather than estimating the probability of forfeiture at the date of grant. Accordingly, the Company recognizes the full grant-date fair value of these +39 +awards on a straight-line basis throughout the requisite service period, reversing any expense if, and only if, there is a forfeiture . There was $ 84.7 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2021 , which is expected to be recognized over a weighted - average period of 1.75 years . The total fair value of shares vested during the years ended December 31, 2021 , 2020 and 2019 was $ 43.1 million , $ 41.6 million and $ 36.3 million . +STOCK PURCHASE PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2018 Employee Stock Purchase Plan (the “2018 ESPP”) provides a total of 5,000,000 shares of Class A Common Stock for sale. The 2018 ESPP provides eligible employees of the Company and its subsidiaries the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the fair market value on the first trading day or last trading day of each purchase period, whichever is lower. Eligible employees can invest up to 15 % of their compensation through payroll deductions during each purchase period. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense, which is computed using the Black-Scholes valuation model. +Under the 2018 ESPP, the Company received approximately $ 7.3 million, $ 5.9 million and $ 6.2 million, and issued 225,665 , 232,904 and 260,630 shares, respectively, for the years ended December 31, 2021, 2020 and 2019. +( 9 ) +EARNINGS PER SHARE +Basic EPS and diluted EPS are calculated by dividing net earnings by the following: for basic EPS, the weighted-average number of common shares outstanding for the period; and for diluted EPS, the sum of the weighted-average number of both outstanding common shares and potentially dilutive common shares using the treasury stock method. +The calculation of EPS is as follows: +Year Ended December 31, +(in thousands, except per share data) +2021 +2020 +2019 +Net earnings attributable to Skechers U.S.A., Inc. +$ +741,503 +$ +98,564 +$ +346,560 +Weighted-average common shares outstanding, basic +155,539 +154,184 +153,392 +Dilutive effect of nonvested shares +1,255 +710 +759 +Weighted-average common shares outstanding, diluted +156,794 +154,894 +154,151 +Anti-dilutive common shares excluded above +5 +69 +11 +Net earnings attributable to Skechers U.S.A., Inc. per common share: +Basic +$ +4.77 +$ +0.64 +$ +2.26 +Diluted +$ +4.73 +$ +0.64 +$ +2.25 +( 1 0 ) +INCOME TAXES +The Company’s earnings before income tax expense consists of the following: +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +U.S. operations +$ +71,900 +$ +( 112,671 +) +$ +4,999 +Foreign operations +497,857 +267,400 +511,006 +Earnings before income taxes +$ +569,757 +$ +154,729 +$ +516,005 +40 +Income tax consists of the following: +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Current +Federal +$ +34,288 +$ +( 30,094 +) +$ +22,899 +State +7,268 +3,841 +6,384 +Foreign +102,062 +56,530 +66,656 +143,618 +30,277 +95,939 +Deferred +Federal +( 27,074 +) +( 2,208 +) +( 3,583 +) +State +( 4,481 +) +( 3,070 +) +( 813 +) +Foreign +( 357,938 +) +( 16,497 +) +( 2,790 +) +( 389,493 +) +( 21,775 +) +( 7,186 +) +Income tax expense (benefit) +$ +( 245,875 +) +$ +8,502 +$ +88,753 +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows: +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Expected income tax expense +$ +119,649 +$ +32,493 +$ +108,361 +State income tax, net of federal benefit +( 172 +) +( 2,394 +) +1,278 +Rate differential on foreign income +( 24,615 +) +( 27,426 +) +( 43,327 +) +Change in unrecognized tax benefits +11,538 +6,084 +2,739 +Intra-entity intellectual property transfer +( 346,776 +) +— +— +FDII deduction +( 10,695 +) +— +— +Non-deductible compensation +8,693 +7,119 +7,126 +Tax credits +( 7,547 +) +( 6,312 +) +( 3,264 +) +Excess tax (benefit) on stock compensation +976 +703 +( 251 +) +Benefits provided by the Coronavirus Aid, Relief, and Economic Security Act +( 905 +) +( 15,863 +) +— +Non-deductible share cancellation +— +4,048 +— +U.S. tax on foreign earnings +— +— +9,786 +Other +( 927 +) +( 463 +) +3,440 +Change in valuation allowance +4,906 +10,513 +2,865 +Income tax expense (benefit) +$ +( 245,875 +) +$ +8,502 +$ +88,753 +Effective tax rate +( 43.2 ) +% +5.5 +% +17.2 +% +The Company’s income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0.0 % to 34.0 %. The Company’s income tax expense (benefit) was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. For 2021 , the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25 %, primarily due to tax benefits related to the intra-entity transfer of certain intellectual property rights, as further described below, and earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. +In December 2021, the Company completed an intra-entity transfer of certain intellectual property rights to Switzerland primarily to align with current and future international operations. The transfer resulted in a step-up in the Swiss tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets, based on the estimated fair value of the transferred intellectual property rights to be amortized. As a result, the Company recorded a tax benefit of $ 346.8 million, net of uncertain tax positions of $ 25.2 million. +The Company is entitled to a deduction against foreign-derived intangible income (“FDII”) which had an immaterial impact in prior years. The Company is also subject to a tax on global intangible low-taxed income (“GILTI”). GILTI taxes foreign income in excess of a deemed return on tangible assets of foreign corporations and is treated as a period cost. +41 +The tax effects of temporary differences giving rise to deferred tax assets and liabilities are presented below: +As of December 31, +(in thousands) +2021 +2020 +Deferred tax assets +Inventory adjustments +$ +9,099 +$ +5,788 +Accrued expenses +76,412 +59,266 +Allowances for bad debts and chargebacks +4,667 +5,820 +Advance payment +27,594 +— +Intra-entity IP transfer +346,776 +— +Loss carryforwards +38,273 +34,396 +Business credit carryforward +15,537 +13,130 +Share-based compensation +6,479 +5,194 +Operating lease liabilities +337,399 +305,261 +Valuation allowance +( 48,463 +) +( 43,557 +) +Total deferred tax assets +813,773 +385,298 +Deferred tax liabilities +Prepaid expenses +4,116 +8,076 +Right-of-use assets +337,371 +305,231 +Depreciation on property, plant and equipment +32,751 +19,546 +Total deferred tax liabilities +374,238 +332,853 +Net deferred tax assets +$ +439,535 +$ +52,445 +At December 31, 2021, combined foreign net operating loss carry-forwards were approximately $ 127.9 million of which $ 1.4 million expire in 2022 and $ 26.5 million can be carried forward indefinitely. A valuation allowance of $ 33.1 million is recorded for the amount which is not likely to be fully utilized. The $ 4.9 million increase in the valuation allowance primarily relates to increases in deferred tax assets in certain foreign non-benefited loss jurisdictions. +U.S. federal tax credit and net operating loss carry-forwards at December 31, 2021 were $ 1.7 million and zero . State tax credit and net operating loss carry-forwards at December 31, 2021 were $ 12.5 million and $ 43.5 million. These tax credit and net operating loss carry-forward amounts begin to expire in 2030 . No valuation allowance has been recorded, as the Company believes they will be fully utilized. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +As of December 31, +(in thousands) +2021 +2020 +Beginning balance +$ +21,511 +$ +10,566 +Additions for current year tax positions +34,975 +9,804 +Additions for prior year tax positions +15,256 +2,735 +Reductions for prior year tax positions +( 361 +) +— +Settlement of uncertain tax positions +( 812 +) +— +Reductions related to lapse of statute of limitations +( 3,618 +) +( 1,594 +) +Ending balance +$ +66,951 +$ +21,511 +Current unrecognized tax benefits are recorded as a reduction in prepaid expense and included in tax expense when recorded. Long-term unrecognized tax benefits are recorded as an increase in long-term taxes payable with a portion included in tax expense and a portion recorded as a reduction in deferred tax liabilities when recorded. If recognized, $ 50.1 million of unrecognized tax benefits would be recorded as a reduction in income tax expense, and $ 16.9 million would be recorded as an increase in deferred tax liabilities. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +The Company estimates interest and penalties related to income tax matters which are included in income tax expense. Amounts were $ 3.6 million, $ 0.3 million, and $ 0.4 million for the years ended December 31, 2021, 2020, and 2019. Accrued interest and penalties were $ 6.2 million and $ 2.4 million as of December 31, 2021 and 2020. +42 +As of December 31, 2021, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2017, and in several Asian and European tax jurisdictions for years ending on or after December 31, 2011. During the year, the Company reduced the balance of unrecognized tax benefits by $ 3.6 million as a result of expiring statutes and $ 0.8 million from the settlement of domestic and foreign audits. Additionally, the Company has applied for certain U.S. and foreign tax rulings which remain undecided as of December 31, 2021. It is reasonably possible that certain domestic and foreign statutes will expire, certain domestic and foreign audits will be settled, and certain U.S. and foreign tax rulings will be decided during the next twelve months which would reduce the balance of 2021 and prior year unrecognized tax benefits by $ 1.4 million, $ 4.1 million, and $ 30.9 million. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2021. The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. In addition to certain tax restrictions, our joint venture in China has limitations on its distribution of earnings, as local law currently requires it to maintain $ 23.9 million of its earnings in a statutory reserve. +(1 1 ) +EMPLOYEE BENEFIT PLANS +The Company has a 401(k) profit sharing plan covering employees who are 21 years of age and have completed six months of service. The Company’s contribution is based on a non-discretionary match as defined by the plan which vests immediately. Company contributions for 2020 and 2019 were discretionary and vested over six years . The Company made contributions of $ 4.7 million, $ 2.8 million, and $ 2.4 million to the plan for the years ended December 31, 2021, 2020, and 2019. +The Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”) allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees as determined by the Company’s Compensation Committee. Contributions were $ 0.1 million, $ 0.3 million, and $ 0.1 million for the years ended December 31, 2021, 2020 and 2019. Deferred compensation is recognized based on the fair value of the participants’ accounts. +(1 2 ) +RELATED PARTY TRANSACTIONS +The Skechers Foundation (the “Foundation”) is a 501(c)(3) non-profit entity and not a subsidiary or otherwise affiliated with the Company. The Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are also officers and directors of the Foundation. During the years ended December 31, 2021, 2020, and 2019, the Company made contributions of $ 3.0 million, $ 2.3 million, and $ 1.0 million to the Foundation. +The Company had receivables from officers and employees of $ 1.3 million and $ 1.0 million at December 31, 2021 and 2020. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. In March 2021, the Company purchased two properties for $ 2.7 million, from an entity controlled by its President, Michael Greenberg, to facilitate future expansion of the Company’s corporate office buildings in Manhattan Beach, California. The terms of the sale were no less favorable than could be obtained from an unrelated third party. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +43 +( 1 3 ) +SEGMENT AND GEOGRAPHIC INFORMATION +The Company’s operations and segments are organized along its distribution channels with three reportable segments : Domestic Wholesale, International Wholesale, and Direct-to-Consumer . Management evaluates segment performance based primarily on sales and gross margin. All other costs and expenses of the Company are analyzed on an aggregate basis and not allocated to the segments . The following summarizes the Company’s operations by segment and geographic area: +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Sales +Domestic Wholesale +$ +1,438,038 +$ +1,126,564 +$ +1,247,550 +International Wholesale +3,025,479 +2,257,846 +2,462,632 +Direct-to-Consumer +1,821,512 +1,213,004 +1,509,869 +Total +$ +6,285,029 +$ +4,597,414 +$ +5,220,051 +Gross profit +Domestic Wholesale +$ +523,165 +$ +431,603 +$ +457,944 +Gross margin +36.4 +% +38.3 +% +36.7 +% +International Wholesale +1,364,347 +1,023,183 +1,133,573 +Gross margin +45.1 +% +45.3 +% +46.0 +% +Direct-to-Consumer +1,211,700 +734,995 +899,640 +Gross margin +66.5 +% +60.6 +% +59.6 +% +Total +$ +3,099,212 +$ +2,189,781 +$ +2,491,157 +Sales (1) +United States +$ +2,553,056 +$ +1,913,409 +$ +2,197,391 +International +3,731,973 +2,684,005 +3,022,660 +Total +$ +6,285,029 +$ +4,597,414 +$ +5,220,051 +(1) +During the years ended December 31, 2021 , 2020 and 2019 , s ales in China were $ 1,247.9 million, $ 924.5 million and $ 850.0 million. +The Company’s sales to its five largest customers accounted for approximately 8.6 %, 8.8 % and 9.6 % for the years ended December 31, 2021, 2020 and 2019. +The following summarizes the Company’s assets by segment and geographic area : +As of December 31, +(in thousands) +2021 +2020 +Identifiable assets +Domestic Wholesale +$ +1,939,857 +$ +1,945,681 +International Wholesale +3,128,996 +2,436,568 +Direct-to-Consumer +1,422,427 +1,430,120 +Total +$ +6,491,280 +$ +5,812,369 +Year Ended December 31, +(in thousands) +2021 +2020 +2019 +Additions to property, plant and equipment +Domestic Wholesale +$ +195,060 +$ +129,165 +$ +75,037 +International Wholesale +54,248 +120,983 +109,205 +Direct-to-Consumer +60,366 +59,768 +51,869 +Total +$ +309,674 +$ +309,916 +$ +236,111 +As of December 31, +(in thousands) +2021 +2020 +Property, plant and equipment, net (1) +United States +$ +708,763 +$ +535,648 +International +420,146 +399,793 +Total +$ +1,128,909 +$ +935,441 +(1) Property, plant and equipment, net in China was $ 255.4 million and $ 241.6 million at December 31, 2021 and 2020 . +44 +Assets located outside the U.S. consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and operating lease ROU assets. Net assets held outside the U.S. were $ 4.2 billion and $ 3.1 billion at December 31, 2021 and 2020. +The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable generally do not require collateral. Foreign accounts receivable are generally collateralized by letters of credit. The Company’s additions to the provision for expected credit losses charged to expense for the years ended December 31, 2021, 2020 and 2019 were $ 3.3 million, $ 18.7 million and $ 2.7 million. +The Company’s accounts receivables, excluding allowances, in different geographic areas are summarized as follows: +As of December 31, +(in thousands) +2021 +2020 +Domestic Accounts Receivable +$ +270,404 +$ +230,546 +Foreign Accounts Receivable +525,073 +437,816 +The Company’s top five manufacturers produced the following: +Year Ended December 31, +(Percentage of Total Production) +2021 +2020 +2019 +Manufacturer #1 +18.0 +21.0 +16.0 +Manufacturer #2 +5.3 +6.2 +7.3 +Manufacturer #3 +4.8 +5.8 +7.2 +Manufacturer #4 +4.6 +4.9 +5.1 +Manufacturer #5 +4.4 +4.2 +5.0 +37.1 +42.1 +40.6 +45 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2021. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2021, which is set forth below. +Inherent Limitations on Effectiveness of Controls +Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2021. +46 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 25, 2022, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 25, 2022 +47 +ITEM 9B. +OTHER INFORMATION +None. +ITEM 9 C . +DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +Not applicable. +48 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. +ITEM 11. +EXECUTIVE COMPENSATION +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. +ITEM 14. +PRINCIPAL ACCOUNTING FEES AND SERVICES +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. +49 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +1. +Financial Statements: See “Index to Consolidated Financial Statements and Financial Statement Schedule” in Part II, Item 8 on page 23 of this annual report on Form 10-K. +2. +Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 51 of this annual report on Form 10-K. +ITEM 16. +FORM 10-K SUMMARY +None. +50 +SCHEDULE II +SKECHERS U.S.A., INC. AND SUBSIDIARIES +VALUATION AND QUALIFYING ACCOUNTS +(in thousands) +Balance at +Beginning of Year +Costs +Charged to +Expenses +Deductions +and +Write-offs +Balance at +End of Year +Year-ended December 31, 2019 +Allowance for chargebacks +$ +18,773 +$ +3,931 +$ +( 5,291 +) +$ +17,413 +Allowance for doubtful accounts +6,843 +2,471 +( 2,621 +) +6,693 +Return reserve liability +48,466 +46,054 +( 25,472 +) +69,048 +Inventory reserves +12,753 +14,593 +( 20,618 +) +6,728 +Year-ended December 31, 2020 +Allowance for chargebacks +$ +17,413 +$ +12,734 +$ +( 3,473 +) +$ +26,674 +Allowance for doubtful accounts +6,693 +19,940 +( 4,745 +) +21,888 +Return reserve liability +69,048 +18,023 +( 9,852 +) +77,219 +Inventory reserves +6,728 +15,920 +( 14,428 +) +8,220 +Year-ended December 31, 2021 +Allowance for chargebacks +$ +26,674 +$ +45,957 +( 32,497 +) +$ +40,134 +Allowance for doubtful accounts +21,888 +10,551 +( 9,889 +) +22,550 +Return reserve liability +77,219 +6,263 +( 14,538 +) +68,944 +Inventory reserves +8,220 +24,899 +( 25,608 +) +7,511 +See accompanying report of independent registered public accounting firm +51 +INDEX TO EXHIBITS +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 20, 2007). +3.2(c) +Third Amendment to Bylaws dated as of May 15, 2019 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on May 17, 2019). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed on May 12, 1999). +4.2 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 3, 2013). +10.1(a)* +First Amendment to the Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1(a) of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.3* +2007 Incentive Award Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2007). +10.4* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.5* +Form of Restricted Stock Agreement (Time-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.6* +Form of Restricted Stock Agreement (Performance-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.7* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.8 +Form of Indemnification Agreement between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.9 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.10* +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.11* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2019). +52 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10.1 2 +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.2 of the Registrant’s Form 8-K filed on May 24, 2019). +10.13 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.13(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on August 17, 2015). +10.13(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018). +10.13(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(c) of the Registrant’s Form 10-K for the year ended December 31, 2019). +10.14 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed on August 17, 2015). +10.14(a)** +First Amendment to Amended and Restated Loan Agreement dated as of March 18, 2020, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders. (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on March 24, 2020). +10.15 +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.16 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.17** +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.18 +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +53 +EXHIBIT +NUMBER +DESCRIPTION OF EXHIBIT +10. 19 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.19(a) +First Amendment to Credit Agreement dated March 23, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended March 31, 2021. +10.19(b) +Second Amendment to Credit Agreement dated December 15, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.20 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.21 +Reaffirmation Agreement dated December 15, 2021 by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, and Bank of America N.A. (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data file - the cover page from the Company's Annual Report on Form 10-K for the year ended December 31, 2020 has been formatted in Inline XBRL. +* +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** +C onfidential treatment has been granted by the SEC with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +54 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 25th day of February 2022. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +SIGNATURE +TITLE +DATE +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 25, 2022 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 25, 2022 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 25, 2022 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 25, 2022 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Katherine Blair +Director +February 25, 2022 +Katherine Blair +/s/ Morton D. Erlich +Director +February 25, 2022 +Morton D. Erlich +/s/ Zulema Garcia +Director +February 25, 2022 +Zulema Garcia +/s/ Richard Siskind +Director +February 25, 2022 +Richard Siskind +55 \ No newline at end of file diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/filing_metadata.csv b/raw/filings/0001065837/2021/0001564590-22-007170/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..13778b4d158679d0d8c3c6d0859310d2843a14f8 --- /dev/null +++ b/raw/filings/0001065837/2021/0001564590-22-007170/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2022-02-25,2021-12-31,2022-02-25T21:16:44.000Z,0001564590-22-007170,skx-10k_20211231.htm,10-K,14827304,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000156459022007170/skx-10k_20211231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459022007170/,2021,2021,1 diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/item1.txt b/raw/filings/0001065837/2021/0001564590-22-007170/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..aee1b58b0d7aa5a2a4afc1e9ac381cab6f764165 --- /dev/null +++ b/raw/filings/0001065837/2021/0001564590-22-007170/item1.txt @@ -0,0 +1,147 @@ +ITEM 1. +BUSINESS +Skechers U.S.A., Inc., The Comfort Technology Company TM , was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under U.S. generally accepted accounting principles. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website at www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, performance footwear for men and women under the Skechers Performance brand name, and work footwear for men and women under Skechers Work brand name. We design and market Skechers branded lifestyle apparel, and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and medical scrubs, among others. Skechers footwear reflects a combination of innovation, style, comfort, quality and value that appeals to a broad range of consumers. Our product offering is sold through wholesale distribution to department and specialty stores, athletic and independent retailers, and e-commerce retailers and directly to consumers through retail stores and digital sales. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and various distribution channels. +We believe that brand recognition is an important element for success in the footwear business. We aggressively market our brands through comprehensive marketing campaigns for men, women and children. The Skechers brand is supported by print, television, digital, radio, outdoor and press campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we enlist numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2021 , our brand ambassadors included Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Rusty Wallace and Brooke Burke, along with athletes Clayton Kershaw, Edward Cheserek, Meb Keflezighi, Colin Montgomerie and Brooke Henderson. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account and customer base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, innovation and affordability. Our Performance lines benefit from our marketing, product development, technology, and feedback from athletes and wear testers. To promote innovation and brand relevance, we manage our product lines through separate dedicated sales and design teams. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines, many of which have categories that have developed into well-known names. Most of these categories are marketed and packaged with unique shoe boxes, hangtags and in-store support. +Lifestyle Brands . Our lifestyle offering includes categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Foamies, Mark Nason, the charity-minded BOBS from Skechers collection, among others. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and fashion. Innovation is also important within our lifestyle offering and select styles include patented designs including podiatrist-certified arch support and outsoles for enhanced traction, stability and durability. Within our lifestyle collections are collaborations with known brands and properties—including street artists, designers and well-known animated characters. +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed for specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight ULTRA GO and HYPER BURST midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines of Skechers GOrun, Skechers GOwalk, Skechers GOtrain, Skechers GOtrail, and Skechers GO Golf. +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection; Skechers Mega-Craft, S-Lights, SKECH-AIR, Foamies, Twinkle Toes, Skechers Stretch Fit, and Skechers Street. +Skechers Work. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers +2 +comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology . +Skechers Apparel. Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear products. The Skechers apparel collection is sold at Skechers retail stores, on our websites and through wholesale customers. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. Our occupational footwear is designed to meet the specifications and demands of the service, medical and construction industries while also meeting testing specifications in the markets where the product is sold. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and improve our most successful styles. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with the civility and respect they deserve. +Quality Control. We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we will perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +Sustainability. We believe sustainability is an important responsibility in managing our business. We recently launched Our Planet Matters, a collection of sustainable products utilizing recycled materials. We partnered with a global conservation organization to help fund their organization’s global efforts which align with our core values and commitment to reduce tree harvesting and emissions through packaging. +We worked to make our packaging more sustainable for the more-than-200 million units of Skechers that consumers purchased in 2021. Since 2016, we’ve reduced our products’ packaging plastics by 99% down to less than 1%; all of which are recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging are recyclable and printed with soy-or water-based ink. Further, 99% of our shoeboxes meet the FSC® standard for responsible resources, and we continually look for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed +3 +with soy-or-water-based ink and are 100% recyclable, and at the distribution center s managing more than 90% of our business, our outbound shipping cartons are made with 96%-100% recycl ed materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our expanding corporate offices in Los Angeles, California are being designed and developed to qualify for LEED certification. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing plan has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity endorsers in some of our advertisements. +PRODUCT DISTRIBUTION CHANNELS +We have three reportable segments: Domestic Wholesale, International Wholesale, and Direct-to-Consumer. In the U.S., our products are available through a network of wholesale customers comprised of department, athletic and specialty stores and e-commerce retailers. Internationally, our products are available through wholesale customers in more than 180 countries and territories via our global network of distributors as well as through our subsidiaries in Asia, Europe, Canada, and Latin America. Skechers owns and operates retail stores both domestically and internationally through three integrated retail formats—concept, factory outlet and big box stores. Each of these channels serves an integral function in the global distribution of our products. +Domestic Wholesale. We distribute our footwear domestically to department stores, wholesale clubs, specialty stores, athletic specialty shoe stores, independent retailers, and internet retailers. Skechers footwear is available through a variety of wholesale customers, many of whom operate stores within the same retail locations due to our distinct product lines, variety of styles and the price criteria of their specific customers. An integral component of our strategy is to offer our accounts the highest level of customer service so that our products will be fully represented in existing and new customer retail locations. +International Wholesale. Our products are sold in more than 180 countries and territories throughout the world. We generate revenues from outside the U.S. from sales to department stores, specialty, independent and internet retailers. To support our global operations, we have offices and showrooms in over 20 countries. +Our subsidiaries and joint ventures merchandise, market and distribute Skechers product to generate sales in their countries, and we consolidate their results in our financial statements. Our joint venture interests include: China, Malaysia and Singapore (50%), Thailand and Israel (51%), Mexico (60%), and South Korea (65%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores. Our distributors, licensees and franchisees own and operate the following retail stores around the world: +Number of Store Locations at December 31, 2020 +Opened during 2021 +Closed during 2021 +Number of Store Locations at December 31, 2021 +Distributor, licensee and franchise stores +Africa +67 +1 +— +68 +Asia +1,797 +545 +(278 +) +2,064 +Australasia +121 +28 +— +149 +Central America +19 +10 +— +29 +Europe +352 +57 +(2 +) +407 +Middle East +165 +13 +— +178 +North America +12 +1 +— +13 +South America +37 +2 +(1 +) +38 +Total distributor, licensee and franchise stores +2,570 +657 +(281 +) +2,946 +Direct-to-Consumer. We pursue our direct-to-consumer strategy through our integrated retail formats: e-commerce, concept stores, factory outlet and big box stores. Our formats enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E-commerce – Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which has improved our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are +4 +generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as marketing and product testing venues. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise. Unlike our big box stores, inventory in these stores is supplemented by certain first-line styles sold at full retail price points. +• +Big Box Stores – Our free-standing and attached big box stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory. We seek to open our big box stores in areas that are in close proximity to our concept stores to facilitate the timely transfer of inventory. +Store count, openings and closings for our domestic, international and consolidated joint venture stores are as follows: +Number of Store Locations at December 31, 2020 +Opened during 2021 +Closed during 2021 +Number of Store Locations at December 31, 2021 +Domestic stores +523 +18 +(26 +) +515 +International stores +331 +33 +(6 +) +358 +Joint venture stores +467 +128 +(108 +) +487 +Total domestic, international and joint venture stores +1,321 +179 +(140 +) +1,360 +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers broadens and enhances the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. +As of December 31, 2021 , we had 25 active licensing agreements in which we are the licensor. These include a variety of Skechers-branded products including apparel, accessories, socks and eyewear; medical scrubs; fitness and yoga accessories, and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; BOBS from Skechers socks and backpacks; and Skechers Work socks. We also have BOBS from Skechers pet accessories in Petco. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Our distribution network includes (i) an approximately 2.8 million square-foot North American distribution center located in California, (ii) an approximately 2.2 million square-foot European distribution center located in Belgium, (iii) an approximately 1.6 million square foot China distribution center, (iv) an approximately 0.3 million square foot United Kingdom distribution center, (v) company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, and (vi) third-party manufacturers and other international third-party distribution centers. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in approximately 155 foreign countries. We have design patents and pending design and utility patent applications in both the U.S. and approximately 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect valuable intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +5 +HUMAN CAPITAL +As of December 31, 2021 , we employed approximately 11,700 persons, of whom approximately 6,200 were employed on a full-time basis and approximately 5,500 were employed on a part-time basis, primarily in our retail stores. +Social Responsibility. As a family-focused brand, Skechers was founded on inclusivity, diversity, respect and entrepreneurial spirit with the philosophy of putting people first – offering comfort and care to our employees and customers. In conjunction with our policy against discrimination, Skechers emphasizes that every employee, applicant, contractor and customer is entitled to be treated with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of our company – including our factories and suppliers. All full-time and part-time corporate employees in the U.S. undergo harassment and diversity training, and employees of our wholly-owned operations in other countries comply with their local laws regarding human rights, harassment and diversity training in the workplace. As it relates to our factories and suppliers specifically, we provide employee and management training to ensure that employees and companies who oversee our production and manufacturer auditing know the most current issues regarding human rights. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify these values and our commitment to diversity, equity and inclusion. +Skechers is also focused on reducing its carbon footprint. We have made environmental advancements a top priority at our corporate facilities. Now under construction, our expanding corporate offices remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four buildings are being designed to receive LEED Gold certification upon completion, and include solar panels. +Community. Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2021, the Company donated over 50,000 pairs of new shoes to those in need, $1.0 million in support of earthquake relief efforts in Haiti, and we formed a partnership with a global conservation organization to contribute to their efforts to protect the world’s lands and waters. +Health and Safety. Skechers’ lifestyle and performance product offering has shaped our culture with a focus on wellness, and a commitment to providing a safe and healthful work environment for all employees. The Company offers healthy lunch options, an in-house fitness consultant and corporate exercise programs. We offer paid time off to get the COVID-19 vaccine and provided on-site vaccination clinics for our corporate employees and our domestic distribution center employees. We made changes to our corporate facilities, increasing cleaning protocols and distributing personal protective equipment and cleaning supplies to employees; instituting temperature screenings; installing touchless doors and faucets in common areas; limiting building occupancy; and staggering work schedules. +Talent. We offer competitive benefits in a casual, creative atmosphere and a fun, fast-paced environment where employees can always learn and grow. Employee benefits are designed to help employees and their families stay healthy, meet their financial goals, and help them balance their work and personal lives. Benefits include health and wellness programs, training and development programs, an employee stock purchase program, a childcare incentive program, on-site electric vehicle charging stations, and product discounts. \ No newline at end of file diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/item13.txt b/raw/filings/0001065837/2021/0001564590-22-007170/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..416d3b84ebfe7f0c9b4d6d003677b75e86f365b1 --- /dev/null +++ b/raw/filings/0001065837/2021/0001564590-22-007170/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2021 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/item9a.txt b/raw/filings/0001065837/2021/0001564590-22-007170/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..2c818136d9fa256579df4063fa20f4aa5993f045 --- /dev/null +++ b/raw/filings/0001065837/2021/0001564590-22-007170/item9a.txt @@ -0,0 +1,38 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2021. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2021, which is set forth below. +Inherent Limitations on Effectiveness of Controls +Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2021. +46 +Report of Independent Registered Public Accounting Firm +Stockholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 25, 2022, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 25, 2022 +47 \ No newline at end of file diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/rp_note.txt b/raw/filings/0001065837/2021/0001564590-22-007170/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2021/0001564590-22-007170/rpt_disclosure.txt b/raw/filings/0001065837/2021/0001564590-22-007170/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..33ac7681add8875f8258f986b37c54e42c899337 --- /dev/null +++ b/raw/filings/0001065837/2021/0001564590-22-007170/rpt_disclosure.txt @@ -0,0 +1,14 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in the section entitled “ Corporate Code of Conduct and Code of Ethic s ”), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A Common Stock or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2021. Each of these transactions was reviewed, and approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +Related Person Transactions +On November 12, 2021, we paid $200,000 to The Beach Life Festival for Skechers marketing and sponsorship. The Beach Life Festival is owned and operated by Beach Life Festival, LLC, of which Michael Greenberg owned an 8% beneficial ownership interest. Skechers had no outstanding accounts receivable or payable with The Beach Life Festival or Beach Life Festival, LLC as of December 31, 2021. +On March 31, 2021, we purchased two properties for $2.7 million, from an entity controlled by Michael Greenberg, to facilitate future expansion of our corporate office buildings in Manhattan Beach, California. The terms of the sale were no less favorable than could be obtained from an unrelated third party. +43 +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg has agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for the fourth time for an additional year with the same terms and conditions effective as of February 1, 202 2 . +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2021, we made contributions of $3,000,000 to the Foundation. +Jeffrey Greenberg, Jason Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $319,738, $4,146,195, $3,407,625 and $338,830, respectively, in 2021. Chase Greenberg , who is the son of Michael Greenberg, is a non-executive employee of Skechers, and he earned total compensation of $776,185 in 2021. +Andrew Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $967,038 and $832,831, respectively, in 2021. \ No newline at end of file diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/filing.txt b/raw/filings/0001065837/2022/0001564590-23-002740/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..3ce7a7cfd1c9f1f7339f8cec24f1856777c201ab --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/filing.txt @@ -0,0 +1,4482 @@ +skx-10k_20221231.htm +false +2022 +FY +SKECHERS USA INC +0001065837 +--12-31 +0.0290 +0.0341 +P30D +0.0341 +0.0290 +P3Y +0001065837 +2022-01-01 +2022-12-31 +xbrli:shares +0001065837 +us-gaap:CommonClassAMember +2023-02-15 +0001065837 +us-gaap:CommonClassBMember +2023-02-15 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+0001065837 +us-gaap:AllowanceForNotesReceivableMember +2022-12-31 +0001065837 +skx:LiabilityForSalesReturnsAndAllowancesMember +2022-12-31 +0001065837 +us-gaap:InventoryValuationReserveMember +2022-12-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2022 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant ’ s executive o fficers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2022, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 4.9 billion based upon the closing price of $35.58 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 15, 2023: 134,473,612 . +The number of shares of Class B Common Stock outstanding as of February 15, 2023: 20,810,041 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2023 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +Form 10-K +Table of Contents +PART I +Item 1. +B usiness +2 +Item 1A. +R isk F actors +6 +Item 1B. +U nsolved S taff C omments +14 +Item 2. +Pr operties +14 +Item 3. +L egal P roceedings +14 +Item 4. +M ine S afety D isclosures +15 +PART II +Item 5. +M arket f or R egistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +16 +Item 6. +[ R eserved ] +16 +Item 7. +M anagement’s Discussion and Analysis of Financial Condition and Results of Operations +17 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +22 +Item 8. +Financial Statements and Supplementary Data +23 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +45 +Item 9A. +Controls and Procedures +45 +Item 9B. +Other Information +48 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +48 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +49 +Item 11. +Executive Compensation +49 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +49 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +49 +Item 14. +Principal Accountant Fees and Services +49 +PART IV +Item 15. +Exhibit and Financial Statement Schedules +50 +Item 16. +Form 10-K Summary +53 +SIGNATURES +54 +i +Special Note on Forward-Looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 , including statements with regards to future revenue, projected operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our future performance. Factors that might cause or contribute to such differences include: +• +the COVID-19 pandemic and its adverse impact on our operations and our business, sales and results of operations around the world; +• +our ability to manage the impact from delays and disruptions in our supply chain; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; and +• +global economic, political and market conditions including the effects of inflation and foreign currency exchange rate fluctuations around the world, the challenging consumer retail market in the United States (“U.S.”) and the impact of Russia’s war with Ukraine. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and state securities laws. +1 +PART I +Item 1. +Business +Skechers U.S.A., Inc., The Comfort Technology Company TM , was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under U.S. generally accepted accounting principles. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website, www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, performance footwear for men and women under the Skechers Performance brand name, and work footwear for men and women under Skechers Work brand name. We design and market Skechers branded lifestyle apparel and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and medical scrubs, among other categories. Skechers footwear reflects a combination of style, quality, comfort, innovation and value that appeals to a broad range of consumers. Our product offering is sold through wholesale distribution to department and specialty stores, athletic and independent retailers, and e-commerce retailers, and directly to consumers through Skechers brick and mortar and digital stores. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and various distribution channels. +We believe that brand recognition is an important element for success in the footwear business. We aggressively market our brands through comprehensive marketing campaigns for men, women and children. The Skechers brand is supported by print, television, digital, radio, outdoor and press campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we enlist numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2022 , our brand ambassadors included television personalities and entertainers Martha Stewart, Amanda Kloots, Brooke Burke, Willie Nelson and Chesca, athlete Clayton Kershaw, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Meb Keflezighi, and Rusty Wallace. More recently, culture and entertainment icon Snoop Dogg joined our stable of brand ambassadors. Additionally, athletes supporting our performance footwear included runner Edward Cheserek, elite golfers Matt Fitzpatrick, Brooke Henderson and Colin Montgomerie, and pro pickleball players Tyson McGuffin and Catherine Parenteau. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account and customer base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, and innovation all at a reasonable price. Our Performance lines benefit from our marketing, product development, technology, wins on the course or track, and feedback from athletes and wear testers. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines, many of which have collections that have developed into well-known names. Most of these collections are marketed and packaged with unique shoe boxes, hangtags and in-store support. +From fashion styles to lifestyle product and performance shoes for sport enthusiasts, our offering is enhanced with the Company’s signature comfort innovations—including its Skechers Arch Fit® Technology, Skechers Max Cushioning® Technology, Skechers Air‑Cooled Memory Foam®, Skechers Relaxed Fit® Technology, Skechers Stretch Fit® Technology, Skechers Hands Free Slip-ins® Technology, Skechers Hyper Burst® Technology, and Massage Fit® Technology. +Lifestyle Brands . Our lifestyle offering includes categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Foamies, Mark Nason, the charity-minded BOBS from Skechers collection, and the recycled materials line Our Planet Matters, among others. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and fashion, and also include the well-known Skechers Uno, Skechers Arch Fit®, and new in 2022, Skechers Hands Free Slip-ins™. Innovation is also important within our lifestyle offering and select styles include patented designs including podiatrist-certified arch support and outsoles for enhanced traction, stability and durability. +Within our lifestyle collections are collaborations with known brands and properties—including street artists like James Goldcrown and well-known animated characters like tokidoki. +2 +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed for specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight U ltra GO and H yper B urst midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines Skechers GOrun , Skechers GOwalk , Skechers GOtrain , Skechers GOtrail , and Skechers GO Golf as well as Skechers Viper Court for pickleball . +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection, S-Lights, Skech-Air, Foamies, Twinkle Toes, Skechers Stretch Fit, and Skechers Street. +Skechers Work . Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology. +Skechers Apparel . Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear products. The Skechers apparel collection is sold at Skechers retail stores, on our websites and through wholesale customers. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. Our occupational footwear is designed to meet the specifications and demands of the service, medical and construction industries while also meeting testing specifications in the markets where the product is sold. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and improve our most successful styles. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. +Quality Control. We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +3 +Sustainability. We believe sustainability is an important responsibility in managing our business. In 2021, we introduced Our Planet Matters, a collection for men, women and kids that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interest s and commitment to reduce tree harvesting and emissions through packaging. +We worked to make our packaging more sustainable for the more-than-225 million units of Skechers that consumers purchased in 2022. Since 2016, we have reduced our products’ packaging plastics by 99% down to less than 1%; all of which is recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging are recyclable and printed with soy-or water-based ink. Further, 99% of our shoeboxes meet the FSC® standard for responsible resources, and we continually look for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are composed of 96%-100% recycled materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our expanding corporate offices in Los Angeles, California are being designed and developed to qualify for LEED Gold certification. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted and 360-degree approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing strategy has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity and athlete endorsers in some of our advertisements. +PRODUCT DISTRIBUTION +We have two reportable segments: Wholesale and Direct-to-Consumer. The Company’s collections are available in approximately 180 countries and territories through department and specialty stores, and direct to consumers through digital stores and approximately 4,540 Company- and third-party-owned physical retail stores. The Company manages its international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. +Our subsidiaries and joint ventures merchandise, market and distribute Skechers product to generate sales in their countries, and we consolidate their results in our financial statements. Our joint venture interests include China, Malaysia and Singapore (50%), Thailand and Israel (51%), Mexico (60%), and South Korea (65%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores. +Wholesale. Our Wholesale segment primarily comprises sales to a vast network of partners. These include: department stores, family shoe stores, specialty running and sporting goods retailers, and big box club stores; franchisee and licensee third-party store operators representing approximately 3,100 Skechers branded stores worldwide; dedicated e-commerce retailers; and international distributors. +Direct-to-Consumer. Our Direct-to-Consumer segment primarily comprises sales by Skechers directly to consumers through a combination of channels. These include approximately 1,450 company-owned retail stores in formats consisting of concept, factory outlet and big box; digital commerce sites and mobile applications; and hosted direct-to-consumer sales through marketplaces in select international markets +We pursue our direct-to-consumer strategy through our integrated retail formats, which enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E- commerce – Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which continues to improve our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as product testing venues. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise. +4 +• +Big Box Stores – Our free-standing and attached big box stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory. +Store count, openings and closings for our domestic, international and third-party stores are as follows: +Number of locations +December 31 2021 +Opened +Closed (1) +December 31, 2022 +Domestic stores +515 +43 +(19 +) +539 +International stores +845 +172 +(112 +) +905 +Distributor, licensee and franchise stores +2,946 +529 +(382 +) +3,093 +Total Skechers stores +4,306 +744 +(513 +) +4,537 +(1) +Does not reflect temporary closures due to the COVID-19 pandemic. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers broadens and enhances the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. +As of December 31, 2022 , we had 27 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel, accessories, socks and eyewear; medical scrubs; fitness and yoga accessories, and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; BOBS from Skechers socks and backpacks; and Skechers Work socks. We also have BOBS from Skechers pet accessories in Petco. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Our distribution network includes (i) an approximately 2.6 million square-foot North American distribution center located in California, (ii) an approximately 2.2 million square-foot European distribution center located in Belgium, (iii) an approximately 1.6 million square foot China distribution center, (iv) an approximately 0.3 million square foot United Kingdom distribution center, (v) company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, and (vi) third-party manufacturers and other international third-party distribution centers. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 162 foreign countries. We have design patents and pending design and utility patent applications in both the U.S. and 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect our intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +HUMAN CAPITAL +As of December 31, 2022 , we employed approximately 15,100 persons, of whom approximately 7,800 were employed on a full-time basis and approximately 7,300 were employed on a part-time basis, primarily in our retail stores. +Social Responsibility . As a family-focused brand, Skechers was founded on inclusivity, diversity, respect and entrepreneurial spirit with the philosophy of putting people first – offering comfort and care to our employees and customers. In conjunction with our policy against discrimination, Skechers emphasizes that every employee, applicant, contractor and customer is entitled to be treated with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. All full-time and part-time corporate employees in the U.S. undergo harassment and diversity training, and +5 +employees of our wholly-owned operations in other countries comply with their local laws regarding human rights, harassment and diversity training in the workplace . As it relates to our factories and suppliers specifically, we provide employee and management training to ensure that employees and companies who oversee our production and manufacturer auditing know the most current issues regarding human rights . Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify these values and our commitment to diversity, equity and inclusion. These c odes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at https://investors.skechers.com/corporate-governance/governance-documents . We intend to post any amendment to, or waiver s of , these codes on our website. The information found on, or otherwise accessible through our website, is not incorporated into, and does not form a part of this annual report. +Skechers is focused on reducing its carbon footprint. We have made environmental advancements a top priority at our corporate facilities. Now under construction, our expanding corporate offices remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four corporate buildings are being designed to receive LEED Gold certification upon completion, and include solar panels. +Community . Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2022, the Company donated over 105,000 pairs of new shoes to those in need, more than $1.5 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. +Health and Safety . Skechers’ lifestyle and performance product offering has shaped our culture with a focus on wellness, and a commitment to providing a safe and healthful work environment for all employees. The Company offers healthy lunch options, an in-house fitness consultant and corporate exercise programs. We offer paid time off to get the COVID-19 vaccine and provided on-site vaccination clinics for our corporate employees and our domestic distribution center employees. We made changes to our corporate facilities, increasing cleaning protocols and distributing personal protective equipment and cleaning supplies to employees; installing touchless doors and faucets in common areas. +Talent. We offer competitive benefits in a casual, creative atmosphere and a fun, fast-paced environment where employees can always learn and grow. Employee benefits are designed to help employees and their families stay healthy, meet their financial goals, and help them balance their work and personal lives. Benefits include health and wellness programs, training and development programs, an employee stock purchase program, a childcare incentive program, on-site electric vehicle charging stations, and product discounts. +Item 1A. +Risk Factors +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +RISKS RELATED TO OUR BUSINESS AND INDUSTRY +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has largely been due to the strength of the Skechers brand. Maintaining, promoting, and growing our brand depends on our ability to develop high-quality, innovative, and fashion forward products, as well as our ability to create fresh and relevant marketing and advertising campaigns. The inability to execute or adverse developments in these areas could negatively impact our brand. Our brand could also be negatively impacted if we or any of our products were to receive negative publicity of any kind. If we are unable to maintain, promote and grow our brand, then our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Future Success Also Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear requires us to accurately identify changing consumer preferences and effectively respond in a timely manner. Demand for and market acceptance of existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +commitment to product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends. +We are often required to make decisions about product designs and marketing expenditures several months in advance of when consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences with new products that achieve market acceptance. If we fail to identify and effectively respond to changing consumer preferences, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +6 +We Face Intense Competition, Including Competition From Companies In The Performance Footwear Market and With Significantly Greater Resources Than Ours, And If We Are Unable To Compete Effectively, Our Market Share May Decline And Our Business Could Be Harmed. +We face intense competition from other established companies in the footwear industry in the areas of product offerings, pricing, costs of production, and advertising and marketing expenditures. Consumer demand for our products may decline significantly if we do not adequately and timely anticipate and respond to our competitors. Some of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on price and production, more effectively keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition. In addition, negative consumer perceptions of our performance features due to our historical reputation as a fashion and lifestyle footwear company may place us at a competitive disadvantage in the performance footwear market. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially adversely impact our business, results of operations and financial condition. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, new stores could be opened in regions in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those we encounter in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, any new store openings in existing markets could result in reduced sales in existing stores in those markets. We may decide to close stores that experience sales declines, which could result in additional costs, expenses, asset impairments or asset write-downs. +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory, and personnel. We have also made significant operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, the poor performance or closure of stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to digital and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially affect our results of operations, financial position, and cash flows. +Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +Many of our concept stores are in shopping malls and some of our factory outlet stores are in manufacturers’ outlet malls. We depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. The overall success of the malls can be negatively impacted by factors outside of our control, such as store closures by other retailers. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Tourism can be adversely affected by external factors such as an economic slowdown or social or political events. Any substantial decrease in customer traffic generated by malls or tourism has, and may continue to have, an adverse effect on sales in our existing stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed. +Our future success depends upon the continued services of Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. The loss of the services of any of these individuals or any other key employee could harm us. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. +7 +We H ave A S ignificant W ork F orce A nd A re S ubject T o R isks R elated T o H uman C apital M anagement. +We employ approximately 15,100 employees worldwide and a significant portion of our operating expenses relate to compensation and benefits. Although we spend a significant amount of time and expense on human capital management, we cannot ensure that we will be able to maintain a happy and productive workforce. If we are unable to offer competitive compensation and benefits, appropriate training and development, and a compelling work environment or sustain employee satisfaction, our culture may be adversely affected, our reputation may be damaged, and we may incur costs related to turnover. +RISKS RELATED TO SUPPLY CHAIN +Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive all our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill customer orders, and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Any unanticipated decline in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast demand, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels exceeding customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply products when we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Manufacture Or Sell Our Products, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all our sales during the year ended December 31, 2022 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; changes in domestic and foreign governmental policies; and the potential for circumstances where we may have to incur premium freight charges to expedite the delivery of product to our customers. If we incur a significant amount of premium charges to airfreight product for our customers and we are not able to collect those charges, our gross profit will be negatively affected. Apart from the impacts of the COVID-19 pandemic, including supply chain constraints, we have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, results of operations, financial condition and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in the People’s Republic of China (“PRC”). The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate under the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During the year ended December 31, 2022, the top five manufacturers of our products produced approximately 39.0% of our total purchases. One manufacturer accounted for 16.5% of total purchases for the year ended December 31, 2022. +8 +We compete with other footwear companies for production facilities, and we do not have long-term contracts with any of our contract manufacturers. Under our current arrangements with them, these manufacturers generally may unilaterally terminate their relationship with us at any time. If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our footwear is delayed or becomes more expensive, our business and financial condition would be harmed. +While not a material issue as of the filing date of this report, the COVID-19 pandemic previously led to the Chinese and Vietnamese governments imposing temporary closures of some of our factories in China and restrictions on others in Vietnam that caused delays in shipment of our products. We may encounter similar challenges yet again with these manufacturers, or new difficulties could arise with our manufacturers or any raw material suppliers on which our manufacturers rely, including prolonged manufacturing or transportation disruptions due to public health conditions, such as the recent COVID-19 pandemic, reductions in the availability of production capacity due to government imposed restrictions, failure to meet our quality control standards, failure to meet production deadlines or increased manufacturing costs. This could result in our customers canceling orders, refusing to accept deliveries or demanding reductions in purchase prices, any of which could have a negative impact on our cash flows and harm our business and results of operations. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistics and distribution systems include computer-controlled and automated equipment, which may be subject to risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all our products are distributed from a few locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the potential adverse effects of significant disruptions to our distribution system, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales, and achieve operating efficiencies could be materially adversely affected. +RISKS RELATED TO ECONOMIC AND POLITICAL CONDITIONS, PANDEMICS AND OTHER EXTERNAL FACTORS +The Uncertainty Of Global Market Conditions May Continue To Have A Negative Impact On Our Business, Results Of Operations Or Financial Condition. +The uncertain state of global economic and political conditions, including the impact of inflation and challenging consumer retail market, may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending. If the current economic situation does not improve or if it weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. +Russia’s ongoing war with Ukraine and the subsequent economic sanctions imposed by the U.S., NATO and other countries may impact global economic conditions or our ability to sell products to customers in the affected regions. The conflict could also have broader implications on economics outside the region, such as the global inflationary impact of a potential boycott of Russian oil and gas by other countries. Furthermore, any unfavorable developments in global political, social and regulatory conditions, including geopolitical conflicts, political unrest, civil strife, terrorist activity, acts of war, public corruption, expropriation, nationalism and other economic or political uncertainties in the U.S. or internationally, could also impact our business. Any negative sentiment toward the U.S. as a result of any such developments could also adversely affect our business and reputation. If the uncertain global market conditions continue for a significant period or worsen, our results of operations, financial condition, and cash flows could be materially adversely affected. +9 +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Our Customers Due To Global Economic Conditions. +A global financial crisis could affect the banking system and financial markets and result in a tightening in the credit markets, more stringent lending standards and terms, higher inflation, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely harm our business, results of operations, financial condition and cash flows. +Natural Disasters, The Effects Of Climate Change, Pandemics, Including the COVID-19 Pandemic, And Other Events Beyond Our Control Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce, and the global economy, and thus could have a negative effect on us. Our business operations are subject to interruption from earthquakes, hurricanes, tornadoes, floods, fires, extreme weather events, power shortages, pandemics such as COVID-19, terrorism, political unrest, telecommunications failure, vandalism, cyber-attacks, geopolitical instability, war, the effects of climate change, and other events beyond our control. Although we maintain disaster recovery plans, such events could disrupt our operations or those of our customers and suppliers, including through the inability of employees and contract professionals to work, destruction of facilities, loss of life, and adverse effects on supply chains, power, infrastructure and the integrity of information technology systems, all of which could materially increase our costs and expenses, delay or decrease revenue from our customers and disrupt our ability to maintain business continuity. We could incur significant costs to improve the climate-related resiliency of our infrastructure and otherwise prepare for, respond to, and mitigate the effects of climate changes. Our insurance may not be sufficient or cover losses or additional expenses that we may sustain. A significant natural disaster or other event that disrupts our operations or those of our customers or suppliers could have a material adverse effect on our business, results of operations, financial condition, and prospects. +Our business relies heavily on the health and safety of our employees, contract professionals and customers. The impact of a health crisis such as the COVID-19 pandemic on our business, operations, and future financial performance could include, but is not limited to, adverse impacts to our operating income, operating margin, net income, earnings per share and operating cash flows, as expenses may not decrease at the same rate as revenues decline. In addition, our quarterly and annual revenue growth rates and expenses as a percentage of our revenues may differ significantly from our historical rates, and our future operating results may fall below expectations. +Our Sales Are Influenced By Economic Conditions And Uncertainty That Impact Consumer Spending And Consumer Confidence. +Consumer confidence and spending on discretionary items generally declines during periods of economic uncertainty or recession. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and/or increasing promotional activity. Our retail stores are also affected by these conditions and may experience declines in consumer traffic and spending. As a result, factors that diminish consumer confidence and spending, particularly deterioration in general economic conditions, consumer credit availability, consumer debt levels, inflation, the impact of foreign exchange fluctuations on tourism and tourist spending, volatility in investment returns, fear of unemployment, increases in energy costs or taxes or interest rates, housing market downturns, fear about and impact of pandemic illness (such as the impact of the COVID-19 pandemic), and other factors such as acts of war, natural disasters or terrorist or political events that impact consumer confidence, have had, and may continue to have (with respect to the COVID-19 pandemic), a material adverse effect on our operations and financial condition through their negative impact on our wholesale customers as well as decreased spending in our retail stores and potentially via our e-commerce business. +Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales Revenue. +A substantial portion of our operations are in California, including 96 of our retail stores, our headquarters in Manhattan Beach, and our North America distribution center in Rancho Belago. A decline in the economic conditions in California could have a material adverse impact on our business. Furthermore, a natural disaster or other catastrophic event in California, such as an earthquake or wildfire, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +10 +Our Environmental, Social And Governance ( “ ESG ” ) Commitments and Disclosures May Expose Us To Reputational Risks And Legal Liability. +Our brand and reputation are associated with our public commitments to various corporate ESG initiatives, including our goals relating to sustainability and diversity and inclusion. Our disclosures on these matters and any failure or perceived failure to achieve or accurately report on our commitments, could harm our reputation and adversely affect our client relationships or our recruitment and retention efforts, as well as expose us to potential legal liability. Increasing focus on ESG matters has resulted in, and is expected to continue to result in, the adoption of legal and regulatory requirements designed to mitigate the effects of climate change on the environmental, as well as legal and regulatory requirements requiring climate-related disclosures. If new laws or regulations are more stringent than current legal or regulatory requirements, we may experience increased compliance burdens and costs to meet such obligations. Our selection of voluntary disclosure frameworks and standards, and the interpretation or application of those frameworks and standards, may change from time to time or may not meet the expectations of investors or other stakeholders. Our processes and controls for reporting ESG matters across our operations and supply chain are evolving along with multiple disparate standards for identifying, measuring, and reporting ESG metrics, including ESG-related disclosures that may be required by the SEC, European and other regulators, and such standards may change over time, which could result in significant revisions to our current goals, reported progress in achieving such goals, or ability to achieve such goals in the future. +RISKS RELATED TO CURRENCY EXCHANGE RATES +Foreign Currency Exchange Rate Fluctuations Could Have A Material Adverse Effect On Our Business And Results Of Operations. +Foreign currency fluctuations affect our revenue and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for us, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars, which causes the cost of those products to vary depending on the foreign currency exchange rates and impacts the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our revenues and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency exchange rates. Although we typically work to mitigate the impact of exchange rate fluctuations through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts, as changes in the value of the U.S. dollar relative to other currencies could have a material adverse effect on our business, results of operations, financial position and cash flows. +RISKS RELATED TO LEGAL AND REGULATORY MATTERS +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions Could Have An Adverse Impact On Our Sales And Profitability. +All our products manufactured overseas and imported into the U.S., the European Union and other countries are subject to customs duties. We are unable to predict whether there may be unfavorable changes in tax laws in the U.S. or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on our sales and results of operations. +Changes To U.S. Or Other Countries’ Trade Policies And Import/Export Regulations Or Our Failure To Comply With Such Regulations May Have A Material Effect On Our Reputation, Business, Financial Condition And Results Of Operations. +Changes in laws and policies governing foreign trade, manufacturing, development and investment in the territories or countries where we currently sell our products or conduct our business could adversely affect our business. U.S. presidential administrations have instituted or proposed changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes. +11 +In addition, c hanges or proposed changes in U.S. or other countries' trade policies may result in restrictions and economic disincentives on international trade. Tariffs and other changes in U.S. trade policy have in the past and could in the future trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing retaliatory measures on certain U.S. goods. Further, any emerging protectionist or nationalist trends either in the U.S. or in other countries could affect the trade environment. The Company, similar to many other multinational corporations, does a significant amount of business that would be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact the U.S. economy or certain sectors thereof or the economy of another country in which we conduct operations, our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition and results of operations +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the U.S., it could result in adverse publicity for us, damage our reputation in the U.S., or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and have a negative impact on our operating results. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations, Financial Condition And Cash Flows. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future claims could have a material adverse effect on our business or financial condition. +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our Skechers ® , Skechers Slip-ins ® Skechers Hands Free Slip-ins ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GO golf ® , Skechers GOtrain ® , Skechers on-the-GO ® , ® , ® , ® , ® , ® , Skechers Cali ® , Skechers Street™, Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Max Cushioning ® , Massage Fit ® , Mark Nason ® , D’Lites ® , DLT-A ® , BOBS ® , Glide Step ® , Skech-Air ® , Skechers Kids™, Twinkle Toes ® , S Lights ® , Relaxed Fit ® , Arch Fit ® , Ultra GO ® , Hyper Burst ® , Skechers Memory Foam ™ , and Air-cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and utility patents covering components and features used in various shoes. We believe that our patents and trademarks are sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been sued in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made +12 +by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the U.S. We cannot be assured that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of counterfeit products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Exposure Of Private Information, Disruption Of Our Business And Damage To Our Reputation, Which Could Harm Our Business, Results Of Operation And Financial Condition. +As a routine part of our business, we utilize information security and information technology systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. In addition, data and security breaches can also occur due to non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. Misuse of or failure to secure personal information could also result in violation of data privacy laws and regulations, proceedings against us by governmental entities or others, damage to our reputation and credibility and could have a negative impact on revenues and profits. +RISKS RELATED TO OUR STOCK AND STOCK PRICE +Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Fluctuations In Demand For Footwear, Delivery Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly revenues and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts and from time to time cancel orders, change delivery schedules, or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. Furthermore, our expenses are partially based on our expectations of future sales, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shifts. As a result, our expenses may be disproportionately large relative to our revenues, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter. Any quarterly fluctuations in our annualized tax rate could have a material impact on our quarterly operating results and the results for any one quarter may not be indicative of results for the full year. Any shortfall in revenues or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +13 +One Principal Stockholder Is Able To Control Substantially All Matters Requiring Approval By Our Stockholders And His Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2022, our Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 87.3% of our outstanding Class B Common Stock, members of Mr. Greenberg’s immediate family beneficially owned an additional 8.1% of our outstanding Class B Common Stock. The holders of Class A Common Stock and Class B Common Stock have identical rights except that holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a result, as of December 31, 2022, Mr. Greenberg beneficially owned 53.1% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by other members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 58.6% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Mr. Greenberg is able to exert significant control over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Mr. Greenberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A Common Stock. Because Mr. Greenberg’s interests may differ from the interests of the other stockholders, his ability to substantially control, actions requiring stockholder approval, may result in the Company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A Common Stock to the extent that investors or any potential future purchaser view the voting rights of our Class B Common Stock to have superior value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +Item 1B. +Unresolved Staff Comments +None. +Item 2. +Properties +Our corporate headquarters are located at several properties in or near Los Angeles, California, which consist of an aggregate of approximately 248,000 square feet. We own and lease portions of our corporate headquarters. +Our North America distribution center occupies approximately 2.6 million square feet on its main campus in Southern California, which is leased from a joint venture, HF Logistics-SKX (the “JV”). The JV was formed with HF Logistics I, LLC (“HF”) in January 2010 for the purpose of building and operating the facility and is consolidated in our financial statements. An additional 2.4 million square feet of distribution center space is leased from third parties. The main campus leases expire at various dates through August 2036, and the leases for the remaining space expire at various dates through May 2028. +Our European distribution center occupies approximately 2.2 million square feet in Liege, Belgium under operating leases. These leases provide for original terms of 10 to 15 years, commencing between January 2016 and July 2020, subject to automatic extensions for recurring periods of five years unless we or the landlord terminates the lease in writing 12 months prior to the expiration of the original lease term or 12 months prior to the end of the then applicable five-year extension. +Our China distribution center occupies approximately 1.6 million square feet in Taicang, China. +Substantially all of our retail stores and showrooms are leased with terms expiring through January 2036. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. +We lease most of our international administrative offices, showrooms and distribution facilities located in Asia, Central America, Europe, North America and South America. The property leases expire on various dates through October 2037. +Item 3. +Legal Proceedings +Michael Conte v. Robert Greenberg, et al. – On July 21, 2022, Skechers and certain past and present members of the Board of Directors were sued by a stockholder on behalf of our company in a derivative action in the Chancery Court of the State of Delaware, Case No. 2022-0633, alleging breach of fiduciary duty, waste of corporate assets, breach of duty of candor and breach of contract in connection with certain executive officers’ personal use of two company-owned aircraft. The complaint seeks actual damages in favor of Skechers sustained as the alleged result of defendants’ alleged breaches of fiduciary duties, judgment directing our company to take +14 +all necessary actions to reform and improve its corporate governance practices, termination of certain executive officers for allegedly violating their employment agreements, judgment directing the sale of one of the company-owned aircraft and attorneys’, accountants’ and experts’ fees, costs and expenses. We believe that we have meritorious defenses and intend to defend this matter vigorously. Notwithstanding, given the early stages of these proceedings and the limited information available, we cannot predict the outcome of this legal proceeding or whether an adverse result in this case would have a material adverse impact on our results of operations or financial position. +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation arising from the normal course of business, and we are unable to determine the extent of any liability that may arise from any such unanticipated future litigation. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against the Company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +Item 4. +Mine Safety Disclosures +Not applicable. +15 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Our Class A Common Stock trades under the symbol “SKX” on the New York Stock Exchange. +HOLDERS +As of February 15, 2023, there were 81 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 39 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND INFORMATION +Since inception, we have not declared or paid any cash dividends on our common stock, and we have no present intention of paying any dividends on our common stock in the foreseeable future. Our Board of Directors periodically reviews our dividend policy to determine whether the declaration of dividends is appropriate. +COMPANY PURCHASES OF EQUITY SECURITIES +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. There were no repurchases during the three months ended December 31, 2022 and the maximum dollar value of shares that may yet be purchased under the share program was $425.8 million . +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information is provided as set forth in Part III, Item 12 of this annual report on Form 10-K. +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2017 to December 31, 2022, relative to the performance of the Russell 1000 Index, S&P Retail Select Industry Index, and the peer group index, which is consists of Nike, Inc., adidas AG, Steven Madden, Ltd., Wolverine World Wide, Inc., Crocs, Inc., and Deckers Outdoor Corporation. As of fiscal year 2022, we believe the members of the S&P Retail Select Industry Index better represents our business. +Comparison of 5 Year Cumulative Total Returns +(in dollars) +2017 +2018 +2019 +2020 +2021 +2022 +Skechers U.S.A., Inc. +100.00 +60.49 +114.14 +94.98 +114.69 +110.86 +Russell 1000 +100.00 +95.22 +125.14 +151.37 +191.42 +154.80 +S&P Retail Select Industry +100.00 +92.12 +104.99 +148.70 +212.60 +145.17 +Peer Group +100.00 +116.76 +165.94 +219.31 +243.31 +166.51 +Item 6. +[Reserved] +16 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. We intend for this discussion to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of our company as a whole. +During the first quarter of 2022, the Company realigned its reporting structure to two reportable segments, Wholesale and Direct-to-Consumer. Prior period amounts have been recast. Wholesale includes sales to department stores, family shoe stores, specialty running and sporting goods retailers, and big box club stores; franchisee and licensee third-party store operators; dedicated e-commerce retailers; and international distributors. Direct-to-Consumer includes direct sales to consumers through an integrated retail format of company-owned physical stores and digital platforms and hosted digital marketplaces in select international markets. With the exception of our segment realignment, t his section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on February 25, 2022 . +OVERVIEW +This year was a significant milestone for the Company. Not only was it our 30 th year in business, we also achieved record sales of $7.4 billion, an increase of $1.1 billion or 18% over the prior year. Our continued growth demonstrates the strength of our brand and the robust demand for our innovative product portfolio. The year also presented challenges, including temporary COVID-related store closures predominantly in China, rising freight and logistics costs, elevated inventory levels and supply chain disruptions that created congestion in our distribution network. We were able to manage these challenges due to the flexibility, creativity and dedication of the global Skechers organization. +Our core product philosophy of comfort, style, innovation, and quality at the right price continues to resonate with consumers, and we remain focused on delivering our comfort technology footwear as quickly as possible to meet consumer demand. We remain focused on executing against our long-term growth strategies and believe we are well positioned to meet our sales goal of $10 billion by 2026. We are committed to the following investments in support of our global growth strategy: +• +Wholesale: product development, marketing, distribution infrastructure and sales capabilities. +• +Direct-to-Consumer: product development, marketing, new stores, digital commerce capabilities and distribution infrastructure. +Growth in the Wholesale segment is expected to derive from expanding our existing shelf-space with current partners, acquiring new partners, supporting the growth of incremental franchise and licensed Skechers branded stores, as well as the introduction of new products to existing partners. Growth in the Direct-to-Consumer segment is expected to derive from increasing our digital commerce capabilities, expanding our physical retail footprint and leveraging third-party digital platforms and marketplaces. +17 +RESULTS OF OPERATIONS +Selected information from our results of operations follows: +Year Ended December 31, +Change +(in thousands) +2022 +2021 +$ +% +Sales +$ +7,444,550 +$ +6,310,187 +1,134,363 +18.0 +Cost of sales +3,929,193 +3,185,816 +743,377 +23.3 +Gross profit +3,515,357 +3,124,371 +390,986 +12.5 +Gross margin +47.2 +% +49.5 +% +(230 +)bps +Operating expenses +Selling +583,626 +499,532 +84,094 +16.8 +General and administrative +2,385,061 +2,026,652 +358,409 +17.7 +Total operating expenses +2,968,687 +2,526,184 +442,503 +17.5 +As a % of sales +39.9 +% +40.0 +% +(20 +)bps +Earnings from operations +546,670 +598,187 +(51,517 +) +(8.6 +) +Operating margin +7.3 +% +9.5 +% +(210 +)bps +Other expense +(24,413 +) +(28,430 +) +4,017 +(14.1 +) +Earnings before income taxes +522,257 +569,757 +(47,500 +) +(8.3 +) +Income tax expense (benefit) +93,095 +(245,875 +) +338,970 +n/m +Net earnings +429,162 +815,632 +(386,470 +) +(47.4 +) +Less: Net earnings attributable to noncontrolling interests +56,134 +74,129 +(17,995 +) +(24.3 +) +Net earnings attributable to Skechers U.S.A., Inc. +$ +373,028 +$ +741,503 +(368,475 +) +(49.7 +) +Sales +Sales increased $1.1 billion, or 18.0%, to $7.4 billion as a result of a 20.0% increase domestically and a 16.6% increase internationally. Wholesale sales increased 23.2% and Direct-to-Consumer increased 10.2%. Sales increased overall due to improved volume and higher average selling prices. +Gross margin +Gross margin decreased 230 basis points to 47.2% primarily driven by increased freight and logistics costs, partially offset by average selling price increases. +Operating expenses +Operating expenses increased $442.5 million, or 17.5%, to $3.0 billion, and as a percentage of sales improved 20 basis points to 39.9%. Selling expenses increased $84.1 million, or 16.8%, to $583.6 million, primarily due to higher demand creation expenditures in digital advertising and global marketing. General and administrative expenses increased $358.4 million, or 17.7%, to $2.4 billion, due to higher labor and compensation costs of $193.9 million and warehouse and distribution expenses of $75.4 million as a result of supply chain and logistics challenges at the domestic distribution center and higher volume driven expenses. Included in these costs is approximately $90.0 million of labor and distribution expenses related to the supply chain challenges at the domestic distribution center. +Other expense +Other expense decreased $4.0 million to $24.4 million, compared to $28.4 million, primarily due to improvements in foreign currency exchange rates in Europe, Middle East & Africa. +Income taxes +Income tax expense (benefit) and the effective tax rate were as follows: +Year Ended December 31, +(in thousands) +2022 +2021 +Income tax expense (benefit) +$ +93,095 +$ +(245,875 +) +Effective tax rate +17.8 +% +(43.2 +)% +Income tax expense was $93.1 million as compared to an income tax benefit of $245.9 million in 2021 due to the establishment of deferred tax assets from an intra-entity transfer of certain intellectual property rights of $346.8 million. Our effective tax rate was 17.8% as compared to negative 43.2% tax rate in the prior year, which included the impact of a 60.9% benefit from the intellectual property rights transfer. +Our income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (losses) before income taxes. In the foreign jurisdictions in which we have operations, the applicable statutory rates range from 0.0% to 34.0%, which on average are generally significantly lower than the U.S. federal and state combined statutory rate of approximately 25.0%. +18 +See Note 1 0 – Income Taxes of the Consolidated Financial Statements for additional information. +Noncontrolling interest in net earnings of consolidated subsidiaries +Noncontrolling interest represents the share of net earnings or loss that is attributable to our joint venture partners. Net earnings attributable to noncontrolling interest decreased $18.0 million to $56.1 million as compared to $74.1 million, primarily due to reduced earnings by our joint ventures, predominantly China, due to store closures resulting from COVID in China. +RESULTS OF SEGMENT OPERATIONS +Wholesale +Year Ended December 31, +2022 vs 2021 Change +2021 vs 2020 Change +(in thousands) +2022 +2021 +2020 +$ +% +$ +% +Sales +$ +4,632,429 +$ +3,758,640 +$ +2,835,010 +873,789 +23.2 +923,630 +32.6 +Gross profit +1,669,276 +1,437,517 +1,112,558 +231,759 +16.1 +324,959 +29.2 +Gross margin +36.0 +% +38.2 +% +39.2 +% +(220 +)bps +(100 +)bps +2022 to 2021 Comparison +Wholesale sales increased $0.9 billion, or 23.2%, to $4.6 billion, driven primarily by growth of 28.7% in the Americas and Europe, Middle East & Africa of 33.9%. Volume increased 18.2% in the number of units sold and average selling price per unit increased 4.8% . +Wholesale gross margin decreased 220 basis points to 36.0% due to higher average cost per unit, primarily driven by increased freight and logistics costs, partially offset by average selling price increases. +2021 to 2020 Comparison +Wholesale sales increased $0.9 billion, or 32.6% to $3.8 billion, as a result of growth across the Americas of 30.1%, Europe, Middle East & Africa of 37.3% and Asia Pacific of 32.3% which were impacted by 2020 COVID-related market closures. Volume increased 27.9% in the number of units sold and average selling price per unit increased 3.6%. +Wholesale gross margin decreased 100 basis points to 38.2% primarily due to higher average cost per unit, partially offset by the increase in the average selling price per unit. +Direct-to-Consumer +Year Ended December 31, +2022 vs 2021 Change +2021 vs 2020 Change +(in thousands) +2022 +2021 +2020 +$ +% +$ +% +Sales +$ +2,812,121 +$ +2,551,547 +$ +1,778,420 +260,574 +10.2 +773,127 +43.5 +Gross profit +1,846,081 +1,686,854 +1,093,240 +159,227 +9.4 +593,614 +54.3 +Gross margin +65.6 +% +66.1 +% +61.5 +% +(50 +)bps +460 +bps +2022 to 2021 Comparison +Direct-to-Consumer sales increased $260.6 million, or 10.2%, to $2.8 billion, led by increases in the Americas of 13.8%, Europe, Middle East & Africa of 25.3%, and Asia Pacific of 1.8%. Volume increased 6.6% in the number of units sold and average selling price per unit increased 3.4%. +Direct-to-Consumer gross margin decreased 50 basis points to 65.6%, due to higher average cost per unit, primarily driven by increased freight costs, partially offset by average selling price increases. +2021 to 2020 Comparison +Direct-to-Consumer sales increased $0.8 billion, or 43.5%, to $2.6 billion, driven by increases of 48.6% in the Americas, 31.6% in Asia Pacific, and 76.8% in Europe, Middle East & Africa which experienced COVID restrictions in 2020. Average selling price per unit increased 14.7% and volume increased 25.0% in the number of units sold. +Direct-to-Consumer gross margin increased 460 basis points to 66.1%, primarily driven by higher average selling prices. +LIQUIDITY AND CAPITAL RESOURCES +Liquidity outlook +We have cash and cash equivalents of $615.7 million at December 31, 2022. Amounts held outside the U.S. were $516.8 million, or 83.9%, and approximately $206.7 million was available for repatriation to the U.S. as of December 31, 2022 without incurring additional U.S. federal income taxes and applicable non-U.S. income and withholding taxes. +19 +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers , h owever, we have long-standing relationships with many and believe our relationships to be positive . +At December 31, 2022, we have unused credit capacity of $747.3 million on our revolving credit facility, with an additional $250.0 million available through an accordion feature. We believe that anticipated cash flows from operations, existing cash and investments balances, available borrowings under our revolving credit facility, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements for the next twelve months. +Cash Flows +Our working capital at December 31, 2022 was $2.0 billion, an increase of $0.1 billion from working capital of $1.9 billion at December 31, 2021. Our cash and cash equivalents at December 31, 2022 were $615.7 million, compared to $796.3 million at December 31, 2021. Our primary source of operating cash is collections from customers. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $238.3 million for 2022 and $212.2 million for 2021. The $26.2 million increase in cash flows from operating activities in 2022 resulted from lower inventory purchases, partially offset by higher accounts receivables balances on wholesale sales. +Investing Activities +Net cash used in investing activities was $287.5 million for 2022 as compared to $344.7 million for 2021. The $57.2 million decrease was due to lower investment purchases and proceeds, partially offset by increased capital expenditures. +Our capital investments remain focused on supporting our strategic growth priorities, growing our Direct-to-Consumer business, as well as expanding the presence of our brand internationally. Capital expenditures for the year ended December 31, 2022 were approximately $359.0 million, which included $132.3 million for the expansion of our global distribution infrastructure, $103.7 million for investments in our retail stores and direct-to-consumer technologies, and $88.8 million of investments in our expanded corporate offices domestically and in India. We expect our capital expenditures for 2023 to be approximately $300.0 million to $350.0 million, as we continue to invest in our strategic priorities, including additional stores, added omnichannel capabilities and incremental distribution capacity in key markets. We expect to fund ongoing capital expenses through a combination of available cash and borrowings . +Financing Activities +Net cash used in financing activities was $118.1 million during 2022 compared to $433.9 million in 2021. The decrease is primarily the result of lower payments on long-term borrowings of $392.0 million, partially offset by the repurchase of $74.2 million of common stock. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. As of December 31, 2022 , $425.8 million remains available under the Share Repurchase Program. +Financing Arrangements +As of December 31, 2022, outstanding short-term and long-term borrowings were $339.3 million, of which, $257.4 million relates to loans for our domestic and China distribution centers, $54.4 million relates to our operations in China and the remainder relates to our international operations. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. See Note 6 – Financial Commitments of the Consolidated Financial Statements for additional information. +Commitments +Our material cash requirements as of December 31, 2022 which are not reflected as liabilities in the consolidated balance sheets include open purchase commitments with our foreign manufacturers of approximately $1.1 billion. +20 +We are required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the consolidated balance sheets. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +The preparation of our consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements. +Reserves for returns and chargebacks . Revenue is recorded net of estimates for returns from our customers and potential disputed amounts or chargebacks. We accrue a liability for product returns at the time of sale based on our historical experience. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. +Allowance for bad debts . Accounts receivable is recorded net of estimated losses from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ countries or industries, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for bad debts are recorded to general and administrative expenses. +The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory reserves . Inventory is stated at the lower of cost or net realizable value. Inventory reserves are recorded for excess and slow-moving inventory. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value is determined based on historical sales experience on a style-by-style basis. The valuation of inventory could be impacted by changes in public and consumer preferences, demand for product, changes in the buying patterns of both retailers and consumers and inventory management of customers. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates . The establishment of deferred tax assets from intra-entity transfers of certain intellectual property rights and other transactions requires management to make significant estimates and assumptions to determine the fair value of such intellectual property rights. The valuation of deferred tax assets requires significant estimates and assumptions including, but not limited to, future revenue growth, discount rates and the expected life of the assets, which by their nature are inherently uncertain and may ultimately differ materially from our actual results. We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may impact our cost of goods in the future. During 2022 and 2021, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +21 +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +Item 7A. +Quantitative and Qualitative Disclosure About Market Risk +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. Changes in interest rates and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2022, we have $122.8 million and $216.5 million of outstanding current and long-term borrowings, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by approximately $6.6 million for the year ended December 31, 2022. We do not expect changes in interest rates to have a material impact on our financial condition or results of operations or cash flows during the remainder of 2023. The interest rate charged on our unsecured revolving credit facility is based on SOFR, our North America distribution center construction loan is based on the one-month Bloomberg Short-Term Bank Yield Index (“BSBY”). Our China distribution center and China operational loans are based on a reference rate provided by the People’s Bank of China. Our loan with the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), is based on the LIBOR Daily Floating Rate plus a margin of 1.75%. Changes in these interest rates will have an effect on the interest charged on outstanding balances. +We may enter into derivative financial instruments such as interest rate swaps in order to limit our interest rate risk on our long-term debt. We had one derivative instrument in place as of December 31, 2022 to hedge the cash flows on our $129.5 million variable rate debt on our North America distribution center, which was entered into by the JV. This instrument was a variable to fixed derivative with a notional amount of $129.5 million at December 31, 2022. Our receive rate was one-month LIBOR and the average pay rate was 0.795%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest payments. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have an impact on the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. +Assets and liabilities outside the U.S. are located in regions where we have subsidiaries or joint ventures: the Americas, Europe, Middle East & Africa, and Asia-Pacific. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation loss of $36.6 million and loss of $21.0 million, for the years ended December 31, 2022 and 2021, that are deferred and recorded as a component of accumulated other comprehensive loss in stockholders’ equity. A 200-basis point reduction in each of these exchange rates at December 31, 2022 would have reduced the values of our net investments by approximately $87.5 million. +22 +Item 8. +Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Page +Report of Independent Registered Public Accounting Firm ( BDO USA, LLP ; Los Angeles, California ; PCAOB ID # 243 ) +24 +Consolidated Balance Sheets +26 +Consolidated Statements of Earnings +27 +Consolidated Statements of Comprehensive Income +28 +Consolidated Statements of Equity +29 +Consolidated Statements of Cash Flows +30 +Notes to Consolidated Financial Statements +31 +23 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 28, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates. +Accounting for Income Taxes +As described in Note 10 to the Company’s consolidated financial statements, the Company’s income tax expense for the fiscal year ended December 31, 2022 was $93.1 million, of which $7.3 million represented U.S. Federal tax expense, $8.3 million represented U.S. State tax expense, and the remaining $77.5 million represented foreign tax expense. The Company operates in multiple jurisdictions worldwide through its wholly-owned subsidiaries and several joint ventures. +We identified accounting for the Company’s income tax provision as a critical audit matter. The Company’s income tax provision processes include the following: (i) reporting and data accumulation from multiple foreign jurisdictions, (ii) assessment of deferred tax assets and liabilities, and (iii) development of certain complex assumptions used in transfer pricing studies and related determinations. Auditing these certain elements of the income tax provision involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed. +The primary procedures we performed to address this critical audit matter included: +• +Evaluating management’s computation of deferred tax assets and liabilities. +24 +• +Testing mathematical accuracy and computation of the tax provision and agreeing to relevant source information. +• +Utilizing personnel with specialized skill and knowledge in transfer pricing to assist in evaluating the reasonableness of certain assumptions, and overall conclusions related to the Company’s transfer pricing studies over inter-company transactions. +• +Utilizing personnel with specialized skill and knowledge in domestic and foreign taxes to assist in assessing the appropriateness and accuracy of the income tax provision . +/s/ BDO USA, LLP +We have served as the Company's auditor since 2013. +Los Angeles, California +February 28, 2023 +25 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Balance Sheets +As of December 31, +(in thousands, except par values ) +2022 +2021 +ASSETS +Current assets +Cash and cash equivalents +$ +615,733 +$ +796,283 +Short-term investments +102,166 +98,580 +Trade accounts receivable, less allowances of $ 59,472 and $ 62,684 +848,287 +732,793 +Other receivables +86,036 +80,043 +Inventory +1,818,016 +1,470,994 +Prepaid expenses and other +176,035 +193,547 +Total current assets ($ 1,014,962 and $ 1,040,765 related to VIEs) +3,646,273 +3,372,240 +Property, plant and equipment, net +1,345,370 +1,128,909 +Operating lease right-of-use assets +1,200,565 +1,224,580 +Deferred tax assets +454,190 +451,355 +Long-term investments +70,498 +145,590 +Goodwill +93,497 +93,497 +Other assets, net +83,094 +75,109 +Total non-current assets ($ 598,973 and $ 608,607 related to VIEs) +3,247,214 +3,119,040 +TOTAL ASSETS +$ +6,893,487 +$ +6,491,280 +LIABILITIES AND EQUITY +Current liabilities +Accounts payable +$ +957,384 +$ +876,342 +Accrued expenses +294,143 +265,420 +Operating lease liabilities +238,694 +225,658 +Current installments of long-term borrowings +103,184 +76,967 +Short-term borrowings +19,635 +1,195 +Total current liabilities ($ 568,158 and $ 601,929 related to VIEs) +1,613,040 +1,445,582 +Long-term operating lease liabilities +1,063,672 +1,094,748 +Long-term borrowings +216,488 +263,445 +Deferred tax liabilities +8,656 +11,820 +Other long-term liabilities +120,045 +133,613 +Total non-current liabilities ($ 293,726 and $ 368,994 related to VIEs) +1,408,861 +1,503,626 +Total liabilities +3,021,901 +2,949,208 +Commitments and contingencies (Note 7) +Stockholders’ equity +Preferred Stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; +134,473 and 135,107 shares issued and outstanding +134 +135 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; +20,810 and 20,939 shares issued and outstanding +21 +21 +Additional paid-in capital +403,799 +429,608 +Accumulated other comprehensive loss +( 84,897 +) +( 48,323 +) +Retained earnings +3,250,931 +2,877,903 +Skechers U.S.A., Inc. equity +3,569,988 +3,259,344 +Noncontrolling interests +301,598 +282,728 +Total stockholders' equity +3,871,586 +3,542,072 +TOTAL LIABILITIES AND EQUITY +$ +6,893,487 +$ +6,491,280 +See accompanying notes to consolidated financial statements. +26 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Earnings +Year Ended December 31, +(in thousands, except per share data) +2022 +2021 +2020 +Sales +$ +7,444,550 +$ +6,310,187 +$ +4,613,430 +Cost of sales +3,929,193 +3,185,816 +2,407,632 +Gross profit +3,515,357 +3,124,371 +2,205,798 +Operating expenses +Selling +583,626 +499,532 +351,471 +General and administrative +2,385,061 +2,026,652 +1,720,643 +Total operating expenses +2,968,687 +2,526,184 +2,072,114 +Earnings from operations +546,670 +598,187 +133,684 +Total other income (expense) +( 24,413 +) +( 28,430 +) +21,045 +Earnings before income taxes +522,257 +569,757 +154,729 +Income tax expense (benefit) +93,095 +( 245,875 +) +8,502 +Net earnings +429,162 +815,632 +146,227 +Less: Net earnings attributable to noncontrolling interest +56,134 +74,129 +47,663 +Net earnings attributable to Skechers U.S.A., Inc. +$ +373,028 +$ +741,503 +$ +98,564 +Net earnings per share attributable to Skechers U.S.A., Inc. +Basic +$ +2.40 +$ +4.77 +$ +0.64 +Diluted +$ +2.38 +$ +4.73 +$ +0.64 +Weighted-average shares used in calculating net earnings per share attributable to Skechers U.S.A., Inc. +Basic +155,627 +155,539 +154,184 +Diluted +156,608 +156,794 +154,894 +See accompanying notes to consolidated financial statements. +27 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Comprehensive Income +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Net earnings +$ +429,162 +$ +815,632 +$ +146,227 +Other comprehensive income, net of tax +Net unrealized gain (loss) on derivative contract +9,787 +3,372 +( 1,649 +) +Gain (loss) on foreign currency translation adjustment +( 53,552 +) +( 22,141 +) +11,540 +Comprehensive income +385,397 +796,863 +156,118 +Less: Comprehensive income attributable to noncontrolling interests +48,190 +76,398 +54,846 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +337,207 +$ +720,465 +$ +101,272 +See accompanying notes to consolidated financial statements. +28 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Equity +Shares +Amount +Accumulated +Class A +Class B +Class A +Class B +Additional +other +Skechers +Total +Common +Common +Common +Common +paid-in +comprehensive +Retained +U.S.A., Inc. +Noncontrolling +stockholders' +(in thousands) +Stock +Stock +Stock +Stock +capital +loss +earnings +equity +interests +equity +Balance at December 31, 2019 +131,071 +22,408 +$ +131 +$ +22 +$ +306,669 +$ +( 29,993 +) +$ +2,037,836 +$ +2,314,665 +$ +221,442 +$ +2,536,107 +Net earnings +— +— +— +— +— +— +98,564 +98,564 +47,663 +146,227 +Foreign currency translation adjustment +— +— +— +— +— +2,708 +— +2,708 +8,832 +11,540 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 81,105 +) +( 81,105 +) +Noncontrolling interest of acquired businesses +— +— +— +— +— +— +— +— +49,045 +49,045 +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 1,649 +) +( 1,649 +) +Stock compensation expense +— +— +— +— +65,240 +— +— +65,240 +— +65,240 +Proceeds from the employee stock purchase plan +233 +— +1 +— +5,915 +— +— +5,916 +— +5,916 +Shares issued under the incentive award plan +1,094 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 172 +) +— +— +— +( 5,658 +) +— +— +( 5,658 +) +— +( 5,658 +) +Conversion of Class B Common Stock into Class A Common Stock +1,392 +( 1,392 +) +1 +( 1 +) +— +— +— +— +— +— +Balance at December 31, 2020 +133,618 +21,016 +$ +134 +$ +21 +$ +372,165 +$ +( 27,285 +) +$ +2,136,400 +$ +2,481,435 +$ +244,228 +$ +2,725,663 +Net earnings +— +— +— +— +— +— +741,503 +741,503 +74,129 +815,632 +Foreign currency translation adjustment +— +— +— +— +— +( 21,038 +) +— +( 21,038 +) +( 1,103 +) +( 22,141 +) +Contributions from noncontrolling interests +— +— +— +— +— +— +— +— +6,731 +6,731 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 41,557 +) +( 41,557 +) +Purchase of noncontrolling interest +— +— +— +— +( 6,856 +) +— +— +( 6,856 +) +( 3,072 +) +( 9,928 +) +Net unrealized gain on derivative contract +— +— +— +— +— +— +— +— +3,372 +3,372 +Stock compensation expense +— +— +— +— +60,108 +— +— +60,108 +— +60,108 +Proceeds from the employee stock purchase plan +226 +— +— +— +7,276 +— +— +7,276 +— +7,276 +Shares issued under the incentive award plan +1,252 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 66 +) +— +— +— +( 3,084 +) +— +— +( 3,084 +) +— +( 3,084 +) +Conversion of Class B Common Stock into Class A Common Stock +77 +( 77 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2021 +135,107 +20,939 +$ +135 +$ +21 +$ +429,608 +$ +( 48,323 +) +$ +2,877,903 +$ +3,259,344 +$ +282,728 +$ +3,542,072 +Net earnings +— +— +— +— +— +— +373,028 +373,028 +56,134 +429,162 +Foreign currency translation adjustment +— +— +— +— +— +( 36,574 +) +— +( 36,574 +) +( 16,978 +) +( 53,552 +) +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 29,320 +) +( 29,320 +) +Net unrealized gain on derivative contract +— +— +— +— +753 +— +— +753 +9,034 +9,787 +Stock compensation expense +— +— +— +— +59,874 +— +— +59,874 +— +59,874 +Proceeds from the employee stock purchase plan +243 +— +— +— +8,131 +— +— +8,131 +— +8,131 +Shares issued under the incentive award plan +1,424 +— +2 +— +( 1 +) +— +— +1 +— +1 +Shares redeemed for employee tax withholdings +( 503 +) +— +( 1 +) +— +( 20,323 +) +— +— +( 20,324 +) +— +( 20,324 +) +Repurchases of common stock +( 1,927 +) +— +( 2 +) +— +( 74,243 +) +— +— +( 74,245 +) +— +( 74,245 +) +Conversion of Class B Common Stock into Class A Common Stock +129 +( 129 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2022 +134,473 +20,810 +$ +134 +$ +21 +$ +403,799 +$ +( 84,897 +) +$ +3,250,931 +$ +3,569,988 +$ +301,598 +$ +3,871,586 +See accompanying notes to consolidated financial statements. +29 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Cash flows from operating activities +Net earnings +$ +429,162 +$ +815,632 +$ +146,227 +Adjustments to reconcile net earnings to net cash provided by operating activities +Depreciation and amortization +153,716 +139,577 +142,810 +Provision for bad debts and returns +37,806 +62,771 +50,696 +Stock compensation +59,874 +60,108 +65,240 +Deferred income taxes +( 6,489 +) +( 387,250 +) +( 19,568 +) +Net settlement gain +— +— +( 13,877 +) +Net foreign currency adjustments +( 2,366 +) +2,154 +( 13,854 +) +Changes in operating assets and liabilities +Receivables +( 179,734 +) +( 154,248 +) +13,259 +Inventory +( 389,026 +) +( 458,002 +) +78,632 +Other assets +( 33,007 +) +( 110,464 +) +( 153,092 +) +Accounts payable +107,199 +135,140 +( 37,714 +) +Other liabilities +61,190 +106,734 +72,694 +Net cash provided by operating activities +238,325 +212,152 +331,453 +Cash flows from investing activities +Capital expenditures +( 358,992 +) +( 309,674 +) +( 309,916 +) +Purchases of investments +( 70,837 +) +( 215,164 +) +( 166,614 +) +Proceeds from sales and maturities of investments +142,343 +180,172 +164,062 +Net cash used in investing activities +( 287,486 +) +( 344,666 +) +( 312,468 +) +Cash flows from financing activities +Net proceeds from the employee stock purchase plan +8,131 +7,276 +5,916 +Repayments on long-term borrowings +( 95,410 +) +( 487,441 +) +( 86,357 +) +Proceeds from long-term borrowings +74,670 +96,187 +702,998 +Net proceeds from (repayments on) short-term borrowings +18,439 +( 2,102 +) +( 2,492 +) +Payments for employee taxes related to stock compensation +( 20,324 +) +( 3,084 +) +( 5,658 +) +Repurchases of common stock +( 74,245 +) +— +— +Purchase of noncontrolling interest +— +( 9,928 +) +— +Contributions from noncontrolling interests +— +6,731 +— +Distributions to noncontrolling interests +( 29,320 +) +( 41,557 +) +( 81,105 +) +Net cash provided by (used in) financing activities +( 118,059 +) +( 433,918 +) +533,302 +Effect of exchange rates on cash and cash equivalents +( 13,330 +) +( 8,111 +) +( 6,337 +) +Net change in cash and cash equivalents +( 180,550 +) +( 574,543 +) +545,950 +Cash and cash equivalents at beginning of the period +796,283 +1,370,826 +824,876 +Cash and cash equivalents at end of the period +$ +615,733 +$ +796,283 +$ +1,370,826 +Supplemental disclosures of cash flow information +Cash paid during the period for: +Interest +$ +19,293 +$ +14,579 +$ +15,987 +Income taxes, net +113,933 +125,082 +55,825 +Non-cash transactions: +Purchase price adjustment for Skechers Mexico +— +— +49,045 +ROU assets exchanged for lease liabilities +327,022 +356,855 +318,713 +See accompanying notes to consolidated financial statements. +30 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +Notes to Consolidated Financial Statements +(1) +Summary of Significant Accounting Policies +BASIS OF PRESENTATION +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the consolidated financial statements in prior years to conform to the current year presentation , including but not limited to combining royalty income into sales. +USE OF ESTIMATES +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Significant areas requiring the use of estimates relate primarily to allowances for bad debts, returns and customer chargebacks, inventory reserves, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +REVENUE RECOGNITION +The Company derives income from the sale of footwear and apparel and royalties earned from licensing the Skechers brand. The Company recognizes sales revenue, net of estimated returns and excluding sales and value added taxes. Revenue is recognized at point of sale or upon shipment, the point in time where control transfers to the customer. +Wholesale sales are recognized upon shipment. Direct-to-consumer revenues are recognized at the point of sale for transactions with customers at the Company’s retail stores and recognized upon shipment for sales made through its websites. +Sales are reduced by an estimate of customer merchandise returns, which is calculated based on historical experience. The Company reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a collectability percentage calculated using factors such as historical trends, current economic conditions and nature of the chargeback. +The Company earns royalty income from symbolic licensing arrangements in which third parties sell product with the Company’s brand. Upon signing a new licensing agreement, the Company receives up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized based on sales of licensed product when the Company expects royalties to exceed the minimum guarantee. For those arrangements in which the Company does not expect royalties to exceed the minimum guarantee, an estimate of the royalties expected to be recouped is recognized on a straight-line basis over the license term. +ALLOWANCE FOR BAD DEBTS +The Company provides a reserve for estimated losses that may result from its customers’ inability to pay. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and its customers’ credit-worthiness. Allowances for bad debts are recorded to general and administrative expenses. +WAREHOUSE AND DISTRIBUTION COSTS +The Company’s distribution network-related costs are included in general and administrative expenses. Distribution expenses, including the functions of purchasing, receiving, inspecting, allocating, surface transportation, warehousing and packaging product totaled $ 538.7 million, $ 376.5 million and $ 315.8 million for 2022, 2021 and 2020. +PRODUCT DESIGN AND DEVELOPMENT COSTS +The Company charges product design and development costs to general and administrative expenses. Aggregate product design and development costs were approximately $ 28.1 million, $ 24.6 million, and $ 17.9 million during the years ended December 31, 2022, 2021 and 2020. +ADVERTISING +Advertising costs are expensed in the period in which an advertisement first runs, or over the life of an endorsement contract. Advertising expense for the years ended December 31, 2022, 2021 and 2020 was approximately $ 473.7 million, $ 375.0 million and $ 248.7 million. Prepaid advertising costs were $ 17.2 million and $ 9.7 million at December 31, 2022 and 2021. Prepaid amounts represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run. +31 +INCOME TAXES +The Company recognizes deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +CASH AND CASH EQUIVALENTS +Cash and cash equivalents include short-term investments, which are highly liquid investments with maturities of three months or less when purchased. +INVENTORY +Inventory is stated at the lower of cost (based on the first-in, first-out method) or net realizable value. Cost of product includes shipping and handling fees. The Company estimates losses from obsolete or slow-moving inventory and reserves the cost of inventory at the time such determinations are made. Expense associated with inventory reserves is recognized in cost of sales. +PROPERTY, PLANT, AND EQUIPMENT +Property, plant and equipment are stated at cost, net of accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The Company reviews stores for impairment annually or when facts and circumstances indicate that the carrying values may be impaired. The Company did not record material impairment charges during the years ended December 31, 2022, 2021 or 2020. The principal estimated useful lives are as follows: +Buildings +20 to 40 years +Building improvements +10 to 20 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Shorter of useful life or remaining lease term +GOODWILL +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. As of December 31, 2022, and December 31, 2021, the Company had $ 93.5 million of goodwill included in the Wholesale segment. Goodwill is not amortized but is tested at least annually in the fourth quarter for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. +INTANGIBLE ASSETS +Within other assets, net, the Company has amortizable intangible assets consisting of reacquired rights with a gross carrying value of $ 49.1 million and accumulated amortization of $ 25.9 million and $ 19.0 million as of December 31, 2022 and 2021. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Amortization expense related to amortizable intangible assets was $ 6.9 million for both years ended December 31, 2022 and 2021. Future amortization expense related to amortizable intangible assets will be approximately $ 6.9 million per year for the each of the years 2023 through 2025, $ 1.9 million for 2026, $ 0.3 million for 2027, and $ 0.4 million thereafter. The weighted-average amortization period for amortizable reacquired rights is 7 years. +NONCONTROLLING INTERESTS +The Company established several joint ventures either to distribute the Company’s products or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”), and the Company is considered the primary beneficiary. This determination is based on the relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. Specifically, the Company has both of the following characteristics: (a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE, or the right to receive benefits from the entity that could potentially be significant to the VIE. The assets and liabilities and results of operations of these entities are included in the Company’s consolidated financial statements, even though the Company may not hold a majority equity interest. +In March 2021, the minority interest related to the Hong Kong joint venture was purchased for $ 10.0 million. The change in the Company’s ownership of the Hong Kong entity continues to be included in the Company’s consolidated financial statements. There have been no changes during 2022 in the accounting treatment or characterization of any previously identified VIEs. The Company continues to reassess these relationships based on events and circumstances. The assets of these joint ventures are restricted, as they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. +32 +FOREIGN CURRENCY TRANSLATION +The Company’s reporting currency is the U.S. dollar. Certain international operations use the respective local currency as their functional currency, while others use the U.S. dollar as their functional currency. Translation adjustments for subsidiaries with non-U.S. dollar functional currencies are included in other comprehensive income. Foreign currency transaction gains (losses), resulting from exchange rate fluctuations, on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated at the balance sheet date exchange rate. Net earnings and cash flow items are translated at the weighted-average exchange rates during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +FAIR VALUE OF FINANCIAL INSTRUMENTS +The fair value hierarchy as defined by applicable accounting standards prioritizes the use of inputs used in valuation techniques into the following three levels: +• +Level 1: Quoted market prices in active markets for identical assets or liabilities. +• +Level 2: Other observable market-based inputs or unobservable inputs that are corroborated by market data. +• +Level 3: Unobservable inputs that cannot be corroborated by market data that reflect the reporting entity’s own assumptions. +The Company’s Level 1 investments primarily include money market funds and U.S. Treasury securities; Level 2 investments primarily include corporate notes and bonds, asset-backed securities, and actively traded mutual funds; and the Company does not currently have any Level 3 assets or liabilities. The Company has one Level 2 derivative instrument which is an interest rate swap (see Note 6 – Financial Commitments) classified as other assets, net at both December 31, 2022 and 2021. The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements . +The carrying amount of receivables, payables and other amounts arising out of the normal course of business approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based on current rates and terms available to the Company for similar debt. +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company uses an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap, designated as a cash flow hedge, involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. As of December 31, 2022, all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +RECENT ACCOUNTING PRONOUNCEMENTS +In March 2020, the FASB issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, as amended and supplemented by subsequent ASUs (collectively, “ASU 2020-04” and “ASU 2022-06”), which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for borrowing instruments, which use LIBOR as a reference rate, and is available through December 31, 2024. The Company has evaluated this ASU and does not expect its adoption to have a material impact on its consolidated financial statements. +33 +(2) +Cash, Cash Equivalents, Short-term and Long-term Investments +The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category: +As of December 31, 2022 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +539,730 +$ +539,730 +$ +539,730 +$ +— +$ +— +Level 1 +Money market funds +71,503 +71,503 +71,503 +— +— +U.S. Treasury securities +18,201 +18,201 +2,000 +16,201 +— +Total level 1 +89,704 +89,704 +73,503 +16,201 +— +Level 2 +Corporate notes and bonds +101,959 +101,959 +2,500 +85,731 +13,728 +Asset-backed securities +4,641 +4,641 +— +234 +4,407 +Mutual funds +N/A +5,893 +— +— +5,893 +Total level 2 +106,600 +112,493 +2,500 +85,965 +24,028 +Total +$ +736,034 +$ +741,927 +$ +615,733 +$ +102,166 +$ +24,028 +As of December 31, 2021 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +664,220 +$ +664,220 +$ +664,220 +$ +— +$ +— +Level 1 +Money market funds +132,063 +132,063 +132,063 +— +— +U.S. Treasury securities +25,437 +25,437 +— +8,896 +16,541 +Total level 1 +157,500 +157,500 +132,063 +8,896 +16,541 +Level 2 +Corporate notes and bonds +148,373 +148,373 +— +84,783 +63,590 +Asset-backed securities +17,180 +17,180 +— +4,901 +12,279 +Mutual funds +N/A +4,301 +— +— +4,301 +Total level 2 +165,553 +169,854 +— +89,684 +80,170 +Total +$ +987,273 +$ +991,574 +$ +796,283 +$ +98,580 +$ +96,711 +The Company’s investments consist of U.S. Treasury securities, corporate notes and bonds, and asset-backed securities, which the Company has the intent and ability to hold to maturity and therefore are classified as held-to-maturity. The Company holds mutual funds in its deferred compensation plan which are classified as trading securities. The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are less than two years . The Company minimizes the potential risk of principal loss by investing in highly-rated securities and limiting the amount of credit exposure to any one issuer. Fair values were determined for each individual security in the investment portfolio. Included in long-term investments are company owned life insurance contracts of $ 46.5 million and $ 48.9 million as of December 31, 2022, and December 31, 2021. Interest income was $ 6.0 million, $ 3.3 million, and $ 5.9 million for the years ended December 31, 2022, 2021 and 2020. +When evaluating an investment for its current expected credit losses, the Company reviews factors such as historical experience with defaults, losses, credit ratings, term and macroeconomic trends, including current conditions and forecasts to the extent they are reasonable and supportable. +(3) +Leases +The Company regularly enters into non-cancellable operating leases for retail stores, distribution facilities, offices, showrooms and automobiles. Retail stores typically have initial terms ranging from 5 to 10 years and other real estate or facility leases may have initial lease terms of up to 20 years. The Company’s leases are recorded as operating lease right-of-use (“ROU”) assets and operating leases liabilities. Operating lease liabilities are recognized based on the present value of the fixed portion of lease payments over the lease term at the commencement date. Net present value is calculated using an incremental borrowing rate based on a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. Many of the Company’s real estate leases include options to extend and are included in the lease obligations when considered reasonably certain. ROU assets are recognized based on operating lease liabilities reduced by lease incentives and initial direct costs incurred. Fixed lease cost is recognized on a straight-line basis over the lease term. +34 +The Company’s real estate leases may require additional payments for percentage rent, real estate taxes, or other occupancy-related costs. Percentage ren t , a variable cost, is recognized in the consolidated financial statements when incurred and is based on the specific terms in the lease agreement. Real estate taxes and other occupancy-related costs are non-lease components . +Operating lease cost and other information: +Year Ended December 31, +(in thousands) +2022 +2021 +Fixed lease cost +$ +307,265 +$ +290,509 +Variable lease cost +10,803 +5,354 +Operating cash flows used for leases +303,721 +286,411 +Weighted-average remaining lease term +5.52 years +5.95 years +Weighted-average discount rate +3.12 +% +3.07 +% +The following table presents future lease payments as of December 31, 2022: +Year (in thousands) +Operating Leases +2023 +$ +283,449 +2024 +261,098 +2025 +232,949 +2026 +191,370 +2027 +158,529 +Thereafter +329,775 +Total lease payments +1,457,170 +Less: Imputed interest +( 154,804 +) +Operating lease liabilities +$ +1,302,366 +As of December 31, 2022, the Company has operating leases, primarily for new retail stores, that have not yet commenced which will generate additional ROU assets of $ 35.0 million. +(4) +Property, Plant and Equipment +Property, plant and equipment is summarized as follows: +As of December 31, +(in thousands) +2022 +2021 +Land +$ +122,433 +$ +111,212 +Buildings and improvements +634,683 +658,910 +Furniture, fixtures and equipment +803,043 +584,059 +Leasehold improvements +612,610 +497,646 +Total property, plant and equipment +2,172,769 +1,851,827 +Less accumulated depreciation and amortization +827,399 +722,918 +Property, plant and equipment, net +$ +1,345,370 +$ +1,128,909 +Depreciation expense was $ 131.3 million, $ 122.2 million and $ 115.5 million for the years ended December 31, 2022, 2021 and 2020 as calculated using the straight-line method. +(5) +Accrued Expenses +Accrued expenses at December 31, 2022 and 2021 are summarized as follows: +As of December 31, +(in thousands) +2022 +2021 +Accrued payroll, taxes, and other +$ +143,664 +$ +143,295 +Return reserve liability +60,482 +68,944 +Accrued inventory purchases +89,997 +53,181 +Accrued expenses +$ +294,143 +$ +265,420 +(6) +Financial Commitments +The Company had $ 2.7 million and $ 17.2 million of outstanding letters of credit as of December 31, 2022 and December 31, 2021, and approximately $ 19.6 million and $ 1.2 million in short-term borrowings as of December 31, 2022 and December 31, 2021. Interest expense for the years ended December 31, 2022, 2021 and 2020 was $ 19.7 million, $ 14.9 million and $ 16.3 million. +35 +Long-term borrowings were as follows: +As of December 31, +(in thousands) +2022 +2021 +HF-T1 Distribution Center Loan +$ +129,505 +$ +129,505 +HF-T2 Distribution Center Construction Loan +72,098 +57,227 +China Distribution Center Construction Loan +41,329 +75,621 +China Distribution Center Expansion Construction Loan +14,507 +— +China Operational Loans +54,361 +69,796 +Other +7,872 +8,263 +Subtotal +319,672 +340,412 +Less: Current installments +103,184 +76,967 +Total long-term borrowings +$ +216,488 +$ +263,445 +Revolving Credit Facility +The Company maintains a revolving credit facility to manage liquidity; including working capital and capital expenditures. On December 15, 2021, the Company amended its $ 500.0 million senior, unsecured revolving credit agreement dated November 21, 2019 (the “Amended Credit Agreement”), with Bank of America, N.A., as administrative agent and joint lead arranger, HSBC Bank USA, N.A. and JPMorgan Chase Bank, N.A., as joint lead arrangers, and other lenders. The Amended Credit Agreement expands its senior, unsecured credit facility to $ 750.0 million, which may be increased by up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $ 100.0 million and swingline loans up to a maximum of $ 50.0 million. The Amended Credit Agreement extends the maturity date of the credit agreement, which was due to expire on November 21, 2024 , to December 15, 2026 . The Company may use the proceeds from the Amended Credit Agreement for working capital and other lawful corporate purposes. Borrowings on the Amended Credit Agreement’s revolving credit facility and letters of credit bear interest, at the Company’s option, at a rate equal to (a) Term SOFR plus an applicable margin between 1.000 % and 1.500 % based upon the Company’s Total Adjusted Net Leverage Ratio (as defined in the Amended Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate, (iii) Term SOFR plus 1.00 %, and (iv) 1.00 %) plus an applicable margin between 0 % and 0.500 % based upon the Company’s Total Adjusted Net Leverage Ratio. The weighted-average annual interest rate on borrowings under the revolving credit facility was approximately 3.21 % during the year ended December 31, 2022. The Amended Credit Agreement contains certain customary affirmative and negative covenants and events of default for credit facilities of this type. +The Amended Credit Agreement requires the Company to maintain a maximum Total Adjusted Net Leverage Ratio of 3.75 :1, except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 :1 for the quarter in which such acquisition occurs and for the next three quarters thereafter. +As of December 31, 2022, there was $ 747.3 million available under the Company’s Amended Credit Agreement. As of December 31, 2021, the unused credit capacity of the revolving credit facility was $ 732.8 million. The Company was in compliance with the financial covenants under the Amended Credit Agreement as of December 31, 2022. +HF-T1 Distribution Center Loan +To finance construction and improvements to the Company’s North American distribution center, the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into an amended and restated construction loan agreement with Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (collectively, the “Amended Construction Loan Agreement”) . Under the Amended Construction Loan Agreement, the parties agreed that the lenders would loan $ 70 million to HF-T1 (the “2015 Loan”) at an interest rate per annum of LIBOR Daily Floating Rate (as defined therein) plus a margin of 2 %. On March 18, 2020, HF-T1 entered into an amendment to the 2015 Loan (the “2020 Amendment”) that increased the borrowings under the 2015 Loan to $ 129.5 million and extended the maturity date of the 2015 Loan to March 18, 2025 (the “HF-T1 2020 Loan”). The proceeds of the 2020 Amendment were used by the JV to (i) refinance all amounts owed on the 2015 Loan, (ii) pay $ 1.0 million in accrued interest, loan fees and other closing costs associated with the 2020 Amendment and (iii) make a distribution of $ 64.4 million to HF. Pursuant to the 2020 Amendment, the interest rate per annum on the HF-T1 2020 Loan is the LIBOR Daily Floating Rate (as defined therein) plus a margin of 1.75 %. +HF-T1 also entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) with Bank of America, N.A. to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) as amended (the “Swap Agreement Amendment”) on March 18, 2020 with Bank of America, N.A with a maturity date of March 18, 2025 . The Swap Agreement Amendment fixes the effective interest rate on the HF-T1 2020 Loan at 2.55 % per annum. The HF-T1 2020 Loan and Swap Agreement Amendment are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Company’s revolving credit facility. +36 +As of December 31, 2022 , the Interest Rate Swap had an aggregate notional amount of $ 129.5 million. Under the terms of the Swap Agreement Amendment, the Company will pay a weighted-average fixed rate of 0.795 % on the notional amount and receive payments from the counterparty based on the 30-day LIBOR rate, effectively modifying the Company’s exposure to interest rate risk by converting floating-rate debt to a fixed rate of 4.08 % . The Company continually assesses the creditworthiness of its counterparties. +HF-T2 Distribution Center Construction Loan +On April 3, 2020, the JV, through HF Logistics-SKX T2, LLC, a wholly-owned subsidiary of the JV (“HF-T2”), entered into a construction loan agreement with Bank of America, N.A. as administrative agent and lender (collectively, the “2020 Construction Loan Agreement”), pursuant to which the JV obtained a loan of up to $ 73.0 million used to expand the North American distribution center (the “HF-T2 2020 Construction Loan”). Under the 2020 Construction Loan Agreement, the interest rate per annum on the HF-T2 2020 Construction Loan is based on the Bloomberg Short-Term Bank Yield Index (“BSBY”) Daily Floating Rate (as defined therein) plus a margin of 190 basis points, reducing to 175 basis points upon substantial completion of the construction and certain other conditions being satisfied. The weighted-average annual interest rate on borrowings under the 2020 Construction Loan Agreement was approximately 4.22 % during the year ended December 31, 2022 . The maturity date of the HF-T2 2020 Construction Loan is April 3, 2025 . The obligations of the JV under the 2020 Construction Loan Agreement are guaranteed by TGD Holdings I, LLC, which is an affiliate of HF . +China Distribution Center Construction Loan +On September 29, 2018, through its Taicang subsidiary (“TC Subsidiary”), the Company entered into a 700.0 million yuan loan agreement with China Construction Bank Corporation (“the China DC Loan”) to finance the construction of the Company’s distribution center in China. Interest is paid quarterly. The interest rate floats and is calculated at a reference rate provided by the People’s Bank of China. The interest rate at December 31, 2022 was 4.00 % and may increase or decrease over the life of the loan, and is evaluated every 12 months. Beginning in 2021, the principal of the loan is repaid in semi-annual installments of variable amounts. The China DC Loan contains customary affirmative and negative covenants for secured credit facilities of this type. The China DC Loan matures on September 28, 2023 . The obligations of the TC Subsidiary under the China DC Loan are jointly and severally guaranteed by the Company’s China joint venture. As of December 31, 2022 and 2021, the outstanding balance under this loan included approximately $ 41.3 million and $ 28.2 million classified as current borrowings in the Company’s consolidated balance sheets. +China Distribution Center Expansion Construction Loan +On October 18, 2022, the Company entered into a loan agreement for 1.1 billion yuan with Bank of China Co., Ltd to finance the construction of its distribution center expansion in China. Interest is paid quarterly. The interest rate at December 31, 2022 was 3.4 % and may increase or decrease over the life of the loan, and is evaluated every 12 months. This loan matures 10 years from the initial receipt of funds. Beginning in 2026, the principal of the loan will be repaid in semi-annual installments of variable amounts. The obligations of this loan entered through the Company’s Taicang Subsidiary are jointly and severally guaranteed by the Company’s China joint venture. +China Operational Loans +The Company has entered certain secured credit facilities to support the operations of its China joint venture. The balance of working capital loans at December 31, 2022 was approximately $ 54.4 million with interest rates ranging from 2.90% to 3.41% per annum, payable at terms agreed by the lender. The balance of working capital loans as of December 31, 2021 was approximately $ 52.6 million with interest rates ranging from 1.00 % to 3.70 % per annum. The balance of loans related to a corporate office building in Shanghai was zero as of December 31, 2022 and approximately $ 17.2 million as of December 31, 2021 with interest at 4.28 % per annum, payable at terms agreed by the lender. A s of December 31, 2022, the outstanding balances classified as current borrowings in the Company’s consolidated balance sheets included $ 54.4 million related to the working capital loans. +The following table presents the future principal payments required under the Company’s debt obligations, discussed above: +Year (in thousands) +Maturities +2023 +$ +103,184 +2024 +— +2025 +201,981 +2026 +1,846 +2027 +1,846 +Thereafter +10,815 +$ +319,672 +37 +( 7 ) +Commitments and Contingencies +PRODUCT AND OTHER FINANCING +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.4 % for 30- to 60 -day financing. The amounts included in accounts payable and outstanding under these arrangements were $ 345.4 million and $ 337.0 million at December 31, 2022 and 2021. Interest expense incurred by the Company under these arrangements totaled $ 6.1 million in 2022, $ 6.5 million in 2021, and $ 7.4 million in 2020. The Company has open purchase commitments with its foreign manufacturers of $ 1.1 billion and warehouse and equipment and corporate construction contracts of $ 252.1 million for the expansion of its distribution centers and corporate headquarters, which are not included in the consolidated balance sheets at December 31, 2022. +LITIGATION +In accordance with GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2022, nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. The Company recognizes legal expense in connection with loss contingencies as incurred. +( 8 ) +Stockholders’ Equity and Stock Compensation +COMMON STOCK +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10 million shares of Preferred Stock, par value $ 0.001 per share. +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share (EPS). Basic and diluted net EPS of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +During the years ended December 31, 2022, 2021 and 2020 certain Class B stockholders converted 128,530 , 77,562 and 1,391,670 shares, respectively, of Class B Common Stock to Class A Common Stock. +SHARE REPURCHASE PROGRAM +On January 31, 2022, the Company's Board of Directors authorized a new share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, for an aggregate repurchase price not to exceed $ 500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +The following table provides a summary of the Company’s stock repurchase activities: +Year Ended December 31, +2022 +2021 +Shares repurchased +1,926,781 +— +Average cost per share +$ +38.53 +$ +— +Total cost of shares repurchased (in thousands) +$ +74,245 +$ +— +38 +INCENTIVE AWARD PLAN +A total of 10,000,000 shares of Class A Common Stock were reserved for issuance under the 2017 Incentive Award Plan (the “Plan”). The Plan provides for grants of ISOs, non-qualified stock options, restricted stock and various other types of equity awards as described in the Plan to employees, consultants and directors of the Company. The Plan is administered by the Company’s Board of Directors with respect to awards to non-employee directors and by the Company’s Compensation Committee with respect to other eligible participants. +For the year ended December 31, 2022, the Company granted restricted stock with time-based vesting as well as performance-based awards. The performance-based awards include a market condition tied to the Company’s total shareholder return in relation to its peer companies as well as a financial performance condition tied to annual EPS growth. The vesting and ultimate payout of performance awards is determined at the end of the three-year performance period and can vary from zero to 200 % based on actual results. As of December 31, 2022, a total of 2,749,532 shares remain available for grant as equity awards under the Plan if target levels are achieved for performance-based awards and 2,049,532 available if maximum levels are achieved. +The Company issued the following stock-based instruments: +Year Ended December 31, +2022 +2021 +2020 +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Restricted stock +1,446,550 +$ +38.27 +1,201,600 +$ +42.88 +1,319,300 +$ +36.42 +Performance-based restricted stock +116,250 +$ +42.46 +108,750 +$ +38.95 +125,000 +$ +36.02 +Market-based restricted stock +116,250 +$ +58.85 +108,750 +$ +54.34 +125,000 +$ +49.78 +A summary of the status and changes of the Company’s unvested shares related to the Plan is presented below: +Shares +Weighted-Average Grant-Date Fair Value +Unvested at January 1, 2020 +3,426,823 +32.55 +Granted +1,569,300 +37.45 +Vested/Released +( 1,093,500 +) +32.64 +Cancelled +( 790,600 +) +32.23 +Unvested at December 31, 2020 +3,112,023 +35.06 +Granted +1,419,100 +43.46 +Vested/Released +( 1,252,108 +) +34.36 +Cancelled +( 25,699 +) +39.01 +Unvested at December 31, 2021 +3,253,316 +38.97 +Granted +1,679,050 +39.98 +Vested/Released +( 1,423,531 +) +36.13 +Cancelled +( 84,933 +) +39.72 +Unvested at December 31, 2022 +3,423,902 +40.62 +The Company determines the fair value of restricted stock awards and any performance-related components based on the closing market price of the Company’s common stock on the date of grant. For share-based awards with a performance-based vesting requirement, the Company evaluates the probability of achieving the performance criteria throughout the performance period and will adjust stock compensation expense up or down based on its estimated probable outcome. Certain performance-based awards contain market condition components which are valued on the date of grant using a Monte Carlo simulation model. The fair value of such awards is expensed ratably over the performance period and is not adjusted for actual achievement. +The Company recognized, as part of general and administrative, compensation expense of $ 57.3 million, $ 57.9 million and $ 62.9 million for grants under the Plan for the years ended December 31, 2022, 2021, and 2020. Related excess income tax expenses, recorded in the consolidated statements of earnings, for the years ended December 31, 2022, 2021 and 2020, were $( 1.3 ) million, $( 1.0 ) million, and $( 0.7 ) million. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. For grants that have a service requirement, the Company accounts for forfeitures upon occurrence, rather than estimating the probability of forfeiture at the date of grant. Accordingly, the Company recognizes the full grant-date fair value of these awards on a straight-line basis throughout the requisite service period, reversing any expense if, and only if, there is a forfeiture . There was $ 88.7 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2022, which is expected to be recognized over a weighted-average period of 1.81 years. The total fair value of shares vested during the years ended December 31, 2022, 2021 and 2020 was $ 51.4 million, $ 43.1 million and $ 41.6 million. +39 +STOCK PURCHASE PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2018 Employee Stock Purchase Plan (the “2018 ESPP”) provides a total of 5,000,000 shares of Class A Common Stock for sale. The 2018 ESPP provides eligible employees of the Company and its subsidiaries the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the fair market value on the first trading day or last trading day of each purchase period, whichever is lower. Eligible employees can invest up to 15 % of their compensation through payroll deductions during each purchase period. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense, which is computed using the Black-Scholes valuation model. +For the years ended December 31, 2022, 2021 and 2020 , the Company recognized $ 2.6 million, $ 2.2 million, and $ 2.3 million of ESPP stock compensation expense. Under the 2018 ESPP, the Company received approximately $ 8.1 million, $ 7.3 million and $ 5.9 million, and issued 243,166 , 225,665 and 232,904 shares, respectively, for the years ended December 31, 2022, 2021 and 2020. As of December 31, 2022, there were 3,815,746 shares available for sale under the 2018 ESPP. +( 9 ) +Earnings Per Share +Basic EPS and diluted EPS are calculated by dividing net earnings by the following: for basic EPS, the weighted-average number of common shares outstanding for the period; and for diluted EPS, the sum of the weighted-average number of both outstanding common shares and potentially dilutive common shares using the treasury stock method. +The calculation of EPS is as follows: +Year Ended December 31, +(in thousands, except per share data) +2022 +2021 +2020 +Net earnings attributable to Skechers U.S.A., Inc. +$ +373,028 +$ +741,503 +$ +98,564 +Weighted-average common shares outstanding, basic +155,627 +155,539 +154,184 +Dilutive effect of nonvested shares +981 +1,255 +710 +Weighted-average common shares outstanding, diluted +156,608 +156,794 +154,894 +Anti-dilutive common shares excluded above +37 +5 +69 +Net earnings attributable to Skechers U.S.A., Inc. per common share: +Basic +$ +2.40 +$ +4.77 +$ +0.64 +Diluted +$ +2.38 +$ +4.73 +$ +0.64 +( 1 0 ) +Income Taxes +The Company’s earnings before income tax expense consists of the following: +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +U.S. operations +$ +( 48,311 +) +$ +71,900 +$ +( 112,671 +) +Foreign operations +570,568 +497,857 +267,400 +Earnings before income taxes +$ +522,257 +$ +569,757 +$ +154,729 +Income tax consists of the following: +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Current +Federal +$ +256 +$ +34,288 +$ +( 30,094 +) +State +9,564 +7,268 +3,841 +Foreign +84,904 +102,062 +56,530 +94,724 +143,618 +30,277 +Deferred +Federal +7,043 +( 27,074 +) +( 2,208 +) +State +( 1,287 +) +( 4,481 +) +( 3,070 +) +Foreign +( 7,385 +) +( 357,938 +) +( 16,497 +) +( 1,629 +) +( 389,493 +) +( 21,775 +) +Income tax expense (benefit) +$ +93,095 +$ +( 245,875 +) +$ +8,502 +40 +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows: +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Expected income tax expense +$ +109,674 +$ +119,649 +$ +32,493 +State income tax, net of federal benefit +( 1,597 +) +( 172 +) +( 2,394 +) +Rate differential on foreign income +( 49,175 +) +( 24,615 +) +( 27,426 +) +Change in unrecognized tax benefits +12,310 +11,538 +6,084 +Intra-entity intellectual property transfer +( 3,232 +) +( 346,776 +) +— +FDII deduction +— +( 10,695 +) +— +Non-deductible compensation +13,668 +8,693 +7,119 +Tax credits +( 7,544 +) +( 7,547 +) +( 6,312 +) +Excess tax on stock compensation +1,305 +976 +703 +Benefits provided by the Coronavirus Aid, Relief, and Economic Security Act +— +( 905 +) +( 15,863 +) +Non-deductible share cancellation +— +— +4,048 +U.S. tax on foreign earnings +7,611 +— +— +Other +217 +( 927 +) +( 463 +) +Change in valuation allowance +9,858 +4,906 +10,513 +Income tax expense (benefit) +$ +93,095 +$ +( 245,875 +) +$ +8,502 +Effective tax rate +17.8 +% +( 43.2 +)% +5.5 +% +The Company’s income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0.0 % to 34.0 %. The Company’s income tax expense (benefit) was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. For 2022 , the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25 %, primarily due to tax benefits related to earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. +The Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI taxes foreign income in excess of a deemed return on tangible assets of foreign corporations and is treated as a period cost. +The tax effects of temporary differences giving rise to deferred tax assets and liabilities are presented below: +As of December 31, +(in thousands) +2022 +2021 +Deferred tax assets +Inventory adjustments +$ +10,810 +$ +9,099 +Accrued expenses +92,215 +76,412 +Allowances for bad debts and chargebacks +4,728 +4,667 +Advance payment +6,339 +27,594 +Intra-entity IP transfer +343,106 +346,776 +Section 174 Capitalized Costs +15,721 +— +Loss carryforwards +50,558 +38,273 +Business credit carryforward +25,289 +15,537 +Share-based compensation +7,725 +6,479 +Operating lease liabilities +317,449 +337,399 +Valuation allowance +( 58,321 +) +( 48,463 +) +Total deferred tax assets +815,619 +813,773 +Deferred tax liabilities +Prepaid expenses +5,073 +4,116 +Right-of-use assets +317,449 +337,371 +Depreciation on property, plant and equipment +47,563 +32,751 +Total deferred tax liabilities +370,085 +374,238 +Net deferred tax assets +$ +445,534 +$ +439,535 +41 +At December 31, 2022, combined foreign net operating loss carry-forwards were approximately $ 176.7 million of which $ 3.7 million expire in 2023 and $ 34.3 million can be carried forward indefinitely. A valuation allowance of $ 58.3 million is recorded for the amount of deferred tax assets which is not likely to be fully utilized. The $ 9.9 million increase in the valuation allowance primarily relates to increases in deferred tax assets in certain foreign non-benefited loss jurisdictions. +In December 2021, the Company completed an intra-entity transfer of certain intellectual property rights to Switzerland primarily to align with current and future international operations. The transfer resulted in a step-up in the Swiss tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets, based on the estimated fair value of the transferred intellectual property rights to be amortized. As a result, the Company recorded a tax benefit of $ 346.8 million, net of uncertain tax positions of $ 25.2 million. In 2022, the company obtained a tax ruling on the fair value of the transferred intellectual property rights, resulting in a settlement of the uncertain tax position and an adjusted recorded tax benefit of $ 349.6 million. +U.S. federal and net operating loss carry-forwards at December 31, 2022 was $ 35.0 million which can be carried forward indefinitely. U.S. federal tax credit carry-forward at December 31, 2022 was 12.6 million. State tax credit and net operating loss carry-forwards at December 31, 2022 were $ 15.4 million and $ 43.4 million. These tax credit and net operating loss carry-forward amounts begin to expire in 2030 . No valuation allowance has been recorded, as the Company believes they will be fully utilized. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +As of December 31, +(in thousands) +2022 +2021 +Beginning balance +$ +66,951 +$ +21,511 +Additions for current year tax positions +5,345 +34,975 +Additions for prior year tax positions +4,616 +15,256 +Reductions for prior year tax positions +( 674 +) +( 361 +) +Settlement of uncertain tax positions +( 32,954 +) +( 812 +) +Reductions related to lapse of statute of limitations +( 2,037 +) +( 3,618 +) +Ending balance +$ +41,247 +$ +66,951 +Current unrecognized tax benefits are recorded as a reduction in prepaid expense and included in tax expense when recorded. Long-term unrecognized tax benefits are recorded as an increase in long-term taxes payable with a portion included in tax expense and a portion recorded as a reduction in deferred tax liabilities when recorded. If recognized, $ 29.4 million of unrecognized tax benefits would be recorded as a reduction in income tax expense, and $ 11.8 million would be recorded as an increase in deferred tax liabilities. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +The Company estimates interest and penalties related to income tax matters which are included in income tax expense (benefits). Amounts were $( 1.9 ) million, $ 3.6 million, and $ 0.3 million for the years ended December 31, 2022, 2021, and 2020. Accrued interest and penalties were $ 4.2 million and $ 6.2 million as of December 31, 2022 and 2021. +As of December 31, 2022, the Company’s tax filings are generally subject to examination in the U.S. and most foreign jurisdictions for years ending on or after December 31, 2018, and in several Asian and European tax jurisdictions for years ending on or after December 31, 2012. During the year, the Company reduced the balance of unrecognized tax benefits by $ 2.0 million as a result of expiring statutes and $ 33.0 million from the settlements and decision on a foreign tax ruling. The Company also released $ 2.3 million in interest during the year. It is reasonably possible that certain domestic and foreign statutes will expire and certain domestic and foreign audits will be settled during the next twelve months which would reduce the balance of 2022 and prior year unrecognized tax benefits by $ 1.2 million and $ 2.3 million. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2022. The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. In addition to certain tax restrictions, our joint venture in China has limitations on its distribution of earnings, as local law currently requires it to maintain $ 25.9 million of its earnings in a statutory reserve. +42 +(1 1 ) +Employee Benefit Plans +The Company has a 401(k) profit sharing plan covering U.S. employees who are 21 years of age and have completed six months of service. The Company’s contribution is based on a non-discretionary match as defined by the plan which vests immediately. Company contributions for 2020 were discretionary and vested over six years . The Company made contributions of $ 4.2 million, $ 4.7 million, and $ 2.8 million to the plan for the years ended December 31, 2022, 2021, and 2020. +The Skechers U.S.A., Inc. Deferred Compensation Plan (the “Plan”) allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees as determined by the Company’s Compensation Committee. Contributions were zero , $ 0.1 million, and $ 0.3 million for the years ended December 31, 2022, 2021 and 2020. Deferred compensation is recognized based on the fair value of the participants’ accounts. +(1 2 ) +Related Party Transactions +The Skechers Foundation (the “Foundation”) is a 501(c)(3) non-profit entity and not a subsidiary or otherwise affiliated with the Company. The Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are also officers and directors of the Foundation. During the years ended December 31, 2022, 2021, and 2020, the Company made contributions of $ 2.0 million, $ 3.0 million, and $ 2.3 million to the Foundation. +The Company had receivables from officers and employees of $ 1.9 million and $ 1.3 million at December 31, 2022 and 2021. These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. In March 2021, the Company purchased two properties for $ 2.7 million, from an entity controlled by its President, Michael Greenberg, to facilitate future expansion of the Company’s corporate office buildings in Manhattan Beach, California. The terms of the sale were no less favorable than could be obtained from an unrelated third party. The Company had no other significant transactions with or payables to officers, directors or significant stockholders of the Company. +( 1 3 ) +Segment and Geographic Information +During the first quarter of 2022, the Company refined the way in which management assesses performance and allocates resources and now presents its reportable segment results as Wholesale and Direct-to-Consumer. Comparative periods have been recast to reflect these changes. Management continues to evaluate segment performance based primarily on sales and gross margin. Other costs and expenses of the Company are analyzed on an aggregate basis and not allocated to the segments. The following summarizes the Company’s operations by segment and geographic area: +Segment Information +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Wholesale sales +$ +4,632,429 +$ +3,758,640 +$ +2,835,010 +Gross profit +1,669,276 +1,437,517 +1,112,558 +Gross margin +36.0 +% +38.2 +% +39.2 +% +Direct-to-Consumer sales +$ +2,812,121 +$ +2,551,547 +$ +1,778,420 +Gross profit +1,846,081 +1,686,854 +1,093,240 +Gross margin +65.6 +% +66.1 +% +61.5 +% +Total sales +$ +7,444,550 +$ +6,310,187 +$ +4,613,430 +Gross profit +3,515,357 +3,124,371 +2,205,798 +Gross margin +47.2 +% +49.5 +% +47.8 +% +As of December 31, +(in thousands) +2022 +2021 +Identifiable assets +Wholesale +$ +3,682,860 +$ +3,816,513 +Direct-to-Consumer +3,210,627 +2,674,767 +Total +$ +6,893,487 +$ +6,491,280 +43 +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Additions to property, plant and equipment +Wholesale +$ +255,311 +$ +245,008 +$ +228,448 +Direct-to-Consumer +103,681 +64,666 +81,468 +Total +$ +358,992 +$ +309,674 +$ +309,916 +Geographic Information +Year Ended December 31, +(in thousands) +2022 +2021 +2020 +Geographic sales +Domestic Wholesale +$ +1,831,642 +$ +1,448,339 +$ +1,132,425 +Domestic Direct-to-Consumer +1,243,511 +1,115,018 +786,844 +Total domestic sales +3,075,153 +2,563,357 +1,919,269 +International Wholesale +2,800,787 +2,310,302 +1,702,585 +International Direct-to-Consumer +1,568,610 +1,436,528 +991,576 +Total international sales +4,369,397 +3,746,830 +2,694,161 +Total sales +$ +7,444,550 +$ +6,310,187 +$ +4,613,430 +Regional Sales +Americas (AMER) +$ +3,854,392 +$ +3,152,304 +$ +2,292,540 +Europe, Middle East & Africa (EMEA) +1,699,215 +1,282,902 +899,590 +Asia Pacific (APAC) +1,890,943 +1,874,981 +1,421,300 +Total sales +$ +7,444,550 +$ +6,310,187 +$ +4,613,430 +China sales +$ +1,062,724 +$ +1,247,949 +$ +924,482 +As of December 31, +(in thousands) +2022 +2021 +Property, plant and equipment, net +Domestic +$ +870,924 +$ +708,763 +International +474,446 +420,146 +Total +$ +1,345,370 +$ +1,128,909 +China property plant and equipment, net +$ +264,422 +$ +255,421 +The Company’s sales to its five largest customers accounted for approximately 9.6 %, 8.6 %, and 8.8 % of total sales for the years ended December 31, 2022, 2021 and 2020. +Assets located outside the U.S. consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the U.S. were $ 4.4 billion and $ 4.2 billion at December 31, 2022 and December 31, 2021. +The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable generally do not require collateral. Foreign accounts receivable are generally collateralized by letters of credit. The Company’s additions to the provision for expected credit losses for the year ended December 31, 2022, 2021, and 2020 were $ 5.3 million, $ 3.3 million, and $ 18.7 million. +The Company’s accounts receivables, excluding allowances for bad debts and chargebacks, by geography are summarized as follows: +As of December 31, +(in thousands) +2022 +2021 +Domestic Accounts Receivable +$ +310,138 +$ +270,404 +International Accounts Receivable +597,621 +525,073 +44 +The Company’s top five manufacturers produced the following: +Year Ended December 31, +(percentage of total production) +2022 +2021 +2020 +Manufacturer #1 +16.5 +18.0 +21.0 +Manufacturer #2 +7.0 +5.3 +6.2 +Manufacturer #3 +5.2 +4.8 +5.8 +Manufacturer #4 +5.2 +4.6 +4.9 +Manufacturer #5 +5.1 +4.4 +4.2 +Total +39.0 +37.1 +42.1 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. +Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2022. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2022, which is set forth below. +45 +Inherent Limitations on Effectiveness of Controls +Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2022. +46 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 28, 2023 +47 +Item 9B. +Other Information +None. +Item 9 C . +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +48 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. +Item 11. +Executive Compensation +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. +Item 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. +Item 14. +Principal Accountant Fees and Services +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. +49 +PART IV +Item 15. +Exhibit and Financial Statement Schedules +1. +Financial Statements. The financial statements as set forth under Item 8 of this Annual Report on Form 10-K are incorporated herein. +2. +Financial Statement Schedule. +Schedule II - Valuation and Qualifying Account +(in thousands) +Balance at +Beginning of Year +Costs +Charged to +Expenses +Deductions +and +Write-offs +Balance at +End of Year +Year-ended December 31, 2020 +Allowance for chargebacks +$ +17,413 +$ +12,734 +$ +( 3,473 +) +$ +26,674 +Allowance for doubtful accounts +6,693 +19,940 +( 4,745 +) +21,888 +Liability for sales returns and allowances +69,048 +18,023 +( 9,852 +) +77,219 +Reserve for inventory +6,728 +15,920 +( 14,428 +) +8,220 +Year-ended December 31, 2021 +Allowance for chargebacks +$ +26,674 +$ +45,957 +$ +( 32,497 +) +$ +40,134 +Allowance for doubtful accounts +21,888 +10,551 +( 9,889 +) +22,550 +Liability for sales returns and allowances +77,219 +6,263 +( 14,538 +) +68,944 +Reserve for inventory +8,220 +24,899 +( 25,608 +) +7,511 +Year-ended December 31, 2022 +Allowance for chargebacks +$ +40,134 +$ +25,558 +$ +( 29,275 +) +$ +36,417 +Allowance for doubtful accounts +22,550 +6,804 +( 6,299 +) +23,055 +Liability for sales returns and allowances +68,944 +5,444 +( 13,906 +) +60,482 +Reserve for inventory +7,511 +31,825 +( 21,606 +) +17,730 +See accompanying report of independent registered public accounting firm +50 +Index to Exhibits +Exhibit Number +Description +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 20, 2007). +3.2(c) +Third Amendment to Bylaws dated as of May 15, 2019 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on May 17, 2019). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed on May 12, 1999). +4.2 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 3, 2013). +10.1(a)* +F irst Amendment to the Skechers U.S.A., Inc. Deferred Compensation Plan ( incorporated by reference to exhibit number 10.1(a) of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.3* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.4* +Form of Restricted Stock Agreement (Time-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.5* +Form of Restricted Stock Agreement (Performance-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.6* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.7 +Form of Indemnification Agreement between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.8 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.9* +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.10* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2019). +10.11 +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.2 of the Registrant’s Form 8-K filed on May 24, 2019). +51 +Exhibit Number +Description +10.12 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011). +10.12(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on August 17, 2015). +10.12(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018) . +10.12(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(c) of the Registrant’s Form 10-K for the year ended December 31, 2019) . +10.13 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed on August 17, 2015). +10.13(a)** +First Amendment to Amended and Restated Loan Agreement dated as of March 18, 2020, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders. (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on March 24, 2020). +10.14 +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.15 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.16** +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.17 +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.18 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +52 +Exhibit Number +Description +10.18(a) +First Amendment to Credit Agreement dated M arch 23 , 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended March 31, 2021). +10.18(b) +Second Amendment to Credit Agreement dated December 15, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.19 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.20 +Reaffirmation Agreement dated December 15, 2021 by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, and Bank of America N.A. (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.21 +Loan Contract, dated October 18, 2022, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and Bank of China Co., Ltd., regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2022) . +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) +* +Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** +C onfidential treatment has been granted by the SEC with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +*** +In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +Item 16. +Form 10-K Summary +None. +53 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 28th day of February 2023. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 28, 2023 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 28, 2023 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 28, 2023 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 28, 2023 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Katherine Blair +Director +February 28, 2023 +Katherine Blair +/s/ Morton D. Erlich +Director +February 28, 2023 +Morton D. Erlich +/s/ Zulema Garcia +Director +February 28, 2023 +Zulema Garcia +/s/ Yolanda Macias +Director +February 28, 2023 +Yolanda Macias +/s/ Richard Siskind +Director +February 28, 2023 +Richard Siskind +54 \ No newline at end of file diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/filing_metadata.csv b/raw/filings/0001065837/2022/0001564590-23-002740/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..5baef4216d5ae6cb8e3c0b3efe06b1d0be50d3de --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2023-02-28,2022-12-31,2023-02-28T21:18:37.000Z,0001564590-23-002740,skx-10k_20221231.htm,10-K,15005939,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000156459023002740/skx-10k_20221231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000156459023002740/,2022,2022,1 diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/item1.txt b/raw/filings/0001065837/2022/0001564590-23-002740/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..c0883ffbe5876fadc879c873d4e3251fa191b69c --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/item1.txt @@ -0,0 +1,96 @@ +Item 1. +Business +Skechers U.S.A., Inc., The Comfort Technology Company TM , was incorporated in California in 1992 and reincorporated in Delaware in 1999. Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, is referred to throughout this annual report as “we,” “us,” “our,” “the Company” and “Skechers” unless otherwise indicated. Reference in this annual report to “sales” refers to Skechers’ net sales reported under U.S. generally accepted accounting principles. Our internet address is www.skechers.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of directors, officers and 10% stockholders, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge on our corporate website, www.investors.skechers.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). You can learn more about us by reviewing such filings at www.investors.skechers.com or at the SEC’s website, www.sec.gov . +GENERAL +We design and market Skechers-branded lifestyle footwear for men, women and children, performance footwear for men and women under the Skechers Performance brand name, and work footwear for men and women under Skechers Work brand name. We design and market Skechers branded lifestyle apparel and license the Skechers brand to others for accessories, pet accessories, leather goods, eyewear and medical scrubs, among other categories. Skechers footwear reflects a combination of style, quality, comfort, innovation and value that appeals to a broad range of consumers. Our product offering is sold through wholesale distribution to department and specialty stores, athletic and independent retailers, and e-commerce retailers, and directly to consumers through Skechers brick and mortar and digital stores. Our objective is to profitably grow our operations worldwide while leveraging our recognizable Skechers brand through our diversified product lines, innovative advertising and various distribution channels. +We believe that brand recognition is an important element for success in the footwear business. We aggressively market our brands through comprehensive marketing campaigns for men, women and children. The Skechers brand is supported by print, television, digital, radio, outdoor and press campaigns as well as donation events for BOBS from Skechers. To further drive recognition, we enlist numerous celebrities, former and current athletes, and influencers to appear in our campaigns. In 2022 , our brand ambassadors included television personalities and entertainers Martha Stewart, Amanda Kloots, Brooke Burke, Willie Nelson and Chesca, athlete Clayton Kershaw, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Meb Keflezighi, and Rusty Wallace. More recently, culture and entertainment icon Snoop Dogg joined our stable of brand ambassadors. Additionally, athletes supporting our performance footwear included runner Edward Cheserek, elite golfers Matt Fitzpatrick, Brooke Henderson and Colin Montgomerie, and pro pickleball players Tyson McGuffin and Catherine Parenteau. +Since 1992, when we introduced our first line, Skechers USA Sport Utility Footwear, we have expanded our product offering and grown our sales while substantially increasing the breadth and penetration of our account and customer base. Our men’s, women’s and children’s product lines benefit from the Skechers reputation for style, quality, comfort, and innovation all at a reasonable price. Our Performance lines benefit from our marketing, product development, technology, wins on the course or track, and feedback from athletes and wear testers. +SKECHERS LINES +We offer a wide array of Skechers-branded footwear lines, many of which have collections that have developed into well-known names. Most of these collections are marketed and packaged with unique shoe boxes, hangtags and in-store support. +From fashion styles to lifestyle product and performance shoes for sport enthusiasts, our offering is enhanced with the Company’s signature comfort innovations—including its Skechers Arch Fit® Technology, Skechers Max Cushioning® Technology, Skechers Air‑Cooled Memory Foam®, Skechers Relaxed Fit® Technology, Skechers Stretch Fit® Technology, Skechers Hands Free Slip-ins® Technology, Skechers Hyper Burst® Technology, and Massage Fit® Technology. +Lifestyle Brands . Our lifestyle offering includes categories such as Skechers USA, Skechers Sport, Skechers Active, Modern Comfort, Skechers Street, Foamies, Mark Nason, the charity-minded BOBS from Skechers collection, and the recycled materials line Our Planet Matters, among others. Types of footwear sold under this division include casual, casual athletic, sport athletic, trail, sandals, boots, and fashion, and also include the well-known Skechers Uno, Skechers Arch Fit®, and new in 2022, Skechers Hands Free Slip-ins™. Innovation is also important within our lifestyle offering and select styles include patented designs including podiatrist-certified arch support and outsoles for enhanced traction, stability and durability. +Within our lifestyle collections are collaborations with known brands and properties—including street artists like James Goldcrown and well-known animated characters like tokidoki. +2 +Performance Brands . Skechers Performance encompasses several technical footwear lines, each designed for specific activities to maximize performance and promote comfort. The Skechers Performance division designs footwear to utilize the latest advancements in materials and innovative design, including lightweight U ltra GO and H yper B urst midsole compounds for comfort and responsive feedback. Skechers Performance includes the lines Skechers GOrun , Skechers GOwalk , Skechers GOtrain , Skechers GOtrail , and Skechers GO Golf as well as Skechers Viper Court for pickleball . +Skechers Kids . Skechers Kids is comprised of a wide range of sneakers, casuals, boots, and sandals for boys and girls of all ages – pairing the latest trends with innovative comfort technology. The Skechers Kids offering includes its namesake collection, S-Lights, Skech-Air, Foamies, Twinkle Toes, Skechers Stretch Fit, and Skechers Street. +Skechers Work . Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe casuals, boots, hikers and athletic shoes for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology. +Skechers Apparel . Skechers designs and markets a collection of lifestyle apparel for men, women and kids. The collection features Skechers characteristics that consumers around the world have come to expect from the brand. The activewear garments are designed to directly coordinate with the brand’s footwear products. The Skechers apparel collection is sold at Skechers retail stores, on our websites and through wholesale customers. +PRODUCT DESIGN AND DEVELOPMENT +Our principal goal in product design is to develop innovative, comfortable, stylish, quality footwear at a reasonable price for the entire family. Our performance products are for professional and recreational athletes who want a technical shoe that performs under the demands of competition. Our occupational footwear is designed to meet the specifications and demands of the service, medical and construction industries while also meeting testing specifications in the markets where the product is sold. +We believe that our products’ success is related to our ability to recognize trends in the footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media; consulting with our customers for information on current retail selling trends; participating in major footwear trade shows to stay abreast of popular brands, fashions and styles; and subscribing to various fashion and color information services. In addition, a key component of our design philosophy is to continually reinterpret and improve our most successful styles. +SOURCING +Factories. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. +When possible, we seek to use manufacturers that have previously produced our footwear, which we believe enhances continuity and quality while controlling production costs. To help avoid disruption of our product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +Production Oversight. To safeguard product quality and consistency, we oversee the key aspects of production from initial prototype manufacture, through initial production runs, to final manufacture. Monitoring of all production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. In addition, we require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. +Quality Control. We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and all goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production. For some of our lower volume manufacturers, our staff is on-site during significant production runs, or we perform unannounced visits to their manufacturing sites to further monitor compliance with our manufacturing specifications. +3 +Sustainability. We believe sustainability is an important responsibility in managing our business. In 2021, we introduced Our Planet Matters, a collection for men, women and kids that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interest s and commitment to reduce tree harvesting and emissions through packaging. +We worked to make our packaging more sustainable for the more-than-225 million units of Skechers that consumers purchased in 2022. Since 2016, we have reduced our products’ packaging plastics by 99% down to less than 1%; all of which is recyclable. Many facilities can now recycle 93% of Skechers-branded shoeboxes, and all of our foot forms and tissue paper packaging are recyclable and printed with soy-or water-based ink. Further, 99% of our shoeboxes meet the FSC® standard for responsible resources, and we continually look for new ways to improve with green materials, regular assessments, and assurance that our items are FSC-certified, recycled or ethically harvested. Our shipping methods reflect our green-minded approach to sustainability: master cartons are printed with soy-or-water-based ink and are 100% recyclable, and at the distribution centers managing more than 90% of our business, our outbound shipping cartons are composed of 96%-100% recycled materials and are 100% recyclable. +Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our expanding corporate offices in Los Angeles, California are being designed and developed to qualify for LEED Gold certification. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. +ADVERTISING AND MARKETING +With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted and 360-degree approach to marketing to drive traffic, build brand recognition and properly position our diverse lines within the marketplace. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. Our marketing strategy has an omni-channel approach, and we utilize print, outdoor, television, radio, and digital, along with public relations, influencers and social media, promotions, and in-store events. In addition, we utilize celebrity and athlete endorsers in some of our advertisements. +PRODUCT DISTRIBUTION +We have two reportable segments: Wholesale and Direct-to-Consumer. The Company’s collections are available in approximately 180 countries and territories through department and specialty stores, and direct to consumers through digital stores and approximately 4,540 Company- and third-party-owned physical retail stores. The Company manages its international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. +Our subsidiaries and joint ventures merchandise, market and distribute Skechers product to generate sales in their countries, and we consolidate their results in our financial statements. Our joint venture interests include China, Malaysia and Singapore (50%), Thailand and Israel (51%), Mexico (60%), and South Korea (65%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores. +Wholesale. Our Wholesale segment primarily comprises sales to a vast network of partners. These include: department stores, family shoe stores, specialty running and sporting goods retailers, and big box club stores; franchisee and licensee third-party store operators representing approximately 3,100 Skechers branded stores worldwide; dedicated e-commerce retailers; and international distributors. +Direct-to-Consumer. Our Direct-to-Consumer segment primarily comprises sales by Skechers directly to consumers through a combination of channels. These include approximately 1,450 company-owned retail stores in formats consisting of concept, factory outlet and big box; digital commerce sites and mobile applications; and hosted direct-to-consumer sales through marketplaces in select international markets +We pursue our direct-to-consumer strategy through our integrated retail formats, which enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. +• +E- commerce – Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which continues to improve our customer service and brand experience. +• +Concept Stores – Our concept stores are located at high street locations, major tourist areas or in key shopping malls in metropolitan cities. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as product testing venues. +• +Factory Outlet Stores – Our factory outlet stores are generally located in manufacturers’ direct outlet centers in the U.S. and in select international markets. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise. +4 +• +Big Box Stores – Our free-standing and attached big box stores, which are primarily located throughout the U.S. and Canada, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory. +Store count, openings and closings for our domestic, international and third-party stores are as follows: +Number of locations +December 31 2021 +Opened +Closed (1) +December 31, 2022 +Domestic stores +515 +43 +(19 +) +539 +International stores +845 +172 +(112 +) +905 +Distributor, licensee and franchise stores +2,946 +529 +(382 +) +3,093 +Total Skechers stores +4,306 +744 +(513 +) +4,537 +(1) +Does not reflect temporary closures due to the COVID-19 pandemic. +LICENSING +We believe that selective licensing of the Skechers brand name and our product line names to manufacturers broadens and enhances the individual brands without requiring significant capital investments or additional incremental operating expenses. Our multiple product lines plus additional subcategories present many potential licensing opportunities on terms that we believe will provide more effective manufacturing, distribution or marketing of non-footwear products. +As of December 31, 2022 , we had 27 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel, accessories, socks and eyewear; medical scrubs; fitness and yoga accessories, and cold weather products. Additional category-specific collections include Skechers Sport apparel, bags, backpacks and headwear; Twinkle Toes backpacks and lunchboxes; BOBS from Skechers socks and backpacks; and Skechers Work socks. We also have BOBS from Skechers pet accessories in Petco. +DISTRIBUTION FACILITIES AND OPERATIONS +We believe that strong distribution support is a critical factor in our operations. Our distribution network includes (i) an approximately 2.6 million square-foot North American distribution center located in California, (ii) an approximately 2.2 million square-foot European distribution center located in Belgium, (iii) an approximately 1.6 million square foot China distribution center, (iv) an approximately 0.3 million square foot United Kingdom distribution center, (v) company-operated distribution centers or third-party distribution centers in Central America, South America and Asia, and (vi) third-party manufacturers and other international third-party distribution centers. +INTELLECTUAL PROPERTY RIGHTS +We own and utilize a variety of trademarks, including the Skechers trademark. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 162 foreign countries. We have design patents and pending design and utility patent applications in both the U.S. and 39 foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally, where necessary to protect our intellectual property. We regard our trademarks and other intellectual property as valuable assets and believe that they have significant value in marketing our products. We vigorously protect our trademarks against infringement, including through the use of cease and desist letters, administrative proceedings and lawsuits. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to its entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. +HUMAN CAPITAL +As of December 31, 2022 , we employed approximately 15,100 persons, of whom approximately 7,800 were employed on a full-time basis and approximately 7,300 were employed on a part-time basis, primarily in our retail stores. +Social Responsibility . As a family-focused brand, Skechers was founded on inclusivity, diversity, respect and entrepreneurial spirit with the philosophy of putting people first – offering comfort and care to our employees and customers. In conjunction with our policy against discrimination, Skechers emphasizes that every employee, applicant, contractor and customer is entitled to be treated with dignity and respect. Human rights is a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. All full-time and part-time corporate employees in the U.S. undergo harassment and diversity training, and +5 +employees of our wholly-owned operations in other countries comply with their local laws regarding human rights, harassment and diversity training in the workplace . As it relates to our factories and suppliers specifically, we provide employee and management training to ensure that employees and companies who oversee our production and manufacturer auditing know the most current issues regarding human rights . Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify these values and our commitment to diversity, equity and inclusion. These c odes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at https://investors.skechers.com/corporate-governance/governance-documents . We intend to post any amendment to, or waiver s of , these codes on our website. The information found on, or otherwise accessible through our website, is not incorporated into, and does not form a part of this annual report. +Skechers is focused on reducing its carbon footprint. We have made environmental advancements a top priority at our corporate facilities. Now under construction, our expanding corporate offices remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four corporate buildings are being designed to receive LEED Gold certification upon completion, and include solar panels. +Community . Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2022, the Company donated over 105,000 pairs of new shoes to those in need, more than $1.5 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. +Health and Safety . Skechers’ lifestyle and performance product offering has shaped our culture with a focus on wellness, and a commitment to providing a safe and healthful work environment for all employees. The Company offers healthy lunch options, an in-house fitness consultant and corporate exercise programs. We offer paid time off to get the COVID-19 vaccine and provided on-site vaccination clinics for our corporate employees and our domestic distribution center employees. We made changes to our corporate facilities, increasing cleaning protocols and distributing personal protective equipment and cleaning supplies to employees; installing touchless doors and faucets in common areas. +Talent. We offer competitive benefits in a casual, creative atmosphere and a fun, fast-paced environment where employees can always learn and grow. Employee benefits are designed to help employees and their families stay healthy, meet their financial goals, and help them balance their work and personal lives. Benefits include health and wellness programs, training and development programs, an employee stock purchase program, a childcare incentive program, on-site electric vehicle charging stations, and product discounts. \ No newline at end of file diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/item13.txt b/raw/filings/0001065837/2022/0001564590-23-002740/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..bb173e7a92e83e15312dfa32548f1e13b417bfe3 --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/item13.txt @@ -0,0 +1,3 @@ +Item 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2022 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/item9a.txt b/raw/filings/0001065837/2022/0001564590-23-002740/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..3ef999045673f3dc0b4af1fdc70dcfcdf8ccc442 --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/item9a.txt @@ -0,0 +1,39 @@ +Item 9A. +Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +Based on our evaluation under the framework in Internal Control – Integrated Framework (2013), our management has concluded that our internal control over financial reporting is effective as of December 31, 2022. +Our independent registered public accountants, BDO USA, LLP, audited the consolidated financial statements included in this annual report on Form 10-K and have issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2022, which is set forth below. +45 +Inherent Limitations on Effectiveness of Controls +Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +There were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2022. +46 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, LLP +Los Angeles, California +February 28, 2023 +47 \ No newline at end of file diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/rp_note.txt b/raw/filings/0001065837/2022/0001564590-23-002740/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2022/0001564590-23-002740/rpt_disclosure.txt b/raw/filings/0001065837/2022/0001564590-23-002740/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d31cc014db16de93a451a606c70d8fd022de0b1 --- /dev/null +++ b/raw/filings/0001065837/2022/0001564590-23-002740/rpt_disclosure.txt @@ -0,0 +1,143 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in the section entitled “ Corporate Code of Conduct and Code of Ethics ” in this proxy statement), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A Common Stock or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +65 +We have adopted changes to our policies and procedures to identify and report employees who, pursuant to Item 404 of Regulation S-K under the Exchange Act, are related to a Related Person and earned annual compensation equal to or greater than $120,000. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2022. Each of these transactions was reviewed, and approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +Related Person Transactions +During 2022, we paid $282,216 and $199,034 to The BeachLife Festival and The BeachLife Ranch Festival for Skechers marketing and sponsorship. The Beach LifeFestival is owned and operated by Beach Life Festival, LLC, of which Michael Greenberg owns an 8% beneficial ownership interest. The BeachLife Ranch Festival is owned and operated by Beach Life Festival 2, LLC, of which Michael Greenberg owns an 8% beneficial ownership interest. Skechers had no outstanding accounts receivable or payable with any of these music festivals or their operating entities as of December 31, 2022. +On February 1, 2018, we entered into a consulting agreement with Gil Schwartzberg, who is a beneficial owner of more than 5% of our Class A Common Stock and more than 5% of our Class B Common Stock. Mr. Schwartzberg agreed to provide business and legal advisory services for one year in exchange for a fee of $250,000. The agreement was extended for the fourth time for an additional year with the same terms and conditions effective as of February 1, 2022, but the agreement terminated upon the death of Mr. Schwartzberg on October 30, 2022. +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2022, we made contributions of $2,000,000 to the Foundation. +We recently determined that certain personal expenses incurred by Robert Greenberg, Michael Greenberg and David Weinberg were either not billed to them in a timely manner or otherwise were not previously repaid to us. These Named Executive Officers reimbursed us for the identified personal expenses and the Additional Amounts, respectively, as follows: Robert Greenberg: $621,393 and $43,065 (for the years 2016-2022); Michael Greenberg: $389,218 and $93,135 (for the years 2015-2022); and David Weinberg: $44,415 and $7,686 (for the years 2017-2022). In addition, for Robert Greenberg, we identified a Skechers-owned real estate asset for which he reimbursed us an estimated fair market value rental charge of $486,360 and paid an Additional Amount of $21,742 for 2022 and 2021. See footnote 4 to the table in the section entitled “Executive Compensation–Adjustments to All Other Compensation” in this proxy statement for further explanation. +Jason Greenberg, Jeffrey Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $6,342,104, $128,429, $5,658,530 and $351,887, respectively, in 2022. Marlene Greenberg, who is Robert Greenberg’s sister, is a non-executive employee of Skechers, and she earned total compensation of $551,870 in 2022. Ms. Greenberg also earned total compensation of $486,790 in 2021, which was not previously reported. Chase Greenberg, who is the son of Michael Greenberg, is a non-executive employee of Skechers, and he earned total compensation of $211,058 in 2022. Andrew Bronstein, who is Michael Greenberg’s brother-in-law, is a non-executive employee of Skechers, and he earned total compensation of $121,757 in 2022. Mr. Bronstein also earned total compensation of $213,645 and $155,419 in 2020 and 2021, respectively, which was not previously reported. +Andrew Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $803,715 and $233,308, respectively, in 2022. +66 +The following table adjusts the total compensation previously reported in 2021, 2020, 2019 and 2018 for Jason Greenberg, Jeffrey Greenberg, Joshua Greenberg, Jennifer Greenberg Messer and Andrew Weinberg. +Name +Year +Total +Compensation +Previously +Reported ($) +Additional +Health +Insurance +Premiums ($)(1) +Automobile +Insurance +Premiums ($)(2) +Total +Compensation +As +Adjusted ($) +Jason Greenberg +2021 +4,146,195 +2,322 +— +4,148,517 +2020 +3,395,951 +2,302 +— +3,398,253 +2019 +4,540,542 +2,246 +— +4,542,788 +2018 +3,276,757 +2,361 +— +3,279,118 +Jeff Greenberg +2021 +319,738 +8,667 +— +328,405 +2020 +322,232 +8,596 +— +330,828 +2019 +257,010 +8,396 +— +265,406 +2018 +349,842 +8,729 +— +358,571 +Joshua Greenberg +2021 +3,407,625 +3,782 +2,053 +3,413,460 +2020 +2,605,044 +3,752 +— +2,608,796 +2019 +3,867,611 +3,724 +— +3,871,335 +2018 +2,738,616 +4,511 +— +2,743,127 +Jennifer Greenberg Messer +2021 +338,830 +8,667 +3,933 +351,430 +2020 +354,239 +8,596 +— +362,835 +2019 +350,389 +8,396 +— +358,785 +2018 +357,312 +8,729 +— +366,041 +Andrew Weinberg +2021 +967,038 +8,667 +— +975,705 +2020 +496,669 +8,596 +— +505,265 +2019 +811,869 +8,396 +— +820,265 +2018 +363,422 +8,729 +— +372,151 +(1) +Represents health insurance premiums paid by us on behalf of these individuals in excess of the health insurance premiums that we typically pay on behalf of all salaried employees participating in the same plans with identical benefits. +(2) +Represents auto insurance premiums paid by us on behalf of Joshua Greenberg and Jennifer Greenberg Messer. \ No newline at end of file diff --git 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0001065837 us-gaap:AccumulatedOtherComprehensiveIncomeMember 2022-01-01 2022-12-31 skx:Derivative skx:Customer xbrli:pure xbrli:shares iso4217:CNY iso4217:USD xbrli:shares iso4217:USD +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2023 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2023, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 7.3 billion based upon the closing price of $52.66 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 21, 2024: 133,094,103 . +The number of shares of Class B Common Stock outstanding as of February 21, 2024: 20,181,683 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2024 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +Form 10-K +Table of Contents +PART I +Item 1 +Business +2 +Item 1A +Risk Factors +6 +Item 1B +Unresolved Staff Comments +14 +Item 1C +Cybersecurity +14 +Item 2 +Properties +15 +Item 3 +Legal Proceedings +17 +Item 4 +Mine Safety Disclosures +17 +PART II +Item 5 +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +19 +Item 6 +[Reserved] +19 +Item 7 +Management’s Discussion and Analysis of Financial Condition and Results of Operations +20 +Item 7A +Quantitative and Qualitative Disclosures About Market Risk +25 +Item 8 +Financial Statements and Supplementary Data +26 +Item 9 +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +48 +Item 9A +Controls and Procedures +48 +Item 9B +Other Information +51 +Item 9C +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +51 +PART III +Item 10 +Directors, Executive Officers and Corporate Governance +51 +Item 11 +Executive Compensation +51 +Item 12 +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +51 +Item 13 +Certain Relationships and Related Transactions, and Director Independence +51 +Item 14 +Principal Accountant Fees and Services +51 +PART IV +Item 15 +Exhibit and Financial Statement Schedules +52 +Item 16 +Form 10-K Summary +56 +Signatures +57 +i +S pecial Note on Forward-Looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our future performance. Factors that might cause or contribute to such differences include: +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +global economic, political and market conditions including the effects of inflation and foreign currency exchange rate fluctuations around the world, the challenging consumer retail market in the United States (“U.S.”) and the impact of war and other conflicts around the world; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; and +• +our ability to manage the impact from delays and disruptions in our supply chain. +The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and state securities laws. +1 +PART I +Item 1. Business +DESCRIPTION OF BUSINESS +Skechers U.S.A., Inc., designs, develops and markets a diverse range of footwear, apparel, and accessories. Our company was incorporated in California in 1992 and reincorporated in Delaware in 1999. For over 30 years, we have expanded our product offering and grown our sales while substantially increasing the breadth of our consumer and customer base. Our objective is to profitably grow our operations worldwide by delivering stylish, comfortable, innovative and high-quality products at a reasonable price. +Skechers is the third largest athletic footwear company in the world due to our innovative comfort technology products, supported by impactful marketing, a diverse distribution strategy, and a dedicated global employee base and loyal network of partners. +In this annual report on Form 10-K for the fiscal year ended December 31, 2023, Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, are referred to as “Skechers,” “the Company,” “we,” “us,” or “our.” Reference in this annual report to “sales” refers to Skechers net sales reported under U.S. generally accepted accounting principles. +SEGMENTS +We have two reportable segments: Wholesale and Direct-to-Consumer. +Wholesale . Our Wholesale segment is comprised of sales to a network of partners including: +• +Skechers-branded stores operated by third-party franchisees and licensees; +• +Family shoe stores, specialty athletic and sporting goods retailers, department stores and big box club stores; and +• +Distributors in select international markets. +Growth in the Wholesale segment is expected to derive from adding new partners, more Skechers-branded stores, as well as expanding our existing shelf-space with current partners from the introduction of new products. +Direct-to-Consumer . Our Direct-to-Consumer segment comprises sales by us directly to consumers through a combination of channels including: +• +Company-owned Skechers-branded stores; +• +Company-owned e-commerce sites; and +• +Leading third-party marketplaces and digital platforms. +Growth in the Direct-to-Consumer segment is expected to derive from expanding our footprint, leveraging third-party digital marketplaces and platforms and introducing new products. +PRODUCTS +Skechers is a product-driven company and innovation is at the core of our design process. We offer footwear, apparel, and accessories for men, women, and kids. We market our products at multiple price points and provide consumers with products that we believe offer superior in comfort technology. +Product design and development is essential to our success and is driven by our ability to recognize trends and to design products that anticipate and accommodate consumers’ evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media. We also consult with our customers on current retail selling trends and collaborate with partners and ambassadors to ensure that our products are designed to address the intended market opportunity and convey the distinctive perspective and lifestyle associated with our brand. A key component of our design philosophy is to continually reinterpret and improve our most successful styles. +Footwear. We offer a comprehensive line of Skechers-branded performance and lifestyle footwear for men, women, and kids – with the Company’s signature comfort features and innovations. We develop footwear for all walks of life: athletes at all levels, everyday comfort needs, as well as occupational requirements. Our footwear categories include the following: +• +Lifestyle – Forward, innovative and on trend, the brand’s fashion, athleisure, and casual collections inspire millions to enjoy the style, comfort and quality synonymous with Skechers. Our lifestyle offering delivers comfort technologies such as Skechers Hands Free Slip-ins®, Skechers Arch Fit®, and Skechers Air-Cooled Memory Foam®, among others. With a street, fashion and court classic range, Skechers is able to reach a younger demographic. +2 +• +Performance – Winner of numerous awards, the Skechers Performance collection offers elite athletes and enthusiast groundbreaking technologies for running, walking, golf, and pickleball, as well as two new additions in 2023 – football and basketball. The Skechers Performance division develops footwear utilizing the latest advancements in materials and innovative design, including Skechers Hyper Burst®, Goodyear ® Resagrip Technology, and Skechers Arch Fit®. To support and market our Performance footwear, we have a roster of elite athletes, including Harry Kane, Europe's top football scorer for 2023 and captain of the England national team; NBA stars Julius Randle and Terance Mann; Major golfers Matt Fitzpatrick and Brooke Henderson; and pickleball pros Tyson McGuffin and Catherine Parenteau. +• +Kids – Skechers appeals to kids with bright and bold colors and designs and are made with the latest comfort features specific to growing children’s feet. Along with unique styles just for children like S-Lights, Skechers Kids also includes take-downs of our most popular products, including Skech-Air, Foamies, Skechers Hands Free Slip-ins, Skechers Stretch Fit, and Skechers Street. +• +Work – A leading work brand in the United States, Skechers Work is made to last – offering service and occupational employees style, comfort and industry certified quality for all-day protection. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe shoes and boots for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology. +• +Earth-Friendly – Skechers Our Planet Matters line is made with recycled materials to help reduce our environmental impact. An important part of our product innovation process includes seeking out new material and textile technologies to improve upon the recycled content in Our Planet Matters products. +Apparel . We offer the latest trends in athletic lifestyle apparel. Our collections are designed to complement our footwear products, by offering apparel that is stylish, high-quality and comfortable all at a reasonable price. +Accessories . Skechers licenses a variety of Skechers-branded products including socks, eyewear; medical scrubs; undergarments, fitness and yoga accessories, and cold weather products. +TRADEMARKS, PATENTS AND LICENSING +We own and utilize a variety of trademarks, including the Skechers trademark. We consider our Skechers trademark a significant factor in building our brand image and in distinguishing our products from those of others. We vigorously protect our trademarks against infringement, including through the use of cease-and-desist letters, administrative proceedings and lawsuits. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 164 foreign countries. Further, we have design patents and pending design and utility patent applications in both the U.S. and a myriad of foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally. +We believe that selective licensing of the Skechers brand name to manufacturers broadens and enhances the brand without requiring incremental capital investments or operating expenses. As of December 31, 2023, we had 28 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel and accessories. +MARKETING +Brand recognition is an important element for success in the footwear business. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. We aggressively market our brands through comprehensive marketing campaigns. The Skechers brand is supported by television, digital, print, radio, outdoor, and press campaigns. To further drive recognition, we enlist numerous celebrities, athletes, and influencers to appear in our campaigns. We strategically select our ambassadors who we believe work well with the Company to promote the brand and support the product. +In 2023, our brand ambassadors included television personalities and entertainers Martha Stewart, Snoop Dogg, Amanda Kloots, Brooke Burke, and Chesca, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Meb Keflezighi, and Rusty Wallace. Additionally, athletes supporting our performance footwear included runner Edward Cheserek, elite golfers Matt Fitzpatrick and Brooke Henderson, pro pickleball players Tyson McGuffin and Catherine Parenteau, and Los Angeles Dodgers pitcher Clayton Kershaw. During the year, we partnered with NBA pros Julius Randle and Terance Mann, and Bayern Munich's Harry Kane, as well as a team of premier league players to support our new basketball and football divisions. We identify athletes who benefit from the comfort and technologies that our brand has to offer, and whose performance on the field, court, or course is augmented through the product. +3 +SOURCING AND MANUFACTURING +Our suppliers are integral partners in delivering stylish, high-quality footwear and apparel to our consumers worldwide. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. To minimize disruption of our product supply due to potential political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +To safeguard product quality and consistency, we monitor the key aspects of production from initial prototype manufacturing, through initial production runs, to final manufacturing. Monitoring of production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. +We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production and ensure that leading manufacturers comply with our Supplier Code of Conduct. +OUR MARKET +Our collections are available in approximately 180 countries and territories and can be accessed in digital or physical stores. We are continually expanding and enhancing our distribution and logistics facilities and systems to support our omni-channel capabilities and provide greater access to merchandise selection and faster delivery. Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which continues to improve our customer service and brand experience. We manage our international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. Our joint venture interests include China, Malaysia and Singapore (50%), Thailand (51%), Mexico (60%), and South Korea (65%), and Israel (75%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores, as well as in Skechers-branded retail stores. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to our entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers, and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We believe, however, that we have competitive advantages because of our brand recognition, our quality comfort technology products, and our application of pricing and distribution strategies, among other factors. +HUMAN CAPITAL +Skechers employees are central to our success. We are a family brand at the core, and our commitment to family extends to our diverse team of global employees. We believe our unique backgrounds and experiences have made us stronger, inspired new ideas, and driven our innovative spirit. From our corporate offices to our retail stores and our distribution centers, we aim to build a workplace that supports each employee’s well-being and encourages everyone to grow in their careers and give back to their community. We are focused on creating a positive, supportive work environment where our team can work and feel their best every day. +Employees . As of December 31, 2023, we employed approximately 17,900 persons worldwide, of whom approximately 9,200 were employed on a full-time basis and approximately 8,700 were employed on a part-time basis, primarily in our retail stores. +Compensation and Benefits. We seek to provide market-competitive compensation and benefits that not only attract the best talent, but also retain our current employees. We offer a broad range of benefits including medical, prescription, dental and vision plans, flexible spending accounts, company-provided disability insurance, pet insurance, paid sick and vacation time, employee assistance program, childcare subsidies, parental leave and tuition reimbursement. Additional benefits for certain employees include a 401K plan, 529 college savings plan, pensions and pet insurance. +4 +Diversity, Equity, and Inclusion. Skechers was founded on inclusivity, diversity, respect, and entrepreneurial spirit with the philosophy of putting people first. In conjunction with our corporate policy against discrimination, Skechers emphasizes that every employee, applicant, contractor, and customer is entitled to be treated with dignity and respect. Human rights are a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify our commitment to these values. These codes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at investors.skechers.com/corporate-governance/governance-documents. We intend to post any amendment to, or waivers of, these codes on our website. +CORPORATE RESPONSIBILITY +Despite the dynamic growth we have seen over the years, we remain firmly rooted in the same community where we began while dedicated to serving the people of the world. In so doing, we take seriously our position as a steward of the many communities and stakeholders we impact in our daily business activities. This increasingly involves considering the multiple ways we can evolve our business practices and processes to improve the health of our planet, the lives of our people and our communities. Corporate responsibility is a top priority for our leadership, who are investing in plans to further our environmental, social and governance ("ESG") efforts. +Sustainability . We believe it is our responsibility as a family-focused footwear and apparel brand to create and implement sustainable strategies across our operations to minimize our impact on the environment and support our customers, employees, and partners. Environmental advancements are a top priority in the development of our corporate offices as well as logistic centers. Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. Additionally, our China Distribution Center in Taicang incorporates sustainable features such as natural lighting, LED motion detectors and temperature controllers; and our newly opened India Distribution Center outside Mumbai is designed as a LEED building with certification pending. +In 2021, we introduced Our Planet Matters, a collection for men, women and kids that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interests and commitment to reduce tree harvesting and emissions through packaging. These efforts represent our growing focus on more environmentally sustainable manufacturing, packaging, distribution, product development, corporate processes, and activities. +Human Rights. We require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. This code outlines our policies and expectations on topics including discrimination, harassment and abuse, forced labor, freedom of association, compensation and benefits, and health and safety, among others. +Community . Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2023, we donated more than $1.1 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. +For additional information on how Skechers value creation and global impact, refer to our Impact Report which can be found on our website at about.skechers.com/social-responsibility. +AVAILABLE INFORMATION +We file annual, quarterly, and current reports, proxy statements and other documents with the Securities and Exchange Commission (“SEC”). The SEC maintains an internet site at sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Our internet address is www.skechers.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information are also made available, free of charge, on our investor relations website at investors.skechers.com as soon as reasonably practicable after we file or furnish with the SEC. The information found on, or otherwise accessible through our website, is not incorporated into, and does not form a part of this annual report on Form 10-K or our other filings with the SEC. +5 +Item 1A. Risk Factors +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +RISKS RELATED TO OUR BUSINESS AND INDUSTRY +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has largely been due to the strength of the Skechers brand. Maintaining, promoting, and growing our brand depends on our ability to develop high-quality, innovative, and fashion forward products, as well as our ability to create fresh and relevant marketing and advertising campaigns. The inability to execute or adverse developments in these areas could negatively impact our brand. Our brand could also be negatively impacted if we or any of our products were to receive negative publicity. If we are unable to maintain, promote and grow our brand, then our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Future Success Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear requires us to accurately identify changing consumer preferences and effectively respond in a timely manner. Demand for and market acceptance of existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +execution of product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends. +We are often required to make decisions about product designs and marketing expenditures several months in advance of when consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences with new products that achieve market acceptance. If we fail to identify and effectively respond to changing consumer preferences, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +We Face Intense Competition, Including Competition From Companies In The Footwear Industry and With Significantly Greater Resources Than Ours. +We face intense competition from other established companies in the footwear industry in the areas of product offerings, pricing, costs of production, and advertising and marketing expenditures. Consumer demand for our products may decline significantly if we do not adequately and timely anticipate and respond to our competitors. Some of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on price and production, more effectively keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially and adversely affect our business, financial condition, results of operations, and cash flows. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, new stores could be opened in regions in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those we encounter in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, any new store openings in existing markets could result in reduced sales in existing stores in those markets. We may decide to close stores that experience sales declines, which could result in additional costs, expenses, asset impairments or asset write-downs. +6 +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory, and personnel. We have also made significant operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, the poor performance or closure of stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to digital and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially and adversely affect our business, financial condition, results of operations, and cash flows. +Our Retail Stores Depend On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +We have concept stores in shopping malls and factory outlet stores in outlet malls. We depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. The overall success of the malls can be negatively impacted by factors outside of our control, such as store closures by other retailers. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Tourism can be adversely affected by external factors such as an economic slowdown or social or political events. Any substantial decrease in customer traffic generated by malls or tourism has, and may continue to have, an adverse effect on sales in our existing stores or hinder our ability to open retail stores in new markets, which could materially and adversely affect our business, financial condition, results of operations, and cash flows. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Key Personnel, Our Business Could Be Harmed. +We depend upon the continued services of key personnel, including Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. We also depend on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. The loss of the services of senior management and other key personnel or the failure to attract additional personnel and execute a succession plan could materially and adversely affect our business, financial condition, results of operations, and cash flows. +We Have A Significant Work Force And Are Subject To Risks Related To Human Capital Management. +We employ approximately 17,900 employees worldwide and a significant portion of our operating expenses relate to compensation and benefits. Although we spend a significant amount of time and expense on human capital management, we cannot ensure that we will be able to maintain a happy and productive workforce. If we are unable to offer competitive compensation and benefits, appropriate training and development, and a compelling work environment or sustain employee satisfaction, our culture may be adversely affected, our reputation may be damaged, and we may incur costs related to turnover. +RISKS RELATED TO SUPPLY CHAIN +Our Business Could Be Harmed If We Fail To Maintain Appropriate Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive customer orders. We do this to minimize purchasing costs, the time necessary to fill customer orders, and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Unanticipated declines in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast demand, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels exceeding customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply products when we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +7 +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Manufacture Or Sell Our Products, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all our sales during the year ended December 31, 2023 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in several foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; changes in domestic and foreign governmental policies; and the potential for circumstances where we may have to incur premium freight charges to expedite the delivery of product to our customers. Apart from the impacts of the COVID-19 pandemic, including supply chain constraints, we have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, financial condition, results of operations, and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in China. The government of the China has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate under China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of China has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of China will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the government of China could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During the year ended December 31, 2023, the top five manufacturers of our products produced approximately 45.7% of our total purchases. One manufacturer accounted for 21.4% of total purchases for the year ended December 31, 2023. +We compete with other footwear companies for production facilities, and we do not have long-term contracts with any of our contract manufacturers. Under our current arrangements with them, these manufacturers generally may unilaterally terminate their relationship with us at any time. If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our footwear is delayed or becomes more expensive, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistics and distribution systems include computer-controlled and automated equipment, which may be subject to risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all our products are distributed from a few locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the potential adverse effects of significant disruptions to our distribution system, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales, and achieve operating efficiencies could be materially adversely affected. +8 +RISKS RELATED TO ECONOMIC AND POLITICAL CONDITIONS, AND OTHER EXTERNAL FACTORS +The Uncertainty Of Global Market Conditions. +The uncertain state of global economic and political conditions, including the impact of inflation and challenging consumer retail market, may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending. If the economic situation weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. +The impact of wars, acts of war and other conflicts around the world may result in subsequent economic sanctions imposed by the U.S., NATO and other countries. Conflicts may impact global economic conditions or our ability to sell products to customers in the affected regions. Conflicts could also have broader implications on economics outside the directly impacted regions, such as the global inflationary impact of a potential boycott of Russian oil and gas by other countries. Furthermore, any unfavorable developments in global political, social and regulatory conditions, including geopolitical conflicts, political unrest, civil strife, terrorist activity, acts of war, public corruption, expropriation, nationalism and other economic or political uncertainties in the U.S. or internationally, could also impact our business. Any negative sentiment toward the U.S. as a result of any such developments could also adversely affect our business and reputation. If the uncertain global market conditions continue for a significant period or worsen, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Our Customers Due To Global Economic Conditions. +A global financial crisis could affect the banking system and financial markets and result in a tightening in the credit markets, more stringent lending standards and terms, higher inflation, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely materially and adversely affect our business, financial condition, results of operations, and cash flows. +Our Sales Are Influenced By Economic Conditions And Uncertainty That Impact Consumer Spending And Consumer Confidence. +Consumer confidence and spending on discretionary items generally declines during periods of economic uncertainty or recession. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and/or increasing promotional activity. Our retail stores are also affected by these conditions and may experience declines in consumer traffic and spending. As a result, factors that diminish consumer confidence and spending, particularly deterioration in general economic conditions, consumer credit availability, consumer debt levels, inflation, the impact of foreign exchange fluctuations on tourism and tourist spending, volatility in investment returns, fear of unemployment, increases in energy costs or taxes or interest rates, housing market downturns, fear about and impact of pandemic illness, and other factors such as acts of war, natural disasters or terrorist or political events that impact consumer confidence, have had, and may continue to have a material adverse effect on our operations and financial condition through their negative impact on our wholesale customers as well as decreased spending in our retail stores and potentially via our e-commerce business. +Natural Disasters, The Effects Of Climate Change, Pandemics, And Other Events Beyond Our Control. +Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce, and the global economy, and thus could have a negative effect on us. Our business operations are subject to interruption from earthquakes, hurricanes, tornadoes, floods, fires, extreme weather events, power shortages, pandemics, telecommunications failure, vandalism, cyber-attacks, the effects of climate change, and other events beyond our control. Although we maintain disaster recovery plans, such events could disrupt our operations or those of our customers and suppliers, including through the inability of employees and contract professionals to work, destruction of facilities, loss of life, and adverse effects on supply chains, power, infrastructure and the integrity of information technology ("IT") systems, all of which could materially increase our costs and expenses, delay or decrease revenue from our customers and disrupt our ability to maintain business continuity. We could incur significant costs to improve the climate-related resiliency of our infrastructure and otherwise prepare for, respond to, and mitigate the effects of climate changes. Our insurance may not be sufficient or cover losses or additional expenses that we may sustain. A significant natural disaster or other event that disrupts our operations or those of our customers or suppliers could have a material adverse effect on our business, results of operations, financial condition. +9 +Adverse Conditions Or Changes In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales. +A substantial portion of our operations are in California, including 100 of our retail stores, our headquarters in Manhattan Beach, and our North America distribution center in Rancho Belago. A decline in the economic conditions, or increase in regulations or the cost of doing business in California could have a material adverse impact on our business. Furthermore, a natural disaster or other catastrophic event in California, such as an earthquake or wildfire, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Foreign Currency Exchange Rate Fluctuations. +Foreign currency fluctuations affect our sales and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for us, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A: “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars, which causes the cost of those products to vary depending on the foreign currency exchange rates and impacts the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our sales and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency exchange rates. Although we typically work to mitigate the impact of exchange rate fluctuations through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts, as changes in the value of the U.S. dollar relative to other currencies could materially and adversely affect our business, financial condition, results of operations, and cash flows. +RISKS RELATED TO ENVIRONMENT, SOCIAL, AND GOVERNANCE +Our Environmental, Social And Governance Commitments and Disclosures May Expose Us To Reputational Risks And Legal Liability. +Our brand and reputation are associated with our public commitments to various corporate ESG initiatives, including our goals relating to sustainability and diversity and inclusion. Our disclosures on these matters and any failure or perceived failure to achieve or accurately report on our commitments, could harm our reputation and adversely affect our client relationships or our recruitment and retention efforts, as well as expose us to potential legal liability. Increasing focus on ESG matters has resulted in, and is expected to continue to result in, the adoption of legal and regulatory requirements designed to mitigate the effects of climate change on the environmental, as well as legal and regulatory requirements requiring climate-related disclosures. If new laws or regulations are more stringent than current legal or regulatory requirements, we may experience increased compliance burdens and costs to meet such obligations. Our selection of voluntary disclosure frameworks and standards, and the interpretation or application of those frameworks and standards, may change from time to time or may not meet the expectations of investors or other stakeholders. Our processes and controls for reporting ESG matters across our operations and supply chain are evolving along with multiple disparate standards for identifying, measuring, and reporting ESG metrics, including ESG-related disclosures that may be required by the SEC, European and other regulators, and such standards may change over time, which could result in significant revisions to our current goals, reported progress in achieving such goals, or ability to achieve such goals in the future. +RISKS RELATED TO LEGAL AND REGULATORY MATTERS +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions. +Our products manufactured overseas and imported into the U.S., the European Union and other countries are subject to customs duties. We are unable to predict whether there may be unfavorable changes in tax laws in the U.S. or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on our sales and results of operations. +In addition, changes in the tax laws of foreign jurisdictions could arise as a result of the base erosion and profit shifting project that was undertaken by the Organization for Economic Cooperation and Development (“OECD”). The OECD, which represents a coalition of member countries, recommended changes to long-standing tax principles related to transfer pricing and has developed model rules including establishing a global minimum corporate income tax tested on a jurisdictional basis (the “Pillar Two”). Many jurisdictions have adopted or announced an intention to adopt Pillar Two for tax years beginning in 2024. There can be no assurance that our effective tax rate, tax payments or conditional reduced tax rates will not be adversely affected as countries independently amend their tax laws to adopt Pillar Two. Changes in U.S. or foreign tax laws, including new or modified guidance with respect to existing tax laws, could materially and adversely affect our business, financial condition, results of operations, and cash flows. +10 +Changes To U.S. Or Other Countries’ Trade Policies And Import/Export Regulations Or Our Failure To Comply With Such Regulations. +Changes in laws and policies governing foreign trade, manufacturing, development and investment in the territories or countries where we currently sell our products or conduct our business could adversely affect our business. U.S. presidential administrations have instituted or proposed changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes. +In addition, changes or proposed changes in U.S. or other countries' trade policies may result in restrictions and economic disincentives on international trade. Tariffs and other changes in U.S. trade policy have in the past and could in the future trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing retaliatory measures on certain U.S. goods. Further, any emerging protectionist or nationalist trends either in the U.S. or in other countries could affect the trade environment. The Company, similar to many other multinational corporations, does a significant amount of business that would be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact the U.S. economy or certain sectors thereof or the economy of another country in which we conduct operations, our industry and the global demand for our products, and as a result, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the U.S., it could result in adverse publicity for us, damage our reputation in the U.S., or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation and investigations, and we are unable to determine the extent of any liability that may arise from any such matters. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation and investigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation or investigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future matters could materially and adversely affect our business, financial condition, results of operations, and cash flows. +11 +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our ® , ® , ® , ® , ® , Skechers ® , Skechers Slip-ins ® , Skechers Hands Free Slip-ins ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers Viper Court Pro™, Ultra GO ® , Skechers on-the-GO ® , Skechers Cali ® , Skechers Street™, Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Skechers Outdoor™, Max Cushioning ® , Massage Fit ® , Mark Nason ® , Skechers Modern Comfort ® , D’Lites ® , BOBS ® , BOBS Sport™, Our Planet Matters ® , Glide Step ® , Skech-Air ® , Skechers Kids™, Twinkle Toes ® , S Lights ® , Relaxed Fit ® , Arch Fit ® , Hyper Burst ® , and Air-Cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and utility patents covering components and features used in various shoes. We believe that our patents and trademarks are sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been involved with litigation in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the U.S. We cannot be assured that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of counterfeit products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +RISKS RELATED TO INFORMATION SYSTEMS AND DATA SECUITY +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Disruption Of Our Business And Damage To Our Reputation +As a routine part of our business, we utilize information security and IT systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry, has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. +12 +Privacy Breaches And Other Cyber Security Risks Related To Our Business Could Negatively Affect Our Reputation, Credibility And Business. +We are dependent on IT systems and networks for a significant portion of our direct-to-consumer sales, including our e-commerce sites and retail business credit card transaction authorization and processing. We are responsible for storing data relating to our customers and employees and also rely on third-party vendors for the storage, processing and transmission of personal and Company information. Consumers, lawmakers and consumer advocates alike are increasingly concerned over the security of personal information transmitted over the Internet, consumer identity theft and privacy and the retail industry, in particular, has been the target of many recent cyber-attacks. We generally require that third-party service providers implement reasonable security measures to protect our employees’ and customers’ identity and privacy, but we do not control these third-party service providers and cannot guarantee the elimination of electronic or physical computer break-ins or security breaches in the future. Cybersecurity breaches, including physical or electronic break-ins, security breaches due to employee error or misconduct, attacks by “hackers,” phishing scams, malicious software programs such as viruses and malware, and other breaches outside of our control, could result in unauthorized access or damage to our IT systems and the IT systems of our third-party service providers. Despite our efforts and the efforts of our third-party service providers to secure our and their IT systems, attacks on these systems do occur from time to time. As the techniques used to obtain unauthorized access to IT systems become more varied and sophisticated (as cyber criminals are finding new ways to launch their attacks) and if the occurrence of such security breaches becomes more frequent, we and our third-party service providers may be unable to adequately anticipate these techniques and implement appropriate preventative measures. There can be no assurance that our cybersecurity risk management program and processes, including our policies, controls or procedures, will be fully implemented, complied with or effective in protecting our systems and information. While we maintain cyber risk insurance to provide some coverage for certain risks associated with cybersecurity incidents, there is no assurance that such insurance would cover all or a significant portion of the costs or consequences associated with a cybersecurity incident. A significant breach of customer, employee or Company data could damage our reputation, our relationship with customers and our brands, and could result in lost sales, sizable fines, significant breach-notifications and other costs and lawsuits, as well as adversely affect our results of operations. +Additionally, we may incur increased costs and experience a significant strain on our resources to account for implementation of additional required security measures and technologies to protect personal data and confidential information or to comply with current and new state, federal and international laws governing the unauthorized disclosure of confidential information which are continuously being enacted and proposed, such as the General Data Protection Regulation in the EU, various consumer privacy and data privacy and protection acts in the United States, including, but not limited to, the American Data Privacy and Protection Act, the California Consumer Privacy Act and the California Privacy Rights Act, the Virginia Consumer Data Protection Act, the Colorado Privacy Act, the Utah Consumer Privacy Act, the Connecticut Data Privacy Act and the Iowa Consumer Data Protection Act, and the Personal Information Protection Law in China. +Increased scrutiny by federal regulators, such as the Federal Trade Commission, and state attorney generals focused on the retail industry may lead to increased privacy and cybersecurity costs such as organizational changes, deploying additional personnel, acquiring and implementing enhanced privacy and security technologies on e-commerce sites, mandatory employee training for those handling customer and employee personal data, and engaging third-party experts and consultants, and the unauthorized use of proprietary information may materially and adversely affect our business, financial condition, results of operations, and cash flows. +A Material Delay Or Disruption In Our Information Technology Systems Or E-Commerce Websites Or Our Failure Or Inability To Upgrade Our Information Technology Systems Precisely And Efficiently Could Negatively Affect Our Business. +We rely extensively on our IT systems to track inventory, manage our supply chain, record and process transactions, manage customer communications, summarize results and manage our business. The failure of our IT systems to operate properly or effectively, problems with transitioning to upgraded or replacement systems, or difficulty in or failure to implement new systems, could adversely affect our business. We also operate a number of e-commerce websites throughout the world. Our IT systems and e-commerce websites may be subject to damage and/or interruption from power outages, computer, network and telecommunications failures, malicious software, such as viruses and malware, attacks by “hackers”, security breaches, usage errors or misconduct by our employees and bad acts by our customers and website visitors which could materially adversely affect our business. +We are undergoing a multi-year Enterprise Resource Planning (“ERP”) implementation. The implementation of the ERP will require a significant investment in human and financial resources. Implementing new systems also carries substantial risk, including failure to operate as designed, failure to properly integrate with other systems, potential loss of data or information, cost overruns, implementation delays and disruption of operations. Third-party vendors are also relied upon to design, program, maintain and service our ERP implementation program. Any failures of these vendors to properly deliver their services could similarly have a material adverse effect on our business. In addition, any disruptions or malfunctions affecting our ERP implementation plan could cause critical information upon which we rely to be delayed, defective, corrupted, inadequate, inaccessible or lost or otherwise cause delays or disruptions to our operations, and we may have to make significant investments to fix or replace impacted systems. +13 +RISKS RELATED TO OUR STOCK AND STOCK PRICE +Our Quarterly Sales And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Fluctuations In Demand For Footwear, Delivery Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly sales and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts and from time to time cancel orders, change delivery schedules, or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. Furthermore, our expenses are partially based on our expectations of future sales, and we may be unable to adjust spending in a timely manner to compensate for any unexpected sales shifts. As a result, our expenses may be disproportionately large relative to our sales, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter. Any quarterly fluctuations in our annualized tax rate could have a material impact on our quarterly operating results and the results for any one quarter may not be indicative of results for the full year. Any shortfall in sales or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +One Principal Stockholder Is Able To Control Substantially All Matters Requiring Approval By Our Stockholders And His Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2023, Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 89.0% of our outstanding Class B Common Stock, and members of Mr. Greenberg’s immediate family beneficially owned an additional 10.2% of our outstanding Class B Common Stock. The holders of Class A Common Stock and Class B Common Stock have identical rights except that holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As of December 31, 2023, Mr. Greenberg beneficially owned 53.3% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 59.9% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Mr. Greenberg is able to exert significant control over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Mr. Greenberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A Common Stock. Because Mr. Greenberg’s interests may differ from the interests of the other stockholders, his ability to substantially control, actions requiring stockholder approval, may result in our Company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A Common Stock to the extent that investors or any potential future purchaser view the voting rights of our Class B Common Stock to have superior value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +Item 1B. Unresolved Staff Comments +None. +I tem 1C. Cybersecurity +CYBERSECURITY RISK MANAGEMENT AND STRATEGY +We recognize the critical importance of maintaining the safety and security of our systems and data and have a holistic process for overseeing and managing cybersecurity and related risks. This process is supported by both management and our Board of Directors. +We have developed and implemented a Cybersecurity Risk Management Program intended to protect the confidentiality, integrity, and availability of our critical systems and information. Our cybersecurity risk management program includes a cybersecurity incident response plan. +14 +We leverage industry standard frameworks such as the National Institute of Standards and Technology Cybersecurity Framework (“NIST CSF”) and Center for Internet Security (“CIS”) to inform how we identify, assess, and manage cybersecurity risks relevant to our business. +Our Cybersecurity Risk Management Program includes: +• +risk assessments designed to help identify material cybersecurity risks to our critical systems, information, products, services, and our broader enterprise IT environment; +• +a security team principally responsible for managing (1) our cybersecurity risk assessment processes, (2) our security controls, and (3) our response to cybersecurity incidents; +• +cybersecurity awareness training of our employees, and incident response personnel; +• +a cybersecurity incident response plan that includes procedures for responding to cybersecurity incidents; +• +a third-party risk management process for service providers, suppliers, and vendors; and +• +engage third parties for our 24/7 monitoring, detection, and response; regular penetration testing, program controls assessment, and proactive incident preparedness activities. +We have not identified risks from known cybersecurity threats, including as a result of any prior cybersecurity incidents, that have materially affected or are reasonably likely to materially affect us, including our operations, business strategy, results of operations, or financial condition. +Cybersecurity Governance +Our Board of Directors is responsible for overseeing our enterprise risk management activities in general, and each of our Board committees assists the Board in the role of risk oversight. Our Senior Vice President (“SVP”) of Information Technology and the Senior Director of Information Security have overall responsibility for assessing and managing our material risks from cybersecurity threats. To help ensure effective oversight, the Audit Committee receives reports on information security and cybersecurity at least annually, and receives an update quarterly on information security and cybersecurity from materials provided by the Senior Director of Information Security. +The Senior Director of Information Security oversees the Information Security Steering Committee (“Steering Committee”), which provides education on the Company’s cybersecurity programs and controls to key members of the Company. The Steering Committee meets quarterly and is comprised of members from the Executive Leadership Team, including the Chief Financial Officer and Executive Vice President of Business Affairs, as well as the SVP of Information Technology, Senior Director of Information Security, VP of Corporate Communications, SVP of Digital Innovation, and Head of Global Human Resources. +Cybersecurity risk management is led by our SVP of Information Technology, who reports to our Chief Operating Officer, and generally is responsible for management of cybersecurity risk and the protection and defense of our networks and systems. The SVP of Information Technology manages a team of cybersecurity professionals with broad experience, including in cybersecurity threat assessments and detection, mitigation technologies, cybersecurity training, incident response, cyber forensics, insider threats and regulatory compliance. +We continue to invest in cybersecurity and resiliency of our networks and adapt our internal controls and processes, which are designed to help protect our systems and infrastructure, and the information they contain. For more information regarding the risks we face from cybersecurity threats, please see Item 1A Risk Factors. +Item 2. Properties +CORPORATE HEADQUARTERS +Skechers Corporate Headquarters are located at several properties in or near Los Angeles, California, which consist of an aggregate of approximately 0.2 million square feet. We own and lease portions of our corporate headquarters. +We lease most of our international administrative offices and showrooms located in the Americas, Europe and Asia Pacific. The property leases expire on various dates through February 2033. Corporate offices, administrative offices, and showrooms are included within our Wholesale segment. +15 +DISTRIBUTION FACILITIES +We believe that strong distribution is critical to our operations. Our distribution facilities include highly automated solutions to support our future growth in our Company. We regularly evaluate our distribution infrastructure and consolidate or expand our capacity as we believe appropriate for our operations. Our distribution facilities are included within our Wholesale segment. Our principal distribution facilities are as follows: +Americas. Our North America Distribution Center occupies approximately 2.6 million square feet on its main campus in Southern California, which is leased from a joint venture, HF Logistics-SKX (the “JV”). An additional 2.4 million square feet of distribution center space is leased from third parties. The main campus leases expire at various dates through August 2036, and the leases for the remaining space expire at various dates through May 2028. Additionally, our newly opened Canada Distribution Center occupies approximately 0.4 million square feet in British Colombia and the lease is set to expire in December 2032. +Europe, Middle East and Africa. Our European Distribution Center occupies approximately 2.2 million square feet in Liege, Belgium. The leases comprising this Distribution Center provide for original terms of 8 to 15 years. The property leases expire on various dates through April 2031. +Asia Pacific. Our China Distribution Center occupies approximately 1.6 million square feet in Taicang, China. We plan to further expand in this key market with the constructing of a second distribution center in China, which is expected to be an approximately 2.3 million square foot facility. Our Japan Distribution Center is approximately 0.9 million square feet. The lease is set to expire in October 2031. Additionally, we recently opened the first phase of our India Distribution Center which occupies approximately 0.8 million square feet outside of Mumbai and the lease is set to expire in October 2043. +We have additional Company-operated distribution centers as well as third-party distribution centers serving regional markets in the Americas, Europe and Asia Pacific. +COMPANY OWNED AND THIRD-PARTY STORES +In 2023, we surpassed 5,000 Skechers-branded retail store and now have 5,168 stores in 122 countries. The network of stores includes 1,648 Company-owned and 3,520 third-party locations. These third-party stores are distributor, licensed and franchise owned through our Wholesale segment. +Store count, openings and closings for our domestic, international, and third-party stores are as follows: +Number of locations +December 31, 2022 +Opened (1) +Closed (1) +December 31, 2023 +Domestic stores +539 +35 +(11 +) +563 +International stores +905 +268 +(88 +) +1,085 +Distributor, licensee and franchise stores +3,093 +841 +(414 +) +3,520 +Total Skechers stores +4,537 +1,144 +(513 +) +5,168 +(1) Includes the conversion of 58 third-party stores to International stores previously included in Distributor stores as a result of the acquisition of our Scandinavian distributor. +We pursue our direct-to-consumer strategy through our integrated retail formats, which enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. Our retail stores are included in our Direct-to-Consumer segment. Our physical retail formats are as follows: +Concept Stores. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as product testing venues. +Factory Outlet Stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise as well as feature key inline product. +Big Box Stores. Our free-standing and attached big box stores, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory. +Substantially all of our retail stores are leased with terms expiring through March 2038. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. +16 +Item 3. Legal Proceedings +Michael Conte v. Robert Greenberg, et al. – On July 21, 2022, Skechers and certain past and present members of the Board of Directors were sued by a stockholder on behalf of our company in a derivative action in the Chancery Court of the State of Delaware, Case No. 2022-0633, alleging breach of fiduciary duty, waste of corporate assets, breach of duty of candor and breach of contract in connection with certain executive officers’ personal use of two company-owned aircraft. The complaint seeks actual damages in favor of Skechers sustained as the alleged result of defendants’ alleged breaches of fiduciary duties, judgment directing our company to take all necessary actions to reform and improve its corporate governance practices, termination of certain executive officers for allegedly violating their employment agreements, judgment directing the sale of one of the company-owned aircraft and attorneys’, accountants’ and experts’ fees, costs and expenses. The defendants filed motions to dismiss the complaint. On February 2, 2024, the court granted the motions and thereafter dismissed the complaint with prejudice as to all named past and present director-defendants. On February 22, 2024, plaintiff filed a notice of appeal. We cannot predict the outcome of the appeal or any further related legal proceedings or whether an adverse result in such proceedings would have a material adverse impact on our results of operations or financial position. +Nike, Inc., v. Skechers USA, Inc. – On November 6, 2023, Nike filed an action against our company in the United States District Court for the Central District of California, Case No. 2:23-CV-09346, alleging that certain Skechers shoe designs infringe the claims of six Nike utility patents that purportedly cover Nike’s Flyknit technologies. Nike seeks injunctive relief, damages (including treble damages), pre-judgment and post-judgment interest, and costs. On January 12, 2024, we answered Nike’s complaint, denying the allegations, and filed counterclaims seeking declarations of invalidity of the asserted patents, and non-infringement. While it is too early to predict the outcome of the District Court proceedings or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this matter vigorously. +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation and investigations, and we are unable to determine the extent of any liability that may arise from any such matters. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation and investigations is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against the Company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +Item 4. Mine Safety Disclosures +Not applicable. +17 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Our Class A Common Stock trades under the symbol “SKX” on the New York Stock Exchange. +HOLDERS +As of February 21, 2024, there were 72 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 33 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND INFORMATION +Since inception, we have not declared or paid cash dividends on our common stock, and we have no present intention of paying dividends on our common stock in the foreseeable future. +COMPANY PURCHASES OF EQUITY SECURITIES +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +The table below summarizes the number of shares of our Class A Common Stock that were repurchased during the three months ended December 31, 2023. +Month Ended +Total Number of Shares Purchased +Average Price Paid Per Share +Total Number of Shares Purchased under the Share Repurchase Program +Maximum Dollar Value of Shares that May Yet Be Purchased under the Program +(in thousands) +October 31, 2023 +— +$ +— +— +$ +325,714 +November 30, 2023 +900,300 +51.11 +900,300 +279,696 +December 31, 2023 +235,894 +59.37 +235,894 +265,692 +Total +1,136,194 +$ +52.83 +1,136,194 +$ +265,692 +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information required by this item is hereby incorporated by reference to the information in Part III, Item 12 of this annual report on Form 10-K. +18 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2018 to December 31, 2023, relative to the performance of the Russell 1000 Index and S&P Retail Select Industry Index. +Comparison of 5 Year Cumulative Total Returns +(in dollars) +2018 +2019 +2020 +2021 +2022 +2023 +Skechers U.S.A., Inc. +100.00 +188.69 +157.01 +189.60 +183.27 +272.35 +Russell 1000 +100.00 +131.43 +158.98 +201.03 +162.58 +205.72 +S&P Retail Select Industry +100.00 +113.97 +161.41 +230.77 +157.58 +191.51 +Item 6. [ Reserved] +19 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. We intend for this discussion to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of our company as a whole. +This section of this Form 10-K generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 2022 filed with the SEC on February 28, 2023. +OVERVIEW +When Skechers was founded in 1992, our focus was on creating a lifestyle brand centered on delivering products with comfort, style, innovation and quality at a reasonable price. Thirty years later, now with a diverse product assortment that includes award-winning Performance Division, we can meet most of the footwear needs of men, women and kids, we remain committed to our design principles. Our objective is to profitably grow our operations worldwide by delivering stylish, comfortable, innovative and high-quality products at a reasonable price. Through the efforts of our dedicated teams globally, our strong partner relationships and loyal consumers, we believe we will continue to achieve well-managed growth and ensure the longevity of both the company and the Skechers brand. +For the year ended December 31, 2023, compared to the year ended December 31, 2022, sales increased 7.5% to $8.0 billion, a new annual record, and four consecutive quarterly sales records. Gross margins improved to 51.9% and inventory was reduced by 16.1%. Our financial results reflect the significant market demand for our product offerings and the value that we provide. +Key highlights for 2023 include: +• +Debuting on the Fortune 500® list; +• +Expanding performance product offerings to include Skechers Football and Skechers Basketball; +• +Surpassing 5,000 retail stores; and +• +Opening distribution centers in India and Canada. +We believe brand recognition is paramount to continued success. We drive awareness and demand through comprehensive marketing campaigns. During the year, we introduced partnerships and a capsule collection with Martha Stewart and Snoop Dogg. Skechers Performance signed Harry Kane, Europe’s top goal scorer for 2023, as well as other premier players for the launch of Skechers Football, and New York Knicks all-star Julius Randle and Los Angeles Clippers Terance Mann, who both compete in Skechers Basketball. +Our core product philosophy of comfort, style, innovation, and quality at the right price continues to resonate with consumers, and we remain focused on delivering our comfort technology footwear as quickly as possible to meet consumer demand. We are committed to the following investments to execute our long-term global growth strategy: +• +Continue to develop new products and technologies; +• +Expand our distribution infrastructure to support growth; +• +Open new stores and extend our digital capabilities to drive Direct-to-Consumer growth; and +• +Innovative market strategies to broaden our reach globally and attract new partners and consumers. +20 +RESULTS OF OPERATIONS +Selected information from our results of operations follows: +Year Ended December 31, +Change +(in thousands) +2023 +2022 +$ +% +Sales +$ +8,000,342 +$ +7,444,550 +555,792 +7.5 +Cost of sales +3,847,938 +3,929,193 +(81,255 +) +(2.1 +) +Gross profit +4,152,404 +3,515,357 +637,047 +18.1 +Gross margin +51.9 +% +47.2 +% +470 bps +Operating expenses +Selling +676,890 +583,626 +93,264 +16.0 +General and administrative +2,690,728 +2,385,061 +305,667 +12.8 +Total operating expenses +3,367,618 +2,968,687 +398,931 +13.4 +As a % of sales +42.1 +% +39.9 +% +220 bps +Earnings from operations +784,786 +546,670 +238,116 +43.6 +Operating margin +9.8 +% +7.3 +% +250 bps +Other income (expense) +16,086 +(24,413 +) +40,499 +n/m +Earnings before income taxes +800,872 +522,257 +278,615 +53.3 +Income tax expense +150,949 +93,095 +57,854 +62.1 +Net earnings +649,923 +429,162 +220,761 +51.4 +Less: Net earnings attributable to noncontrolling interests +104,124 +56,134 +47,990 +85.5 +Net earnings attributable to Skechers U.S.A., Inc. +$ +545,799 +$ +373,028 +172,771 +46.3 +Sales +Sales increased $0.6 billion, or 7.5%, to $8.0 billion as a result of a 13.3% increase internationally and a 0.8% decrease domestically. Direct-to-Consumer sales increased 24.3% and Wholesale sales decreased 2.8%. Sales increased overall due to higher sales volume in Direct-to-Consumer and higher average selling prices. +Gross margin +Gross margin increased 470 basis points to 51.9% primarily due to higher average selling prices and a higher proportion of Direct-to-Consumer sales. +Operating expenses +Operating expenses increased $398.9 million, or 13.4%, to $3.4 billion, and as a percentage of sales increased 220 basis points to 42.1%. Selling expenses increased $93.3 million, or 16.0%, to $676.9 million, primarily due to higher demand creation expenditures in global marketing and digital advertising. General and administrative expenses increased $305.7 million, or 12.8%, to $2.7 billion, due to an increase in labor costs of $104.6 million, facility related costs of $83.7 million, including rent and depreciation, and warehouse and distribution costs of $16.6 million. These increases were partially offset by a decrease of $33.7 million in volume-driven labor and warehouse and distribution expenses from the supply chain and logistical challenges in the prior year. +Other income (expense) +Other income (expense), improved $40.5 million to $16.1 million, compared to other expense of $24.4 million in the prior year, primarily due to favorable foreign currency exchange rates in Europe, Middle East & Africa and Asia Pacific, and increased interest income. +Income taxes +Income tax expense and the effective tax rate were as follows: +Year Ended December 31, +(in thousands) +2023 +2022 +Income tax expense +$ +150,949 +$ +93,095 +Effective tax rate +18.8 +% +17.8 +% +Income tax expense was $150.9 million as compared to $93.1 million in 2022. Our effective tax rate was 18.8% as compared to 17.8% in the prior year. The increase in tax rate is due to the impact of tax reserves and the non-recurrence of favorable deferred tax adjustments in the prior year. +Our income tax expense and effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (losses) before income taxes. In the foreign jurisdictions in which we have operations, the applicable statutory rates range from 0% to 35%, which on average are generally significantly lower than the U.S. federal and state combined statutory rate of approximately 25.1%. +21 +The OECD has issued various proposals that would change long-standing global tax principles, namely, its Pillar Two framework, which imposes a global minimum corporate tax rate of 15% for large companies. The European Union (“EU”) member states formally adopted the EU’s Pillar Two Directive, which generally provides for a 15% minimum effective tax rate for multinational enterprises, in every jurisdiction in which they operate. This did not have an impact to the tax provision and effective tax rate for the year ended December 31, 2023 and we do not anticipate that this will have a material impact on our tax provision or effective tax rate in 2024. We will continue to evaluate the potential impact of the Pillar Two framework on future periods, pending legislative adoption by individual countries. +See Note 10 – Income Taxes of the Consolidated Financial Statements for additional information. +Noncontrolling interest in net earnings of consolidated subsidiaries +Noncontrolling interest represents the share of net earnings or loss that is attributable to our joint venture partners. Net earnings attributable to noncontrolling interest increased $48.0 million to $104.1 million as compared to $56.1 million in the prior year, primarily due to higher earnings by our joint ventures, predominantly in China. +RESULTS OF SEGMENT OPERATIONS +Wholesale +Year Ended December 31, +Change +(in thousands) +2023 +2022 +$ +% +Sales +$ +4,504,776 +$ +4,632,429 +(127,653 +) +(2.8 +) +Gross profit +1,846,819 +1,669,276 +177,543 +10.6 +Gross margin +41.0 +% +36.0 +% +500 bps +Wholesale sales decreased $127.7 million, or 2.8%, to $4.5 billion, due to a decrease in the Americas of 10.6%, partially offset by an increase in Asia Pacific of 12.6% and Europe, Middle East & Africa of 0.1%. Volume decreased 8.7% in the number of units sold and average selling price per unit increased 6.3%. +Wholesale gross margin increased 500 basis points to 41.0% due to higher average selling prices and lower costs per unit. +Direct-to-Consumer +Year Ended December 31, +Change +(in thousands) +2023 +2022 +$ +% +Sales +$ +3,495,566 +$ +2,812,121 +683,445 +24.3 +Gross profit +2,305,585 +1,846,081 +459,504 +24.9 +Gross margin +66.0 +% +65.6 +% +30 bps +Direct-to-Consumer sales increased $683.4 million, or 24.3%, to $3.5 billion, led by increases in the Americas of 21.5%, Asia Pacific of 22.0% and Europe, Middle East & Africa of 49.2%. Volume increased 19.6% in the number of units sold and average selling price per unit increased 4.0%. +Direct-to-Consumer gross margin increased 30 basis points to 66.0%, due to higher average selling prices and channel mix, partially offset by increased costs per unit. +LIQUIDITY AND CAPITAL RESOURCES +Liquidity outlook +We have cash and cash equivalents of $1,189.9 million at December 31, 2023. Amounts held outside the U.S. were $954.7 million, or 80.2%, and approximately $424.8 million was available for repatriation to the U.S. as of December 31, 2023 without incurring additional U.S. federal income taxes and applicable non-U.S. income and withholding taxes. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers, however, we have long-standing relationships with many and believe our relationships to be positive. +At December 31, 2023, we have unused credit capacity of $746.9 million on our revolving credit facility, with an additional $250.0 million available through an accordion feature. We believe that anticipated cash flows from operations, existing cash and investments balances, available borrowings under our revolving credit facility, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements for the next twelve months. +22 +Cash Flows +Our working capital at December 31, 2023 was $2.3 billion, an increase of $0.3 billion from working capital of $2.0 billion at December 31, 2022. Our cash and cash equivalents at December 31, 2023 were $1,189.9 million, compared to $615.7 million at December 31, 2022. Our primary source of operating cash is collections from customers. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $1,231.2 million for 2023 and $238.3 million for 2022. The $992.8 million increase in cash flows from operating activities in 2023 resulted from favorable changes in working capital, primarily inventory, and increased earnings. +Investing Activities +Net cash used in investing activities was $418.0 million for 2023 as compared to $287.5 million for 2022. The $130.5 million increase was due to increased net investment activity of $95.4 million and the acquisition of our Scandinavian distributor of $70.4 million, offset by decreased capital expenditures of $35.3 million. +Our capital investments remain focused on supporting our strategic growth priorities, growing our Direct-to-Consumer business, as well as expanding the presence of our brand internationally. Capital expenditures for the year ended December 31, 2023 were $323.7 million, which included $104.3 million for the expansion of our global distribution infrastructure, $99.0 million for investments in our retail stores and direct-to-consumer technologies, and $64.3 million of investments in our new corporate offices and transportation. We expect our capital expenditures for 2024 to be approximately $350.0 to $400.0 million, as we continue to invest in our strategic priorities, including new stores, added omnichannel capabilities and incremental distribution capacity in key markets. We expect to fund ongoing capital expenditures through a combination of available cash and borrowings. +Financing Activities +Net cash used in financing activities was $234.7 million during 2023 compared to $118.1 million in 2022. The increase is primarily the result of higher repurchases of common stock of $85.8 million and decreased net proceeds from short-term borrowing of $26.2 million. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, par value $0.001 per share, for an aggregate repurchase price not to exceed $500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. As of December 31, 2023, $265.7 million remains available under the Share Repurchase Program. +Financing Arrangements +As of December 31, 2023, outstanding short-term and long-term borrowings were $301.4 million, of which, $242.9 million relates to loans for our domestic and China distribution centers, $46.2 million relates to our operations in China and the remainder relates to our international operations. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. See Note 6 – Financial Commitments of the Consolidated Financial Statements for additional information. +Commitments +Our material cash requirements as of December 31, 2023 which are not reflected as liabilities in the consolidated balance sheets include open purchase commitments with our foreign manufacturers of approximately $1.4 billion. +We are required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the consolidated balance sheets. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +The preparation of our consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. +23 +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements. +Reserves for returns and chargebacks . Revenue is recorded net of estimates for returns from our customers and potential disputed amounts or chargebacks. We accrue a liability for product returns at the time of sale based on our historical experience. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. +Allowance for bad debts . Accounts receivable is recorded net of estimated losses from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for bad debts are recorded to general and administrative expenses. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory reserves . Inventory is stated at the lower of cost or net realizable value. Inventory reserves are recorded for excess and slow-moving inventory. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value is determined based on historical sales experience on a style-by-style basis. The valuation of inventory could be impacted by changes in public and consumer preferences, demand for product, changes in the buying patterns of both retailers and consumers and inventory management of customers. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates . The establishment of deferred tax assets from intra-entity transfers of certain intellectual property rights and other transactions requires management to make significant estimates and assumptions to determine the fair value of such intellectual property rights. The valuation of deferred tax assets requires significant estimates and assumptions including, but not limited to, future sales growth, discount rates and the expected life of the assets, which by their nature are inherently uncertain and may ultimately differ materially from our actual results. We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +Business Combinations. We use the acquisition method of accounting for business combinations and recognize assets acquired and liabilities assumed measured at their fair values on the date acquired. Goodwill is measured as of the acquisition date as the excess of consideration transferred over the net acquisition date fair value of the assets acquired and the liabilities assumed. The valuation of identifiable intangible assets reflects management's estimates based on, among other factors, use of established valuation methods, including, but not limited to, the multi-period excess earnings method income approach. Further estimates within these models include, but are not limited to, future expected cash flows, including revenues and expenses, and applicable discount rates. These estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed may be recorded, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations and comprehensive income (loss). +EXCHANGE RATES +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may impact our cost of goods in the future. During 2023 and 2022, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +24 +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +Item 7A. Quantitative and Qualitative Disclosure About Market Risk +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. Changes in interest rates and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2023, we have $58.5 million and $242.9 million of outstanding current and long-term borrowings, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by approximately $6.0 million for the year ended December 31, 2023. We do not expect changes in interest rates to have a material impact on our financial condition or results of operations or cash flows during the remainder of 2024. The interest rate charged on our unsecured revolving credit facility is based on SOFR, our North America distribution center construction loan is based on the one-month Bloomberg Short-Term Bank Yield Index (“BSBY”). Our China distribution center and China operational loans are based on a reference rate provided by the People’s Bank of China. Our loan with the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”), through a wholly-owned subsidiary of the JV (“HF-T1”), was based on the SOFR Daily Floating Rate plus a margin of 1.75%. During the second quarter of 2023, the Company amended certain terms of our loan agreement with Bank of America and the related interest rate swap to replace the LIBOR with SOFR as part of our planned reference rate reform activities, as discussed in Note 4 - Financial Commitments. Prior to the effective date of the amended swap agreement, our loan was based on the LIBOR Daily Floating Rate plus a margin of 1.75%. Changes in these interest rates will have an effect on the interest charged on outstanding balances. +We may enter into derivative financial instruments such as interest rate swaps in order to limit our interest rate risk on our long-term debt. We had one derivative instrument in place as of December 31, 2023 to hedge the cash flows on our $129.5 million variable rate debt on our North America distribution center, which was entered into by the JV. This instrument was a variable to fixed derivative with a notional amount of $129.5 million at December 31, 2023. Our receive rate was one-month LIBOR and the average pay rate was 0.795% through the effective date of the interest swap amendment. Since the effective date of the amended swap agreement, our receive rate was 30-day SOFR rate and the average pay rate was 0.778%. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan, thus reducing the impact of interest-rate changes on future interest payments. +Foreign exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ sales, expenses, assets and liabilities. In addition, changes in foreign exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have an impact on the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. +Assets and liabilities outside the U.S. are located in regions where we have subsidiaries or joint ventures: the Americas, Europe, Middle East & Africa, and Asia-Pacific. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation gain of $11.5 million and loss of $36.6 million, for the years ended December 31, 2023 and 2022, that are deferred and recorded as a component of accumulated other comprehensive loss in stockholders’ equity. A 200-basis point reduction in each of these exchange rates at December 31, 2023 would have reduced the values of our net investments by approximately $102.4 million. +25 +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Page +Report of Independent Registered Public Accounting Firm (BDO USA, P.C.; Los Angeles California; PCAOB ID: # 243 ) +27 +Consolidated Balance Sheets +29 +Consolidated Statements of Earnings +30 +Consolidated Statements of Comprehensive Income +31 +Consolidated Statements of Equity +32 +Consolidated Statements of Cash Flows +33 +Notes to Consolidated Financial Statements +34 +26 +Report of Independent Regist ered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 28, 2024 expressed an adverse opinion thereon. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates. +Accounting for Income Taxes +The Company is a U.S. based multinational entity subject to taxes in the U.S. and multiple foreign jurisdictions which affect the Company’s provision for income taxes. The income tax provision is determined by management based on current enacted tax regulations at each jurisdiction with consideration of intercompany transactions across multiple tax jurisdictions. As indicated in Note 10 to the consolidated financial statements, total income tax expense for the year ended December 31, 2023 was $150.9 million, of which $14.7 million represented U.S. Federal tax expense, $3.4 million represented U.S. State tax expense, and the remaining $132.8 million represented foreign tax expense. +We identified the accounting for the Company’s income tax provision as a critical audit matter due to the complexity involved in: (i) the application of relevant tax laws and regulations in calculating taxable income and deferred tax balances in certain jurisdictions, and (ii) the application of transfer pricing guidelines to various intercompany transactions. Auditing these elements required challenging auditor judgment and an increased extent of audit effort, including the use of professionals with specialized skills and knowledge. +27 +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain internal controls related to management’s accounting for income taxes, including controls over: (i) calculating taxable income and deferred tax balances in certain jurisdictions, and (ii) the application of transfer pricing guidelines to various intercompany transactions. +• +Testing the completeness and accuracy of the underlying data used to determine taxable income, deferred tax balances and transfer pricing adjustments. +• +Utilizing personnel with specialized skill and knowledge in accounting for income taxes to assist in evaluating management’s application of relevant tax laws and regulations in calculating taxable income and deferred tax balances in certain jurisdictions. +• +Utilizing personnel with specialized skill and knowledge in transfer pricing to assist in evaluating management’s application of transfer pricing guidelines to various intercompany transactions. +/s/ BDO USA, P.C. +We have served as the Company's auditor since 2013. +Los Angeles, California +February 28, 2024 +28 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Balance Sheets +As of December 31, +(in thousands, except par value) +2023 +2022 +ASSETS +Current assets +Cash and cash equivalents +$ +1,189,910 +$ +615,733 +Short-term investments +72,595 +102,166 +Trade accounts receivable, less allowances of $ 57,867 and $ 59,472 +860,300 +848,287 +Other receivables +82,253 +86,036 +Inventory +1,525,409 +1,818,016 +Prepaid expenses and other +222,137 +176,035 +Total current assets ($ 1,252,372 and $ 1,014,962 related to VIEs) +3,952,604 +3,646,273 +Property, plant and equipment, net +1,506,690 +1,345,370 +Operating lease right-of-use assets +1,276,171 +1,200,565 +Deferred tax assets +450,574 +454,190 +Long-term investments +123,996 +70,498 +Goodwill +101,230 +93,497 +Other assets, net +136,086 +83,094 +Total non-current assets ($ 641,879 and $ 598,973 related to VIEs) +3,594,747 +3,247,214 +TOTAL ASSETS +$ +7,547,351 +$ +6,893,487 +LIABILITIES AND EQUITY +Current liabilities +Accounts payable +$ +1,008,001 +$ +957,384 +Accrued expenses +320,105 +294,143 +Operating lease liabilities +274,296 +238,694 +Current installments of long-term borrowings +46,571 +103,184 +Short-term borrowings +11,894 +19,635 +Total current liabilities ($ 600,337 and $ 568,158 related to VIEs) +1,660,867 +1,613,040 +Long-term operating lease liabilities +1,108,110 +1,063,672 +Long-term borrowings +242,944 +216,488 +Deferred tax liabilities +12,594 +8,656 +Other long-term liabilities +122,794 +120,045 +Total non-current liabilities ($ 329,219 and $ 293,726 related to VIEs) +1,486,442 +1,408,861 +Total liabilities +3,147,309 +3,021,901 +Commitments and contingencies (Note 7 ) +Stockholders’ equity +Preferred Stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; 132,837 and 134,473 shares issued and outstanding +133 +134 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; 20,182 and 20,810 shares issued and outstanding +20 +21 +Additional paid-in capital +295,847 +403,799 +Accumulated other comprehensive loss +( 73,388 +) +( 84,897 +) +Retained earnings +3,796,730 +3,250,931 +Skechers U.S.A., Inc. equity +4,019,342 +3,569,988 +Noncontrolling interests +380,700 +301,598 +Total stockholders' equity +4,400,042 +3,871,586 +TOTAL LIABILITIES AND EQUITY +$ +7,547,351 +$ +6,893,487 +See accompanying notes to consolidated financial statements. +29 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Earnings +Year Ended December 31, +(in thousands, except per share data) +2023 +2022 +2021 +Sales +$ +8,000,342 +$ +7,444,550 +$ +6,310,187 +Cost of sales +3,847,938 +3,929,193 +3,185,816 +Gross profit +4,152,404 +3,515,357 +3,124,371 +Operating expenses +Selling +676,890 +583,626 +499,532 +General and administrative +2,690,728 +2,385,061 +2,026,652 +Total operating expenses +3,367,618 +2,968,687 +2,526,184 +Earnings from operations +784,786 +546,670 +598,187 +Total other income (expense) +16,086 +( 24,413 +) +( 28,430 +) +Earnings before income taxes +800,872 +522,257 +569,757 +Income tax expense (benefit) +150,949 +93,095 +( 245,875 +) +Net earnings +649,923 +429,162 +815,632 +Less: Net earnings attributable to noncontrolling interest +104,124 +56,134 +74,129 +Net earnings attributable to Skechers U.S.A., Inc. +$ +545,799 +$ +373,028 +$ +741,503 +Net earnings per share attributable to Skechers U.S.A., Inc. +Basic +$ +3.53 +$ +2.40 +$ +4.77 +Diluted +$ +3.49 +$ +2.38 +$ +4.73 +Weighted-average shares used in calculating net earnings per share attributable to Skechers U.S.A., Inc. +Basic +154,533 +155,627 +155,539 +Diluted +156,256 +156,608 +156,794 +See accompanying notes to consolidated financial statements. +30 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statement s of Comprehensive Income +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Net earnings +$ +649,923 +$ +429,162 +$ +815,632 +Other comprehensive income, net of tax +Net unrealized gain (loss) on derivative contract +( 3,888 +) +9,787 +3,372 +Gain (loss) on foreign currency translation adjustment +11,241 +( 53,552 +) +( 22,141 +) +Comprehensive income +657,276 +385,397 +796,863 +Less: Comprehensive income attributable to noncontrolling interests +99,968 +48,190 +76,398 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +557,308 +$ +337,207 +$ +720,465 +See accompanying notes to consolidated financial statements. +31 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Equity +Shares +Amount +Accumulated +(in thousands) +Class A Common Stock +Class B Common Stock +Class A Common Stock +Class B Common Stock +Additional paid-in capital +other comprehensive loss +Retained earnings +Skechers U.S.A., Inc. equity +Noncontrolling interests +Total stockholders' equity +Balance at December 31, 2020 +133,618 +21,016 +$ +134 +$ +21 +$ +372,165 +$ +( 27,285 +) +$ +2,136,400 +$ +2,481,435 +$ +244,228 +$ +2,725,663 +Net earnings +— +— +— +— +— +— +741,503 +741,503 +74,129 +815,632 +Foreign currency translation adjustment +— +— +— +— +— +( 21,038 +) +— +( 21,038 +) +( 1,103 +) +( 22,141 +) +Contributions from noncontrolling interests +— +— +— +— +— +— +— +— +6,731 +6,731 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 41,557 +) +( 41,557 +) +Purchase of noncontrolling interest +— +— +— +— +( 6,856 +) +— +— +( 6,856 +) +( 3,072 +) +( 9,928 +) +Net unrealized gain on derivative contract +— +— +— +— +— +— +— +— +3,372 +3,372 +Stock compensation expense +— +— +— +— +60,108 +— +— +60,108 +— +60,108 +Proceeds from the employee stock purchase plan +226 +— +— +— +7,276 +— +— +7,276 +— +7,276 +Shares issued under the incentive award plan +1,252 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 66 +) +— +— +— +( 3,084 +) +— +— +( 3,084 +) +— +( 3,084 +) +Conversion of Class B Common Stock into Class A Common Stock +77 +( 77 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2021 +135,107 +20,939 +$ +135 +$ +21 +$ +429,608 +$ +( 48,323 +) +$ +2,877,903 +$ +3,259,344 +$ +282,728 +$ +3,542,072 +Net earnings +— +— +— +— +— +— +373,028 +373,028 +56,134 +429,162 +Foreign currency translation adjustment +— +— +— +— +— +( 36,574 +) +— +( 36,574 +) +( 16,978 +) +( 53,552 +) +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 29,320 +) +( 29,320 +) +Net unrealized gain on derivative contract +— +— +— +— +753 +— +— +753 +9,034 +9,787 +Stock compensation expense +— +— +— +— +59,874 +— +— +59,874 +— +59,874 +Proceeds from the employee stock purchase plan +243 +— +— +— +8,131 +— +— +8,131 +— +8,131 +Shares issued under the incentive award plan +1,424 +— +2 +— +( 1 +) +— +— +1 +— +1 +Shares redeemed for employee tax withholdings +( 503 +) +— +( 1 +) +— +( 20,323 +) +— +— +( 20,324 +) +— +( 20,324 +) +Repurchases of common stock +( 1,927 +) +— +( 2 +) +— +( 74,243 +) +— +— +( 74,245 +) +— +( 74,245 +) +Conversion of Class B Common Stock into Class A Common Stock +129 +( 129 +) +— +— +— +— +— +— +— +— +Balance at December 31, 2022 +134,473 +20,810 +$ +134 +$ +21 +$ +403,799 +$ +( 84,897 +) +$ +3,250,931 +$ +3,569,988 +$ +301,598 +$ +3,871,586 +Net earnings +— +— +— +— +— +— +545,799 +545,799 +104,124 +649,923 +Foreign currency translation adjustment +— +— +— +— +— +11,509 +— +11,509 +( 268 +) +11,241 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 17,719 +) +( 17,719 +) +Purchase of noncontrolling interest +— +— +— +— +( 2,853 +) +— +— +( 2,853 +) +( 3,147 +) +( 6,000 +) +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 3,888 +) +( 3,888 +) +Stock compensation expense +— +— +— +— +67,960 +— +— +67,960 +— +67,960 +Proceeds from the employee stock purchase plan +242 +— +— +— +9,445 +— +— +9,445 +— +9,445 +Shares issued under the incentive award plan +1,120 +— +1 +— +( 1 +) +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 429 +) +— +— +— +( 22,442 +) +— +— +( 22,442 +) +— +( 22,442 +) +Repurchases of common stock +( 3,197 +) +— +( 3 +) +— +( 160,061 +) +— +— +( 160,064 +) +— +( 160,064 +) +Conversion of Class B Common Stock into Class A Common Stock +628 +( 628 +) +1 +( 1 +) +— +— +— +— +— +— +Balance at December 31, 2023 +132,837 +20,182 +$ +133 +$ +20 +$ +295,847 +$ +( 73,388 +) +$ +3,796,730 +$ +4,019,342 +$ +380,700 +$ +4,400,042 +See accompanying notes to consolidated financial statements. +32 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Cash flows from operating activities +Net earnings +$ +649,923 +$ +429,162 +$ +815,632 +Adjustments to reconcile net earnings to net cash provided by operating activities +Depreciation and amortization +181,925 +153,716 +139,577 +Provision for bad debts and returns +48,539 +37,806 +62,771 +Stock compensation +67,960 +59,874 +60,108 +Deferred income taxes +( 2,370 +) +( 6,489 +) +( 387,250 +) +Net foreign currency adjustments +( 18,492 +) +( 2,366 +) +2,154 +Changes in operating assets and liabilities +Receivables +( 3,416 +) +( 179,734 +) +( 154,248 +) +Inventory +324,193 +( 389,026 +) +( 458,002 +) +Other assets +( 98,041 +) +( 33,007 +) +( 110,464 +) +Accounts payable +41,565 +107,199 +135,140 +Other liabilities +39,378 +61,190 +106,734 +Net cash provided by operating activities +1,231,164 +238,325 +212,152 +Cash flows from investing activities +Capital expenditures +( 323,722 +) +( 358,992 +) +( 309,674 +) +Acquisitions, net of cash acquired +( 70,370 +) +— +— +Purchases of investments +( 160,233 +) +( 70,837 +) +( 215,164 +) +Proceeds from sales and maturities of investments +136,306 +142,343 +180,172 +Net cash used in investing activities +( 418,019 +) +( 287,486 +) +( 344,666 +) +Cash flows from financing activities +Net proceeds from the employee stock purchase plan +9,445 +8,131 +7,276 +Repayments on long-term borrowings +( 78,256 +) +( 95,410 +) +( 487,441 +) +Proceeds from long-term borrowings +48,100 +74,670 +96,187 +Net proceeds from (repayments on) short-term borrowings +( 7,741 +) +18,439 +( 2,102 +) +Payments for employee taxes related to stock compensation +( 22,442 +) +( 20,324 +) +( 3,084 +) +Repurchases of common stock +( 160,064 +) +( 74,245 +) +— +Purchase of noncontrolling interest +( 6,000 +) +— +( 9,928 +) +Contributions from noncontrolling interests +— +— +6,731 +Distributions to noncontrolling interests +( 17,719 +) +( 29,320 +) +( 41,557 +) +Net cash used in financing activities +( 234,677 +) +( 118,059 +) +( 433,918 +) +Effect of exchange rates on cash and cash equivalents +( 4,291 +) +( 13,330 +) +( 8,111 +) +Net change in cash and cash equivalents +574,177 +( 180,550 +) +( 574,543 +) +Cash and cash equivalents at beginning of the period +615,733 +796,283 +1,370,826 +Cash and cash equivalents at end of the period +$ +1,189,910 +$ +615,733 +$ +796,283 +Supplemental disclosures of cash flow information +Cash paid during the period for: +Interest +$ +21,871 +$ +19,293 +$ +14,579 +Income taxes, net +147,095 +113,933 +125,082 +Non-cash transactions: +Right-of-use assets exchanged for lease liabilities +343,438 +327,022 +356,855 +Non-cash consideration for acquired business +8,873 +— +— +See accompanying notes to consolidated financial statements. +33 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +Notes to Consolidated Financial Statements +(1) +Summary of Significant Accounting Policies +BASIS OF PRESENTATION +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear, apparel and accessories. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior period balances have been made to conform to current presentation. +USE OF ESTIMATES +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Significant areas requiring the use of estimates relate primarily to allowances for bad debts, returns and customer chargebacks, inventory reserves, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +REVENUE RECOGNITION +The Company derives income from the sale of footwear, apparel and accessories and royalties earned from licensing the Skechers brand. The Company recognizes sales revenue, net of estimated returns and excluding sales and value added taxes. Revenue is recognized at point of sale or upon shipment, the point in time where control transfers to the customer. +Wholesale sales are recognized upon shipment. Direct-to-consumer sales are recognized at the point of sale for transactions with customers at the Company’s retail stores and recognized upon shipment for sales made through its websites. +Sales are reduced by an estimate of customer merchandise returns, which is calculated based on historical experience. The Company reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a factors such as historical trends, customer behavior and nature of the chargeback. +ALLOWANCE FOR BAD DEBTS +The Company provides a reserve for estimated losses that may result from its customers’ inability to pay. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and its customers’ credit-worthiness. Allowances for bad debts are recorded to general and administrative expenses. +WAREHOUSE AND DISTRIBUTION COSTS +The Company’s distribution network-related costs are included in general and administrative expenses. Distribution expenses, including the functions of purchasing, receiving, inspecting, allocating, surface transportation, warehousing and packaging product totaled $ 565.1 million, $ 538.7 million and $ 376.5 million for 2023, 2022 and 2021 . +PRODUCT DESIGN AND DEVELOPMENT COSTS +The Company charges product design and development costs to general and administrative expenses. Aggregate product design and development costs were approximately $ 27.9 million, $ 28.1 million, and $ 24.6 million during the years ended December 31, 2023, 2022 and 2021 . +ADVERTISING +Advertising costs are expensed in the period in which an advertisement first runs, or over the life of an endorsement contract. Advertising expense for the years ended December 31, 2023, 2022 and 2021 was approximately $ 562.1 million, $ 473.7 million and $ 375.0 million. Prepaid advertising costs were $ 24.3 million at December 31, 2023 , consisting of $ 13.8 million short-term and $ 10.5 million long-term, which is included in other assets, net, in the Company’s consolidated balance sheets. Prepaid amounts represent the unamortized portion of endorsement contracts, advertising in trade publications and media productions created, but not run. +INCOME TAXES +The Company recognizes deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +CASH AND CASH EQUIVALENTS +Cash and cash equivalents include short-term investments, which are highly liquid investments with maturities of three months or less when purchased. +34 +INVENTORY +Inventory is stated at the lower of cost (based on the first-in, first-out method) or net realizable value. Cost of product includes shipping and handling fees. The Company estimates losses from obsolete or slow-moving inventory and reserves the cost of inventory at the time such determinations are made. Expense associated with inventory reserves is recognized in cost of sales. +PROPERTY, PLANT, AND EQUIPMENT +Property, plant and equipment are stated at cost, net of accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The Company reviews stores for impairment annually or when facts and circumstances indicate that the carrying values may be impaired. The Company did not record material impairment charges during the years ended December 31, 2023, 2022 or 2021 . The principal estimated useful lives are as follows: +Buildings +20 to 40 years +Building improvements +10 to 20 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Shorter of useful life or remaining lease term +GOODWILL +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. As of December 31, 2023 and December 31, 2022 , the Company had $ 101.2 million and $ 93.5 million of goodwill included in the Wholesale segment. The increase of $ 7.7 million of goodwill included in the Wholesale segment relates to the acquisition of Sports Connection. Goodwill is not amortized but is tested at least annually in the fourth quarter for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. +See Note 14 – Business Combinations of the Consolidated Financial Statements for additional information. +INTANGIBLE ASSETS +Within other assets, net, the Company has amortizable intangible assets consisting of reacquired rights with a gross carrying value of $ 108.4 million and $ 49.1 million and accumulated amortization of $ 42.2 million and $ 25.9 million as of December 31, 2023 and December 31, 2022 . Purchased intangible assets with finite lives are amortized over their estimated useful lives. Amortization expense related to amortizable intangible assets were $ 11.4 million, $ 6.9 million and $ 6.9 million for years ended December 31, 2023, 2022 and 2021 . Future amortization expense related to amortizable intangible assets is expected to be approximately $ 14.6 million per year for each of the years 2024 and 2025, $ 9.7 million for 2026, $ 8.1 million for each of the years 2027 and 2028, and $ 11.1 million thereafter. The weighted-average amortization period for amortizable reacquired rights is 7 years. +NONCONTROLLING INTERESTS +The Company established several joint ventures either to distribute the Company’s products or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”), and the Company is considered the primary beneficiary. This determination is based on the relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. Specifically, the Company has both of the following characteristics: (a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance; and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE, or the right to receive benefits from the entity that could potentially be significant to the VIE. The assets and liabilities and results of operations of these entities are included in the Company’s consolidated financial statements, even though the Company may not hold a majority equity interest. The Company continues to reassess these relationships based on events and circumstances. The assets of these joint ventures are restricted, as they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. +In December 2023, the Company increased the ownership interest related to the Israel joint venture from 51 % to 75 % for $ 6.0 million. In March 2021, the minority interest related to the Hong Kong joint venture was purchased for $ 10.0 million. The change in the Company’s ownership of the Hong Kong and Israel entities continues to be included in the Company’s consolidated financial statements. +FOREIGN CURRENCY TRANSLATION +The Company’s reporting currency is the U.S. dollar. Certain international operations use the respective local currency as their functional currency, while others use the U.S. dollar as their functional currency. Translation adjustments for subsidiaries with non-U.S. dollar functional currencies are included in other comprehensive income. Foreign currency transaction gains (losses), resulting from exchange rate fluctuations, on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated at the balance sheet date exchange rate. Net earnings and cash flow items are translated at the weighted-average exchange rates during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +35 +FAIR VALUE OF FINANCIAL INSTRUMENTS +The fair value hierarchy as defined by applicable accounting standards prioritizes the use of inputs used in valuation techniques into the following three levels: +• +Level 1: Quoted market prices in active markets for identical assets or liabilities. +• +Level 2: Other observable market-based inputs or unobservable inputs that are corroborated by market data. +• +Level 3: Unobservable inputs that cannot be corroborated by market data that reflect the reporting entity’s own assumptions. +The Company’s Level 1 investments primarily include money market funds, U.S. Treasury securities and mutual funds; Level 2 investments primarily include corporate notes and bonds, asset-backed securities and U.S. Agency securities ; and the Company does not currently have any Level 3 assets or liabilities. The Company has one Level 2 derivative instrument which is an interest rate swap (see Note 6 – Financial Commitments) classified as other assets, net at both December 31, 2023 and 2022. The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. +The carrying amount of receivables, payables and other amounts arising out of the normal course of business approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based on current rates and terms available to the Company for similar debt. +DERIVATIVE INSTRUMENTS +The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company uses an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap, designated as a cash flow hedge, involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. As of December 31, 2023 , all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +RECENT ACCOUNTING PRONOUNCEMENTS +In November 2023, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2023-07 Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. Among other new disclosure requirements, ASU 2023-07 requires companies to disclose significant segment expenses that are regularly provided to the chief operating decision maker. ASU 2023-07 will be effective for annual periods beginning on January 1, 2024 and interim periods beginning on January 1, 2025. ASU 2023-07 must be applied retrospectively to all prior periods presented in the financial statements. We are currently evaluating the disclosure impact of ASU 2023-07. +In December 2023, the FASB issued ASU No. 2023-09 Income Taxes (Topic 740): Improvements to Income Tax Disclosures . ASU 2023-09 requires companies to disclose, on an annual basis, specific categories in the effective tax rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold. In addition, ASU 2023-09 requires companies to disclose additional information about income taxes paid. ASU 2023-09 will be effective for annual periods beginning January 1, 2025 and will be applied on a prospective basis with the option to apply the standard retrospectively. We are evaluating the disclosure impact of ASU 2023-09; however, the standard will not have an impact on the company’s consolidated financial position, results of operations and/or cash flows. +RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS +In March 2020, the FASB issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , as amended and supplemented by subsequent ASUs (collectively, “ASU 2020-04” and “ASU 2022-06”), which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for borrowing instruments, which use London Interbank Offered Rate ("LIBOR") as a reference rate, and is available through December 31, 2024. During the second quarter of 2023, the Company amended certain terms of our loan agreement with Bank of America and the related interest rate swap to replace the LIBOR with the daily Secured Overnight Financing Rate ("SOFR") as part of our planned reference rate reform activities, as discussed in Note 6 - Financial Commitments. The Company elected to apply the practical expedient which allows us to account for the modification of the amended agreements as if the modifications were not substantial. These amendments did not result in any change to our application of hedge accounting and did not have a material impact to our consolidated financial statements. +36 +(2) +Cash, Cash Equivalents, Short-term and Long-term Investments +The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category: +As of December 31, 2023 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +972,278 +$ +972,278 +$ +972,278 +$ +— +$ +— +Level 1 +Money market funds +176,317 +176,317 +176,317 +— +— +U.S. Treasury securities +39,769 +39,769 +29,942 +9,827 +— +Mutual funds +N/A +8,535 +— +— +8,535 +Total level 1 +216,086 +224,621 +206,259 +9,827 +8,535 +Level 2 +Corporate notes and bonds +97,795 +97,795 +9,374 +50,949 +37,472 +Asset-backed securities +11,159 +11,159 +— +— +11,159 +U.S. Agency securities +27,269 +27,269 +1,999 +11,819 +13,451 +Total level 2 +136,223 +136,223 +11,373 +62,768 +62,082 +Total +$ +1,324,587 +$ +1,333,122 +$ +1,189,910 +$ +72,595 +$ +70,617 +As of December 31, 2022 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +539,730 +$ +539,730 +$ +539,730 +$ +— +$ +— +Level 1 +Money market funds +71,503 +71,503 +71,503 +— +— +U.S. Treasury securities +18,201 +18,201 +2,000 +16,201 +— +Mutual funds +N/A +5,893 +— +— +5,893 +Total level 1 +89,704 +95,597 +73,503 +16,201 +5,893 +Level 2 +Corporate notes and bonds +101,959 +101,959 +2,500 +85,731 +13,728 +Asset-backed securities +4,641 +4,641 +— +234 +4,407 +Total level 2 +106,600 +106,600 +2,500 +85,965 +18,135 +Total +$ +736,034 +$ +741,927 +$ +615,733 +$ +102,166 +$ +24,028 +The Company’s investments consist of U.S. Treasury securities, corporate notes and bonds, asset-backed securities and U.S. agency securities, which the Company has the intent and ability to hold to maturity and therefore are classified as held-to-maturity. The Company holds mutual funds in its deferred compensation plan which are classified as trading securities. The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are less than two years . The Company minimizes the potential risk of principal loss by investing in highly-rated securities and limiting the amount of credit exposure to any one issuer. Fair values were determined for each individual security in the investment portfolio. Included in long-term investments on the Consolidated Balance Sheets are company owned life insurance contracts of $ 53.4 million and $ 46.5 million as of December 31, 2023 and December 31, 2022 . Interest income was $ 24.8 million, $ 6.0 million, and $ 3.3 million for years ended December 31, 2023, 2022 and 2021. +When evaluating an investment for its current expected credit losses, the Company reviews factors such as historical experience with defaults, losses, credit ratings, term and macroeconomic trends, including current conditions and forecasts to the extent they are reasonable and supportable. +(3) +Leases +The Company regularly enters into non-cancellable operating leases for retail stores, distribution facilities, offices, showrooms and automobiles. Retail stores typically have initial terms ranging from 5 to 10 years and other real estate or facility leases may have initial lease terms of up to 25 years. The Company’s leases are recorded as operating lease right-of-use (“ROU”) assets and operating leases liabilities. Operating lease liabilities are recognized based on the present value of the fixed portion of lease payments over the lease term at the commencement date. Net present value is calculated using an incremental borrowing rate based on a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. Many of the Company’s real estate leases include options to extend and are included in the lease obligations when considered reasonably certain. ROU assets are recognized based on operating lease liabilities reduced by lease incentives and initial direct costs incurred. Fixed lease cost is recognized on a straight-line basis over the lease term. +37 +The Company’s real estate leases may require additional payments for percentage rent, real estate taxes, or other occupancy-related costs. Percentage rent, a variable cost, is recognized in the consolidated financial statements when incurred and is based on the specific terms in the lease agreement. Real estate taxes and other occupancy-related costs are non-lease components. +Operating lease cost and other information: +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Fixed lease cost +$ +361,894 +$ +307,265 +$ +290,509 +Variable lease cost +11,424 +10,803 +5,354 +Operating cash flows used for leases +359,727 +303,721 +286,411 +Weighted-average remaining lease term +5.43 years +5.52 years +5.95 years +Weighted-average discount rate +4.16 +% +3.12 +% +3.07 +% +The following table presents future lease payments as of December 31, 2023: +Year (in thousands) +Operating Leases +2024 +$ +327,964 +2025 +289,527 +2026 +235,132 +2027 +194,505 +2028 +145,699 +Thereafter +409,751 +Total lease payments +1,602,578 +Less: Imputed interest +( 220,172 +) +Operating lease liabilities +$ +1,382,406 +As of December 31, 2023, the Company has operating leases, primarily for new retail stores, that have not yet commenced which will generate additional ROU assets of $ 45.5 million. +(4) +Property, Plant and Equipment +Property, plant and equipment is summarized as follows: +As of December 31, +(in thousands) +2023 +2022 +Land +$ +122,433 +$ +122,433 +Buildings and improvements +720,663 +634,683 +Furniture, fixtures and equipment +954,482 +803,043 +Leasehold improvements +669,886 +612,610 +Total property, plant and equipment +2,467,464 +2,172,769 +Less accumulated depreciation and amortization +960,774 +827,399 +Property, plant and equipment, net +$ +1,506,690 +$ +1,345,370 +Depreciation expense was $ 156.5 million, $ 131.3 million and $ 122.2 million for the years ended December 31, 2023, 2022 and 2021 as calculated using the straight-line method. +(5) +Accrued Expenses +Accrued expenses at December 31, 2023 and 2022 are summarized as follows: +As of December 31, +(in thousands) +2023 +2022 +Accrued payroll, taxes, and other +$ +166,132 +$ +143,664 +Return reserve liability +80,968 +60,482 +Accrued inventory purchases +73,005 +89,997 +Accrued expenses +$ +320,105 +$ +294,143 +(6) +Financial Commitments +The Company had $ 32.5 million and $ 2.7 million of outstanding letters of credit as of December 31, 2023 and December 31, 2022, and approximately $ 11.9 million and $ 19.6 million in short-term borrowings as of December 31, 2023 and December 31, 2022. Interest expense for the years ended December 31, 2023, 2022 and 2021 was $ 22.4 million, $ 19.7 million and $ 14.9 million. +38 +Long-term borrowings were as follows: +As of December 31, +(in thousands) +2023 +2022 +HF-T1 Distribution Center Loan +$ +129,505 +$ +129,505 +HF-T2 Distribution Center Construction Loan +73,017 +72,098 +China Distribution Center Construction Loan +— +41,329 +China Distribution Center Expansion Construction Loan +40,330 +14,507 +China Operational Loans +46,228 +54,361 +Other +435 +7,872 +Subtotal +289,515 +319,672 +Less: Current installments +46,571 +103,184 +Total long-term borrowings +$ +242,944 +$ +216,488 +Revolving Credit Facility +The Company maintains a revolving credit facility with Bank of America, N.A. which allows for an unsecured credit facility to $ 750.0 million, which may be increased up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $ 100.0 million and swingline loans up to a maximum of $ 50.0 million. The expiration date is December 15, 2026 . The Company may use the proceeds for working capital and other lawful corporate purposes. Borrowings and letters of credit bear interest, at the Company’s option, at a rate equal to (a) Term SOFR plus an applicable margin between 1.000 % and 1.500 % based upon the Company’s Total Adjusted Net Leverage Ratio or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate, (iii) Term SOFR plus 1.00 %, and (iv) 1.00 %) plus an applicable margin between 0 % and 0.500 % based upon the Company’s Total Adjusted Net Leverage Ratio. As of December 31, 2023 , there was no outstanding balance under this revolving credit facility. The unused credit capacity was $ 746.9 million and $ 747.3 million as of December 31, 2023 and December 31, 2022. +The Company is required to maintain a maximum total adjusted net leverage ratio of 3.75 :1, except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 :1 for the quarter in which such acquisition occurs and for the next three quarters thereafter. The Company was in compliance with the financial covenants as of December 31, 2023. +Our subsidiary in India had a line of credit of $ 42.4 million and $ 34.1 million at December 31, 2023 and December 31, 2022, and a weighted average interest rate of 8.0 % for the year ended December 31, 2023 . Borrowings on the line of credit are due in 180 days . The balances of $ 6.0 million and $ 14.5 million were recorded as short-term borrowings as of December 31, 2023 and December 31, 2022. +HF-T1 Distribution Center Loan +To finance construction and improvements to the Company’s North American distribution center, the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a $ 129.5 million construction loan agreement which matures on March 18, 2025 (the “HF-T1 2020 Loan”) with interest of SOFR Daily Floating Rate plus a margin of 1.75 % per annum . +HF-T1 also entered into an ISDA master agreement (together with the schedule related thereto, the “Swap Agreement”) with Bank of America, N.A. to govern derivative and/or hedging transactions that HF-T1 concurrently entered into with Bank of America, N.A. Pursuant to the Swap Agreement, on August 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the “Interest Rate Swap”) as amended (the “Swap Agreement Amendment”) on March 18, 2020 with Bank of America, N.A. with a maturity date of March 18, 2025 . The Swap Agreement Amendment fixes the effective interest rate on the HF-T1 2020 Loan at 2.55 % per annum. During the second quarter of 2023, the Company amended certain terms of our loan agreement with Bank of America and the related interest rate swap to replace the LIBOR with the daily SOFR as part of our planned reference rate reform activities. The HF-T1 2020 Loan and Swap Agreement Amendment are subject to customary covenants and events of default. Bank of America, N.A. also acts as a lender and syndication agent under the Company’s revolving credit facility. The obligations of the JV under this loan are guaranteed by HF. +The Interest Rate Swap involves the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreement without exchange of the underlying notional amount. As of both December 31, 2023 and December 31, 2022, the Interest Rate Swap had an aggregate notional amount of $ 129.5 million. Under the terms of the Swap Agreement Amendment, the Company will pay a weighted-average fixed rate of 0.778 % on the notional amount and receive payments from the counterparty based on the 30-day SOFR rate, effectively modifying the Company’s exposure to interest rate risk by converting floating-rate debt to a fixed rate of 2.63 %. +39 +HF-T2 Distribution Center Construction Loan +On April 3, 2020, the JV, through HF Logistics-SKX T2, LLC, a wholly-owned subsidiary of the JV (“HF-T2”), entered into a construction loan agreement up to $ 73.0 with Bank of America, N.A. to expand the North American distribution center. The maturity date is April 3, 2025 . The interest rate is based on the Bloomberg Short-Term Bank Yield Index Daily Floating Rate plus a margin of 190 basis points, reducing to 175 basis points upon substantial completion of the construction and certain other conditions being satisfied. The weighted-average annual interest rate on borrowings was 6.86 % during the year ended December 31, 2023. The obligations of the JV are guaranteed by TGD Holdings I, LLC, which is an affiliate of HF. +China Distribution Center Construction Loan +The Company had a loan agreement to finance the construction of its distribution center in China which matured on September 28, 2023 . The interest rate was 4.00 % at December 31, 2022. +China Distribution Center Expansion Construction Loan +On October 18, 2022, the Company entered into a loan agreement for 1.1 billion yuan with Bank of China Co., Ltd to finance the construction of its distribution center expansion in China. Interest is paid quarterly. The interest rate at December 31, 2023 was 3.40 % and may increase or decrease over the life of the loan, and is evaluated every 12 months. This loan matures 10 years from the initial receipt of funds. Beginning in 2026, the principal of the loan will be repaid in semi-annual installments of variable amounts. The obligations of this loan entered through the Company’s Taicang Subsidiary are jointly and severally guaranteed by the Company’s China joint venture. +China Operational Loans +The Company has certain secured credit facilities to support the operations of its China joint venture. The balance at December 31, 2023 was $ 46.2 million with interest rates ranging from 2.75 % to 2.90 % per annum, payable at terms agreed by the lender and at December 31, 2022, was $ 54.4 million with interest rates ranging from 2.90 % to 3.41 % per annum. As of December 31, 2023, the outstanding balances is classified as current borrowings in the Company’s consolidated balance sheets. +The following table presents the future principal payments required under the Company’s debt obligations, discussed above: +Year (in thousands) +Maturities +2024 +$ +46,571 +2025 +202,615 +2026 +5,133 +2027 +5,133 +2028 +5,133 +Thereafter +24,930 +$ +289,515 +(7) +Commitments and Contingencies +PRODUCT AND OTHER FINANCING +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.4 % for 30 - to 60 -day financing. The amounts included in accounts payable and outstanding under these arrangements were $ 298.9 million and $ 345.4 million at December 31, 2023 and 2022. Interest expense incurred by the Company under these arrangements totaled $ 6.5 million in 2023, $ 6.1 million in 2022, and $ 6.5 million in 2021. The Company has open purchase commitments with its foreign manufacturers of $ 1.4 billion and warehouse and equipment and corporate construction contracts of $ 168.0 million for the expansion of its distribution centers and corporate headquarters, which are not included in the consolidated balance sheets at December 31, 2023. +LITIGATION +In accordance with GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2023 , nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. The Company recognizes legal expense in connection with loss contingencies as incurred. +40 +(8) +Stockholders’ Equity and Stock Compensation +COMMON STOCK +The authorized capital stock of the Company consists of 500 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10 million shares of Preferred Stock, par value $ 0.001 per share. +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share (“EPS”). Basic and diluted net EPS of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +During the years ended December 31, 2023, 2022 and 2021 certain Class B stockholders converted 627,632 , 128,530 and 77,562 shares, respectively, of Class B Common Stock to Class A Common Stock. +SHARE REPURCHASE PROGRAM +On January 31, 2022, the Company's Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may, from time to time, purchase shares of its Class A Common Stock, for an aggregate repurchase price not to exceed $ 500 million. The Share Repurchase Program expires on January 31, 2025 and does not obligate the Company to acquire any particular amount of shares. +The following table provides a summary of the Company’s stock repurchase activities: +Year Ended December 31, +2023 +2022 +Shares repurchased +3,197,345 +1,926,781 +Average cost per share +$ +50.06 +$ +38.53 +Total cost of shares repurchased (in thousands) +$ +160,064 +$ +74,245 +INCENTIVE AWARD PLAN +On April 6, 2023, the Company's Board of Directors adopted the 2023 Incentive Award Plan (the "2023 Plan"), which became effective upon approval by the Company's stockholders on June 12, 2023. The 2023 Plan superseded prior plans. Awards issued and outstanding under the prior plan vest in accordance with the original terms. A total of 7,500,000 shares of Class A Common Stock are reserved for issuance under the 2023 Plan, which provides for the grants of restricted stock, restricted stock units and various other types of equity awards as described in the plan to the employees, consultants, and directors of the Company. The 2023 Plan is administered by the Company's Board of Directors with respect to awards to non-employee directors and by the Company's Compensation Committee with respect to other eligible participants. +For the year ended December 31, 2023 , the Company granted restricted stock with time-based vesting as well as performance-based awards. The performance-based awards include a market condition tied to the Company’s total shareholder return in relation to its peer companies as well as a financial performance condition tied to annual EPS growth. The vesting and ultimate payout of performance awards is determined at the end of the three-year performance period and can vary from zero to 200 % based on actual results. As of December 31, 2023, a total of 6,523,913 shares remain available for grant as equity awards under the 2023 Plan if target levels are achieved for performance-based awards and 5,862,548 available if maximum levels are achieved. +The Company issued the following stock-based instruments: +Year Ended December 31, +2023 +2022 +2021 +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Restricted stock +959,690 +$ +46.24 +1,446,550 +$ +38.27 +1,201,600 +$ +42.88 +Performance-based restricted stock +121,225 +$ +43.34 +116,250 +$ +42.46 +108,750 +$ +38.95 +Market-based restricted stock +121,225 +$ +59.71 +116,250 +$ +58.85 +108,750 +$ +54.34 +41 +A summary of the status and changes of the Company’s unvested shares related to the Plan is presented below: +Shares +Weighted-Average Grant-Date Fair Value +Unvested at December 31, 2020 +3,112,023 +35.06 +Granted +1,419,100 +43.46 +Vested/Released +( 1,252,108 +) +34.36 +Cancelled +( 25,699 +) +39.01 +Unvested at December 31, 2021 +3,253,316 +38.97 +Granted +1,679,050 +39.98 +Vested/Released +( 1,423,531 +) +36.13 +Cancelled +( 84,933 +) +39.72 +Unvested at December 31, 2022 +3,423,902 +40.62 +Granted +1,202,140 +47.31 +Vested/Released +( 1,119,837 +) +38.76 +Cancelled +( 43,500 +) +41.19 +Unvested at December 31, 2023 +3,462,705 +43.54 +The Company determines the fair value of restricted stock awards and any performance-related components based on the closing market price of the Company’s common stock on the date of grant. For share-based awards with a performance-based vesting requirement, the Company evaluates the probability of achieving the performance criteria throughout the performance period and will adjust stock compensation expense up or down based on its estimated probable outcome. Certain performance-based awards contain market condition components which are valued on the date of grant using a Monte Carlo simulation model. The fair value of such awards is expensed ratably over the performance period and is not adjusted for actual achievement. +The Company recognized, as part of general and administrative, compensation expense of $ 65.1 million, $ 57.3 million and $ 57.9 million for grants under the Plan for the years ended December 31, 2023, 2022, and 2021. Related excess tax expense (benefit) on stock compensation recorded in the consolidated statements of earnings, for the years ended December 31, 2023, 2022 and 2021, were $ ( 0.9 ) million, $ 1.3 million, and $ 1.0 million. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. For grants that have a service requirement, the Company accounts for forfeitures upon occurrence, rather than estimating the probability of forfeiture at the date of grant. Accordingly, the Company recognizes the full grant-date fair value of these awards on a straight-line basis throughout the requisite service period, reversing any expense if, and only if, there is a forfeiture. There was $ 80.4 million of unrecognized compensation cost related to nonvested common shares as of December 31, 2023, which is expected to be recognized over a weighted-average period of 1.34 years. The total fair value of shares vested during the years ended December 31, 2023, 2022 and 2021 was $ 43.4 million, $ 51.4 million and $ 43.1 million. +STOCK PURCHASE PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2018 Employee Stock Purchase Plan (the “2018 ESPP”) provides a total of 5,000,000 shares of Class A Common Stock for sale. The 2018 ESPP provides eligible employees of the Company and its subsidiaries the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the fair market value on the first trading day or last trading day of each purchase period, whichever is lower. Eligible employees can invest up to 15 % of their compensation through payroll deductions during each purchase period. The purchase price discount and the look-back feature cause the 2018 ESPP to be compensatory and the Company recognizes compensation expense, which is computed using the Black-Scholes valuation model. +For the years ended December 31, 2023, 2022 and 2021 , the Company recognized $ 2.9 million, $ 2.6 million, and $ 2.2 million of ESPP stock compensation expense. Under the 2018 ESPP, the Company received approximately $ 9.4 million, $ 8.1 million and $ 7.3 million, and issued 242,166 , 243,166 and 225,665 shares, for the years ended December 31, 2023, 2022 and 2021. As of December 31, 2023 , there were 3,573,580 shares available for sale under the 2018 ESPP. +(9) +Earnings Per Share +Basic EPS and diluted EPS are calculated by dividing net earnings by the following: for basic EPS, the weighted-average number of common shares outstanding for the period; and for diluted EPS, the sum of the weighted-average number of both outstanding common shares and potentially dilutive common shares using the treasury stock method. +42 +The calculation of EPS is as follows: +Year Ended December 31, +(in thousands, except per share data) +2023 +2022 +2021 +Net earnings attributable to Skechers U.S.A., Inc. +$ +545,799 +$ +373,028 +$ +741,503 +Weighted-average common shares outstanding, basic +154,533 +155,627 +155,539 +Dilutive effect of nonvested shares +1,723 +981 +1,255 +Weighted-average common shares outstanding, diluted +156,256 +156,608 +156,794 +Anti-dilutive common shares excluded above +5 +37 +5 +Net earnings attributable to Skechers U.S.A., Inc. per common share: +Basic +$ +3.53 +$ +2.40 +$ +4.77 +Diluted +$ +3.49 +$ +2.38 +$ +4.73 +(10) +Income Taxes +The Company’s earnings before income tax expense consists of the following: +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +U.S. operations +$ +16,740 +$ +( 48,311 +) +$ +71,900 +Foreign operations +784,132 +570,568 +497,857 +Earnings before income taxes +$ +800,872 +$ +522,257 +$ +569,757 +Income tax consists of the following: +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Current +Federal +$ +16,839 +$ +256 +$ +34,288 +State +7,986 +9,564 +7,268 +Foreign +130,655 +84,904 +102,062 +155,480 +94,724 +143,618 +Deferred +Federal +( 2,079 +) +7,043 +( 27,074 +) +State +( 4,598 +) +( 1,287 +) +( 4,481 +) +Foreign +2,146 +( 7,385 +) +( 357,938 +) +( 4,531 +) +( 1,629 +) +( 389,493 +) +Income tax expense (benefit) +$ +150,949 +$ +93,095 +$ +( 245,875 +) +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows: +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Expected income tax expense +$ +168,183 +$ +109,674 +$ +119,649 +State income tax, net of federal benefit +( 832 +) +( 1,597 +) +( 172 +) +Rate differential on foreign income +( 27,931 +) +( 49,175 +) +( 24,615 +) +Change in unrecognized tax benefits +3,841 +12,310 +11,538 +Intra-entity intellectual property transfer +— +( 3,232 +) +( 346,776 +) +FDII deduction +— +— +( 10,695 +) +Non-deductible compensation +14,397 +13,668 +8,693 +Tax credits +( 6,813 +) +( 7,544 +) +( 7,547 +) +Excess tax expense (benefit) on stock compensation +( 854 +) +1,305 +976 +Benefits provided by the Coronavirus Aid, Relief, and Economic Security Act +— +— +( 905 +) +U.S. tax on foreign earnings +8,180 +7,611 +— +Other +( 5,235 +) +217 +( 927 +) +Change in valuation allowance +( 1,987 +) +9,858 +4,906 +Income tax expense (benefit) +$ +150,949 +$ +93,095 +$ +( 245,875 +) +Effective tax rate +18.8 +% +17.8 +% +( 43.2 +)% +43 +The Company’s income tax expense (benefit) and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0 % to 35 % . The Company’s income tax expense (benefit) was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) while the Company’s effective tax rate is calculated by dividing income tax expense (benefit) by earnings before income taxes. For 2023 , the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 25.1 %, primarily due to tax benefits related to earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. +The Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI taxes foreign income in excess of a deemed return on tangible assets of foreign corporations and is treated as a period cost. +The tax effects of temporary differences giving rise to deferred tax assets and liabilities are presented below: +As of December 31, +(in thousands) +2023 +2022 +Deferred tax assets +Inventory adjustments +$ +9,413 +$ +10,810 +Accrued expenses +109,510 +99,185 +Allowances for bad debts and chargebacks +5,648 +4,728 +Advance payment +— +6,339 +Intra-entity IP transfer +330,545 +343,106 +Section 174 Capitalized Costs +43,130 +15,721 +Loss carryforwards +46,021 +50,558 +Business credit carryforward +22,571 +25,289 +Share-based compensation +10,486 +7,725 +Operating lease liabilities +338,389 +317,449 +Valuation allowance +( 56,334 +) +( 58,321 +) +Total deferred tax assets +859,379 +822,589 +Deferred tax liabilities +Prepaid expenses +3,873 +5,073 +Right-of-use assets +338,389 +317,449 +Foreign intangibles +16,116 +6,970 +Depreciation on property, plant and equipment +63,021 +47,563 +Total deferred tax liabilities +421,399 +377,055 +Net deferred tax assets +$ +437,980 +$ +445,534 +At December 31, 2023 , combined foreign net operating loss carry-forwards were approximately $ 157.0 million of which $ 1.2 million expire in 2024 and $ 40.9 million can be carried forward indefinitely. A valuation allowance of $ 56.3 million is recorded for the amount of deferred tax assets which is not likely to be fully utilized. The $ 2.0 million decrease in the valuation allowance primarily relates to decreases in deferred tax assets in certain foreign non-benefited loss jurisdictions. +U.S. federal tax credit carry-forward at December 31, 2023 was $ 5.0 million. State tax credit and net operating loss carry-forwards at December 31, 2023 were $ 27.2 million and $ 53.8 million. The state tax credit carries forward indefinitely and the net operating loss carry-forward amounts begin to expire in 2033 . No valuation allowance has been recorded, as the Company believes they will be fully utilized. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +As of December 31, +(in thousands) +2023 +2022 +Beginning balance +$ +41,247 +$ +66,951 +Additions for current year tax positions +4,530 +5,345 +Additions for prior year tax positions +1,379 +4,616 +Reductions for prior year tax positions +— +( 674 +) +Settlement of uncertain tax positions +( 1,722 +) +( 32,954 +) +Reductions related to lapse of statute of limitations +( 2,218 +) +( 2,037 +) +Ending balance +$ +43,216 +$ +41,247 +Current unrecognized tax benefits are recorded as a reduction in prepaid expense and included in tax expense when recorded. Long-term unrecognized tax benefits are recorded as an increase in long-term taxes payable with a portion included in tax expense and a portion recorded as a reduction in deferred tax liabilities when recorded. If recognized, $ 37.4 million of unrecognized tax benefits would be recorded as a reduction in income tax expense, and $ 5.8 million would be recorded as a net increase in deferred tax liabilities. +44 +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +As of December 31, 2023, our U.S. federal tax returns are under investigation for fiscal years ended December 31, 2015, 2018, 2019 and 2020 by the Internal Revenue Service. We are unable to determine the impact of this examination due to the audit process having not been completed. As of December 31, 2023 , the Company’s tax filings are generally subject to examination in most foreign jurisdictions for years ending on or after December 31, 2019, and in several Asian and European tax jurisdictions for years ending on or after December 31, 2013. During the year, the Company reduced the balance of unrecognized tax benefits by $ 2.2 million as a result of expiring statutes and $ 1.7 million from the settlements and decision on a foreign tax ruling. It is reasonably possible that certain foreign statutes will expire and certain domestic audits will be settled during the next twelve months which would reduce the balance of 2023 and prior year unrecognized tax benefits by $ 0.3 million and $ 11.9 million. +The Company estimates interest and penalties related to income tax matters which are included in income tax expense (benefits). Amounts were $ 2.3 million, $ ( 1.9 ) million, and $ 3.6 million for the years ended December 31, 2023, 2022, and 2021 . Accrued interest and penalties were $ 6.4 million and $ 4.2 million as of December 31, 2023 and 2022. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2023 . The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. In addition to certain tax restrictions, our joint venture in China has limitations on its distribution of earnings, as local law currently requires it to maintain $ 27.5 million of its earnings in a statutory reserve. +(11) +Employee Benefit Plans +The Company has a 401(k) profit sharing plan covering U.S. employees who are 21 years of age. The Company’s contribution is based on a non-discretionary match as defined by the plan which vests immediately. The Company made contributions of $ 6.5 million, $ 4.2 million, and $ 4.7 million to the plan for the years ended December 31, 2023, 2022, and 2021. +The Skechers U.S.A., Inc. Deferred Compensation Plan allows eligible employees to defer compensation up to a maximum amount to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees as determined by the Company’s Compensation Committee. No contributions were made for the years ended December 31, 2023, and 2022 and $ 0.1 million was contributed for the year ended December 31, 2021. Deferred compensation is recognized based on the fair value of the participants’ accounts. +(12) +Related Party Transactions +The Skechers Foundation (the “Foundation”) is a 501(c)(3) non-profit entity and not a subsidiary or otherwise affiliated with the Company. The Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are officers and directors of the Foundation. During the years ended December 31, 2023, 2022, and 2021 , the Company made contributions of $ 2.0 million, $ 2.0 million, and $ 3.0 million to the Foundation. +The Company had receivables from officers and employees of $ 0.6 million and $ 1.9 million at December 31, 2023 and 2022 . These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. +45 +(13) +Segment and Geographic Information +The Company has two reportable segments, Wholesale and Direct-to-Consumer. Management evaluates segment performance based primarily on sales and gross margin. Other costs and expenses of the Company are analyzed on an aggregate basis and not allocated to the segments. The following summarizes the Company’s operations by segment and geographic area: +Segment Information +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Wholesale sales +$ +4,504,776 +$ +4,632,429 +$ +3,758,640 +Gross profit +1,846,819 +1,669,276 +1,437,517 +Gross margin +41.0 +% +36.0 +% +38.2 +% +Direct-to-Consumer sales +$ +3,495,566 +$ +2,812,121 +$ +2,551,547 +Gross profit +2,305,585 +1,846,081 +1,686,854 +Gross margin +66.0 +% +65.6 +% +66.1 +% +Total sales +$ +8,000,342 +$ +7,444,550 +$ +6,310,187 +Gross profit +4,152,404 +3,515,357 +3,124,371 +Gross margin +51.9 +% +47.2 +% +49.5 +% +As of December 31, +(in thousands) +2023 +2022 +Identifiable assets +Wholesale +$ +3,607,537 +$ +3,682,860 +Direct-to-Consumer +3,939,814 +3,210,627 +Total +$ +7,547,351 +$ +6,893,487 +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Additions to property, plant and equipment +Wholesale +$ +225,217 +$ +255,311 +$ +245,008 +Direct-to-Consumer +98,505 +103,681 +64,666 +Total +$ +323,722 +$ +358,992 +$ +309,674 +Geographic Information +Year Ended December 31, +(in thousands) +2023 +2022 +2021 +Geographic sales +Domestic Wholesale +$ +1,567,806 +$ +1,831,642 +$ +1,448,339 +Domestic Direct-to-Consumer +1,482,392 +1,243,511 +1,115,018 +Total domestic sales +3,050,198 +3,075,153 +2,563,357 +International Wholesale +2,936,970 +2,800,787 +2,310,302 +International Direct-to-Consumer +2,013,174 +1,568,610 +1,436,528 +Total international sales +4,950,144 +4,369,397 +3,746,830 +Total sales +$ +8,000,342 +$ +7,444,550 +$ +6,310,187 +Regional Sales +Americas (AMER) +$ +3,945,735 +$ +3,854,392 +$ +3,152,304 +Europe, Middle East & Africa (EMEA) +1,831,848 +1,699,215 +1,282,902 +Asia Pacific (APAC) +2,222,759 +1,890,943 +1,874,981 +Total sales +$ +8,000,342 +$ +7,444,550 +$ +6,310,187 +China sales +$ +1,228,630 +$ +1,062,724 +$ +1,247,949 +46 +As of December 31, +(in thousands) +2023 +2022 +Property, plant and equipment, net +Domestic +$ +957,569 +$ +870,924 +International +549,121 +474,446 +Total +$ +1,506,690 +$ +1,345,370 +China property plant and equipment, net +$ +286,854 +$ +264,422 +The Company’s sales to its five largest customers accounted for approximately 8.4 % , 9.6 % , and 8.6 % of total sales for the years ended December 31, 2023, 2022 and 2021. +Assets located outside the U.S. consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Net assets held outside the U.S. were $ 5.1 billion and $ 4.4 billion at December 31, 2023 and December 31, 2022. +The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated doubtful accounts. Domestic accounts receivable generally do not require collateral. Foreign accounts receivable are generally collateralized by letters of credit. The Company’s additions to the provision for expected credit losses for the year ended December 31, 2023, 2022, and 2021 were $ 3.9 million, $ 5.3 million, and $ 3.3 million. +The Company’s accounts receivables, excluding allowances for bad debts and chargebacks, by geography are summarized as follows: +As of December 31, +(in thousands) +2023 +2022 +Domestic Accounts Receivable +$ +276,918 +$ +310,138 +International Accounts Receivable +641,249 +597,621 +The Company’s top five manufacturers produced the following: +Year Ended December 31, +(percentage of total production) +2023 +2022 +2021 +Manufacturer #1 +21.4 +16.5 +18.0 +Manufacturer #2 +7.5 +7.0 +5.3 +Manufacturer #3 +6.7 +5.2 +4.8 +Manufacturer #4 +5.6 +5.2 +4.6 +Manufacturer #5 +4.5 +5.1 +4.4 +45.7 +39.0 +37.1 +(14) +Business Combinations +Business acquisitions are accounted for under the acquisition method by assigning the purchase consideration to tangible and intangible assets acquired and liabilities assumed. The results of businesses acquired in a business combination are included in the consolidated financial statements from the date of acquisition. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase consideration over the amounts assigned is recorded as goodwill. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Fair value determinations require judgment and may involve the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives, and market multiples, among other items. +On May 31, 2023, the Company acquired 100 % of the equity interests of Sports Connection Holdings ApS (“Sports Connection”), a Denmark-based company and a former distributor, to further broaden our reach in Europe. The total consideration is approximately $ 83.7 million and consisted of an initial cash payment of $ 74.8 million, the settlement of pre-existing receivables of $ 1.7 million and a contingent consideration payable of up to $ 7.5 million, subject to the acquiree achieving certain 2023 financial results, and reduced by a working capital adjustment of $ 0.3 million. On the acquisition date, we re corded intangible assets of $ 54.4 million, goodwill of $ 7.7 million and other net assets of $ 21.6 million. The intangible assets have an estimated life of 7 years and are primarily related to reacquired rights. The acquisition is a non-taxable business combination and goodwill is not deductible for tax purposes. +The results of Sports Connection's operations have been included in, but are not material to, the Company's consolidated results of operations since the date of acquisition. Unaudited supplemental pro forma results of operations have not been presented because the effect of the acquisition was not material to the Company's consolidated financial statements. One-time acquisition related costs of $ 1.6 million were expensed as general and administrative expenses as incurred. +The purchase accounting for the Sports Connection acquisition remains preliminary. Although the Company uses its best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, as well as any contingent consideration, the estimates are inherently uncertain and subject to refinement. As a result, any adjustments will be recognized in the reporting period in which the amounts are determined, but not to exceed twelve months from the acquisition date. +47 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, management concluded that our disclosure controls and procedures are not effective as a result of a material weakness in internal controls over financial reporting described below. Notwithstanding the material weakness, our management has concluded that the consolidated financial statements fairly present, in all material respects, its financial condition, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation , we concluded that our internal control over financial reporting is not effective as of December 31, 2023. We reviewed the results of management’s assessment with the Audit Committee of our Board. +A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +We identified a material weakness in our internal control over financial reporting related to the information technology general controls related to segregation of duties within an information system relevant to the preparation of the Company’s consolidated financial statements. +Under the direction of the Audit Committee, our management has begun the process of designing and implementing effective internal control measures to remediate the material weakness. These efforts will include: +• +Rationalizing user access roles and privileges; +• +Implementing user activity monitoring; and +• +Formalizing additional compensating control activities over the completeness and accuracy of data provided by the affected system. +The material weakness will not be considered remediated until the enhanced controls operate for a sufficient period of time and management has concluded, through testing, that the related controls are effective. We will monitor the effectiveness of the remediation plan and refine the remediation plan as appropriate. +Our independent registered public accountants, BDO USA, P.C., who audited the consolidated financial statements included in this annual report on Form 10-K, has issued an adverse opinion on the effectiveness of our internal control over financial reporting as of December 31, 2023, which is set forth below. +48 +Inherent Limitations on Effectiveness of Controls +Our management, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +Other than the material weakness noted above, there were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2023. +49 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on the COSO criteria. +We do not express an opinion or any other form of assurance on management’s statements referring to any corrective actions taken by the Company after the date of management’s assessment. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2023 and 2022, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2024 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness regarding management’s failure to design and maintain effective information technology general controls related to segregation of duties within the information system relevant to the preparation of the Company’s consolidated financial statements has been identified and described in management’s assessment. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2023 financial statements, and this report does not affect our report dated February 28, 2024, on those financial statements. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, P.C. +Los Angeles, California +February 28, 2024 +50 +Item 9B. Other Information +During the quarter ended December 31, 2023, no director or officer of the Company adopted or terminated a “Rule 10b-1 trading agreement” or “non-Rule 10b-1 trading agreement” as each such term is defined in Item 408 of Regulation S-K. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. +Item 11. Executive Compensation +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. +Item 14. Principal Accountant Fees and Services +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. +51 +PART IV +Item 15. Ex hibit and Financial Statement Schedules +1. +Financial Statements. The financial statements as set forth under Item 8 of this Annual Report on Form 10-K are incorporated herein. +2. +Financial Statement Schedule. +Schedule II - Valuation and Qualifying Account +(in thousands) +Balance at +Beginning of Year +Costs +Charged to +Expenses +Deductions +and +Write-offs +Balance at +End of Year +Year-ended December 31, 2021 +Allowance for chargebacks +$ +26,674 +$ +45,957 +$ +( 32,497 +) +$ +40,134 +Allowance for doubtful accounts +21,888 +10,551 +( 9,889 +) +22,550 +Liability for sales returns and allowances +77,219 +6,263 +( 14,538 +) +68,944 +Reserve for inventory +8,220 +24,899 +( 25,608 +) +7,511 +Year-ended December 31, 2022 +Allowance for chargebacks +$ +40,134 +$ +25,558 +$ +( 29,275 +) +$ +36,417 +Allowance for doubtful accounts +22,550 +6,804 +( 6,299 +) +23,055 +Liability for sales returns and allowances +68,944 +5,444 +( 13,906 +) +60,482 +Reserve for inventory +7,511 +31,825 +( 21,606 +) +17,730 +Year-ended December 31, 2023 +Allowance for chargebacks +$ +36,417 +$ +24,076 +$ +( 27,190 +) +$ +33,303 +Allowance for doubtful accounts +23,055 +3,665 +( 2,156 +) +24,564 +Liability for sales returns and allowances +60,482 +20,798 +( 312 +) +80,968 +Reserve for inventory +17,730 +29,703 +( 30,524 +) +16,909 +See accompanying report of independent registered public accounting firm +52 +Index to Exhibits +Exhibit Number +Description +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(b) +Second Amendment to Amended and Restated Certificate of Incorporation dated June 12, 2023 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended June 30, 2023). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 20, 2007). +3.2(c) +Third Amendment to Bylaws dated as of May 15, 2019 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on May 17, 2019). +3.2(d) +Fourth Amendment to Bylaws dated as of March 9, 2023 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on March 15, 2023). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed on May 12, 1999). +4.2 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 3, 2013). +10.1(a)* +First Amendment to the Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1(a) of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.3* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.4* +Form of Restricted Stock Award Agreement (Time-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.5* +Form of Restricted Stock Award Agreement (Performance-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.6* +2023 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant's Definitive Proxy Statement filed on May 1, 2023). +10.7* +Form of Restricted Stock Unit Agreement under 2023 Incentive Award Plan. +10.8* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.9 +Form of Indemnification Agreement between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +53 +Exhibit Number +Description +10.10 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.11* +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.12* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2019). +10.13* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.2 of the Registrant’s Form 8-K filed on May 24, 2019). +10.14 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011) . +10.14(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on August 17, 2015). +10.14(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018). +10.14(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(c) of the Registrant’s Form 10-K for the year ended December 31, 2019). +10.15 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed on August 17, 2015). +10.15(a)** +First Amendment to Amended and Restated Loan Agreement dated as of March 18, 2020, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders.(incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on March 24, 2020) . +10.16 +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.17 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.18** +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank +54 +Exhibit Number +Description +Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.19 +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.20 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.20(a) +First Amendment to Credit Agreement dated March 23, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended March 31, 2021). +10.20(b) +Second Amendment to Credit Agreement dated December 15, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.21 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.22 +Reaffirmation Agreement dated December 15, 2021 by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, and Bank of America N.A. (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.23 +Loan Contract, dated October 18, 2022, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and Bank of China Co., Ltd., regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2022) . +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +97 +Policy for Recovery of Erroneously Awarded Compensation +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema with embedded Linkbases Document +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) +55 +* Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** Confidential treatment has been granted by the SEC with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +*** In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +Item 16. Form 10-K Summary +None. +56 +SIGN ATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 28th day of February 2024. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 28, 2024 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 28, 2024 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 28, 2024 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 28, 2024 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Katherine Blair +Director +February 28, 2024 +Katherine Blair +/s/ Morton D. Erlich +Director +February 28, 2024 +Morton D. Erlich +/s/ Zulema Garcia +Director +February 28, 2024 +Zulema Garcia +/s/ Yolanda Macias +Director +February 28, 2024 +Yolanda Macias +/s/ Richard Siskind +Director +February 28, 2024 +Richard Siskind +57 \ No newline at end of file diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/filing_metadata.csv b/raw/filings/0001065837/2023/0000950170-24-022106/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..81e56534a82e84e48a4c8951997d31859acccf02 --- /dev/null +++ b/raw/filings/0001065837/2023/0000950170-24-022106/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2024-02-28,2023-12-31,2024-02-28T21:15:56.000Z,0000950170-24-022106,skx-20231231.htm,10-K,13027098,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000095017024022106/skx-20231231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000095017024022106/,2023,2023,1 diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/item1.txt b/raw/filings/0001065837/2023/0000950170-24-022106/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..708c3f5e9d6bd2537d57c54ef0001fb0f8824444 --- /dev/null +++ b/raw/filings/0001065837/2023/0000950170-24-022106/item1.txt @@ -0,0 +1,71 @@ +Item 1. Business +DESCRIPTION OF BUSINESS +Skechers U.S.A., Inc., designs, develops and markets a diverse range of footwear, apparel, and accessories. Our company was incorporated in California in 1992 and reincorporated in Delaware in 1999. For over 30 years, we have expanded our product offering and grown our sales while substantially increasing the breadth of our consumer and customer base. Our objective is to profitably grow our operations worldwide by delivering stylish, comfortable, innovative and high-quality products at a reasonable price. +Skechers is the third largest athletic footwear company in the world due to our innovative comfort technology products, supported by impactful marketing, a diverse distribution strategy, and a dedicated global employee base and loyal network of partners. +In this annual report on Form 10-K for the fiscal year ended December 31, 2023, Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, are referred to as “Skechers,” “the Company,” “we,” “us,” or “our.” Reference in this annual report to “sales” refers to Skechers net sales reported under U.S. generally accepted accounting principles. +SEGMENTS +We have two reportable segments: Wholesale and Direct-to-Consumer. +Wholesale . Our Wholesale segment is comprised of sales to a network of partners including: +• +Skechers-branded stores operated by third-party franchisees and licensees; +• +Family shoe stores, specialty athletic and sporting goods retailers, department stores and big box club stores; and +• +Distributors in select international markets. +Growth in the Wholesale segment is expected to derive from adding new partners, more Skechers-branded stores, as well as expanding our existing shelf-space with current partners from the introduction of new products. +Direct-to-Consumer . Our Direct-to-Consumer segment comprises sales by us directly to consumers through a combination of channels including: +• +Company-owned Skechers-branded stores; +• +Company-owned e-commerce sites; and +• +Leading third-party marketplaces and digital platforms. +Growth in the Direct-to-Consumer segment is expected to derive from expanding our footprint, leveraging third-party digital marketplaces and platforms and introducing new products. +PRODUCTS +Skechers is a product-driven company and innovation is at the core of our design process. We offer footwear, apparel, and accessories for men, women, and kids. We market our products at multiple price points and provide consumers with products that we believe offer superior in comfort technology. +Product design and development is essential to our success and is driven by our ability to recognize trends and to design products that anticipate and accommodate consumers’ evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, clothing, and trend-setting media. We also consult with our customers on current retail selling trends and collaborate with partners and ambassadors to ensure that our products are designed to address the intended market opportunity and convey the distinctive perspective and lifestyle associated with our brand. A key component of our design philosophy is to continually reinterpret and improve our most successful styles. +Footwear. We offer a comprehensive line of Skechers-branded performance and lifestyle footwear for men, women, and kids – with the Company’s signature comfort features and innovations. We develop footwear for all walks of life: athletes at all levels, everyday comfort needs, as well as occupational requirements. Our footwear categories include the following: +• +Lifestyle – Forward, innovative and on trend, the brand’s fashion, athleisure, and casual collections inspire millions to enjoy the style, comfort and quality synonymous with Skechers. Our lifestyle offering delivers comfort technologies such as Skechers Hands Free Slip-ins®, Skechers Arch Fit®, and Skechers Air-Cooled Memory Foam®, among others. With a street, fashion and court classic range, Skechers is able to reach a younger demographic. +2 +• +Performance – Winner of numerous awards, the Skechers Performance collection offers elite athletes and enthusiast groundbreaking technologies for running, walking, golf, and pickleball, as well as two new additions in 2023 – football and basketball. The Skechers Performance division develops footwear utilizing the latest advancements in materials and innovative design, including Skechers Hyper Burst®, Goodyear ® Resagrip Technology, and Skechers Arch Fit®. To support and market our Performance footwear, we have a roster of elite athletes, including Harry Kane, Europe's top football scorer for 2023 and captain of the England national team; NBA stars Julius Randle and Terance Mann; Major golfers Matt Fitzpatrick and Brooke Henderson; and pickleball pros Tyson McGuffin and Catherine Parenteau. +• +Kids – Skechers appeals to kids with bright and bold colors and designs and are made with the latest comfort features specific to growing children’s feet. Along with unique styles just for children like S-Lights, Skechers Kids also includes take-downs of our most popular products, including Skech-Air, Foamies, Skechers Hands Free Slip-ins, Skechers Stretch Fit, and Skechers Street. +• +Work – A leading work brand in the United States, Skechers Work is made to last – offering service and occupational employees style, comfort and industry certified quality for all-day protection. Skechers Work offers a complete line of men’s and women’s slip-resistant and safety-toe shoes and boots for professionals who use protective footwear in their work environments. Skechers Work styles include Skechers comfort technologies along with safety and durability features such as steel, composite and lightweight safety toes; high-abrasion soles; puncture resistance; waterproofing and electrostatic-dissipative technology. +• +Earth-Friendly – Skechers Our Planet Matters line is made with recycled materials to help reduce our environmental impact. An important part of our product innovation process includes seeking out new material and textile technologies to improve upon the recycled content in Our Planet Matters products. +Apparel . We offer the latest trends in athletic lifestyle apparel. Our collections are designed to complement our footwear products, by offering apparel that is stylish, high-quality and comfortable all at a reasonable price. +Accessories . Skechers licenses a variety of Skechers-branded products including socks, eyewear; medical scrubs; undergarments, fitness and yoga accessories, and cold weather products. +TRADEMARKS, PATENTS AND LICENSING +We own and utilize a variety of trademarks, including the Skechers trademark. We consider our Skechers trademark a significant factor in building our brand image and in distinguishing our products from those of others. We vigorously protect our trademarks against infringement, including through the use of cease-and-desist letters, administrative proceedings and lawsuits. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 164 foreign countries. Further, we have design patents and pending design and utility patent applications in both the U.S. and a myriad of foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally. +We believe that selective licensing of the Skechers brand name to manufacturers broadens and enhances the brand without requiring incremental capital investments or operating expenses. As of December 31, 2023, we had 28 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel and accessories. +MARKETING +Brand recognition is an important element for success in the footwear business. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. We aggressively market our brands through comprehensive marketing campaigns. The Skechers brand is supported by television, digital, print, radio, outdoor, and press campaigns. To further drive recognition, we enlist numerous celebrities, athletes, and influencers to appear in our campaigns. We strategically select our ambassadors who we believe work well with the Company to promote the brand and support the product. +In 2023, our brand ambassadors included television personalities and entertainers Martha Stewart, Snoop Dogg, Amanda Kloots, Brooke Burke, and Chesca, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Cris Carter, Meb Keflezighi, and Rusty Wallace. Additionally, athletes supporting our performance footwear included runner Edward Cheserek, elite golfers Matt Fitzpatrick and Brooke Henderson, pro pickleball players Tyson McGuffin and Catherine Parenteau, and Los Angeles Dodgers pitcher Clayton Kershaw. During the year, we partnered with NBA pros Julius Randle and Terance Mann, and Bayern Munich's Harry Kane, as well as a team of premier league players to support our new basketball and football divisions. We identify athletes who benefit from the comfort and technologies that our brand has to offer, and whose performance on the field, court, or course is augmented through the product. +3 +SOURCING AND MANUFACTURING +Our suppliers are integral partners in delivering stylish, high-quality footwear and apparel to our consumers worldwide. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production work force. To minimize disruption of our product supply due to potential political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. +To safeguard product quality and consistency, we monitor the key aspects of production from initial prototype manufacturing, through initial production runs, to final manufacturing. Monitoring of production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. +We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production and ensure that leading manufacturers comply with our Supplier Code of Conduct. +OUR MARKET +Our collections are available in approximately 180 countries and territories and can be accessed in digital or physical stores. We are continually expanding and enhancing our distribution and logistics facilities and systems to support our omni-channel capabilities and provide greater access to merchandise selection and faster delivery. Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective retail distribution channel, which continues to improve our customer service and brand experience. We manage our international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. Our joint venture interests include China, Malaysia and Singapore (50%), Thailand (51%), Mexico (60%), and South Korea (65%), and Israel (75%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores, as well as in Skechers-branded retail stores. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to our entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers, and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence for a longer period of time, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We believe, however, that we have competitive advantages because of our brand recognition, our quality comfort technology products, and our application of pricing and distribution strategies, among other factors. +HUMAN CAPITAL +Skechers employees are central to our success. We are a family brand at the core, and our commitment to family extends to our diverse team of global employees. We believe our unique backgrounds and experiences have made us stronger, inspired new ideas, and driven our innovative spirit. From our corporate offices to our retail stores and our distribution centers, we aim to build a workplace that supports each employee’s well-being and encourages everyone to grow in their careers and give back to their community. We are focused on creating a positive, supportive work environment where our team can work and feel their best every day. +Employees . As of December 31, 2023, we employed approximately 17,900 persons worldwide, of whom approximately 9,200 were employed on a full-time basis and approximately 8,700 were employed on a part-time basis, primarily in our retail stores. +Compensation and Benefits. We seek to provide market-competitive compensation and benefits that not only attract the best talent, but also retain our current employees. We offer a broad range of benefits including medical, prescription, dental and vision plans, flexible spending accounts, company-provided disability insurance, pet insurance, paid sick and vacation time, employee assistance program, childcare subsidies, parental leave and tuition reimbursement. Additional benefits for certain employees include a 401K plan, 529 college savings plan, pensions and pet insurance. +4 +Diversity, Equity, and Inclusion. Skechers was founded on inclusivity, diversity, respect, and entrepreneurial spirit with the philosophy of putting people first. In conjunction with our corporate policy against discrimination, Skechers emphasizes that every employee, applicant, contractor, and customer is entitled to be treated with dignity and respect. Human rights are a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify our commitment to these values. These codes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at investors.skechers.com/corporate-governance/governance-documents. We intend to post any amendment to, or waivers of, these codes on our website. +CORPORATE RESPONSIBILITY +Despite the dynamic growth we have seen over the years, we remain firmly rooted in the same community where we began while dedicated to serving the people of the world. In so doing, we take seriously our position as a steward of the many communities and stakeholders we impact in our daily business activities. This increasingly involves considering the multiple ways we can evolve our business practices and processes to improve the health of our planet, the lives of our people and our communities. Corporate responsibility is a top priority for our leadership, who are investing in plans to further our environmental, social and governance ("ESG") efforts. +Sustainability . We believe it is our responsibility as a family-focused footwear and apparel brand to create and implement sustainable strategies across our operations to minimize our impact on the environment and support our customers, employees, and partners. Environmental advancements are a top priority in the development of our corporate offices as well as logistic centers. Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. Additionally, our China Distribution Center in Taicang incorporates sustainable features such as natural lighting, LED motion detectors and temperature controllers; and our newly opened India Distribution Center outside Mumbai is designed as a LEED building with certification pending. +In 2021, we introduced Our Planet Matters, a collection for men, women and kids that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interests and commitment to reduce tree harvesting and emissions through packaging. These efforts represent our growing focus on more environmentally sustainable manufacturing, packaging, distribution, product development, corporate processes, and activities. +Human Rights. We require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. This code outlines our policies and expectations on topics including discrimination, harassment and abuse, forced labor, freedom of association, compensation and benefits, and health and safety, among others. +Community . Skechers encourages active participation in the greater community, with annual charity walks for children in the U.S. and around the world. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives, and shoe drives. Additionally, we regularly donate product to not-for-profit organizations. In 2023, we donated more than $1.1 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. +For additional information on how Skechers value creation and global impact, refer to our Impact Report which can be found on our website at about.skechers.com/social-responsibility. +AVAILABLE INFORMATION +We file annual, quarterly, and current reports, proxy statements and other documents with the Securities and Exchange Commission (“SEC”). The SEC maintains an internet site at sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Our internet address is www.skechers.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information are also made available, free of charge, on our investor relations website at investors.skechers.com as soon as reasonably practicable after we file or furnish with the SEC. The information found on, or otherwise accessible through our website, is not incorporated into, and does not form a part of this annual report on Form 10-K or our other filings with the SEC. +5 \ No newline at end of file diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/item13.txt b/raw/filings/0001065837/2023/0000950170-24-022106/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..055e986cb8bef168fda27131f3521261ccce7c5f --- /dev/null +++ b/raw/filings/0001065837/2023/0000950170-24-022106/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2023 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/item9a.txt b/raw/filings/0001065837/2023/0000950170-24-022106/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..f10b28cfbd172f38114331d979807749e357a5e0 --- /dev/null +++ b/raw/filings/0001065837/2023/0000950170-24-022106/item9a.txt @@ -0,0 +1,49 @@ +Item 9A. Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, management concluded that our disclosure controls and procedures are not effective as a result of a material weakness in internal controls over financial reporting described below. Notwithstanding the material weakness, our management has concluded that the consolidated financial statements fairly present, in all material respects, its financial condition, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation , we concluded that our internal control over financial reporting is not effective as of December 31, 2023. We reviewed the results of management’s assessment with the Audit Committee of our Board. +A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +We identified a material weakness in our internal control over financial reporting related to the information technology general controls related to segregation of duties within an information system relevant to the preparation of the Company’s consolidated financial statements. +Under the direction of the Audit Committee, our management has begun the process of designing and implementing effective internal control measures to remediate the material weakness. These efforts will include: +• +Rationalizing user access roles and privileges; +• +Implementing user activity monitoring; and +• +Formalizing additional compensating control activities over the completeness and accuracy of data provided by the affected system. +The material weakness will not be considered remediated until the enhanced controls operate for a sufficient period of time and management has concluded, through testing, that the related controls are effective. We will monitor the effectiveness of the remediation plan and refine the remediation plan as appropriate. +Our independent registered public accountants, BDO USA, P.C., who audited the consolidated financial statements included in this annual report on Form 10-K, has issued an adverse opinion on the effectiveness of our internal control over financial reporting as of December 31, 2023, which is set forth below. +48 +Inherent Limitations on Effectiveness of Controls +Our management, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +Other than the material weakness noted above, there were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2023. +49 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on the COSO criteria. +We do not express an opinion or any other form of assurance on management’s statements referring to any corrective actions taken by the Company after the date of management’s assessment. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2023 and 2022, the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2024 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness regarding management’s failure to design and maintain effective information technology general controls related to segregation of duties within the information system relevant to the preparation of the Company’s consolidated financial statements has been identified and described in management’s assessment. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2023 financial statements, and this report does not affect our report dated February 28, 2024, on those financial statements. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, P.C. +Los Angeles, California +February 28, 2024 +50 \ No newline at end of file diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/rp_note.txt b/raw/filings/0001065837/2023/0000950170-24-022106/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2023/0000950170-24-022106/rpt_disclosure.txt b/raw/filings/0001065837/2023/0000950170-24-022106/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..b66af9de53f6acf90f68f72c2cb19364d3146f0f --- /dev/null +++ b/raw/filings/0001065837/2023/0000950170-24-022106/rpt_disclosure.txt @@ -0,0 +1,16 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in the section entitled “ Code of Business Conduct and Ethics and Corporate Code of Conduct ” in this Proxy Statement), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and Proxy Statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A Common Stock or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +We have adopted changes to our policies and procedures to identify and report employees who, pursuant to Item 404 of Regulation S-K under the Exchange Act, are related to a Related Person and earned annual compensation equal to or greater than $120,000. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2024. Each of these transactions was reviewed, and either approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +50 +Related Person Transactions +During 2024, we paid $267,488 and $135,000 to The BeachLife Festival and The BeachLife Ranch Festival for Skechers marketing and sponsorship. The BeachLife Festival is owned and operated by BeachLife Festival, LLC, of which Michael Greenberg owns a 10% beneficial ownership interest. The BeachLife Ranch Festival is owned and operated by BeachLife Festival 2, LLC, of which Michael Greenberg owns a 10% beneficial ownership interest. Skechers had no outstanding accounts receivable or payable with any of these music festivals or their operating entities as of December 31, 2024. +During 2024, we paid $399,566 to the Redondo Beach Hospitality Company, LLC ("RBHC") for lodging, food and events, including the Company's 2024 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. In addition, we made payments of $495,028, $597,063 and $126,534 to RBHC for lodging, food and events in 2023, 2022 and 2021, respectively, that were not previously reported. Michael Greenberg owns a 9% beneficial ownership interest in RBHC, and three other officers, directors and senior vice presidents of Skechers own in aggregate an additional 7% beneficial ownership in RBHC. Skechers had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach at December 31, 2024. +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2024, we made cash contributions of $2,000,000 to the Foundation and provided support services with a value of $300,000. +As of December 31, 2024, Robert Greenberg and Michael Greenberg owed unreimbursed expenses of $144,948 and $3,099, respectively, to Skechers. These amounts have since been repaid in the ordinary course of our reimbursement practices, which occurs on a regular cadence. +Jason Greenberg, Jeffrey Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $6,183,967, $122,903, $5,476,325 and $331,289, respectively, in 2024. Marlene Greenberg, who is Robert Greenberg’s sister, is a non-executive employee of Skechers, and she earned total compensation of $400,472 in 2024. Chase Greenberg, who is the son of Michael Greenberg, is a non-executive employee of Skechers, and he earned total compensation of $1,519,331 in 2024. Andrew Bronstein, who is Michael Greenberg’s brother-in-law, is a non-executive employee of Skechers, and he earned total compensation of $196,910 in 2024. Danielle Coates, a personal acquaintance of Robert Greenberg, is a non-executive employee of Skechers, and she earned compensation of $135,544 in 2024. Miguel Escobar, who is Robert Greenberg’s brother-in-law, and who provided services as a consultant to Skechers, earned compensation of $165,000 in 2024. +Andrew Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $943,260 and $663,424, respectively, in 2024. +During 2024, we paid $120,000 to El Camino Media Services, which provides music procurement services to Skechers. El Camino Media Services is owned by Jennifer Greenberg Messer's husband, Matthew Messer, who is the son-in-law of Robert Greenberg and the brother-in-law of Michael Greenberg. In addition, for each of the years from 2016 through 2023, we paid $120,000 to El Camino Media Services, which were not previously reported. \ No newline at end of file diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/filing.txt b/raw/filings/0001065837/2024/0000950170-25-030016/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..62547cfe4177b27e1e741c0c26444b8664cad35a --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/filing.txt @@ -0,0 +1,3446 @@ +10-K +false 0001065837 FY SKECHERS USA INC http://fasb.org/us-gaap/2024#UsefulLifeShorterOfTermOfLeaseOrAssetUtilityMember http://fasb.org/us-gaap/2024#SecuredOvernightFinancingRateSofrMember one year http://fasb.org/srt/2024#ChiefOperatingOfficerMember 0001065837 us-gaap:CommonClassBMember 2024-12-31 0001065837 skx:AllowanceForChargebacksMember 2024-01-01 2024-12-31 0001065837 us-gaap:AccumulatedOtherComprehensiveIncomeMember 2023-01-01 2023-12-31 0001065837 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iso4217:USD xbrli:shares iso4217:USD +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2024 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 001-14429 +SKECHERS U.S.A., INC. +(Exact name of registrant as specified in its charter) +Delaware +95-4376145 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +228 Manhattan Beach Blvd. , +Manhattan Beach , California 90266 +( 310 ) 318-3100 +(Address, including zip code, and telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Class A Common Stock, par value $0.001 per share +SKX +New York Stock Exchange +(Title of each class) +(Trading symbol) +(Name of each exchange on which registered) +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☒ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☒ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +As of June 30, 2024, the aggregate market value of the voting and non-voting Class A and Class B Common Stock held by non-affiliates of the registrant was approximately $ 6.8 billion based upon the closing price of $69.12 of the Class A Common Stock on the New York Stock Exchange on such date. +The number of shares of Class A Common Stock outstanding as of February 19, 2025 : 130,041,034 . +The number of shares of Class B Common Stock outstanding as of February 19, 2025 : 19,313,651 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement issued in connection with the 2025 Annual Meeting of the Stockholders of the registrant are incorporated by reference into Part III. +Skechers U.S.A., INC. and subsidiaries +Form 10-K +Table of Contents +PART I +Item 1 +Business +2 +Item 1A +Risk Factors +6 +Item 1B +Unresolved Staff Comments +14 +Item 1C +Cybersecurity +14 +Item 2 +Properties +15 +Item 3 +Legal Proceedings +17 +Item 4 +Mine Safety Disclosures +17 +PART II +Item 5 +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +18 +Item 6 +[Reserved] +19 +Item 7 +Management’s Discussion and Analysis of Financial Condition and Results of Operations +20 +Item 7A +Quantitative and Qualitative Disclosures About Market Risk +25 +Item 8 +Financial Statements and Supplementary Data +26 +Item 9 +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A +Controls and Procedures +50 +Item 9B +Other Information +53 +Item 9C +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +53 +PART III +Item 10 +Directors, Executive Officers and Corporate Governance +53 +Item 11 +Executive Compensation +53 +Item 12 +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +53 +Item 13 +Certain Relationships and Related Transactions, and Director Independence +53 +Item 14 +Principal Accountant Fees and Services +53 +PART IV +Item 15 +Exhibit and Financial Statement Schedules +54 +Item 16 +Form 10-K Summary +58 +Signatures +59 +i +S pecial Note on Forward-Looking Statements +This annual report on Form 10-K contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements with regards to future revenue, projected operating results, earnings, spending, margins, cash flow, orders, expected timing of shipment of products, inventory levels, future growth or success in specific countries, categories or market sectors, continued or expected distribution to specific retailers, liquidity, capital resources and market risk, strategies and objectives. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or simply state future results, performance or achievements, and can be identified by the use of forward-looking language such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will,” “could,” “may,” “might,” or any variations of such words with similar meanings. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in forward-looking statements, and reported results shall not be considered an indication of our future performance. Factors that might cause or contribute to such differences include: +• +our ability to maintain our brand image and to anticipate, forecast, identify, and respond to changes in fashion trends, consumer demand for the products and other market factors; +• +our ability to sustain, manage and forecast our costs and proper inventory levels; +• +our ability to remain competitive among sellers of footwear for consumers, including in the highly competitive performance footwear market; +• +global economic, political and market conditions including the effects of inflation and foreign currency exchange rate fluctuations around the world, the challenging consumer retail market in the United States (“U.S.”) and the impact of war and other conflicts around the world; +• +the loss of any significant customers, decreased demand by industry retailers and the cancellation of order commitments; +• +our ability to continue to manufacture and ship our products that are sourced in China and Vietnam, which could be adversely affected by various economic, political, health or trade conditions, or a natural disaster in China or Vietnam; and +• +our ability to manage the impact from delays and disruptions in our supply chain. +The risks included here are not exhaustive. Other sections of this report include additional factors that could adversely impact our business, financial condition and results of operations. Moreover, we operate in a very competitive and rapidly changing environment, and new risk factors emerge from time to time. We cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these inherent and changing risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this annual report, as a prediction of actual results. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document, except as otherwise required by reporting requirements of applicable federal and state securities laws. +1 +PART I +Item 1. Business +DESCRIPTION OF BUSINESS +Skechers U.S.A., Inc., designs, develops and markets a diverse range of footwear, apparel, and accessories. Our company was incorporated in California in 1992 and reincorporated in Delaware in 1999. For over 30 years, we have expanded our product offering and grown our sales while substantially increasing the breadth of our consumer and customer base. Our objective is to profitably grow our operations worldwide by delivering stylish, comfortable, innovative and high-quality products at a reasonable price. +Skechers is the third largest athletic footwear company in the world due to our innovative comfort technology products, supported by impactful marketing, as well as a diverse distribution strategy, a dedicated global employee base and a loyal network of partners. +In this annual report on Form 10-K for the fiscal year ended December 31, 2024, Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, are referred to as “Skechers,” “the Company,” “we,” “us,” or “our.” Reference in this annual report to “sales” refers to Skechers net sales reported under U.S. generally accepted accounting principles. +SEGMENTS +We have two reportable segments: Wholesale and Direct-to-Consumer. +Wholesale . Our Wholesale segment is comprised of sales to a network of partners including: +• +Skechers-branded stores operated by third-party franchisees and licensees; +• +Family shoe stores, specialty athletic and sporting goods retailers, department stores and big box club stores; +• +E-commerce retailers; and +• +Distributors in select international markets. +Growth in the Wholesale segment is expected to derive from adding new partners, more third-party Skechers-branded stores, as well as expanding our existing shelf space with current partners from the introduction of new products. +Direct-to-Consumer . Our Direct-to-Consumer segment comprises sales by us directly to consumers through a combination of channels including: +• +Company-owned Skechers-branded stores; +• +Company-owned e-commerce sites; and +• +Leading third-party marketplaces and digital platforms. +Growth in the Direct-to-Consumer segment is expected to derive from expanding our footprint, leveraging third-party digital marketplaces and platforms and introducing new products. +PRODUCTS +Skechers is a product-driven company with comfort and innovation at the core of our design process. We offer footwear and accessories for men, women and kids, as well as apparel for men and women. We market our products at multiple price points and provide consumers with what we believe is an offering with superior comfort technology. +Product design and development is essential to our success and is driven by our ability to recognize trends and to design products that anticipate and accommodate consumers’ evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, and fashion media. We also consult with our customers on current retail selling trends and collaborate with partners and ambassadors to ensure that our products are designed to address the intended market opportunity and convey the distinctive perspective and lifestyle associated with our brand. A key component of our design philosophy is to continually reinterpret and improve our most successful styles. +Footwear. We offer a comprehensive line of Skechers-branded performance and lifestyle footwear for men, women, and kids – with the Company’s signature comfort features and innovations. We develop footwear for athletes at all levels, everyday comfort needs, as well as occupational requirements. Our footwear categories include the following: +• +Lifestyle – Forward, innovative and on trend, the brand’s fashion, athleisure, and casual collections inspire millions to enjoy the style, comfort and quality synonymous with Skechers. Our lifestyle offering delivers comfort technologies such as Skechers Hands Free Slip-ins®, Skechers Arch Fit®, and Skechers Air-Cooled Memory Foam®, among others. With a street, fashion and court classic range, Skechers is able to reach a younger demographic. +2 +• +Performance – Winner of numerous awards, the Skechers Performance collection offers elite athletes and enthusiasts innovative technologies for soccer/football, basketball, golf, pickleball, running and walking, as well as cricket in India in 2024. The Skechers Performance division develops footwear utilizing the latest advancements in materials and works with its athletes to develop superior designs. Signature technologies include Skechers Hyper Burst®, Goodyear ® Resagrip Technology, Skechers Hands Free Slip-ins® and Skechers Arch Fit®. To support and market our Performance footwear, we have a roster of elite athletes, including Harry Kane, Europe’s top football scorer for 2023 and captain of the England national team; NBA players Julius Randle, Terance Mann, Joel Embiid, Jabari Walker and WNBA player Rickea Jackson; Major golfers Matt Fitzpatrick and Brooke Henderson; pickleball pros Tyson McGuffin and Catherine Parenteau; and cricketers Ishan Kishan and Yastika Bhatia. +• +Kids – Skechers appeals to kids with bright and bold colors and designs and are made with the latest comfort features specific to growing children’s feet. Along with unique styles for children like S-Lights, Skechers Kids also includes take-downs of our most popular products, including Skech-Air, Foamies, Skechers Hands Free Slip-ins®, Skechers Stretch Fit, and Skechers Street. +• +Work – A leading work brand in the United States and other international markets, Skechers Work is made to last – offering service and occupational employees style, comfort and industry-certified quality for all-day protection. Available for men and women, the Skechers Work line includes slip-resistant and safety-toe shoes and boots for professionals who use protective footwear in their work environments with safety and durability features such as steel, composite and lightweight safety toes, high-abrasion soles, puncture resistance, waterproofing and electrostatic-dissipative technology. +• +Earth-Friendly – Skechers Our Planet Matters line is made with recycled materials to help reduce our environmental impact. An important part of our product innovation process includes seeking out new material and textile technologies to improve upon the recycled content in Skechers Our Planet Matters products. +Apparel . We offer the latest trends in athletic and lifestyle apparel. Our collections are designed to complement our footwear products, by offering apparel that is stylish, high-quality and comfortable all at a reasonable price. +Accessories . Skechers licenses a variety of Skechers-branded products including socks, eyewear, medical scrubs, undergarments, fitness and yoga accessories, and cold weather products. +TRADEMARKS, PATENTS AND LICENSING +We own and utilize a variety of trademarks, including the Skechers trademark. We consider our Skechers trademark a significant factor in building our brand image and in distinguishing our products from those of others. We vigorously protect our trademarks against infringement, including through the use of cease-and-desist letters, administrative proceedings and lawsuits. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 165 foreign countries. Further, we have design patents and pending design and utility patent applications in both the U.S. and a myriad of foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally. +We believe that selective licensing of the Skechers brand name to manufacturers broadens and enhances the brand without requiring incremental capital investments or operating expenses. As of December 31, 2024, we had 25 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel and accessories. +MARKETING +Brand recognition is an important element for success in the footwear business. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. We aggressively market our brands through comprehensive marketing campaigns. The Skechers brand is supported by television, digital, print, radio, outdoor, and press campaigns. To further drive recognition, we enlist numerous celebrities, athletes, and influencers to appear in our campaigns. We strategically select ambassadors who we believe work well with the Company to promote the brand and support the product. In 2024, our brand ambassadors included television personalities and entertainers Martha Stewart, Snoop Dogg, Amanda Kloots, Brooke Burke, Howie Mandel, Myleene Klass, Andy Reid and Vanessa Mai, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Jamie Redknapp, Fabio Cannavaro, Ruud, Gullet and Frank Leboeuf. +Additionally, athletes supporting our performance footwear included elite golfers Matt Fitzpatrick and Brooke Henderson, professional pickleball players Tyson McGuffin and Catherine Parenteau, and Major League Baseball players Clayton Kershaw, Chris Taylor, Brendan Donovan, Aaron Nola and Wade Miley. Skechers Football launched at the start of the 2023/24 season when the Company signed Bayern Munich striker Harry Kane as the first professional to compete in the boot. Skechers expanded its roster with a number of Premier League athletes including Mohammed Kudus, Oleksandr Zinchenko and Anthony Elanga, as well as Indian Super League all-time top scorer Sunil Chhetri and Turkey’s Super Lig and national team player Baris Alper Yilmaz. Skechers Basketball launched at the start of the 2023/24 season with NBA pros Julius Randle and Terance Mann. The roster expanded in 2024 with gold-medal winner Joel Embiid, Jabari Walker and Rickea Jackson, our first WNBA athlete. For the 2024 launch of Skechers Cricket, we signed Mumbai Indian cricketers Ishan Kishan and Yastika Bhatia. We identify athletes who benefit from the comfort and technologies that our brand has to offer, and whose performance on the field, court, pitch, or course is augmented through the product. +3 +SOURCING AND MANUFACTURING +Our suppliers are integral partners in delivering stylish, high-quality footwear and apparel to our consumers worldwide. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production workforce. To minimize disruption of our product supply due to potential political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle our expected volume in the foreseeable future. +To safeguard product quality and consistency, we monitor the key aspects of production from initial prototype manufacturing, through initial production runs, to final manufacturing. Monitoring of production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. +We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production and ensure that manufacturers comply with our Supplier Code of Conduct. +OUR MARKET +Our collections are available in approximately 180 countries and territories and can be accessed in digital or physical stores. We are continually expanding and enhancing our distribution and logistics facilities and systems to support our omni-channel capabilities and provide greater access to merchandise selection and faster delivery. Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective direct-to-consumer distribution channel, which continues to improve our customer service and brand experience. We manage our international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. Our joint venture interests include China, Malaysia, Vietnam and Singapore (50%), Thailand (51%), Mexico (60%), South Korea (65%) and Israel (75%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores, and digital stores, as well as in Skechers-branded retail stores. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to our entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers, and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence longer, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We believe, however, that we have competitive advantages because of our brand recognition, our quality comfort technology products, and our application of pricing and distribution strategies, among other factors. +HUMAN CAPITAL +Skechers employees are central to our success. We are a family brand at the core, and our commitment to family extends to our diverse team of global employees. We believe our unique backgrounds and experiences have made us stronger, inspired new ideas, and driven our innovative spirit. From our corporate offices to our retail stores and our distribution centers, we aim to build a workplace that supports each employee’s well-being and encourages everyone to grow in their careers and give back to their community. We are focused on creating a positive, supportive work environment where our team can work and feel their best every day. +Employees . As of December 31, 2024, we employed approximately 20,100 persons worldwide, of whom approximately 10,100 were employed on a full-time basis and approximately 10,000 were employed on a part-time basis, primarily in our retail stores. +Compensation and Benefits. We seek to provide market-competitive compensation and benefits that attract and retain the best talent. We offer a broad range of benefits including medical, prescription, dental and vision plans, flexible spending accounts, company-provided disability insurance, pet insurance, paid sick and vacation time, employee assistance program, childcare subsidies, parental leave and tuition reimbursement. Additional benefits for certain employees include a 401(k) plan, 529 college savings plan and pensions. +4 +Workplace Culture. Skechers was founded on inclusivity, diversity, respect, and entrepreneurial spirit with the philosophy of putting people first. In conjunction with our corporate policy against discrimination, Skechers emphasizes that every employee, applicant, contractor, and customer is entitled to be treated with dignity and respect. Human rights are a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify our commitment to these values. These codes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at investors.skechers.com/corporate-governance/governance-documents. We intend to post any amendment to, or waivers of, these codes on our website. +CORPORATE RESPONSIBILITY +Despite the dynamic growth we have seen over the years, we remain firmly rooted in the same community where we began while dedicated to serving the people around the world. In so doing, we take seriously our position as a steward of the many communities and stakeholders we impact in our daily business activities. This increasingly involves considering multiple ways we can evolve our business practices and processes to improve the health of our planet, the lives of our people and our communities. Corporate responsibility is a top priority for our leadership, who are investing in plans to further our environmental, social and governance ("ESG") efforts. +Sustainability. We believe it is our responsibility as a family-focused footwear and apparel brand to create and implement sustainable strategies across our operations to minimize our impact on the environment and support our customers, employees, and partners. Environmental advancements are a top priority in the development of our corporate offices as well as logistic centers. Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. Additionally, our China Distribution Center in Taicang incorporates sustainable features such as natural lighting, LED motion detectors and temperature controllers; and our recently opened India Distribution Center outside Mumbai is designed as a LEED building with certification pending. Now under construction, our corporate offices in Manhattan Beach remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four new buildings are being designed to receive LEED Gold certification upon completion. +In 2021, we introduced Our Planet Matters, a collection for men and women that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interests and commitment to reduce tree harvesting and emissions through packaging. These efforts represent our growing focus on more environmentally sustainable manufacturing, packaging, distribution, product development, corporate processes, and activities. +Human Rights. We require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. This code outlines our policies and expectations on topics including discrimination, harassment and abuse, forced labor, freedom of association, compensation and benefits, and health and safety, among others. +Community. Skechers encourages active participation in the greater community, with annual charity walks for children near our corporate offices and in select global markets. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives and shoe drives. Additionally, we regularly donate product to not-for-profit organizations and for humanitarian relief. In 2024, we donated $1.6 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. In addition, in 2024, we donated $2.0 million to the Skechers Foundation which is dedicated to ensuring the well-being of youth around the world. +For additional information on Skechers value creation and global impact, refer to our Impact Report which can be found on our website at about.skechers.com/social-responsibility. +AVAILABLE INFORMATION +We file annual, quarterly, and current reports, proxy statements and other documents with the Securities and Exchange Commission (“SEC”). The SEC maintains an internet site at sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Our internet address is www.skechers.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information are also made available, free of charge, on our investor relations website at investors.skechers.com as soon as reasonably practicable after we file or furnish with the SEC. The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of this annual report on Form 10-K or our other filings with the SEC. +5 +Item 1A. Risk Factors +In addition to the other information in this annual report, the following factors should be considered in evaluating us and our business. +RISKS RELATED TO OUR BUSINESS AND INDUSTRY +Our Future Success Depends On Our Ability To Maintain Our Brand Name And Image With Consumers. +Our success to date has largely been due to the strength of the Skechers brand. Maintaining, promoting, and growing our brand depends on our ability to develop high-quality, innovative, and fashion forward products, as well as our ability to create fresh and relevant marketing and advertising campaigns. The inability to execute or adverse developments in these areas could negatively impact our brand. Our brand could also be negatively impacted if we or any of our products were to receive negative publicity. If we are unable to maintain, promote and grow our brand, then our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +Our Future Success Depends On Our Ability To Respond To Changing Consumer Preferences, Identify And Interpret Consumer Trends, And Successfully Market New Products. +The footwear industry is subject to rapidly changing consumer preferences. The continued popularity of our footwear requires us to accurately identify changing consumer preferences and effectively respond in a timely manner. Demand for and market acceptance of existing and new products are uncertain and depend on the following factors: +• +substantial investment in product innovation, design and development; +• +execution of product quality; and +• +significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends. +We are often required to make decisions about product designs and marketing expenditures several months in advance of when consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences with new products that achieve market acceptance. If we fail to identify and effectively respond to changing consumer preferences, we could experience excess inventories, higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +We Face Intense Competition, Including Competition From Companies In The Footwear Industry and With Significantly Greater Resources Than Ours. +We face intense competition from other established companies in the footwear industry in the areas of product offerings, pricing, costs of production, and advertising and marketing expenditures. Consumer demand for our products may decline significantly if we do not adequately and timely anticipate and respond to our competitors. Some of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on price and production, more effectively keep up with rapid changes in footwear technology, and more quickly develop new products. New companies may also enter the markets in which we compete, further increasing competition. We may not be able to compete successfully in the future, and increased competition may result in price reductions, cost increases, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, which would materially and adversely affect our business, financial condition, results of operations and cash flows. +Our Strategies Involve A Number Of Risks That Could Prevent Or Delay The Successful Opening Of New Stores As Well As Negatively Impact The Performance Of Our Existing Stores. +Our ability to successfully open and operate new stores depends on many factors, including our ability to identify suitable store locations, the availability of which is outside of our control; negotiate acceptable lease terms, including desired tenant improvement allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and retain store personnel; successfully integrate new stores into our existing operations; and satisfy the fashion preferences in new geographic areas. +In addition, new stores could be opened in regions in which we currently have few or no stores. Any expansion into new markets may present competitive, merchandising and distribution challenges that are different from those we encounter in our existing markets. Any of these challenges could adversely affect our business and results of operations. In addition, any new store openings in existing markets could result in reduced sales in existing stores in those markets. We may decide to close stores that experience sales declines, which could result in additional costs, expenses, asset impairments or asset write-downs. +6 +Our Global Retail Business Has Required, And Will Continue To Require, A Substantial Investment And Commitment Of Resources And Is Subject To Numerous Risks And Uncertainties. +Our global retail business has required substantial investments in leasehold improvements, inventory, and personnel. We have also made significant operating lease commitments for retail space worldwide. Due to the high fixed-cost structure associated with our global retail business, the poor performance or closure of stores could result in significant lease termination costs, write-offs or impairments of leasehold improvements, and employee-related termination costs. The success of our global retail operations also depends on our ability to identify and adapt to changes in consumer spending patterns and retail shopping preferences globally, including the shift from brick and mortar to digital and mobile channels. Our failure to successfully respond to these factors could adversely affect our retail business, as well as damage our brand and reputation, and could materially and adversely affect our business, financial condition, results of operations and cash flows. +Our Retail Stores Depend On The Customer Traffic Generated By Shopping And Factory Outlet Malls Or By Tourism. +We have concept stores in shopping malls and factory outlet stores in outlet malls. We depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. The overall success of the malls can be negatively impacted by factors outside of our control, such as store closures by other retailers. Some of our concept stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Tourism can be adversely affected by external factors such as an economic slowdown or social or political events. Any substantial decrease in customer traffic generated by malls or tourism has, and may continue to have, an adverse effect on sales in our existing stores or hinder our ability to open retail stores in new markets, which could materially and adversely affect our business, financial condition, results of operations and cash flows. +We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If We Are Unable To Retain Key Personnel, Our Business Could Be Harmed. +We depend upon the continued services of key personnel, including Robert Greenberg, Chairman of the Board and Chief Executive Officer; Michael Greenberg, President and a member of our Board of Directors; and David Weinberg, Executive Vice President, Chief Operating Officer and a member of our Board of Directors. We also depend on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense, and we may not be successful in attracting and retaining such personnel. The loss of the services of senior management and other key personnel or the failure to attract additional personnel and execute a succession plan could materially and adversely affect our business, financial condition, results of operations and cash flows. +We Have A Significant Work Force And Are Subject To Risks Related To Human Capital Management. +We employ approximately 20,100 employees worldwide and a significant portion of our operating expenses relate to compensation and benefits. Although we spend a significant amount of time and expense on human capital management, we cannot ensure that we will be able to maintain a happy and productive workforce. If we are unable to offer competitive compensation and benefits, appropriate training and development, and a compelling work environment or sustain employee satisfaction, our culture may be adversely affected, our reputation may be damaged, and we may incur costs related to turnover. +RISKS RELATED TO SUPPLY CHAIN +Our Business Could Be Harmed If We Fail To Maintain Appropriate Inventory Levels. +We place orders with our manufacturers for some of our products prior to the time we receive customer orders. We do this to minimize purchasing costs, the time necessary to fill customer orders, and the risk of non-delivery. We also maintain an inventory of certain products that we anticipate will be in greater demand. Unanticipated declines in the popularity of Skechers footwear or other unforeseen circumstances may make it difficult for us and our customers to accurately forecast demand, and we may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels exceeding customer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could significantly impair our brand image and have a material adverse effect on our operating results, financial condition and cash flows. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply products when we need them, we may experience inventory shortages. Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty. +7 +Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business Abroad, Particularly In China and Vietnam, Which Could Affect Our Ability To Manufacture Or Sell Our Products, Obtain Products From Foreign Suppliers Or Control The Costs Of Our Products. +Substantially all our sales during the year ended December 31, 2024 were derived from sales of footwear manufactured in foreign countries, with most manufactured in China and Vietnam. We also sell our footwear in foreign countries and plan to increase our international sales efforts as part of our growth strategy. Foreign manufacturing and sales are subject to a number of risks, including the following: political and social unrest, including terrorism; changing economic conditions, including higher labor costs; increased costs of raw materials; currency exchange rate fluctuations; labor shortages and work stoppages, including those due to the outbreak of a disease leading to an epidemic or pandemic spread; electrical shortages; transportation delays; loss or damage to products in transit; expropriation; nationalization; the adjustment, elimination or imposition of domestic and international duties, tariffs, quotas, import and export controls and other non-tariff barriers; exposure to different legal standards (particularly with respect to intellectual property); compliance with foreign laws; changes in domestic and foreign governmental policies; and the potential for circumstances where we may have to incur premium freight charges to expedite the delivery of product to our customers. Apart from the impacts of the COVID-19 pandemic, including supply chain constraints, we have not, to date, been materially affected by any such risks, but we cannot predict the likelihood of such developments occurring or the resulting long-term adverse impact on our business, financial condition, results of operations and cash flows. +In particular, because most of our products are manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations with China or Vietnam, political instability in China or Vietnam, increases in labor costs, the occurrence of prolonged adverse weather conditions or a natural disaster such as an earthquake or typhoon in China or Vietnam, or the outbreak of a pandemic disease in China or Vietnam could severely interfere with the manufacturing and/or shipment of our products and would have a material adverse effect on our operations. Our business operations may be adversely affected by the current and future political environment in China. The government of China has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate under China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under its current leadership, the government of China has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of China will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice. A change in policies by the government of China could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. +We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Disruptions In Product Supply. +Our footwear products are currently manufactured by independent contract manufacturers. During the year ended December 31, 2024, the top five manufacturers of our products produced approximately 42.4% of our total purchases. One manufacturer accounted for 20.4% of total purchases for the year ended December 31, 2024. +We compete with other footwear companies for production facilities, and we do not have long-term contracts with any of our contract manufacturers. Under our current arrangements with them, these manufacturers generally may unilaterally terminate their relationship with us at any time. If our current manufacturers cease doing business with us, we could experience an interruption in the manufacture of our products. Although we believe that we could find alternative manufacturers, we may be unable to establish relationships with alternative manufacturers that will be as favorable as the relationships we have now. For example, new manufacturers may have higher prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or higher lead times for delivery. If we are unable to provide products consistent with our standards or the manufacture of our footwear is delayed or becomes more expensive, our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Ability To Deliver Our Products To The Market Could Be Disrupted If We Encounter Problems Affecting Our Logistics And Distribution Systems. +We rely on owned or independently operated distribution facilities to transport, warehouse and ship products to our customers. Our logistics and distribution systems include computer-controlled and automated equipment, which may be subject to risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Substantially all our products are distributed from a few locations. Therefore, our operations could be interrupted by travel restrictions, earthquakes, floods, fires or other natural disasters near our distribution centers. Our business interruption insurance may not adequately protect us from the potential adverse effects of significant disruptions to our distribution system, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. If we encounter problems affecting our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected. +8 +RISKS RELATED TO ECONOMIC AND POLITICAL CONDITIONS, AND OTHER EXTERNAL FACTORS +The Uncertainty Of Global Market Conditions. +The uncertain state of global economic and political conditions, including the impact of inflation and challenging consumer retail market, may negatively impact our business, which depends on the general economic environment and levels of consumers’ discretionary spending. If the economic situation weakens, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage of sales. Additionally, if there is an unexpected decline in sales, our results of operations will depend on our ability to implement a corresponding and timely reduction in our costs and manage other aspects of our operations. These challenges include (i) managing our infrastructure, (ii) hiring and maintaining, as required, the appropriate number of qualified employees, (iii) managing inventory levels and (iv) controlling other expenses. +The impact of wars, acts of war and other conflicts around the world may result in subsequent economic sanctions imposed by the U.S., NATO and other countries. Conflicts may impact global economic conditions or our ability to sell products to customers in the affected regions. Conflicts could also have broader implications on economics outside the directly impacted regions, such as the global inflationary impact of a potential boycott of Russian oil and gas by other countries. Furthermore, any unfavorable developments in global political, social and regulatory conditions, including geopolitical conflicts, political unrest, civil strife, terrorist activity, acts of war, public corruption, expropriation, nationalism and other economic or political uncertainties in the U.S. or internationally, could also impact our business. Any negative sentiment toward the U.S. as a result of any such developments could also adversely affect our business and reputation. If the uncertain global market conditions continue for a significant period or worsen, our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Business Could Be Adversely Affected By Changes In The Business Or Financial Condition Of Our Customers Due To Global Economic Conditions. +A global financial crisis could affect the banking system and financial markets and result in a tightening in the credit markets, more stringent lending standards and terms, higher inflation, and higher volatility in fixed income, credit, currency and equity markets. In addition, our business could be adversely affected by other economic conditions, such as the insolvency of certain of our key distributors, which could impair our distribution channels, or the diminished liquidity or an inability to obtain credit to finance purchases of our product by our significant customers. Our customers may also experience weak demand for our products or other difficulties in their businesses. If economic, financial or political conditions in global markets deteriorate in the future, demand may be lower than forecasted and insufficient to achieve our anticipated financial results. Any of these events would likely materially and adversely affect our business, financial condition, results of operations and cash flows. +Our Sales Are Influenced By Economic Conditions And Uncertainty That Impact Consumer Spending And Consumer Confidence. +Consumer confidence and spending on discretionary items generally declines during periods of economic uncertainty or recession. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and/or increasing promotional activity. Our retail stores are also affected by these conditions and may experience declines in consumer traffic and spending. As a result, factors that diminish consumer confidence and spending, particularly deterioration in general economic conditions, consumer credit availability, consumer debt levels, inflation, the impact of foreign currency exchange fluctuations on tourism and tourist spending, volatility in investment returns, fear of unemployment, increases in energy costs or taxes or interest rates, housing market downturns, fear about and impact of pandemic illness, and other factors such as acts of war, natural disasters or terrorist or political events that impact consumer confidence, have had, and may continue to have a material adverse effect on our operations and financial condition through their negative impact on our wholesale customers as well as decreased spending in our retail stores and potentially via our e-commerce business. +Natural Disasters, The Effects Of Climate Change, Pandemics, And Other Events Beyond Our Control. +Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce, and the global economy, and thus could have a negative effect on us. Our business operations are subject to interruption from earthquakes, hurricanes, tornadoes, floods, fires, extreme weather events, power shortages, pandemics, telecommunications failure, vandalism, cyber-attacks, the effects of climate change, and other events beyond our control. Although we maintain disaster recovery plans, such events could disrupt our operations or those of our customers and suppliers, including through the inability of employees and contract professionals to work, destruction of facilities, loss of life, and adverse effects on supply chains, power, infrastructure and the integrity of information technology (“IT”) systems, all of which could materially increase our costs and expenses, delay or decrease revenue from our customers and disrupt our ability to maintain business continuity. We could incur significant costs to improve the climate-related resiliency of our infrastructure and otherwise prepare for, respond to, and mitigate the effects of climate changes. Our insurance may not be sufficient, or cover losses or additional expenses that we may sustain. A significant natural disaster or other event that disrupts our operations or those of our customers or suppliers could have a material adverse effect on our business, results of operations, financial condition and cash flows. +9 +Adverse Conditions Or Changes In California Could Increase Our Operating Expenses Or Adversely Affect Our Sales. +A substantial portion of our operations are in California, including 106 of our retail stores, our headquarters in Manhattan Beach and our North America distribution center in Rancho Belago. A decline in the economic conditions, or increase in regulations or the cost of doing business in California could have a material adverse impact on our business. Furthermore, a natural disaster or other catastrophic event in California, such as an earthquake or wildfire, could significantly disrupt our business including the operation of our only domestic distribution center. We may be more susceptible to these issues than our competitors whose operations are not as concentrated in California. +Foreign Currency Exchange Rate Fluctuations. +Foreign currency fluctuations affect our sales and profitability. Changes in currency exchange rates may impact our financial results positively or negatively in one period and not another, which may make it difficult to compare our operating results from different periods. Currency exchange rate fluctuations may also adversely impact third parties that manufacture our products by making their costs of raw materials or other production costs more expensive and more difficult to finance, thereby raising prices for us, our distributors and/or our licensees. We do not currently engage in hedging activities with respect to these currency exchange rate risks. For a more detailed discussion of the risks related to foreign currency fluctuation, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk.” +In addition, our foreign subsidiaries purchase products in U.S. dollars, which causes the cost of those products to vary depending on the foreign currency exchange rates and impacts the price charged to customers. Our foreign distributors also purchase products in U.S. dollars and sell in local currencies, which impacts the price to foreign consumers. As the U.S. dollar strengthens relative to foreign currencies, our sales and profits are reduced when translated into U.S. dollars and our margins may be negatively impacted by the increase in product costs due to foreign currency exchange rates. Although we typically work to mitigate the impact of exchange rate fluctuations through price increases and further actions to reduce costs, we may not be able to fully offset the impact, if at all. Our success depends, in part, on our ability to manage or mitigate these foreign currency impacts, as changes in the value of the U.S. dollar relative to other currencies could materially and adversely affect our business, financial condition, results of operations and cash flows. +RISKS RELATED TO ENVIRONMENT, SOCIAL, AND GOVERNANCE +Our Environmental, Social And Governance Commitments and Disclosures May Expose Us To Reputational Risks And Legal Liability. +Our brand and reputation are associated with our public commitments to various corporate ESG initiatives, including our goals relating to sustainability and our employees. Our disclosures on these matters and any failure or perceived failure to achieve or accurately report on our commitments, could harm our reputation and adversely affect our client relationships or our recruitment and retention efforts, as well as expose us to potential legal liability. Increasing focus on ESG matters has resulted in, and is expected to continue to result in, the adoption of legal and regulatory requirements designed to mitigate the effects of climate change on the environmental, as well as legal and regulatory requirements requiring climate-related disclosures. If new laws or regulations are more stringent than current legal or regulatory requirements, we may experience increased compliance burdens and costs to meet such obligations. Our selection of voluntary disclosure frameworks and standards, and the interpretation or application of those frameworks and standards, may change from time to time or may not meet the expectations of investors or other stakeholders. Our processes and controls for reporting ESG matters across our operations and supply chain are evolving along with multiple disparate standards for identifying, measuring, and reporting ESG metrics, including ESG-related disclosures that may be required by the SEC, European and other regulators, and such standards may change over time, which could result in significant revisions to our current goals, reported progress in achieving such goals, or ability to achieve such goals in the future. +RISKS RELATED TO LEGAL AND REGULATORY MATTERS +Changes In Tax Laws Or The Potential Imposition Of Additional Duties, Quotas, Tariffs And Other Trade Restrictions. +Our products manufactured overseas and imported into the U.S., the European Union (“EU”) and other countries are subject to customs duties. We are unable to predict whether there may be unfavorable changes in tax laws in the U.S. or overseas, additional customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions imposed on the importation of our products in the future. Such actions could adversely affect our ability to produce and market footwear at competitive prices and might have an adverse impact on our sales and results of operations. +In addition, changes in the tax laws of foreign jurisdictions could arise as a result of the base erosion and profit shifting project that was undertaken by the Organization for Economic Cooperation and Development (“OECD”). The OECD, which represents a coalition of member countries, recommended changes to long-standing tax principles related to transfer pricing and has developed model rules including establishing a global minimum corporate income tax tested on a jurisdictional basis (the “Pillar Two”). Many jurisdictions have adopted or announced an intention to adopt Pillar Two for tax years beginning in 2024. There can be no assurance that our effective tax rate, tax payments or conditional reduced tax rates will not be adversely affected as countries independently amend their tax laws to adopt Pillar Two. Changes in U.S. or foreign tax laws, including new or modified guidance with respect to existing tax laws, could materially and adversely affect our business, financial condition, results of operations and cash flows. +10 +Changes To U.S. Or Other Countries’ Trade Policies And Import/Export Regulations Or Our Failure To Comply With Such Regulations. +Changes in laws and policies governing foreign trade, manufacturing, development and investment in the territories or countries where we currently sell our products or conduct our business could adversely affect our business. U.S. presidential administrations have instituted or proposed changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes. +In addition, changes or proposed changes in U.S. or other countries’ trade policies may result in restrictions and economic disincentives on international trade. Tariffs and other changes in U.S. trade policy have in the past and could in the future trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing retaliatory measures on certain U.S. goods. Further, any emerging protectionist or nationalist trends either in the U.S. or in other countries could affect the trade environment. The Company, similar to many other multinational corporations, does a significant amount of business that would be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact the U.S. economy or certain sectors thereof or the economy of another country in which we conduct operations, our industry and the global demand for our products, and as a result, our business, financial condition, results of operations and cash flows could be materially and adversely affected. +Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor, Trade Or Other Laws. +We require our independent contract manufacturers, suppliers and licensees to operate in compliance with applicable laws and regulations. Manufacturers are required to certify that neither convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by law in the manufacturer’s country) is used in the production process, that compensation is paid in accordance with local law and that their factories are in compliance with local safety regulations. Although we promote ethical business practices and our sourcing personnel periodically visit and monitor the operations of our independent contract manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of our independent contract manufacturers, suppliers or licensees violates labor or other laws or diverges from those labor practices generally accepted as ethical in the U.S., it could result in adverse publicity for us, damage our reputation in the U.S., or render our conduct of business in a particular foreign country undesirable or impractical, any of which could harm our business. +In addition, if we, or our foreign manufacturers, violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record-keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas, or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical, and our business, financial condition, results of operations and cash flows could be materially and adversely affected. +The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future Litigation Against Us. +In addition to the legal matters included in our reserve for loss contingencies, we occasionally become involved in litigation and investigations, and we are unable to determine the extent of any liability that may arise from any such matters. We have no reason to believe that there is a reasonable possibility or that it is probable that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation and investigation is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. Further, any unanticipated litigation or investigation in the future, regardless of its merits, could also significantly divert management’s attention from our operations and result in substantial legal fees being incurred. Such disruptions, legal fees and any losses resulting from these unanticipated future matters could materially and adversely affect our business, financial condition, results of operations and cash flows. +11 +Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property Rights Or If We Are Sued For Intellectual Property Infringement. +We believe that our trademarks, design patents and other proprietary rights are important to our success and our competitive position. We use trademarks on nearly all our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us and in distinguishing our goods from the goods of others. We consider our ® , ® , ® , ® , ® , Skechers ® , Skechers Slip-ins ® , Skechers Hands Free Slip-ins ® , Skechers Performance ™ , Skechers GOrun ® , Skechers GOwalk ® , Skechers GOgolf ® , Skechers Viper Court Pro™, Ultra GO ® , Skechers on-the-GO ® , Skechers Cali ® , Skechers Street™, Skechers USA ® , Skechers Active ™ , Skechers Sport Active ™ , Skechers Work™, Skechers Outdoor™, Max Cushioning ® , Massage Fit ® , Mark Nason ® , Skechers Modern Comfort ® , D’Lites ® , BOBS ® , BOBS Sport™, Our Planet Matters ® , Glide Step ® , Skech-Air ® , Skechers Kids™, Twinkle Toes ® , S Lights ® , Relaxed Fit ® , Arch Fit ® , Hyper Burst ® , and Air-Cooled Memory Foam ® trademarks to be among our most valuable assets, and we have registered these trademarks in many countries. In addition, we own many other trademarks that we utilize in marketing our products. We also have a number of design patents and utility patents covering components and features used in various shoes. We believe that our patents and trademarks are sufficient to permit us to carry on our business as presently conducted. While we vigorously protect our trademarks against infringement, we cannot guarantee that we will be able to secure patents or trademark protection for our intellectual property in the future or that protection will be adequate for future products. Further, we have been involved with litigation in the past for patent and trademark infringement and cannot be sure that our activities do not and will not infringe on the intellectual property rights of others. If we are compelled to prosecute infringing parties, defend our intellectual property or defend ourselves from intellectual property claims made by others, we may face significant expenses and liability as well as the diversion of management’s attention from our business, which could negatively impact our business or financial condition. +In addition, the laws of foreign countries where we source and distribute our products may not protect intellectual property rights to the same extent as do the laws of the U.S. We cannot be assured that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party’s counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. Continued sales of counterfeit products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. +RISKS RELATED TO INFORMATION SYSTEMS AND DATA SECUITY +Breaches Or Compromises Of Our Information Security Systems, Information Technology Systems And Our Infrastructure To Support Our Business Could Result In Disruption Of Our Business And Damage To Our Reputation. +As a routine part of our business, we utilize information security and IT systems and websites that allow for the secure storage and transmission of proprietary or private information regarding our customers, employees, vendors and others. A security breach of our network, hosted service providers, or vendor systems, may expose us to a risk of loss or misuse of this information, litigation and potential liability. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks, and the retail industry has been the target of many recent cyber-attacks. Although we take measures to safeguard this sensitive information, we may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. +We invest in industry standard security technology to protect personal information. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect against transaction or other data being breached or compromised. Although we maintain insurance designed to provide coverage for cyber risks related to what we believe to be adequate and collectible insurance in the event of theft, loss, fraudulent or unlawful use of customer, employee or company data, any compromise or breach of our cyber security systems could result in private information exposure and a violation of applicable privacy and other laws, significant potential liability including legal and financial costs, and loss of confidence in our security measures by customers, which could result in damage to our brand and have an adverse effect on our business, financial condition and reputation. In addition, we must comply with increasingly complex and rigorous regulatory standards enacted to protect business data. Compliance with existing and proposed laws and regulations can be costly, and any failure to comply with these regulatory standards could subject us to legal and reputational risks. +12 +Privacy Breaches And Other Cyber Security Risks Related To Our Business Could Negatively Affect Our Reputation, Credibility And Business. +We are dependent on IT systems and networks for a significant portion of our direct-to-consumer sales, including our e-commerce sites and retail business credit card transaction authorization and processing. We are responsible for storing data relating to our customers and employees and also rely on third-party vendors for the storage, processing and transmission of personal and Company information. Consumers, lawmakers and consumer advocates alike are increasingly concerned over the security of personal information transmitted over the Internet, consumer identity theft and privacy and the retail industry, in particular, has been the target of many recent cyber-attacks. We generally require that third-party service providers implement reasonable security measures to protect our employees’ and customers’ identity and privacy, but we do not control these third-party service providers and cannot guarantee the elimination of electronic or physical computer break-ins or security breaches in the future. Cybersecurity breaches, including physical or electronic break-ins, security breaches due to employee error or misconduct, attacks by hackers, phishing scams, malicious software programs such as viruses and malware, and other breaches outside of our control, could result in unauthorized access or damage to our IT systems and the IT systems of our third-party service providers. Despite our efforts and the efforts of our third-party service providers to secure our and their IT systems, attacks on these systems do occur from time to time. As the techniques used to obtain unauthorized access to IT systems become more varied and sophisticated (as cyber criminals are finding new ways to launch their attacks) and if the occurrence of such security breaches becomes more frequent, we and our third-party service providers may be unable to adequately anticipate these techniques and implement appropriate preventative measures. There can be no assurance that our cybersecurity risk management program and processes, including our policies, controls or procedures, will be fully implemented, complied with or effective in protecting our systems and information. While we maintain cyber risk insurance to provide some coverage for certain risks associated with cybersecurity incidents, there is no assurance that such insurance would cover all or a significant portion of the costs or consequences associated with a cybersecurity incident. A significant breach of customer, employee or Company data could damage our reputation, our relationship with customers and our brands, and could result in lost sales, sizable fines, significant breach-notifications and other costs and lawsuits, as well as adversely affect our results of operations. +Additionally, we may incur increased costs and experience a significant strain on our resources to account for implementation of additional required security measures and technologies to protect personal data and confidential information or to comply with current and new state, federal and international laws governing the unauthorized disclosure of confidential information which are continuously being enacted and proposed, such as the General Data Protection Regulation in the EU, various consumer privacy and data privacy and protection acts in the U.S., including, but not limited to, the American Data Privacy and Protection Act, the California Consumer Privacy Act and the California Privacy Rights Act, the Virginia Consumer Data Protection Act, the Colorado Privacy Act, the Utah Consumer Privacy Act, the Connecticut Data Privacy Act and the Iowa Consumer Data Protection Act, and the Personal Information Protection Law in China. +Increased scrutiny by federal regulators, such as the Federal Trade Commission, and state attorney generals focused on the retail industry may lead to increased privacy and cybersecurity costs such as organizational changes, deploying additional personnel, acquiring and implementing enhanced privacy and security technologies on e-commerce sites, mandatory employee training for those handling customer and employee personal data, and engaging third-party experts and consultants, and the unauthorized use of proprietary information may materially and adversely affect our business, financial condition, results of operations, and cash flows. +A Material Delay Or Disruption In Our Information Technology Systems Or E-Commerce Websites Or Our Failure Or Inability To Upgrade Our Information Technology Systems Precisely And Efficiently Could Negatively Affect Our Business. +We rely extensively on our IT systems to track inventory, manage our supply chain, record and process transactions, manage customer communications, summarize results and manage our business. The failure of our IT systems to operate properly or effectively, problems with transitioning to upgraded or replacement systems, or difficulty in or failure to implement new systems, could adversely affect our business. We also operate a number of e-commerce websites throughout the world. Our IT systems and e-commerce websites may be subject to damage and/or interruption from power outages, computer, network and telecommunications failures, malicious software, such as viruses and malware, attacks by hackers, security breaches, usage errors or misconduct by our employees and bad acts by our customers and website visitors which could materially adversely affect our business. +We are undergoing a multi-year Enterprise Resource Planning (“ERP”) implementation. The implementation of the ERP will require a significant investment in human and financial resources. Implementing new systems also carries substantial risk, including failure to operate as designed, failure to properly integrate with other systems, potential loss of data or information, cost overruns, implementation delays and disruption of operations. Third-party vendors are also relied upon to design, program, maintain and service our ERP implementation program. Any failures of these vendors to properly deliver their services could similarly have a material adverse effect on our business. In addition, any disruptions or malfunctions affecting our ERP implementation plan could cause critical information upon which we rely to be delayed, defective, corrupted, inadequate, inaccessible or lost or otherwise cause delays or disruptions to our operations, and we may have to make significant investments to fix or replace impacted systems. +13 +RISKS RELATED TO OUR STOCK AND STOCK PRICE +Our Quarterly Sales And Operating Results Fluctuate As A Result Of A Variety Of Factors, Including Fluctuations In Demand For Footwear, Delivery Delays And Potential Fluctuations In Our Estimated Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price. +Our quarterly sales and operating results have varied significantly in the past and can be expected to fluctuate in the future due to a number of factors, many of which are beyond our control. Our major customers have no obligation to purchase forecasted amounts and from time to time cancel orders, change delivery schedules, or change the mix of products ordered with minimal notice and without penalty. As a result, we may not be able to accurately predict our quarterly sales. Furthermore, our expenses are partially based on our expectations of future sales, and we may be unable to adjust spending in a timely manner to compensate for any unexpected sales shifts. As a result, our expenses may be disproportionately large relative to our sales, which could have a material adverse effect on our operating results. +Our annualized tax rate is based on projections of our domestic and international operating results for the year, which we review and revise as necessary at the end of each quarter. Any quarterly fluctuations in our annualized tax rate could have a material impact on our quarterly operating results and the results for any one quarter may not be indicative of results for the full year. Any shortfall in sales or net earnings from levels expected by securities analysts and investors could cause a decrease in the trading price of our Class A Common Stock. +One Principal Stockholder Is Able To Control Substantially All Matters Requiring Approval By Our Stockholders And His Interests May Differ From The Interests Of Our Other Stockholders. +As of December 31, 2024, Chairman of the Board and Chief Executive Officer, Robert Greenberg, beneficially owned 92.6% of our outstanding Class B Common Stock, and members of Mr. Greenberg’s immediate family beneficially owned an additional 7.4% of our outstanding Class B Common Stock. The holders of Class A Common Stock and Class B Common Stock have identical rights except that holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As of December 31, 2024, Mr. Greenberg beneficially owned 54.9% of the aggregate number of votes eligible to be cast by our stockholders, and together with shares beneficially owned by members of his immediate family, Mr. Greenberg and his immediate family beneficially owned 59.9% of the aggregate number of votes eligible to be cast by our stockholders. Therefore, Mr. Greenberg is able to exert significant control over all matters requiring approval by our stockholders. Matters that require the approval of our stockholders include the election of directors and the approval of mergers or other business combination transactions. Mr. Greenberg also has significant influence over our management and operations. As a result of such influence, certain transactions are not likely without the approval of Mr. Greenberg, including proxy contests, tender offers, open market purchase programs or other transactions that can give our stockholders the opportunity to realize a premium over the then-prevailing market prices for their shares of our Class A Common Stock. Because Mr. Greenberg’s interests may differ from the interests of the other stockholders, his ability to substantially control actions requiring stockholder approval, may result in our Company taking action that is not in the interests of all stockholders. The differential in the voting rights may also adversely affect the value of our Class A Common Stock to the extent that investors or any potential future purchaser view the voting rights of our Class B Common Stock to have superior value. +Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Adversely Affect The Value Of Our Stock. +Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more difficult for a third party to acquire us, even if closing such a transaction would be beneficial to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and Class B Common Stock, the classification of our Board of Directors and the lack of cumulative voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of our Class A Common Stock. +Item 1B. Unresolved Staff Comments +None. +I tem 1C. Cybersecurity +CYBERSECURITY RISK MANAGEMENT AND STRATEGY +We recognize the critical importance of maintaining the safety and security of our systems and data and have a holistic process for overseeing and managing cybersecurity and related risks. This process is supported by both management and our Board of Directors. +We have developed and implemented a Cybersecurity Risk Management Program intended to protect the confidentiality, integrity, and availability of our critical systems and information. Our cybersecurity risk management program includes a cybersecurity incident response plan. +14 +We leverage industry standard frameworks such as the National Institute of Standards and Technology Cybersecurity Framework (“NIST CSF”) and Center for Internet Security (“CIS”) framework to inform how we identify, assess and manage cybersecurity risks relevant to our business. +Our Cybersecurity Risk Management Program includes: +• +risk assessments designed to help identify material cybersecurity risks to our critical systems, information, products, services, and our broader enterprise IT environment; +• +a security team principally responsible for managing (1) our cybersecurity risk assessment processes, (2) our security controls, and (3) our response to cybersecurity incidents; +• +cybersecurity awareness training of our employees, and incident response personnel; +• +a cybersecurity incident response plan that includes procedures for responding to cybersecurity incidents; +• +a third-party risk management process for service providers, suppliers, and vendors; and +• +engage ment of third parties for our 24/7 monitoring, detection, and response; regular penetration testing, program controls assessment, and proactive incident preparedness activities. +We have not identified risks from known cybersecurity threats, including as a result of any prior cybersecurity incidents, that have materially affected or are reasonably likely to materially affect us, including our operations, business strategy, results of operations, or financial condition. +Cybersecurity Governance +Our Board of Directors is responsible for overseeing our enterprise risk management activities in general, and each of our Board committees assists the Board in the role of risk oversight. Our Senior Vice President (“SVP”) of Information Technology and the Vice President ("VP") of Information Security have overall responsibility for assessing and managing our material risks from cybersecurity threats. To help ensure effective oversight, the Audit Committee receives reports on information security and cybersecurity at least annually, and receives an update quarterly on information security and cybersecurity from materials provided by the VP of Information Security. +The VP of Information Security oversees the Information Security Steering Committee (“Steering Committee”), which provides education on the Company’s cybersecurity programs and controls to key members of the Company. The Steering Committee meets quarterly and is comprised of members from the Executive Leadership Team, including the Chief Financial Officer and Executive Vice President of Business Affairs, as well as the SVP of Information Technology, VP of Information Security, VP of Corporate Communications, SVP of Digital Innovation, and Head of Global Human Resources. +Cybersecurity risk management is led by our VP of Information Security and our SVP of Information Technology, who reports to our Chief Operating Officer, who are generally responsible for management of cybersecurity risk and the protection and defense of our networks, systems and data. The VP of Information Security manages a team of cybersecurity professionals with broad experience, including in cybersecurity threat assessments and detection, mitigation technologies, cybersecurity training, incident response, cyber forensics, digital security and regulatory compliance. +Our VP of Information Security has over 15 years of experience in technology and information security, serves on the board of directors of the Retail & Hospitality Information Sharing and Analysis Center ("RH-ISAC") and holds several cybersecurity and risk management certifications. Our SVP of Information Technology has over 30 years of information technology management and cybersecurity experience and has held leadership roles overseeing all aspects of information technology operations for multiple Fortune 500 and Fortune 50 global companies, particularly in the retail and media & entertainment sectors. +We continue to invest in cybersecurity and resiliency of our networks and adapt our internal controls and processes, which are designed to help protect our systems and infrastructure, and the information they contain. For more information regarding the risks we face from cybersecurity threats, please see Item 1A "Risk Factors." +Item 2. Properties +CORPORATE HEADQUARTERS +Skechers Corporate Headquarters are located at several properties in or near Los Angeles, California, which consist of an aggregate of approximately 0.3 million square feet. We own and lease portions of our corporate headquarters. +We lease most of our international administrative offices and showrooms located in the Americas, Europe and Asia Pacific. The property leases expire on various dates through February 2033. Corporate offices, administrative offices, and showrooms are included within our Wholesale segment. +15 +DISTRIBUTION FACILITIES +We believe that strong distribution is critical to our operations. Our distribution facilities include highly automated solutions to support our future growth in our Company. We regularly evaluate our distribution infrastructure and consolidate or expand our capacity as we believe appropriate for our operations. Our distribution facilities are included within our Wholesale segment. Our principal distribution facilities are as follows: +Americas. Our North America Distribution Center occupies approximately 2.6 million square feet on its main campus in Southern California, which is leased from a joint venture. In 2024, we entered into an agreement with a new joint venture for the future expansion of this distribution center. In addition, we lease 2.4 million square feet of distribution center space from third parties. The main campus leases expire at various dates through September 2036, and the leases for the remaining space expire at various dates through May 2028. Additionally, our Canada Distribution Center occupies approximately 0.4 million square feet in British Colombia and the lease is set to expire in December 2032. +Europe, Middle East and Africa. Our European Distribution Center occupies approximately 2.2 million square feet in Liege, Belgium. The leases comprising this Distribution Center provide for original terms of 8 to 15 years. The property leases expire on various dates through December 2030. We plan to further expand in Europe with the construction of a larger distribution center in Liege, with an estimated relocation in 2028. +Asia Pacific. Our China Distribution Center occupies approximately 1.6 million square feet in Taicang, China. We plan to further expand in this market with the construction of a second distribution center in China, which is expected to be an approximately 2.3 million square foot facility. Our Japan Distribution Center is approximately 0.9 million square feet. The lease is set to expire in October 2031. Our India Distribution Center occupies approximately 0.8 million square feet outside of Mumbai and the lease is set to expire in October 2043. +We have additional Company-operated distribution centers as well as third-party distribution centers serving regional markets in the Americas, Europe and Asia Pacific. +COMPANY OWNED AND THIRD-PARTY STORES +As of December 31, 2024, we had 5,296 Skechers-branded retail stores in 122 countries. The network of stores includes 1,787 Company-owned and 3,509 third-party locations. These third-party stores are distributor, licensed and franchise owned through our Wholesale segment. +Store count, openings and closings for our domestic, international, and third-party stores are as follows: +Number of locations +December 31, 2023 +Opened +Closed +December 31, 2024 +Domestic stores +563 +62 +(15 +) +610 +International stores +1,085 +206 +(114 +) +1,177 +Distributor, licensee and franchise stores +3,520 +413 +(424 +) +3,509 +Total Skechers stores +5,168 +681 +(553 +) +5,296 +We pursue our direct-to-consumer strategy through our integrated retail formats, which enable us to promote the full Skechers product offering in an attractive environment that appeals to a broad group of consumers. Our retail stores are included in our Direct-to-Consumer segment. Our physical retail formats are as follows: +Concept Stores. Our concept stores serve as a showcase for a wide range of our product offering. Retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These stores also serve as product testing venues. +Factory Outlet Stores. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise as well as feature key inline product. +Big Box Stores. Our free-standing and attached big box stores provide opportunities to sell new product while also allowing us to liquidate excess merchandise, discontinued lines and odd-size inventory. +Substantially all of our retail stores are leased, with terms that expire on various dates through February 2044. The leases provide for rent escalations tied to either increases in the lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical area, or a percentage of the store’s gross sales in excess of the base annual rent. +16 +Item 3. Legal Proceedings +Micha el Conte v. Robert Greenberg, et al . – On July 21, 2022, Skechers and certain past and present members of the Board of Directors were sued by a stockholder on behalf of our company in a derivative action in the Chancery Court of the State of Delaware, Case No. 2022-0633, alleging breach of fiduciary duty, waste of corporate assets, breach of duty of candor and breach of contract in connection with certain executive officers’ personal use of two company-owned aircraft. The complaint seeks actual damages in favor of Skechers sustained as the alleged result of defendants’ alleged breaches of fiduciary duties, judgment directing our company to take all necessary actions to reform and improve its corporate governance practices, termination of certain executive officers for allegedly violating their employment agreements, judgment directing the sale of one of the company-owned aircraft and attorneys’, accountants’ and experts’ fees, costs and expenses. The defendants filed motions to dismiss the complaint. On February 2, 2024, the court granted the motions and thereafter dismissed the complaint with prejudice as to all named past and present director-defendants and the plaintiff appealed. On January 23, 2025, the Delaware Supreme Court issued an order affirming the Chancery Court’s dismissal of the matter with prejudice and on February 10, 2025 the case was closed. This matter has been concluded. +Nike, Inc. v. Skechers USA, Inc. – On November 6, 2023, Nike filed an action against our company in the United States District Court for the Central District of California, Case No. 2:23-CV-09346, alleging that certain Skechers shoe designs infringe the claims of six Nike utility patents that purportedly cover Nike’s Flyknit technologies. Nike seeks injunctive relief, damages (including treble damages), pre-judgment and post-judgment interest, and costs. On January 12, 2024, we answered Nike’s complaint, denying the allegations, and filed counterclaims seeking declarations of invalidity of the asserted patents, and non-infringement. The District Court held a claim construction hearing on September 20, 2024, but has not yet issued its ruling. In early November 2024, we filed petitions with the Patent Trial and Appeals Board (“PTAB”) seeking to institute inter partes review of each of the six Nike utility patents being asserted against us, and we are awaiting PTAB’s decisions on our petitions. On February 5, 2025, the District Court, upon our motion and over Nike’s opposition, stayed the case before it pending PTAB's decision on our petitions. While it is too early to predict the outcome of the PTAB proceedings or the District Court case, or whether an adverse result would have a material adverse impact on our operations or financial position, we believe we have meritorious defenses and intend to defend this matter vigorously. +In addition to the matters included in our reserve for loss contingencies, we occasionally become involved in litigation and investigations, and we are unable to determine the extent of any liability that may arise from any such matters. We have no reason to believe that there is a reasonable possibility or a probability that we may incur a material loss, or a material loss in excess of a recorded accrual, with respect to any other such loss contingencies. However, the outcome of litigation and investigations is inherently uncertain and assessments and decisions on defense and settlement can change significantly in a short period of time. Therefore, although we consider the likelihood of such an outcome to be remote with respect to those matters for which we have not reserved an amount for loss contingencies, if one or more of these legal matters were resolved against the Company in the same reporting period for amounts in excess of our expectations, our consolidated financial statements of a particular reporting period could be materially adversely affected. +Item 4. Mine Safety Disclosures +Not applicable. +17 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Our Class A Common Stock trades under the symbol “SKX” on the New York Stock Exchange. +HOLDERS +As of February 19, 2025, there were 69 holders of record of our Class A Common Stock (including holders who are nominees for an undetermined number of beneficial owners) and 32 holders of record of our Class B Common Stock. These figures do not include beneficial owners who hold shares in nominee name. The Class B Common Stock is not publicly traded, but each share is convertible upon request of the holder into one share of Class A Common Stock. +DIVIDEND INFORMATION +Since inception, we have not declared or paid cash dividends on our common stock, and we have no present intention of paying dividends on our common stock in the foreseeable future. +COMPANY PURCHASES OF EQUITY SECURITIES +The table below summarizes the number of shares of our Class A Common Stock that were repurchased during the three months ended December 31, 2024. +Month Ended +Total Number of Shares Purchased +Average Price Paid Per Share +Total Number of Shares Purchased under the Share Repurchase Program +Maximum Dollar Value of Shares that May Yet Be Purchased under the Share Repurchase Program (in thousands) +October 31, 2024 +130,152 +$ +61.50 +130,152 +$ +901,968 +November 30, 2024 +1,375,830 +61.81 +1,375,830 +816,924 +December 31, 2024 +392,199 +68.82 +392,199 +789,935 +Total +1,898,181 +$ +63.24 +1,898,181 +On July 25, 2024, the Company's Board of Directors announced a share repurchase program pursuant to which the Company may purchase shares of its Class A common stock, for an aggregate repurchase price not to exceed $1.0 billion. This repurchase program expires on July 25, 2027 and does not obligate the Company to acquire any particular amount of shares. +EQUITY COMPENSATION PLAN INFORMATION +Our equity compensation plan information required by this item is hereby incorporated by reference to the information in Part III, Item 12 of this annual report on Form 10-K. +18 +PERFORMANCE GRAPH +The following graph demonstrates the total return to stockholders of our Class A Common Stock from December 31, 2019 to December 31, 2024, relative to the performance of the Russell 1000 Index and S&P Retail Select Industry Index. +Comparison of 5 Year Cumulative Total Returns +(in dollars) +2019 +2020 +2021 +2022 +2023 +2024 +Skechers U.S.A., Inc. +100.00 +83.21 +100.49 +97.13 +144.34 +155.68 +Russell 1000 +100.00 +120.96 +152.96 +123.71 +156.53 +194.89 +S&P Retail Select Industry +100.00 +141.63 +202.49 +138.26 +168.04 +188.41 +Item 6. [ Reserved] +19 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. We intend for this discussion to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of our company as a whole. +This section of this Form 10-K generally discusses 2024 and 2023 items and year-to-year comparisons between 2024 and 2023. Discussions of 2022 items and year-to-year comparisons that are not included in this Form 10-K can be found in “ Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and “ —Liquidity and Capital Resources” in our annual report on Form 10-K for the fiscal year ended December 31, 2023 filed with the SEC on February 28, 2024. +OVERVIEW +When Skechers was founded in 1992, our focus was on creating a lifestyle brand centered on delivering products with comfort, style, innovation and quality at a reasonable price. Three decades later, with a diverse portfolio that includes performance product, we remain committed to our design principles and meeting the evolving footwear needs of our customers. Through the efforts of our dedicated teams globally, our strong partner relationships and loyal consumers, we believe we will continue to achieve well-managed profitable growth and ensure the longevity of both the Company and the Skechers brand. +Our financial results reflect the significant market demand for our product offerings and the value that we provide. Key highlights for 2024 include: +• +Sales increased 12.1%, to $8.97 billion, for the year ended December 31, 2024 when compared to the prior year, a new annual record; +• +Gross margin improved to 53.2% and operating margin improved to 10.1% for the year ended December 31, 2024 when compared to the prior year; +• +Twenty-five years as a listed company on the New York Stock Exchange; +• +Expanded performance product offerings to include Skechers Cricket and continued the global rollout of Skechers Football and Skechers Basketball; +• +Opened our first Skechers Performance store in Edmonton, Canada that features half courts for pickleball and basketball; +• +Continued investments in our distribution centers, including planned expansions in North America, China and Europe; and +• +Repurchased 5.2 million shares of our Class A common stock. +We believe brand recognition is paramount to continued success. We drive awareness and demand through comprehensive marketing campaigns. During the year, we introduced a partnership with John Deere for a range of lifestyle and work footwear and a collaboration with the Rolling Stones. Skechers Performance signed additional athletes worldwide, including Joel Embiid, gold medal winner in Paris, WNBA athlete Rickea Jackson, as well as others. +Our core product philosophy of comfort, style, innovation, and quality at the right price continues to resonate with consumers, and we remain focused on delivering our comfort technology footwear as efficiently as possible to meet consumer demand. We are committed to the following investments to execute our long-term global growth strategy: +• +Continue to develop new comfort innovations and deliver more value in our products; +• +Expand our distribution infrastructure to support growth; +• +Open new stores and extend our digital capabilities to drive Direct-to-Consumer growth; and +• +Implement market strategies to broaden our reach globally and attract new partners and consumers. +20 +RESULTS OF OPERATIONS +Selected information from our results of operations follows: +Year Ended December 31, +Change +(in thousands) +2024 +2023 +$ +% +Sales +$ +8,969,351 +$ +8,000,342 +969,009 +12.1 +Cost of sales +4,201,912 +3,847,938 +353,974 +9.2 +Gross profit +4,767,439 +4,152,404 +615,035 +14.8 +Gross margin +53.2 +% +51.9 +% +120 bps +Operating expenses +Selling +800,634 +676,890 +123,744 +18.3 +General and administrative +3,062,548 +2,690,728 +371,820 +13.8 +Total operating expenses +3,863,182 +3,367,618 +495,564 +14.7 +As a % of sales +43.1 +% +42.1 +% +100 bps +Earnings from operations +904,257 +784,786 +119,471 +15.2 +Operating margin +10.1 +% +9.8 +% +30 bps +Other (expense) income +(26,508 +) +16,086 +(42,594 +) +n/m +Earnings before income taxes +877,749 +800,872 +76,877 +9.6 +Income tax expense +148,136 +150,949 +(2,813 +) +(1.9 +) +Net earnings +729,613 +649,923 +79,690 +12.3 +Less: Net earnings attributable to noncontrolling interests and redeemable noncontrolling interest +90,142 +104,124 +(13,982 +) +(13.4 +) +Net earnings attributable to Skechers U.S.A., Inc. +$ +639,471 +$ +545,799 +93,672 +17.2 +n/m: not meaningful. +Sales +Sales increased $969.0 million, or 12.1%, to $8.97 billion as a result of a 12.1% increase in both international and domestic sales. Wholesale sales increased 13.2% and Direct-to-Consumer sales increased 10.7%. Sales increased overall due to higher sales volume, partially offset by lower average selling prices. +Gross margin +Gross margin increased 120 basis points to 53.2% primarily due to lower costs per unit, driven by lower freight. +Operating expenses +Operating expenses increased $495.6 million, or 14.7%, to $3.9 billion, and as a percentage of sales increased 100 basis points to 43.1%. Selling expenses increased $123.7 million, or 18.3%, to $800.6 million, primarily due to higher demand creation expenditures in global marketing and digital advertising. General and administrative expenses increased $371.8 million, or 13.8%, to $3.1 billion. The increased expenses were driven by increases in labor costs of $179.8 million, facility related costs of $79.8 million, including rent and depreciation, and legal costs of $22.3 million. +Other (expense) income +Other expense was $26.5 million compared to other income of $16.1 million in the prior year. The change of $42.6 million was primarily due to unfavorable foreign currency exchange rates in Europe, Middle East & Africa, partially offset by an increase in interest income. +Income taxes +Income tax expense and the effective tax rate were as follows: +Year Ended December 31, +(in thousands) +2024 +2023 +Income tax expense +$ +148,136 +$ +150,949 +Effective tax rate +16.9 +% +18.8 +% +Income tax expense was $148.1 million as compared to $150.9 million in 2023. Our effective tax rate was 16.9% as compared to 18.8% in the prior year. The decrease in tax rate is due to a favorable mix of earnings in lower tax jurisdictions, provision adjustments and the release of certain allowances. +Our income tax expense and effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (losses) before income taxes. In the foreign jurisdictions in which we have operations, the applicable statutory rates range from 0% to 35%, which on average are generally significantly lower than the U.S. federal and state combined statutory rate of approximately 24.9%. +21 +The OECD has issued various proposals that would change long-standing global tax principles, namely, its Pillar Two framework, which imposes a global minimum corporate tax rate of 15% for large multinational companies. The adoption and effective dates of these rules may vary by country and could increase tax complexity and uncertainty and may adversely affect our provision for income taxes and cash tax payments in future periods. Certain countries in which we operate have already enacted the Pillar Two minimum tax regime. This did not have an impact to the tax provision and effective tax rate for the year ended December 31, 2024, however, certain rules begin to be effective for us in fiscal 2025 and we expect our tax rate to increase as a result. For fiscal 2025, we expect our tax rate to be between 22% and 23%. We continue to evaluate the potential impact of enacted and future legislation concerning the Pillar Two framework in the non-U.S. tax jurisdictions we operate in. +See Note 10 – Income Taxes of the Consolidated Financial Statements for additional information. +Noncontrolling interests and redeemable noncontrolling interest in net earnings of joint ventures +Noncontrolling interests and redeemable noncontrolling interest represents the share of net earnings or loss that is attributable to our joint venture partners. Net earnings attributable to noncontrolling interests and redeemable noncontrolling interest decreased $14.0 million to $90.1 million as compared to $104.1 million in the prior year, primarily due to lower earnings by our joint ventures, predominantly in China. +RESULTS OF SEGMENT OPERATIONS +Wholesale +Year Ended December 31, +Change +(in thousands) +2024 +2023 +$ +% +Sales +$ +5,100,479 +$ +4,504,776 +595,703 +13.2 +Gross profit +2,207,596 +1,846,819 +360,777 +19.5 +Gross margin +43.3 +% +41.0 +% +230 bps +Wholesale sales increased $595.7 million, or 13.2%, to $5.1 billion, due to increases in the Americas of 14.5%, Europe, Middle East & Africa of 16.7% and Asia Pacific of 5.7%. Volume increased 13.7% in the number of units sold and average selling price per unit decreased 0.4%. +Wholesale gross margin increased 230 basis points to 43.3% driven by lower cost per unit due to lower freight, and favorable channel mix. +Direct-to-Consumer +Year Ended December 31, +Change +(in thousands) +2024 +2023 +$ +% +Sales +$ +3,868,872 +$ +3,495,566 +373,306 +10.7 +Gross profit +2,559,843 +2,305,585 +254,258 +11.0 +Gross margin +66.2 +% +66.0 +% +20 bps +Direct-to-Consumer sales increased $373.3 million, or 10.7%, to $3.9 billion, due to increases in Europe, Middle East & Africa of 38.3%, the Americas of 6.6% and Asia Pacific of 8.0%. Volume increased 11.2% in the number of units sold and average selling price per unit decreased 0.5%. +Direct-to-Consumer gross margin increased 20 basis points to 66.2% due to favorable channel mix and lower cost per unit, partially offset by a decrease in average selling prices. +LIQUIDITY AND CAPITAL RESOURCES +Liquidity Outlook +We have cash and cash equivalents of $1,116.5 million at December 31, 2024. Amounts held outside the U.S. were $1,027.1 million, or 92.0%, and approximately $362.1 million was available for repatriation to the U.S. as of December 31, 2024 without incurring additional U.S. federal income taxes and applicable non-U.S. income and withholding taxes. +We finance our production activities in part through the use of interest-bearing open purchase arrangements with certain of our contract manufacturers. These facilities currently bear interest at a rate between 0.0% and 0.4% for 30- to 60-day financing, depending on the factory. We believe that the use of these arrangements affords us additional liquidity and flexibility. We do not have any long-term contracts with any of our manufacturers, however, we have long-standing relationships with many and believe our relationships to be positive. +At December 31, 2024, we have unused credit capacity of $745.4 million on our corporate revolving credit facility, with an additional $250.0 million available through an accordion feature. We believe that anticipated cash flows from operations, existing cash and investments balances, available borrowings under our revolving credit facility, and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements for the next twelve months. +22 +Cash Flows +Our working capital at December 31, 2024 was $2.2 billion, a decrease of $0.1 billion from working capital of $2.3 billion at December 31, 2023. Our cash and cash equivalents at December 31, 2024 were $1,116.5 million compared to $1,189.9 million at December 31, 2023. Our primary source of operating cash is collections from customers. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures. +Operating Activities +Net cash provided by operating activities was $687.4 million for 2024 and $1,231.2 million for 2023. The $543.8 million decrease in cash flows from operating activities in 2024 resulted from working capital, primarily higher inventory levels due to elevated merchandise-in-transit, resultant from the Red Sea crisis and growth in our business. These decreases were partially offset by earnings. +Investing Activities +Net cash used in investing activities was $485.4 million for 2024 as compared to $418.0 million for 2023. The $67.3 million increase was due to increased capital expenditures of $93.1 million and net investment activity of $44.6 million, partially offset by acquisitions of $70.4 million in the prior year. +Our capital investments remain focused on supporting our strategic growth priorities, growing our Direct-to-Consumer business, as well as expanding the presence of our brand internationally. Capital expenditures for the year ended December 31, 2024 were $416.8 million, which included $179.8 million for investments in our retail stores and direct-to-consumer technologies, $124.6 million for the expansion of our global distribution infrastructure and $59.1 million of investments in our new corporate offices. We expect our capital expenditures for 2025 to be approximately $600 million to $700 million, which is primarily related to expanding distribution capacity in key markets, new stores and the completion of our corporate offices. We expect to fund ongoing capital expenditures through a combination of available cash and borrowings. +Financing Activities +Net cash used in financing activities was $253.5 million during 2024 compared to $234.7 million in 2023. The increase of $18.8 million is the result of increases in repurchases of common stock of $170.0 million, net payments related to equity awards of $28.8 million, and distributions to noncontrolling interests of $22.2 million. These increases were partially offset by increased borrowings of $194.7 million. +Capital Resources and Prospective Capital Requirements +Share Repurchase Program +On July 25, 2024, the Company's Board of Directors announced a new share repurchase program, pursuant to which the Company may purchase up to $1.0 billion in shares of its Class A common stock. This repurchase program expires on July 25, 2027, does not obligate the Company to acquire any particular amount of shares and replaced the prior share repurchase program authorization. Remaining repurchase authorization under the 2022 Share Repurchase Program was terminated upon commencement of the new program. As of December 31, 2024, $789.9 million remains available under the Share Repurchase Program. +Financing Arrangements +As of December 31, 2024, outstanding short-term and long-term borrowings were $454.9 million, of which, $271.0 million relates to loans for our domestic and China distribution centers, $150.5 million relates to our operations in China and the remainder relates to our international operations. Our short-term and long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. See Note 6 – Financial Commitments of the Consolidated Financial Statements for additional information. +Commitments +Our material cash requirements as of December 31, 2024 which are not reflected as liabilities in the Consolidated Balance Sheets include open purchase commitments with our foreign manufacturers of approximately $1.2 billion. Additionally, in 2024, we created a new joint venture to support the expansion of our North America distribution center and, in 2025, we will contribute the remaining $75.0 million required. +We are required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the Consolidated Balance Sheets. +23 +Exchange Rates +We receive U.S. dollars for substantially all of our domestic and a portion of our international product sales. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between the U.S. dollar and the local currencies of the contract manufacturers, which may impact our cost of goods in the future. During 2024 and 2023, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk. +CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES +The preparation of our consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. +We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements. +Reserves for returns and chargebacks. Revenue is recorded net of estimates for returns from our customers and potential disputed amounts or chargebacks. We accrue a liability for product returns at the time of sale based on our historical experience. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. +Allowance for credit losses. Accounts receivable is recorded net of estimated losses from our customers’ inability to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and our customers’ credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for credit losses are recorded to general and administrative expenses. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. +Inventory reserves . Inventory is stated at the lower of cost or net realizable value. Inventory reserves are recorded for excess and slow-moving inventory. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value is determined based on historical sales experience on a style-by-style basis. The valuation of inventory could be impacted by changes in public and consumer preferences, demand for product, changes in the buying patterns of both retailers and consumers and inventory management of customers. +Litigation reserves . Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. +Tax estimates . The establishment of deferred tax assets from intra-entity transfers of certain intellectual property rights and other transactions requires management to make significant estimates and assumptions to determine the fair value of such intellectual property rights. The valuation of deferred tax assets requires significant estimates and assumptions including, but not limited to, future sales growth, discount rates and the expected life of the assets, which by their nature are inherently uncertain and may ultimately differ materially from our actual results. We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance. +Business Combinations. We use the acquisition method of accounting for business combinations and recognize assets acquired and liabilities assumed measured at their fair values on the date acquired. Goodwill is measured as of the acquisition date as the excess of consideration transferred over the net acquisition date fair value of the assets acquired and the liabilities assumed. The valuation of identifiable intangible assets reflects management's estimates based on, among other factors, use of established valuation methods, including, but not limited to, the multi-period excess earnings method income approach. Further estimates within these models include, but are not limited to, future expected cash flows, including revenues and expenses, and applicable discount rates. These estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed may be recorded, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets +24 +acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our Consolidated Statements of Earnings and Comprehensive Income. +RECENT ACCOUNTING PRONOUNCEMENTS +Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards. +Item 7A. Quantitative and Qualitative Disclosure About Market Risk +Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. Changes in interest rates and changes in foreign currency exchange rates have and will have an impact on our results of operations. +Interest rate fluctuations . As of December 31, 2024, we have $454.9 million of outstanding short-term and long-term borrowings, subject to changes in interest rates. A 200-basis point increase in interest rates would have increased interest expense by approximately $9.1 million for the year ended December 31, 2024. We do not expect changes in interest rates to have a material impact on our financial condition, results of operations or cash flows during 2025. Interest rates on our outstanding borrowings fluctuate based on a variety of base rates, including the following: the Secured Overnight Financing Rate ("SOFR"), the Bloomberg Short-Term Bank Yield Index ("BSBY") and reference rates provided by the People’s Bank of China. Changes in these interest rates will have an effect on the interest charged on outstanding balances. +We may enter into derivative financial instruments such as interest rate swaps in order to limit our interest rate risk on our long-term debt. As of December 31, 2024, we had one derivative instrument in place to hedge the cash flows on our $129.5 million variable rate debt, with a notional amount of the same value. The rate swap agreement utilized by us effectively modifies our exposure to interest rate risk by converting our floating-rate debt to a fixed rate basis over the life of the loan. Our receive rate was 30-day SOFR rate and our average rate paid was 0.778%. +Refer to Note 6 — Financial Commitments in the accompanying Notes to the Consolidated Financial Statements for further details. +Foreign currency exchange rate fluctuations . We face market risk to the extent that changes in foreign currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiaries’ sales, expenses, assets and liabilities. In addition, changes in foreign currency exchange rates may affect the value of our inventory commitments. Also, inventory purchases of our products may be impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of the contract manufacturers, which could have an impact on the cost of goods sold in the future. We manage these risks by primarily denominating these purchases and commitments in U.S. dollars. +Assets and liabilities outside the U.S. are located in regions where we have subsidiaries or joint ventures: the Americas, Europe, Middle East & Africa and Asia-Pacific. Our investments in foreign subsidiaries and joint ventures with a functional currency other than the U.S. dollar are generally considered long-term. The fluctuation of foreign currencies resulted in a cumulative foreign currency translation loss of $97.8 million and gain of $11.5 million, for the years ended December 31, 2024 and 2023, that are deferred and recorded as a component of accumulated other comprehensive loss in Skechers U.S.A., Inc.’s equity. A 200-basis point reduction in each of these exchange rates at December 31, 2024 would have reduced the values of our net investments by approximately $112.8 million. +25 +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Page +Report of Independent Registered Public Accounting Firm (BDO USA, P.C.; Los Angeles California; PCAOB ID: # 243 ) +27 +Consolidated Balance Sheets +29 +Consolidated Statements of Earnings +30 +Consolidated Statements of Comprehensive Income +31 +Consolidated Statements of Stockholders' Equity and Redeemable Noncontrolling Interest +32 +Consolidated Statements of Cash Flows +33 +Notes to Consolidated Financial Statements +34 +26 +Report of Independe nt Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. (the “Company”) as of December 31, 2024 and 2023, the related consolidated statements of earnings, comprehensive income, stockholders' equity and redeemable noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2024, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2024, in conformity with accounting principles generally accepted in the United States of America. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 28, 2025 expressed an unqualified opinion thereon. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Accounting for Income Taxes +The Company is a U.S. based multinational entity subject to taxes in the U.S. and multiple foreign jurisdictions which affect the Company’s provision for income taxes. The income tax provision is determined by management based on current enacted tax regulations at each jurisdiction with consideration of intercompany transactions across multiple tax jurisdictions. As indicated in Note 10 to the consolidated financial statements, total income tax expense for the year ended December 31, 2024 was $148.1 million, of which $9.3 million represented U.S. Federal tax expense, $10.1 million represented U.S. State tax expense, and the remaining $128.7 million represented foreign tax expense. +We identified the accounting for the Company’s income tax provision as a critical audit matter due to the complexity involved in: (i) the application of relevant tax laws and regulations in calculating taxable income and deferred tax balances in certain jurisdictions, and (ii) the application of transfer pricing guidelines to various intercompany transactions. Auditing these elements required challenging auditor judgement and an increased extent of audit effort, including the use of income tax professionals, international tax service professionals, and transfer pricing tax professionals. +27 +The primary procedures we performed to address this critical audit matter included: +• +Testing the design and operating effectiveness of certain internal controls related to management’s accounting for income taxes, including controls over: (i) calculating taxable income and deferred tax balances in certain jurisdictions, and (ii) the application of transfer pricing guidelines to various intercompany transactions. +• +Testing the completeness and accuracy of the underlying data used to determine taxable income, deferred tax balances, and transfer pricing adjustments. +• +Utilizing income tax professionals and international tax service professionals to assist in evaluating management’s application of relevant tax laws and regulations in calculating taxable income and deferred tax balances in certain jurisdictions. +• +Utilizing transfer pricing tax professionals to assist in evaluating management’s application of transfer pricing guidelines to various intercompany transactions. +/s/ BDO USA, P.C. +We have served as the Company's auditor since 2013. +Los Angeles, California +February 28, 2025 +28 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Balance Sheets +As of December 31, +(in thousands, except par value) +2024 +2023 +ASSETS +Current assets +Cash and cash equivalents +$ +1,116,516 +$ +1,189,910 +Short-term investments +118,470 +72,595 +Trade accounts receivable, less allowances of $ 66,616 and $ 57,867 +990,558 +860,300 +Other receivables +98,499 +82,253 +Inventory +1,919,386 +1,525,409 +Prepaid expenses and other +205,994 +222,137 +Total current assets ($ 1,413,643 and $ 1,252,372 related to VIEs) +4,449,423 +3,952,604 +Property, plant and equipment, net +1,834,930 +1,506,690 +Operating lease right-of-use assets +1,363,596 +1,276,171 +Deferred tax assets +440,358 +450,574 +Long-term investments +146,687 +123,996 +Goodwill +94,494 +101,230 +Other assets, net +126,270 +136,086 +Total non-current assets ($ 861,175 and $ 641,879 related to VIEs) +4,006,335 +3,594,747 +TOTAL ASSETS +$ +8,455,758 +$ +7,547,351 +LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND STOCKHOLDERS' EQUITY +Current liabilities +Accounts payable +$ +1,241,838 +$ +1,008,001 +Accrued expenses +330,251 +320,105 +Operating lease liabilities +297,926 +274,296 +Current installments of long-term borrowings +353,131 +46,571 +Short-term borrowings +33,338 +11,894 +Total current liabilities ($ 846,986 and $ 600,337 related to VIEs) +2,256,484 +1,660,867 +Long-term operating lease liabilities +1,176,290 +1,108,110 +Long-term borrowings +68,450 +242,944 +Deferred tax liabilities +11,148 +12,594 +Other long-term liabilities +123,122 +122,794 +Total non-current liabilities ($ 170,341 and $ 329,219 related to VIEs) +1,379,010 +1,486,442 +Total liabilities +3,635,494 +3,147,309 +Commitments and contingencies (Note 7 ) +Redeemable noncontrolling interest (Note 1) +90,099 +89,832 +Stockholders’ equity +Preferred Stock, $ 0.001 par value; 10,000 shares authorized; none issued and outstanding +— +— +Class A Common Stock, $ 0.001 par value; 500,000 shares authorized; 129,854 and 132,837 shares issued and outstanding +130 +133 +Class B Common Stock, $ 0.001 par value; 75,000 shares authorized; 19,379 and 20,182 shares issued and outstanding +19 +20 +Additional paid-in capital +12,170 +295,847 +Accumulated other comprehensive loss +( 171,221 +) +( 73,388 +) +Retained earnings +4,436,201 +3,796,730 +Skechers U.S.A., Inc. equity +4,277,299 +4,019,342 +Noncontrolling interests (Note 1) +452,866 +290,868 +Total stockholders' equity +4,730,165 +4,310,210 +TOTAL LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND STOCKHOLDERS' EQUITY +$ +8,455,758 +$ +7,547,351 +See accompanying notes to consolidated financial statements. +29 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Earnings +Year Ended December 31, +(in thousands, except per share data) +2024 +2023 +2022 +Sales +$ +8,969,351 +$ +8,000,342 +$ +7,444,550 +Cost of sales +4,201,912 +3,847,938 +3,929,193 +Gross profit +4,767,439 +4,152,404 +3,515,357 +Operating expenses +Selling +800,634 +676,890 +583,626 +General and administrative +3,062,548 +2,690,728 +2,385,061 +Total operating expenses +3,863,182 +3,367,618 +2,968,687 +Earnings from operations +904,257 +784,786 +546,670 +Other (expense) income +( 26,508 +) +16,086 +( 24,413 +) +Earnings before income taxes +877,749 +800,872 +522,257 +Income tax expense +148,136 +150,949 +93,095 +Net earnings +729,613 +649,923 +429,162 +Less: Net earnings attributable to noncontrolling interests and redeemable noncontrolling interest (Note 1) +90,142 +104,124 +56,134 +Net earnings attributable to Skechers U.S.A., Inc. +$ +639,471 +$ +545,799 +$ +373,028 +Net earnings per share attributable to Skechers U.S.A., Inc. +Basic +$ +4.21 +$ +3.53 +$ +2.40 +Diluted +$ +4.16 +$ +3.49 +$ +2.38 +Weighted-average shares used in calculating net earnings per share attributable to Skechers U.S.A., Inc. +Basic +151,838 +154,533 +155,627 +Diluted +153,843 +156,256 +156,608 +See accompanying notes to consolidated financial statements. +30 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statement s of Comprehensive Income +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Net earnings +$ +729,613 +$ +649,923 +$ +429,162 +Other comprehensive income, net of tax +Net unrealized (loss) gain on derivative contract +( 4,897 +) +( 3,888 +) +9,787 +(Loss) gain on foreign currency translation adjustment +( 130,926 +) +11,241 +( 53,552 +) +Comprehensive income +593,790 +657,276 +385,397 +Less: Comprehensive income attributable to noncontrolling interests and redeemable noncontrolling interest (Note 1) +52,152 +99,968 +48,190 +Comprehensive income attributable to Skechers U.S.A., Inc. +$ +541,638 +$ +557,308 +$ +337,207 +See accompanying notes to consolidated financial statements. +31 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Stockholders' Equity and Redeemable Noncontrolling Interest +Shares +Amount +(in thousands) +Class A +Common +Stock +Class B +Common +Stock +Class A +Common +Stock +Class B +Common +Stock +Additional paid–in capital +Accumulated other comprehensive loss +Retained +earnings +Skechers U.S.A., +Inc. equity +Noncontrolling interests +(Note 1) +Total stockholders' equity (Note 1) +Redeemable noncontrolling interest (Note 1) +Balance at December 31, 2021 +135,107 +20,939 +$ +135 +$ +21 +$ +429,608 +$ +( 48,323 +) +$ +2,877,903 +$ +3,259,344 +$ +204,523 +$ +3,463,867 +$ +78,205 +Net earnings +— +— +— +— +— +— +373,028 +373,028 +57,744 +430,772 +( 1,610 +) +Foreign currency translation adjustment +— +— +— +— +— +( 36,574 +) +— +( 36,574 +) +( 18,752 +) +( 55,326 +) +1,774 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 29,320 +) +( 29,320 +) +— +Net unrealized gain on derivative contract +— +— +— +— +753 +— +— +753 +9,034 +9,787 +— +Stock compensation expense +— +— +— +— +59,874 +— +— +59,874 +— +59,874 +— +Proceeds from the employee stock purchase plan +243 +— +— +— +8,131 +— +— +8,131 +— +8,131 +— +Shares issued under the incentive award plan +1,424 +— +2 +— +( 1 +) +— +— +1 +— +1 +— +Shares redeemed for employee tax withholdings +( 503 +) +— +( 1 +) +— +( 20,323 +) +— +— +( 20,324 +) +— +( 20,324 +) +— +Repurchases of common stock +( 1,927 +) +— +( 2 +) +— +( 74,243 +) +— +— +( 74,245 +) +— +( 74,245 +) +— +Conversion of Class B Common Stock into Class A Common Stock +129 +( 129 +) +— +— +— +— +— +— +— +— +— +Balance at December 31, 2022 +134,473 +20,810 +$ +134 +$ +21 +$ +403,799 +$ +( 84,897 +) +$ +3,250,931 +$ +3,569,988 +$ +223,229 +$ +3,793,217 +$ +78,369 +Net earnings +— +— +— +— +— +— +545,799 +545,799 +96,766 +642,565 +7,358 +Foreign currency translation adjustment +— +— +— +— +— +11,509 +— +11,509 +( 4,373 +) +7,136 +4,105 +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 17,719 +) +( 17,719 +) +— +Purchase of noncontrolling interest +— +— +— +— +( 2,853 +) +— +— +( 2,853 +) +( 3,147 +) +( 6,000 +) +— +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 3,888 +) +( 3,888 +) +— +Stock compensation expense +— +— +— +— +67,960 +— +— +67,960 +— +67,960 +— +Proceeds from the employee stock purchase plan +242 +— +— +— +9,445 +— +— +9,445 +— +9,445 +— +Shares issued under the incentive award plan +1,120 +— +1 +— +( 1 +) +— +— +— +— +— +— +Shares redeemed for employee tax withholdings +( 429 +) +— +— +— +( 22,442 +) +— +— +( 22,442 +) +— +( 22,442 +) +— +Repurchases of common stock +( 3,197 +) +— +( 3 +) +— +( 160,061 +) +— +— +( 160,064 +) +— +( 160,064 +) +— +Conversion of Class B Common Stock into Class A Common Stock +628 +( 628 +) +1 +( 1 +) +— +— +— +— +— +— +— +Balance at December 31, 2023 +132,837 +20,182 +$ +133 +$ +20 +$ +295,847 +$ +( 73,388 +) +$ +3,796,730 +$ +4,019,342 +$ +290,868 +$ +4,310,210 +$ +89,832 +Net earnings +— +— +— +— +— +— +639,471 +639,471 +78,985 +718,456 +11,157 +Foreign currency translation adjustment +— +— +— +— +— +( 97,833 +) +— +( 97,833 +) +( 22,203 +) +( 120,036 +) +( 10,890 +) +Contribution from noncontrolling interests +— +— +— +— +— +— +— +— +150,000 +150,000 +— +Distributions to noncontrolling interests +— +— +— +— +— +— +— +— +( 39,887 +) +( 39,887 +) +— +Net unrealized loss on derivative contract +— +— +— +— +— +— +— +— +( 4,897 +) +( 4,897 +) +— +Stock compensation expense +— +— +— +— +86,665 +— +— +86,665 +— +86,665 +— +Proceeds from the employee stock purchase plan +214 +— +— +— +11,025 +— +— +11,025 +— +11,025 +— +Shares issued under the incentive award plan +2,001 +— +2 +— +1,609 +— +— +1,611 +— +1,611 +— +Shares redeemed for employee tax withholdings +( 850 +) +— +( 1 +) +— +( 52,878 +) +— +— +( 52,879 +) +— +( 52,879 +) +— +Repurchases of common stock +( 5,151 +) +— +( 5 +) +— +( 330,098 +) +— +— +( 330,103 +) +— +( 330,103 +) +— +Conversion of Class B Common Stock into Class A Common Stock +803 +( 803 +) +1 +( 1 +) +— +— +— +— +— +— +— +Balance at December 31, 2024 +129,854 +19,379 +$ +130 +$ +19 +$ +12,170 +$ +( 171,221 +) +$ +4,436,201 +$ +4,277,299 +$ +452,866 +$ +4,730,165 +$ +90,099 +See accompanying notes to consolidated financial statements. +32 +SKECHERS U.S.A., INC. AND SUBSIDIARIES +Consolidated Statements of Cash Flows +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Cash flows from operating activities +Net earnings +$ +729,613 +$ +649,923 +$ +429,162 +Adjustments to reconcile net earnings to net cash provided by operating activities +Depreciation and amortization +211,499 +181,925 +153,716 +Provision for credit losses and returns +53,847 +48,539 +37,806 +Stock compensation +86,665 +67,960 +59,874 +Deferred income taxes +5,081 +( 2,370 +) +( 6,489 +) +Net foreign currency adjustments +25,762 +( 18,492 +) +( 2,366 +) +Changes in operating assets and liabilities +Receivables +( 248,557 +) +( 3,416 +) +( 179,734 +) +Inventory +( 441,700 +) +324,193 +( 389,026 +) +Other assets +( 140,391 +) +( 98,041 +) +( 33,007 +) +Accounts payable +260,509 +41,565 +107,199 +Other liabilities +145,062 +39,378 +61,190 +Net cash provided by operating activities +687,390 +1,231,164 +238,325 +Cash flows from investing activities +Capital expenditures +( 416,794 +) +( 323,722 +) +( 358,992 +) +Acquisitions, net of cash acquired +— +( 70,370 +) +— +Purchases of investments +( 197,417 +) +( 160,233 +) +( 70,837 +) +Proceeds from sales and maturities of investments +128,851 +136,306 +142,343 +Net cash used in investing activities +( 485,360 +) +( 418,019 +) +( 287,486 +) +Cash flows from financing activities +Proceeds from the employee stock purchase plan +11,025 +9,445 +8,131 +Repayments on long-term borrowings +( 130,280 +) +( 78,256 +) +( 95,410 +) +Proceeds from long-term borrowings +265,171 +48,100 +74,670 +Net proceeds from (repayments on) short-term borrowings +21,882 +( 7,741 +) +18,439 +Net payments related to equity awards +( 51,268 +) +( 22,442 +) +( 20,324 +) +Repurchases of common stock +( 330,103 +) +( 160,064 +) +( 74,245 +) +Purchase of noncontrolling interest +— +( 6,000 +) +— +Distributions to noncontrolling interests +( 39,887 +) +( 17,719 +) +( 29,320 +) +Net cash used in financing activities +( 253,460 +) +( 234,677 +) +( 118,059 +) +Effect of exchange rates on cash and cash equivalents +( 21,964 +) +( 4,291 +) +( 13,330 +) +Net change in cash and cash equivalents +( 73,394 +) +574,177 +( 180,550 +) +Cash and cash equivalents at beginning of the period +1,189,910 +615,733 +796,283 +Cash and cash equivalents at end of the period +$ +1,116,516 +$ +1,189,910 +$ +615,733 +Supplemental disclosures of cash flow information +Cash paid during the period for +Interest +$ +21,290 +$ +21,871 +$ +19,293 +Income taxes, net +175,829 +147,095 +113,933 +Non-cash transactions +Right-of-use assets exchanged for lease liabilities +434,146 +343,438 +327,022 +Contribution from noncontrolling interests +150,000 +— +— +Non-cash consideration for acquired business +— +8,873 +— +See accompanying notes to consolidated financial statements. +33 +SKECHERS U.S.A., INC . AND SUBSIDIARIES +Notes to Consolidated Financial Statements +(1) +Summary of Significant Accounting Policies +BASIS OF PRESENTATION +Skechers U.S.A., Inc. and subsidiaries (the “Company”) designs, develops, markets and distributes footwear, apparel and accessories. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior period balances have been made to conform to current presentation. +USE OF ESTIMATES +The Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Significant areas requiring the use of estimates relate primarily to allowances for credit losses, returns and customer chargebacks, inventory reserves, litigation reserves and valuation of deferred income taxes. Actual results could differ materially from those estimates. +REVENUE RECOGNITION +The Company derives income from the sale of footwear, apparel and accessories and royalties earned from licensing the Skechers brand. The Company recognizes sales revenue, net of estimated returns and excluding sales and value added taxes. Revenue is recognized at point of sale or upon shipment, the point in time where control transfers to the customer. +Wholesale sales are primarily recognized upon shipment, and in certain international markets, upon delivery. Direct-to-Consumer sales are primarily recognized at the point of sale for transactions with customers at the Company’s retail stores and recognized upon shipment for sales made through its websites. +Sales are reduced by an estimate of customer merchandise returns, which is calculated based on historical experience. The Company reserves for potential disputed amounts or chargebacks from its customers. The Company’s chargeback reserve is based on a factors such as historical trends, customer behavior and nature of the chargeback. +COST OF SALES +Cost of sales consists primarily of product costs, including inbound freight costs, purchasing and receiving costs, and third-party royalties. Expense associated with sales return and inventory reserves is recognized in cost of sales. +ALLOWANCE FOR CREDIT LOSSES +The Company provides a reserve for estimated losses that may result from its customers’ inability to pay. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, historical losses and its customers’ credit-worthiness. Allowances for credit losses are recorded to general and administrative expenses. +WAREHOUSE AND DISTRIBUTION COSTS +The Company’s distribution network-related costs are included in general and administrative expenses. Distribution expenses, including the functions of purchasing, receiving, inspecting, allocating, surface transportation, warehousing and packaging product totaled $ 594.0 million, $ 565.1 million and $ 538.7 million for 2024, 2023 and 2022 (which includes rent and depreciation). +PRODUCT DESIGN AND DEVELOPMENT COSTS +The Company charges product design and development costs to general and administrative expenses. Aggregate product design and development costs were approximately $ 33.9 million, $ 27.9 million, and $ 28.1 million during the years ended December 31, 2024, 2023 and 2022 . +ADVERTISING +Advertising costs are expensed in the period in which an advertisement first runs, or over the life of an endorsement contract. Advertising expense for the years ended December 31, 2024, 2023 and 2022 was approximately $ 669.6 million, $ 562.1 million and $ 473.7 million. Prepaid advertising costs were $ 37.0 million at December 31, 2024, consisting of $ 17.3 million short-term and $ 19.7 million long-term, which is included in other assets, net, in the Company’s Consolidated Balance Sheets. Prepaid amounts represent the unamortized portion of endorsement contracts or advertising in trade publications and media productions created, but not run. +34 +INCOME TAXES +The Company recognizes deferred tax liabilities for taxable temporary differences and deferred tax assets for deductible temporary differences and operating loss carry‑forwards using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit or expense is recognized as a result of changes in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all of any deferred tax assets will not be realized. +CASH AND CASH EQUIVALENTS +Cash and cash equivalents include short-term investments, which are highly liquid investments with maturities of three months or less when purchased. +INVENTORY +Inventory is stated at the lower of cost or net realizable value. Cost is primarily based on the first-in, first-out method. The weighted-average cost method is used in certain markets and Direct-to-Consumer channels. Cost of product includes shipping and handling fees. The Company estimates losses from obsolete or slow-moving inventory and reserves the cost of inventory at the time such determinations are made. The Company has consistently applied these inventory cost methods from year to year. +PROPERTY, PLANT, AND EQUIPMENT +Property, plant and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the assets. The Company reviews stores for impairment annually or when facts and circumstances indicate that the carrying values may be impaired. The Company did not record material impairment charges during the years ended December 31, 2024, 2023 or 2022 . The principal estimated useful lives are as follows: +Buildings +20 to 40 years +Building improvements +10 to 20 years +Furniture, fixtures and equipment +5 to 20 years +Leasehold improvements +Shorter of useful life or remaining lease term +GOODWILL +Business acquisitions are accounted for under the acquisition method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. As of December 31, 2024 and 2023 , the Company had $ 94.5 million and $ 101.2 million of goodwill included in the Wholesale segment. The decrease in goodwill relates to the effect of foreign currency exchange translation. Goodwill is not amortized but is tested at least annually in the fourth quarter for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. +INTANGIBLE ASSETS +Other assets, net, includes amortizable intangible assets consisting of reacquired rights with a gross carrying value of $ 103.6 million and $ 108.4 million and accumulated amortization of $ 53.6 million and $ 42.2 million as of December 31, 2024 and 2023 . Purchased intangible assets with finite lives are amortized using the straight-line method over their estimated useful lives. Amortization expense related to amortizable intangible assets were $ 14.7 million, $ 11.4 million and $ 6.9 million for years ended December 31, 2024, 2023 and 2022 . Future amortization expense related to amortizable intangible assets is expected to be approximately $ 13.9 million for 2025, $ 9.4 million for 2026, $ 7.9 million for each of the years 2027 and 2028, $ 7.7 million for 2029 and $ 3.2 million thereafter. The weighted-average amortization period for amortizable reacquired rights is 7 years. +Noncontrolling Interests AND REDEEMABLE NONCONTROLLING INTEREST +The Company has equity interests in several joint ventures that were established either to exclusively distribute the Company’s products throughout China, Israel, South Korea, Mexico and Southeast Asia or to construct the Company’s domestic distribution facility. These joint ventures are variable interest entities (“VIE”) and the Company is considered the primary beneficiary. This determination is based on the relationships between the Company and the VIE, including management agreements, governance documents and other contractual arrangements. Specifically, the Company has both of the following characteristics: (a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE, or the right to receive benefits from the entity that could potentially be significant to the VIE. The assets and liabilities and results of operations of these entities are included in the Company’s consolidated financial statements, even though the Company may not hold a majority equity interest. +In December 2023, the Company increased the ownership interest related to the Israel joint venture from 51 % to 75 % for $ 6.0 million. The Israel entity continues to be included in the Company’s consolidated financial statements. +35 +During 2024, the C ompany created the new joint venture, HF Logistics-SKX T3, LLC ("HF-T3") to support expansion of its North America distribution center. The Company is obligated to contribute $ 150.0 million, of which $ 75.0 million was paid during the year ended December 31, 2024. The joint venture partner contributed land with a value of $ 150.0 million. HF-T3 is fully consolidated in the Company's consolidated financial statements. +The Company continues to reassess these relationships based on events and circumstances. The assets of these joint ventures are restricted, as they are not available for general business use outside the context of such joint ventures. The holders of the liabilities of each joint venture have no recourse to the Company. +A joint venture agreement allows the partner, based on certain triggers, to require the Company to repurchase its noncontrolling interest. As the redemption feature is not solely within the control of the Company, the noncontrolling interest is classified within temporary equity as redeemable noncontrolling interest. As of December 31, 2024 and 2023, it was not probable that the redeemable noncontrolling interest would become redeemable. Prior periods presented were revised to reflect consistent presentation as the result of this correction. The impact to the previously reported Consolidated Balance Sheet as of December 31, 2023, was as follows: +As of December 31, 2023 +(in thousands) +As reported +Revised +Adjustment +Redeemable noncontrolling interest +$ +— +$ +89,832 +$ +89,832 +Noncontrolling interests +380,700 +290,868 +( 89,832 +) +Total stockholders' equity +4,400,042 +4,310,210 +( 89,832 +) +The Consolidated Statements of Earnings and the Consolidated Statements of Comprehensive Income did not have any classification changes, only a change in the category descriptions to indicate as noncontrolling interests and redeemable noncontrolling interest. +FOREIGN CURRENCY TRANSLATION +The Company’s reporting currency is the U.S. dollar. Certain international operations use the respective local currency as their functional currency, while others use the U.S. dollar as their functional currency. Translation adjustments for subsidiaries with non-U.S. dollar functional currencies are included in other comprehensive income. Foreign currency transaction gains (losses), and remeasurement, resulting from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are reported in earnings. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated at the balance sheet date exchange rate. Net earnings and cash flow items are translated at the weighted-average exchange rates during the period. Translations of intercompany loans of a long-term investment nature are included as a component of translation adjustment in other comprehensive income. +FAIR VALUE OF FINANCIAL INSTRUMENTS +The fair value hierarchy as defined by applicable accounting standards prioritizes the use of inputs used in valuation techniques into the following three levels: +• +Level 1: Quoted market prices in active markets for identical assets or liabilities. +• +Level 2: Other observable market-based inputs or unobservable inputs that are corroborated by market data. +• +Level 3: Unobservable inputs that cannot be corroborated by market data that reflect the reporting entity’s own assumptions. +The Company’s Level 1 investments primarily include money market funds, U.S. Treasury securities and actively traded mutual funds; Level 2 investments primarily include corporate notes and bonds, asset-backed securities and U.S. Agency securities ; and the Company does not currently have any Level 3 assets or liabilities. The Company has one Level 2 derivative instrument which is an interest rate swap (see Note 6 – Financial Commitments) classified as other assets, net, at both December 31, 2024 and 2023. The fair value of the interest rate swap was determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipt was based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Credit valuation adjustments were incorporated to appropriately reflect both the Company’s nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. +The carrying amount of receivables, payables and other amounts arising out of the normal course of business approximates fair value because of the relatively short maturity of such instruments. The carrying amount of the Company’s short-term and long-term borrowings, which are considered Level 2 liabilities, approximates fair value based on current rates and terms available to the Company for similar debt. +36 +DERIVATIVE INSTRUMENTS +The Company’s objective in using interest rate derivatives is to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Company uses an interest rate swap as part of its interest rate risk management strategy. The Company’s interest rate swap is designated as a cash flow hedge. By utilizing an interest rate swap, the Company is exposed to credit-related losses in the event that the counterparty fails to perform under the terms of the derivative contract. To mitigate this risk, the Company enters into derivative contracts with major financial institutions based upon credit ratings and other factors. As of December 31, 2024 , all counterparties to the interest rate swap had performed in accordance with their contractual obligations. +RECENT ACCOUNTING PRONOUNCEMENTS +In November 2024, the FASB issued Accounting Standards Update ("ASU") 2024-03, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses . The new guidance requires the disclosure of additional information related to certain costs and expenses, including amounts of inventory purchases, employee compensation and selling expenses included in each income statement line item. This update is effective for annual periods beginning after December 15, 2026, and interim periods beginning after December 15, 2027, and shall be applied either prospectively or retrospectively at the option of the Company and early adoption is permitted. The Company is currently evaluating the impact of the new disclosure requirements. +In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures . ASU 2023-09 requires companies to disclose, on an annual basis, specific categories in the effective tax rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold. In addition, ASU 2023-09 requires companies to disclose additional information about income taxes paid. ASU 2023-09 will be effective for annual periods beginning January 1, 2025 and will be applied on a prospective basis with the option to apply the standard retrospectively. Once adopted, the Company expects to include additional income tax disclosures as required by the new guidance. The standard will not have an impact on the Company’s consolidated financial position, results of operations and cash flows. +RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS +In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures . Among other new disclosure requirements, ASU 2023-07 requires companies to disclose significant segment expenses that are regularly provided to the chief operating decision maker. The Company adopted ASU 2023-07 beginning with its annual period ended December 31, 2024. See Note 13 – Segment and Geographic Information for updated disclosures as a result of the adoption. +In March 2023, the FASB issued ASU 2023-01, Leases (Topic 842): Common Control Arrangements , which requires all lessees to amortize leasehold improvements associated wit h common control leases over their useful life to the common control group. The Company adopted ASU 2023-01 on January 1, 2024 , and the adoption of this ASU did not have a material impact on its consolidated financial statements. +(2) +Cash, Cash Equivalents, Short-term and Long-term Investments +The following tables show the Company’s cash, cash equivalents, short-term and long-term investments by significant investment category: +As of December 31, 2024 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +1,094,228 +$ +1,094,228 +$ +1,094,228 +$ +— +$ +— +Level 1 +Money market funds +15,441 +15,441 +15,441 +— +— +U.S. Treasury securities +26,160 +26,160 +2,849 +14,513 +8,798 +Mutual funds +N/A +2,984 +— +— +2,984 +Total level 1 +41,601 +44,585 +18,290 +14,513 +11,782 +Level 2 +Corporate notes and bonds +129,588 +129,588 +2,998 +85,767 +40,823 +Asset-backed securities +22,073 +22,073 +— +257 +21,816 +U.S. Agency securities +20,091 +20,091 +1,000 +17,933 +1,158 +Total level 2 +171,752 +171,752 +3,998 +103,957 +63,797 +Total +$ +1,307,581 +$ +1,310,565 +$ +1,116,516 +$ +118,470 +$ +75,579 +37 +As of December 31, 2023 +(in thousands) +Adjusted Cost +Fair Value +Cash and Cash Equivalents +Short-Term Investments +Long-Term Investments +Cash +$ +972,278 +$ +972,278 +$ +972,278 +$ +— +$ +— +Level 1 +Money market funds +176,317 +176,317 +176,317 +— +— +U.S. Treasury securities +39,769 +39,769 +29,942 +9,827 +— +Mutual funds +N/A +8,535 +— +— +8,535 +Total level 1 +216,086 +224,621 +206,259 +9,827 +8,535 +Level 2 +Corporate notes and bonds +97,795 +97,795 +9,374 +50,949 +37,472 +Asset-backed securities +11,159 +11,159 +— +— +11,159 +U.S. Agency securities +27,269 +27,269 +1,999 +11,819 +13,451 +Total level 2 +136,223 +136,223 +11,373 +62,768 +62,082 +Total +$ +1,324,587 +$ +1,333,122 +$ +1,189,910 +$ +72,595 +$ +70,617 +The Company’s investments consist of U.S. Treasury securities, corporate notes and bonds, asset-backed securities and U.S. agency securities, which the Company has the intent and ability to hold to maturity and therefore are classified as held-to-maturity. The Company holds mutual funds in its deferred compensation plan which are classified as trading securities. The Company may sell certain of its investments prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The maturities of the Company’s long-term investments are less than two years . The Company minimizes the potential risk of principal loss by investing in highly-rated securities and limiting the amount of credit exposure to any one issuer. Fair values were determined for each individual security in the investment portfolio. Included in long-term investments on the Consolidated Balance Sheets are company owned life insurance contracts of $ 71.1 million and $ 53.4 million as of December 31, 2024 and December 31, 2023. Consolidated interest income was $ 37.3 million, $ 24.8 million, and $ 6.0 million for the years ended December 31, 2024, 2023 and 2022. +When evaluating an investment for its current expected credit losses, the Company reviews factors such as historical experience with defaults, losses, credit ratings, term and macroeconomic trends, including current conditions and forecasts to the extent they are reasonable and supportable. +(3) +Leases +The Company regularly enters into non-cancellable operating leases for retail stores, distribution facilities, offices, showrooms and automobiles. Retail stores typically have initial terms ranging from 5 to 10 years and other real estate or facility leases may have initial lease terms of up to 25 years. The Company’s leases are recorded as operating lease right-of-use (“ROU”) assets and operating leases liabilities. Operating lease liabilities are recognized based on the present value of the fixed portion of lease payments over the lease term at the commencement date. Net present value is calculated using an incremental borrowing rate based on a combination of market-based factors, such as market quoted forward yield curves and Company specific factors, such as lease size and duration. Many of the Company’s real estate leases include options to extend and are included in the lease obligations when considered reasonably certain. ROU assets are recognized based on operating lease liabilities reduced by lease incentives and initial direct costs incurred. Fixed lease cost is recognized on a straight-line basis over the lease term. +The Company’s real estate leases may require additional payments for percentage rent, real estate taxes, or other occupancy-related costs. Percentage rent, a variable cost, is recognized in the consolidated financial statements when incurred and is based on the specific terms in the lease agreement. Real estate taxes and other occupancy-related costs are non-lease components. +Operating lease cost and other information: +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Fixed lease cost +$ +409,936 +$ +361,894 +$ +307,265 +Variable lease cost +11,059 +11,424 +10,803 +Operating cash flows used for leases +411,617 +359,727 +303,721 +Weighted-average remaining lease term +6.44 years +5.43 years +5.52 years +Weighted-average discount rate +4.59 +% +4.16 +% +3.12 +% +38 +The following table presents future lease payments as of December 31, 2024: +Year (in thousands) +Operating Leases +2025 +$ +356,293 +2026 +303,656 +2027 +254,437 +2028 +200,624 +2029 +164,496 +Thereafter +446,351 +Total lease payments +1,725,857 +Less: Imputed interest +( 251,641 +) +Operating lease liabilities +$ +1,474,216 +As of December 31, 2024, the Company has operating leases, primarily for distribution center expansion and retail stores, that have not yet commenced which will generate additional ROU assets o f $ 327.0 million. +(4) +Property, Plant and Equipment +Property, plant and equipment were as follows: +As of December 31, +(in thousands) +2024 +2023 +Land +$ +285,892 +$ +122,433 +Buildings and improvements +814,005 +720,663 +Furniture, fixtures and equipment +1,070,476 +954,482 +Leasehold improvements +723,930 +669,886 +Total property, plant and equipment +2,894,303 +2,467,464 +Less accumulated depreciation and amortization +1,059,373 +960,774 +Property, plant and equipment, net +$ +1,834,930 +$ +1,506,690 +Depreciation expense was $ 179.7 million, $ 156.5 million and $ 131.3 million for the years ended December 31, 2024, 2023 and 2022 . +(5) +Accrued Expenses +Accrued expenses were as follows: +As of December 31, +(in thousands) +2024 +2023 +Accrued payroll, taxes, and other +$ +166,487 +$ +166,132 +Return reserve liability +73,088 +80,968 +Accrued inventory purchases +90,676 +73,005 +Accrued expenses +$ +330,251 +$ +320,105 +(6) +Financial Commitments +The Company had $ 36.6 million and $ 32.5 million letters of credit at December 31, 2024 and 2023. Interest expense was $ 21.9 million, $ 22.4 million and $ 19.7 million for the years ended December 31, 2024, 2023 and 2022. The Company was in compliance with all financial covenants as of December 31, 2024. +SHORT-TERM BORROWINGS +As of December 31, +(in thousands) +Expiration Date +2024 +2023 +Revolving credit facility - Corporate +December 2026 +$ +— +$ +— +Revolving credit facilities - India +Various 2025 +21,209 +6,021 +Other - international facilities +Various 2025 +12,129 +5,873 +Short-term borrowings +$ +33,338 +$ +11,894 +39 +Revolving Credit Facilities +The Company maintains a revolving credit facility with Bank of America, N.A. which allows for an unsecured credit facility to $ 750.0 million, which may be increased up to $ 250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of $ 100.0 million and swingline loans up to a maximum of $ 50.0 million. The Company may use the proceeds for working capital and other lawful corporate purposes. Borrowings and letters of credit bear interest, at the Company’s option, at a rate equal to (a) Term Secured Overnight Financing Rate ("SOFR") plus an applicable margin between 1.000 % and 1.500 % based upon the Company’s Total Adjusted Net Leverage Ratio or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50 %, (ii) the Bank of America prime rate, (iii) Term SOFR plus 1.00 %, and (iv) 1.00 %) plus an applicable margin between 0 % and 0.500 % based upon the Company’s Total Adjusted Net Leverage Ratio. The unused credit capacity was $ 745.4 million and $ 746.9 million as of December 31, 2024 and 2023. +The Company is required to maintain a maximum total adjusted net leverage ratio of 3.75 :1, except in the event of an acquisition in which case the ratio may be increased at the Company’s election to 4.25 :1 for the quarter in which such acquisition occurs and for the next three quarters thereafter. +The Company's subsidiary in India had various line of credits as of December 31, 2024 with unused capacity of $ 37.5 million and a weighted average interest rate of 7.80 % . Borrowings on the line of credit are due in 180 days . Additionally, the Company maintains various credit facilities within its other international markets with an aggregate unused capacity of a pproximately $ 40.3 million that is available for working capital needs and issuance of letters of credit. +LONG-TERM BORROWINGS +As of December 31, +(in thousands) +Maturity Date +2024 +2023 +HF-T1 Distribution Center Loan +March 2025 +$ +129,505 +$ +129,505 +HF-T2 Distribution Center Construction Loan +April 2025 +73,017 +73,017 +China Distribution Center Expansion Construction Loan +December 2032 +68,450 +40,330 +China Operational Loans +Various 2025 +150,517 +46,228 +Other +Various +92 +435 +Subtotal +421,581 +289,515 +Less: Current installments of long-term borrowings +353,131 +46,571 +Long-term borrowings +$ +68,450 +$ +242,944 +HF-T1 Distribution Center Loan +To finance construction and improvements to the Company’s North American distribution center, the Company’s joint venture with HF Logistics I, LLC (“HF”), HF Logistics-SKX, LLC (the “JV”) , through a wholly-owned subsidiary of the JV (“HF - T1”), entered into a $ 129.5 million construction loan agreement with interest of SOFR Daily Floating Rate plus a margin of 1.75 % per annum . +HF-T1 also entered into an interest rate swap agreement with Bank of America with a maturity date of March 18, 2025 , which fixed the effective interest rate on the loan at 2.55 % per annum. During the second quarter of 2023, the Company amended certain terms of the loan agreement and the related interest rate swap to replace the London Interbank Offered Rate ("LIBOR") with the daily SOFR as part of the reference rate reform. The amended loan and interest rate swap agreements are subject to customary covenants and events of default. The obligations of the JV under this loan are guaranteed by HF. +As of both December 31, 2024 and 2023 , the interest rate swap had an aggregate notional amount of $ 129.5 million. Under the terms of the amended swap agreement, the Company will pay a weighted-average fixed rate of 0.778 % on the notional amount and receive payments from the counterparty based on the 30-day SOFR rate, effectively modifying the Company’s exposure to interest rate risk by converting floating-rate debt to a fixed rate of 2.63 %. +HF-T2 Distribution Center Construction Loan +On April 3, 2020, HF Logistics-SKX T2, LLC (“HF-T2”), a joint venture , entered into a construction loan agreement of up to $ 73.0 million with Bank of America to expand the North American distribution center. The interest rate is based on the Bloomberg Short-Term Bank Yield Index ("BSBY") Daily Floating Rate plus a margin of 190 basis points, reducing to 175 basis points upon substantial completion of the construction and certain other conditions being satisfied. In October 2024, the loan was amended to replace the BSBY rate with the SOFR rate. The weighted-average annual interest rate on borrowings was 6.94 % during the year ended December 31, 2024. The obligations of the JV under this loan are guaranteed by TGD Holdings I, LLC, which is an affiliate of HF. +40 +China Distribution Center Expansion Construction Loan +On October 18, 2022, the Company entered into a loan agreement for 1.1 billion yuan with Bank of China Co., Ltd to finance the construction of its distribution center expansion in China. Interest is paid quarterly. The interest rate at December 31, 2024 was 2.95 % and may increase or decrease over the life of the loan, and is evaluated every 12 months. Beginning in 2026, the principal of the loan will be repaid in semi-annual installments of variable amounts. The obligations of this loan entered through the Company’s Taicang Subsidiary are jointly and severally guaranteed by the Company’s China joint venture. +China Operational Loans +The Company has certain secured credit facilities with an aggregate capacity of 1.75 billion yuan to support the operations of its China joint venture. As of December 31, 2024 and 2023 , interest rates on outstanding borrowings ranged from 2.00 % to 2.90 % per annum. +The following table presents the future principal payments required under the Company’s debt obligations, discussed above: +Year (in thousands) +Maturities +2025 +$ +353,131 +2026 +8,712 +2027 +8,712 +2028 +8,712 +2029 +9,957 +Thereafter +32,357 +Total +$ +421,581 +Other Financial Commitments +As of December 31, 2024, the Company had remaining obligations totaling $ 75.0 million that will be contributed to the newly-formed joint venture, HF-T3, during the year ending December 31, 2025. +(7) +Commitments and Contingencies +PRODUCT AND OTHER FINANCING +The Company finances production activities in part through the use of interest-bearing open purchase arrangements with certain of its international manufacturers. These arrangements currently bear interest at rates between 0.0 % and 0.4 % for 30 - to 60 -day financing. The amounts included in accounts payable and outstanding under these arrangements were $ 273.6 million and $ 298.9 million at December 31, 2024 and 2023. Interest expense incurred by the Company under these arrangements totaled $ 5.3 million in 2024, $ 6.5 million in 2023 and $ 6.1 million in 2022. The Company has open purchase commitments with its foreign manufacturers of $ 1.2 billion and warehouse and equipment and corporate construction contracts of $ 184.8 million for the expansion of its distribution centers and corporate headquarters, which are not included in the Consolidated Balance Sheets at December 31, 2024. +LITIGATION +In accordance with GAAP, the Company records a liability in its consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. When determining the estimated loss or range of loss, significant judgment is required to estimate the amount and timing of a loss to be recorded. Estimates of probable losses resulting from litigation and governmental proceedings are inherently difficult to predict, particularly when the matters are in the procedural stages or with unspecified or indeterminate claims for damages, potential penalties, or fines. Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the consolidated financial statements as of December 31, 2024 , nor is it possible to estimate what litigation-related costs will be in the future; however, the Company believes that the likelihood that claims related to litigation would result in a material loss to the Company, either individually or in the aggregate, is remote. The Company recognizes legal expense in connection with loss contingencies as incurred. +(8) +Stockholders’ Equity and Stock Compensation +COMMON STOCK +The authorized capital stock of the Company consists of 500.0 million shares of Class A Common Stock, par value $ 0.001 per share (“Class A Common Stock”), 75.0 million shares of Class B Common Stock, par value $ 0.001 per share (“Class B Common Stock”), and 10.0 million shares of Preferred Stock, par value $ 0.001 per share. +41 +The Company has two classes of issued and outstanding common stock: Class A Common Stock and Class B Common Stock. Holders of Class A Common Stock and holders of Class B Common Stock have substantially identical rights, including rights with respect to any declared dividends or distributions of cash or property, and the right to receive proceeds on liquidation or dissolution of the Company after payment of the Company’s indebtedness. The two classes have different voting rights, with holders of Class A Common Stock entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on all matters submitted to a vote of stockholders. The Company uses the two-class method for calculating net earnings per share (“EPS”). Basic and diluted net EPS of Class A Common Stock and Class B Common Stock are identical. The shares of Class B Common Stock are convertible at any time at the option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition, shares of Class B Common Stock will be automatically converted into a like number of shares of Class A Common Stock upon transfer to any person or entity who is not a permitted transferee. +During the years ended December 31, 2024, 2023 and 2022 certain Class B stockholders converted 803,758 , 627,632 and 128,530 shares, respectively, of Class B Common Stock to Class A Common Stock. +SHARE REPURCHASE PROGRAM +The Company's Board of Directors authorized a new share repurchase program effective July 25, 2024, pursuant to which the Company may purchase shares of its Class A common stock, for an aggregate repurchase price not to exceed $ 1.0 billion. This repurchase program expires on July 25, 2027 , does not obligate the Company to acquire any particular amount of shares, and replaced the prior share repurchase program. At December 31, 2024, there was $ 789.9 million remaining to repurchase shares under the program. +The share repurchase program authorized in 2022 allowed the Company to purchase shares of its Class A common stock for an aggregate price not to exceed $ 500.0 million. The remaining authorization under this repurchase program was terminated upon authorization of the new program in 2024. +The following table provides a summary of the Company’s stock repurchase activities: +Year Ended December 31, +2024 +2023 +Shares repurchased +5,150,502 +3,197,345 +Average cost per share +$ +64.09 +$ +50.06 +Total cost of shares repurchased (in thousands) +$ +330,103 +$ +160,064 +INCENTIVE AWARD PLAN +On April 6, 2023, the Company's Board of Directors adopted the 2023 Incentive Award Plan (the "2023 Plan"), which became effective upon approval by the Company's stockholders on June 12, 2023. The 2023 Plan superseded prior plans. Awards issued and outstanding under the prior plan vest in accordance with the original terms. A total of 7.5 million shares of Class A Common Stock are reserved for issuance under the 2023 Plan, which provides for the grants of restricted stock, restricted stock units and various other types of equity awards as described in the plan to the employees, consultants, and directors of the Company. The 2023 Plan is administered by the Company's Board of Directors with respect to awards to non-employee directors and by the Company's Compensation Committee with respect to other eligible participants. +For the year ended December 31, 2024 , the Company granted restricted stock with time-based vesting, as well as performance-based awards. The performance-based awards include those with a market condition tied to the Company’s total shareholder return in relation to its peer companies as well as those with a financial performance condition tied to annual EPS growth. The vesting and ultimate payout of performance awards is determined at the end of the three-year performance period and can vary from zero to 200 % based on actual results. As of December 31, 2024, a total of 5,807,480 shares remain available for grant as equity awards under the 2023 Plan if target levels are achieved for performance-based awards and 5,223,030 available if maximum levels are achieved. +The Company granted the following stock-based instruments: +Year Ended December 31, +2024 +2023 +2022 +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Granted +Weighted-Average Grant-Date Fair Value +Restricted stock +1,211,160 +$ +59.12 +959,690 +$ +46.24 +1,446,550 +$ +38.27 +Performance-based restricted stock (1) +93,500 +$ +60.91 +121,225 +$ +43.34 +116,250 +$ +42.46 +Market-based restricted stock (1) +93,500 +$ +78.80 +121,225 +$ +59.71 +116,250 +$ +58.85 +________________________________________________ +(1) Based on the target number of shares that may vest. +42 +The Company determines the fair value of restricted stock awards and any performance-related components based on the closing market price of the Company’s common stock on the date of grant. For share-based awards with a performance-based vesting requirement, the Company evaluates the probability of achieving the performance criteria throughout the performance period and will adjust stock compensation expense up or down based on its estimated probable outcome. Certain performance-based awards contain market condition components which are valued on the date of grant using a Monte Carlo simulation model. +A summary of the status and changes of the Company’s unvested shares related to the Plan is presented below: +Shares +Weighted-Average Grant-Date Fair Value +Unvested at December 31, 2021 +3,253,316 +$ +38.97 +Granted +1,679,050 +39.98 +Vested/Released +( 1,423,531 +) +36.13 +Cancelled +( 84,933 +) +39.72 +Unvested at December 31, 2022 +3,423,902 +40.62 +Granted +1,202,140 +47.31 +Vested/Released +( 1,119,837 +) +38.76 +Cancelled +( 43,500 +) +41.19 +Unvested at December 31, 2023 +3,462,705 +43.54 +Granted +1,398,160 +60.56 +Vested/Released +( 1,969,990 +) +42.94 +Cancelled +( 58,650 +) +52.18 +Performance Adjustment +224,809 +46.87 +Unvested at December 31, 2024 +3,057,034 +$ +51.79 +For the year ended December 31, 2024, shares were issued based on the achievement of certain EPS and TSR metrics as presented below: +Year ended December 31, 2024 +Target Shares +Payout Factor +Performance Adjustment +December 2020 EPS Grant +125,000 +133 +% +41,665 +December 2020 TSR Grant +125,000 +162 +% +77,250 +March 2021 EPS Grant +108,750 +133 +% +36,250 +March 2021 TSR Grant +108,750 +164 +% +69,644 +Total Performance Adjustments +224,809 +The Company recognized, as part of general and administrative, compensation expense of $ 83.4 million, $ 65.1 million and $ 57.3 million for grants under the Plan for the years ended December 31, 2024, 2023 and 2022. Related excess tax expense (benefit) on stock compensation recorded in the Consolidated Statements of Earnings for the years ended December 31, 2024, 2023 and 2022 , was $ ( 4.7 ) million, $( 0.9 ) million, and $ 1.3 million. Nonvested shares generally vest over a graded vesting schedule from one to four years from the date of grant. For grants that have a service requirement, the Company accounts for forfeitures upon occurrence, rather than estimating the probability of forfeiture at the date of grant. Accordingly, the Company recognizes the full grant-date fair value of these awards on a straight-line basis throughout the requisite service period. There was $ 83.9 million of unrecognized compensation cost related to nonvested restricted shares as of December 31, 2024, which is expected to be recognized over a weighted-average period of 1.47 years. The total grant-date fair value of shares vested during the years ended December 31, 2024, 2023 and 2022 was $ 84.6 million, $ 43.4 million and $ 51.4 million. +STOCK PURCHASE PLAN +As approved by the Company’s stockholders on May 23, 2017, the 2018 Employee Stock Purchase Plan (the “ESPP”) provides a total of 5.0 million shares of Class A Common Stock for sale. The ESPP provides eligible employees of the Company and its subsidiaries the opportunity to purchase shares of the Company’s Class A Common Stock at a purchase price equal to 85 % of the fair market value on the first trading day or last trading day of each purchase period, whichever is lower. Eligible employees can invest up to 15 % of their compensation through payroll deductions during each purchase period. The purchase price discount and the look-back feature cause the ESPP to be compensatory and the Company recognizes compensation expense, which is computed using the Black-Scholes valuation model. +For the years ended December 31, 2024, 2023 and 2022 , the Company recognized $ 3.3 million, $ 2.9 million, and $ 2.6 million of ESPP stock compensation expense. Under the ESPP, the Company received cash of approximately $ 11.0 million, $ 9.4 million and $ 8.1 million, and issued 213,168 , 242,166 and 243,166 shares, for the years ended December 31, 2024, 2023 and 2022. As of December 31, 2024 , there were 3,360,412 shares available for sale under the ESPP. +43 +(9) +Earnings Per Share +Basic EPS and diluted EPS are calculated by dividing net earnings by the following: for basic EPS, the weighted-average number of common shares outstanding for the period; and for diluted EPS, the sum of the weighted-average number of both outstanding common shares and potentially dilutive common shares using the treasury stock method. +The calculation of EPS is as follows: +Year Ended December 31, +(in thousands, except per share data) +2024 +2023 +2022 +Net earnings attributable to Skechers U.S.A., Inc. +$ +639,471 +$ +545,799 +$ +373,028 +Weighted-average common shares outstanding, basic +151,838 +154,533 +155,627 +Dilutive effect of nonvested shares +2,005 +1,723 +981 +Weighted-average common shares outstanding, diluted +153,843 +156,256 +156,608 +Anti-dilutive common shares excluded above +7 +5 +37 +Net earnings attributable to Skechers U.S.A., Inc. +Basic +$ +4.21 +$ +3.53 +$ +2.40 +Diluted +$ +4.16 +$ +3.49 +$ +2.38 +(10) +Income Taxes +The Company’s earnings before income tax expense consists of the following: +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +U.S. operations +$ +27,136 +$ +16,740 +$ +( 48,311 +) +Foreign operations +850,613 +784,132 +570,568 +Earnings before income taxes +$ +877,749 +$ +800,872 +$ +522,257 +Income tax consists of the following: +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Current +Federal +$ +17,868 +$ +16,839 +$ +256 +State +10,062 +7,986 +9,564 +Foreign +115,125 +130,655 +84,904 +Total current +143,055 +155,480 +94,724 +Deferred +Federal +( 8,601 +) +( 2,079 +) +7,043 +State +89 +( 4,598 +) +( 1,287 +) +Foreign +13,593 +2,146 +( 7,385 +) +Total deferred +5,081 +( 4,531 +) +( 1,629 +) +Income tax expense +$ +148,136 +$ +150,949 +$ +93,095 +44 +Income taxes differ from the statutory tax rates as applied to earnings before income taxes as follows: +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Expected income tax expense +$ +184,327 +$ +168,183 +$ +109,674 +State income tax, net of federal benefit +2,334 +( 832 +) +( 1,597 +) +Rate differential on foreign income +( 48,495 +) +( 27,931 +) +( 49,175 +) +Change in unrecognized tax benefits +4,075 +3,841 +12,310 +Intra-entity intellectual property transfer +— +— +( 3,232 +) +Non-deductible compensation +12,235 +14,397 +13,668 +Tax credits +( 6,489 +) +( 6,813 +) +( 7,544 +) +Excess tax (benefit) expense on stock compensation +( 4,701 +) +( 854 +) +1,305 +U.S. tax on foreign earnings +8,986 +8,180 +7,611 +Other +( 3,978 +) +( 5,235 +) +217 +Change in valuation allowance +( 158 +) +( 1,987 +) +9,858 +Income tax expense +$ +148,136 +$ +150,949 +$ +93,095 +Effective tax rate +16.9 +% +18.8 +% +17.8 +% +The Company’s income tax expense and effective income tax rate are significantly impacted by the mix of the Company’s domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which the Company has operations, the applicable statutory rates are generally lower than in the U.S., ranging from 0 % to 35 % . The Company’s income tax expense was calculated using the applicable rate for each jurisdiction applied to the Company’s pre-tax earnings (loss) while the Company’s effective tax rate is calculated by dividing income tax expense by earnings before income taxes. For 2024 , the effective tax rate was lower than the U.S. federal and state combined statutory rate of approximately 24.9 %, primarily due to tax benefits related to earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. +The Company is subject to a tax on global intangible low-taxed income (“GILTI”). GILTI taxes foreign income in excess of a deemed return on tangible assets of foreign corporations and is treated as a period cost. +The tax effects of temporary differences giving rise to deferred tax assets and liabilities are presented below: +As of December 31, +(in thousands) +2024 +2023 +Deferred tax assets +Inventory adjustments +$ +13,047 +$ +9,413 +Accrued expenses +128,396 +109,510 +Allowances for credit losses and chargebacks +8,635 +5,648 +Intra-entity IP transfer +314,626 +330,545 +Section 174 Capitalized Costs +40,320 +43,130 +Loss carryforwards +36,007 +46,021 +Business credit carryforward +19,309 +22,571 +Share-based compensation +14,264 +10,486 +Operating lease liabilities +363,052 +338,389 +Total deferred tax assets +937,656 +915,713 +Valuation allowance +( 56,176 +) +( 56,334 +) +Total deferred tax assets, net +881,480 +859,379 +Deferred tax liabilities +Prepaid expenses +2,448 +3,873 +Right-of-use assets +363,052 +338,389 +Foreign intangibles +23,068 +16,116 +Depreciation on property, plant and equipment +63,702 +63,021 +Total deferred tax liabilities +452,270 +421,399 +Net deferred tax assets +$ +429,210 +$ +437,980 +At December 31, 2024 , combined foreign net operating loss carry-forwards were approximately $ 122.2 million of which $ 2.2 million expire in 2025 and $ 37.0 million can be carried forward indefinitely. +45 +U.S. federal tax credit carry-forward at December 31, 2024 was $ 3.4 million. State tax credit and net operating loss carry-forwards at December 31, 2024 were $ 28.6 million and $ 52.7 million. The state tax credit carries forward indefinitely and the net operating loss carry-forward amounts begin to expire in 2033. No valuation allowance has been recorded on these amounts as the Company believes they will be fully utilized. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +As of December 31, +(in thousands) +2024 +2023 +Beginning balance +$ +43,216 +$ +41,247 +Additions for current year tax positions +6,168 +4,530 +Additions for prior year tax positions +— +1,379 +Reductions for prior year tax positions +( 7,040 +) +— +Settlement of uncertain tax positions +— +( 1,722 +) +Reductions related to lapse of statute of limitations +( 1,936 +) +( 2,218 +) +Ending balance +$ +40,408 +$ +43,216 +Current unrecognized tax benefits are recorded as a reduction in prepaid expense and included in tax expense when recorded. Long-term unrecognized tax benefits are recorded as an increase in lon g-term taxes payable with a portion included in tax expense and a portion recorded as a reduction in deferred tax liabilities when recorded. If recognized, $ 42.5 million of unrecognized tax benefits would be recorded as a reduction in income tax expense and $ 2.1 million would be rec orded as a net increase in deferred tax asset. +The amount of income taxes the Company pays is subject to ongoing audits by taxing jurisdictions around the world. The Company’s estimate of the potential outcome of any uncertain tax position is subject to its assessment of relevant risks, facts, and circumstances existing at that time. The Company believes that it has adequately provided for these matters. However, the Company’s future results may include favorable or unfavorable adjustments to its estimates in the period the audits are resolved, which may impact the Company’s effective tax rate. +As of December 31, 2024, the Company's U.S. federal tax returns are under examination for fiscal years ended December 31, 2015, 2018, 2019, 2020, 2021 and 2022 by the Internal Revenue Service. Additionally, the Company is currently under examination in certain foreign jurisdictions. The Company is unable to determine the impact as these examinations have not been completed. As of December 31, 2024, the Company’s tax filings are generally subject to examination in most foreign jurisdictions for years ended on or after December 31, 2019. It is reasonably possible that certain foreign statutes will expire during the next twelve months which would reduce the balance of unrecognized tax benefits by $ 0.8 million. +The Company estimates interest and penalties related to income tax matters which are included in income tax expense (benefit). Amounts were $( 0.7 ) million, $ 2.3 million, and $( 1.9 ) million for the years ended December 31, 2024, 2023 and 2022 . Accrued interest and penalties were $ 5.8 million and $ 6.4 million as of December 31, 2024 and 2023. +The Company’s cash and cash equivalents held in the U.S. and cash provided from operations are sufficient to meet the Company’s liquidity needs in the U.S. for the next twelve months. However, the Company may repatriate certain funds held outside the U.S. for which all applicable U.S. and non-U.S. tax has been fully provided as of December 31, 2024 . The Company has provided for the tax impact of expected distributions from its joint venture in China as well as from its subsidiary in Chile to its intermediate parent company in Switzerland. Otherwise, because of the need for cash for operating capital and continued overseas expansion, the Company does not foresee the need for any of its other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if the Company chooses to repatriate some or all of the funds the Company has designated as indefinitely reinvested outside the U.S., the amount repatriated would not be subject to federal income tax but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. In addition to certain tax restrictions, the joint venture in China has limitations on its distribution of earnings, as local law currently requires it to maintain $ 30.0 million of its earnings in a stat utory reserve. On October 18, 2024, the Company repatriated $ 400.0 million of foreign earnings to the U.S. +(11) +Employee Benefit Plans +The Company has a 401(k) defined contribution plan covering U.S. employees who are 21 years of age. The Company’s contribution is based on a non-discretionary match as defined by the plan which vests immediately. The Company made contributions of $ 8.2 million, $ 6.5 million, and $ 4.2 million to the plan for the years ended December 31, 2024, 2023, and 2022. +The Skechers U.S.A., Inc. Deferred Compensation Plan allows eligible employees to defer compensation, up to a maximum amount, to a future date on a nonqualified basis. The Plan provides for the Company to make discretionary contributions to participating employees as determined by the Company’s Compensation Committee. No contributions were made for the years ended December 31, 2024, 2023 and 2022 . Deferred compensation liability is recognized based on the fair value of the participants’ accounts. +46 +(12) +Related Party Transactions +The Skechers Foundation (the “Foundation”) is a 501(c)(3) non-profit entity and not a subsidiary or otherwise affiliated with the Company. The Company does not have a financial interest in the Foundation. However, two officers and directors of the Company, Michael Greenberg, the Company’s President, and David Weinberg, the Company’s Chief Operating Officer, are officers and directors of the Foundation. The Company made cash contributions of $ 2.0 million to the Foundation in each of the years ended December 31, 2024, 2023 and 2022. +The Company had receivables from officers and employees of $ 0.7 million and $ 0.6 million at December 31, 2024 and 2023 . These amounts relate to travel advances, incidental personal purchases on Company-issued credit cards and employee loans. These receivables are short-term and are expected to be repaid within a reasonable period of time. +(13) +Segment and Geographic Information +The Company has two reportable segments, Wholesale and Direct-to-Consumer. Wholesale includes Skechers-branded stores operated by third-party franchisees and licensees, family shoe stores, specialty athletic and sporting goods retailers, department stores and big box club stores, and distributors in select international markets . Direct-to-Consumer includes Company-owned Skechers-branded stores, Company-owned e-commerce sites and leading third-party marketplaces and digital platforms. The Company’s Chief Operating Decision Maker ("CODM") is its Chief Operating Officer , who evaluates segment performance based on sales and gross margin. This information is used by the CODM to analyze the growth of each segment and then m akes decisions about how to allocate capital and other resources to each segment . Other costs and expenses of the Company are analyzed on an aggregate basis and not allocated to the segments. The following summarizes the Company’s operations by segment and geographic area: +Segment Information +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Wholesale sales +$ +5,100,479 +$ +4,504,776 +$ +4,632,429 +Cost of sales +2,892,883 +2,657,957 +2,963,153 +Gross profit +2,207,596 +1,846,819 +1,669,276 +Gross margin +43.3 +% +41.0 +% +36.0 +% +Direct-to-Consumer sales +$ +3,868,872 +$ +3,495,566 +$ +2,812,121 +Cost of sales +1,309,029 +1,189,981 +966,040 +Gross profit +2,559,843 +2,305,585 +1,846,081 +Gross margin +66.2 +% +66.0 +% +65.6 +% +Total sales +$ +8,969,351 +$ +8,000,342 +$ +7,444,550 +Cost of sales +4,201,912 +3,847,938 +3,929,193 +Gross profit +4,767,439 +4,152,404 +3,515,357 +Gross margin +53.2 +% +51.9 +% +47.2 +% +As of December 31, +(in thousands) +2024 +2023 +Identifiable assets +Wholesale +$ +3,915,362 +$ +3,607,537 +Direct-to-Consumer +4,540,396 +3,939,814 +Total +$ +8,455,758 +$ +7,547,351 +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Additions to property, plant and equipment +Wholesale +$ +236,968 +$ +225,217 +$ +255,311 +Direct-to-Consumer +179,826 +98,505 +103,681 +Total +$ +416,794 +$ +323,722 +$ +358,992 +47 +Geographic Information +Year Ended December 31, +(in thousands) +2024 +2023 +2022 +Geographic sales +Domestic Wholesale +$ +1,867,183 +$ +1,567,806 +$ +1,831,642 +Domestic Direct-to-Consumer +1,553,021 +1,482,392 +1,243,511 +Total domestic sales +3,420,204 +3,050,198 +3,075,153 +International Wholesale +3,233,296 +2,936,970 +2,800,787 +International Direct-to-Consumer +2,315,851 +2,013,174 +1,568,610 +Total international sales +5,549,147 +4,950,144 +4,369,397 +Total sales +$ +8,969,351 +$ +8,000,342 +$ +7,444,550 +Regional Sales +Americas (AMER) +$ +4,367,887 +$ +3,945,735 +$ +3,854,392 +Europe, Middle East & Africa (EMEA) +2,224,390 +1,831,848 +1,699,215 +Asia Pacific (APAC) +2,377,074 +2,222,759 +1,890,943 +Total sales +$ +8,969,351 +$ +8,000,342 +$ +7,444,550 +China sales +$ +1,218,186 +$ +1,228,630 +$ +1,062,724 +As of December 31, +(in thousands) +2024 +2023 +Property, plant and equipment, net +Domestic +$ +1,236,882 +$ +957,569 +International +598,048 +549,121 +Total +$ +1,834,930 +$ +1,506,690 +China property plant and equipment, net +$ +303,607 +$ +286,854 +CONCENTRATIONS OF RISK +The Company’s sales to its five largest customers accounted for approximately 10.3 % , 8.4 % , and 9.6 % of total sales for the years ended December 31, 2024, 2023 and 2022. +Assets located outside the U.S. consist primarily of cash, accounts receivable, inventory, property, plant and equipment, and other assets. Assets held outside the U.S. were $ 5.6 billion and $ 5.1 billion at December 31, 2024 and 2023. +The Company performs regular evaluations concerning the ability of customers to satisfy their obligations and provides for estimated credit losses. Domestic accounts receivable generally do not require collateral. Foreign accounts receivable are generally collateralized by letters of credit. The Company’s additions to the provision for expected credit losses for the years ended December 31, 2024, 2023 and 2022 were $ 5.3 million, $ 3.9 million, and $ 5.3 million. +The Company’s accounts receivables, excluding allowances for credit losses and chargebacks, by geography are summarized as follows: +As of December 31, +(in thousands) +2024 +2023 +Domestic accounts receivable +$ +345,488 +$ +276,918 +International accounts receivable +711,686 +641,249 +The Company’s top five manufacturers produced the following: +Year Ended December 31, +(percentage of total production) +2024 +2023 +2022 +Manufacturer #1 +20.4 +21.4 +16.5 +Manufacturer #2 +6.5 +7.5 +7.0 +Manufacturer #3 +6.3 +6.7 +5.2 +Manufacturer #4 +5.6 +5.6 +5.2 +Manufacturer #5 +3.6 +4.5 +5.1 +Total +42.4 +45.7 +39.0 +48 +(14) +Business Combinations +Business acquisitions are accounted for under the acquisition method by assigning the purchase consideration to tangible and intangible assets acquired and liabilities assumed. The results of businesses acquired in a business combination are included in the consolidated financial statements from the date of acquisition. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Fair value determinations require judgment and may involve the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives, and market multiples, among other items. +On May 31, 2023, the Company acquired 100 % of the equity interests of Sports Connection Holdings ApS (“Sports Connection”), a Denmark-based company and a former distributor, to further broaden the Company's reach in Europe. The total consideration was approximately $ 83.7 million and consisted of an initial cash payment of $ 74.8 million, the settlement of pre-existing receivables of $ 1.7 million and a contingent consideration payable of up to $ 7.5 million, and reduced by a working capital adjustment of $ 0.3 million. On the acquisition date, the Company re corded intangible assets of $ 54.4 million, goodwill of $ 7.7 million and other net assets of $ 21.6 million. The intangible assets have an estimated life of 7 years and are primarily related to reacquired rights. The acquisition is a non-taxable business combination and goodwill is not deductible for tax purposes. +The contingent consideration was paid in February 2024 in the amount of $ 7.1 million, which was based on the acquiree achieving certain financial results in 2023. +The results of Sports Connection's operations have been included in, but are not material to, the Company's consolidated results of operations since the date of acquisition. One-time acquisition related costs of $ 1.6 million were expensed as general and administrative expenses in 2023. +49 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time, and that the previously disclosed material weakness has been remediated. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management has concluded that our internal control over financial reporting is effective as of December 31, 2024. We reviewed the results of management’s assessment with the Audit Committee of our Board. +As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023, we identified a material weakness in our internal control over financial reporting related to the information technology general controls related to segregation of duties within an information system relevant to the preparation of the Company’s consolidated financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +We have completed the execution of our remediation plan and to address the material weakness, our management designed and implemented internal control measures, which included: +• +Rationalizing user access roles and privileges; +• +Implementing user activity monitoring; and +• +Formalizing additional control activities over the completeness and accuracy of data provided by the affected system. +During the quarter ended December 31, 2024, management performed adequate testing to conclude that the material weakness has been remediated. +Our independent registered public accountants, BDO USA, P.C., who audited the consolidated financial statements included in this annual report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2024, which is set forth below. +50 +Inherent Limitations on Effectiveness of Controls +Our management does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +Other than the remediation efforts described above, there were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2024. +51 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2024 and 2023, the related consolidated statements of earnings, comprehensive income, stockholders' equity and redeemable noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2024, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2025 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, P.C. +Los Angeles, California +February 28, 2025 +52 +Item 9B. Other Information +During the quarter ended December 31, 2024 , no director or officer of the Company adopted or terminated a “Rule 10b-1 trading agreement” or “non-Rule 10b-1 trading agreement” as each such term is defined in Item 408 of Regulation S-K. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance +We have adopted an insider trading compliance policy that governs the purchase, sale, and/or other dispositions of our securities by our directors, officers, certain employees designated by our company, and certain entities and individuals related to these persons, which is reasonably designed to promote compliance with insider trading laws, rules and regulations, and the listing requirements of the NYSE. A copy of our insider trading compliance policy is filed as Exhibit 19.1 to this Annual Report on Form 10-K. +The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. +Item 11. Executive Compensation +The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. +Item 14. Principal Accountant Fees and Services +The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. +53 +PART IV +Item 15. Ex hibit and Financial Statement Schedules +1. +Financial Statements. The financial statements as set forth under Item 8 of this Annual Report on Form 10-K are incorporated herein. +2. +Financial Statement Schedule. +Schedule II - Valuation and Qualifying Account +(in thousands) +Balance at +Beginning of Year +Costs +Charged to +Expenses +Deductions +and +Write-offs +Balance at +End of Year +Year ended December 31, 2022 +Allowance for chargebacks +$ +40,134 +$ +25,558 +$ +( 29,275 +) +$ +36,417 +Allowance for credit losses +22,550 +6,804 +( 6,299 +) +23,055 +Liability for sales returns and allowances +68,944 +5,444 +( 13,906 +) +60,482 +Reserve for inventory +7,511 +31,825 +( 21,606 +) +17,730 +Year ended December 31, 2023 +Allowance for chargebacks +$ +36,417 +$ +24,076 +$ +( 27,190 +) +$ +33,303 +Allowance for credit losses +23,055 +3,665 +( 2,156 +) +24,564 +Liability for sales returns and allowances +60,482 +20,798 +( 312 +) +80,968 +Reserve for inventory +17,730 +29,703 +( 30,524 +) +16,909 +Year ended December 31, 2024 +Allowance for chargebacks +$ +33,303 +$ +29,496 +$ +( 22,862 +) +$ +39,937 +Allowance for credit losses +24,564 +5,032 +( 2,917 +) +26,679 +Liability for sales returns and allowances +80,968 +19,319 +( 27,199 +) +73,088 +Reserve for inventory +16,909 +15,236 +( 17,839 +) +14,306 +See accompanying report of independent registered public accounting firm +54 +Index to Exhibits +Exhibit Number +Description +3.1 +Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(a) +Amendment to Amended and Restated Certificate of Incorporation dated September 24, 2015 (incorporated by reference to exhibit number 3.2 of the Registrant’s Form 10-Q for the quarter ended September 30, 2015). +3.1(b) +Second Amendment to Amended and Restated Certificate of Incorporation dated June 12, 2023 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 10-Q for the quarter ended June 30, 2023). +3.2 +Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed on July 29, 1998). +3.2(a) +Amendment to Bylaws dated as of April 8, 1999 (incorporated by reference to exhibit number 3.2(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). +3.2(b) +Second Amendment to Bylaws dated as of December 18, 2007 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 20, 2007). +3.2(c) +Third Amendment to Bylaws dated as of May 15, 2019 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on May 17, 2019). +3.2(d) +Fourth Amendment to Bylaws dated as of March 9, 2023 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on March 15, 2023). +3.2(e) +Fifth Amendment to Bylaws dated as of December 18, 2024 (incorporated by reference to exhibit number 3.1 of the Registrant’s Form 8-K filed on December 23, 2024). +4.1 +Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed on May 12, 1999). +4.2 +Description of Securities. +10.1* +Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 3, 2013). +10.1(a)* +First Amendment to the Skechers U.S.A., Inc. Deferred Compensation Plan (incorporated by reference to exhibit number 10.1(a) of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.2* +2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.2(a)* +First Amendment to the 2006 Annual Incentive Compensation Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on April 29, 2016). +10.3* +2017 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.4* +Form of Restricted Stock Award Agreement (Time-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 2017). +10.5* +Form of Restricted Stock Award Agreement (Performance-based Vesting) under 2017 Incentive Award Plan (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K filed for the year ended December 31, 2020). +10.6* +2023 Incentive Award Plan (incorporated by reference to Appendix A of the Registrant's Definitive Proxy Statement filed on May 1, 2023). +10.7* +Form of Restricted Stock Unit Agreement (Time-based Vesting) under 2023 Incentive Award Plan. (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-K filed for the year ended December 31, 2023). +10.8* +Form of Restricted Stock Award Agreement (Performance-based Vesting) under 2023 Incentive Award Plan. +55 +Exhibit Number +Description +10.9* +2018 Employee Stock Purchase Plan (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement filed on May 1, 2017). +10.10 +Form of Indemnification Agreement between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). +10.11 +Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.12* +Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). +10.13* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on May 24, 2019). +10.14* +Employment Agreement, executed May 23, 2019, effective as of January 1, 2019, between the Registrant and David Weinberg (incorporated by reference to exhibit 10.2 of the Registrant’s Form 8-K filed on May 24, 2019). +10.15 +Amended and Restated Limited Liability Company Agreement dated April 12, 2010 between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.11 of the Registrant’s Form 10-K for the year ended December 31, 2011) . +10.15(a) +First Amendment to Amended and Restated Limited Liability Company Agreement dated August 11, 2015 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on August 17, 2015). +10.15(b) +Second Amendment to Amended and Restated Limited Liability Company Agreement dated February 12, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(b) of the Registrant’s Form 10‑K for the year ended December 31, 2018). +10.15(c) +Third Amendment to Amended and Restated Limited Liability Company Agreement dated December 26, 2019 by and between Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, and HF Logistics I, LLC, regarding the ownership and management of the joint venture, HF Logistics-SKX, LLC, a Delaware limited liability company (incorporated by reference to exhibit number 10.14(c) of the Registrant’s Form 10-K for the year ended December 31, 2019). +10.16 +Amended and Restated Loan Agreement dated as of August 12, 2015, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed on August 17, 2015). +10.16(a)** +First Amendment to Amended and Restated Loan Agreement dated as of March 18, 2020, by and among HF Logistics-SKX T1, LLC, which is a wholly owned subsidiary of a joint venture entered into between HF Logistics I, LLC, and Skechers R.B., LLC, a Delaware limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A., as administrative agent and as a lender, and CIT Bank, N.A. and Raymond James Bank, N.A., as lenders.(incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed on March 24, 2020) . +10.17 +China DC Loan Agreement, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.18 +Mortgage Contract, dated August 28, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank +56 +Exhibit Number +Description +Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.19** +Guarantee Agreement, dated July 24, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.3 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.20 +Cooperative Agreement on Close Management of Fixed Asset Loan Project, dated September 29, 2018, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and China Construction Bank Corporation, regarding distribution center in Taicang, China. (Incorporated by reference to exhibit number 10.4 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2018). +10.21 +Credit Agreement dated November 21, 2019, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.21(a) +First Amendment to Credit Agreement dated March 23, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended March 31, 2021). +10.21(b) +Second Amendment to Credit Agreement dated December 15, 2021, by and among the Registrant, and Bank of America, N.A., HSBC Bank USA, N.A., JPMorgan Chase Bank, N.A. and other lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.22 +Guaranty dated November 21, 2019, by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, Bank of America, N.A. and other lenders (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on November 21, 2019). +10.23 +Reaffirmation Agreement dated December 15, 2021 by and among Skechers USA Retail, LLC, a California limited liability company and wholly owned subsidiary of the Registrant, and Bank of America N.A. (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with Securities and Exchange Commission on December 16, 2021) . +10.24 +Loan Contract, dated October 18, 2022, between Skechers Taicang Trading and Logistics Co Limited, a wholly owned subsidiary of Skechers China Limited, which is a joint venture of the Registrant, and Bank of China Co., Ltd., regarding distribution center in Taicang, China (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q (File No.001-14429) for the quarter ended September 30, 2022) . +19.1 +Insider Trading Compliance Policy . +21.1 +Subsidiaries of the Registrant. +23.1 +Consent of Independent Registered Public Accounting Firm. +31.1 +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +31.2 +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. +32.1*** +Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +97 +Policy for Recovery of Erroneously Awarded Compensation. (incorporated by reference to exhibit number 97 of the Registrant’s Form 10-K filed for the year ended December 31, 2023). +101.INS +Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH +Inline XBRL Taxonomy Extension Schema with embedded Linkbases Document +57 +Exhibit Number +Description +104 +Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101) +* Management contract or compensatory plan or arrangement required to be filed as an exhibit. +** Confidential treatment has been granted by the SEC with respect to certain information in the exhibit pursuant to Rule 24b-2 of the Exchange Act. Such information was omitted from the filing and filed separately with the Secretary of the SEC. +*** In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act. +Item 16. Form 10-K Summary +None. +58 +SIGN ATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California on the 28th day of February 2025. +SKECHERS U.S.A., INC. +By: +/s/ Robert Greenberg +Robert Greenberg +Chairman of the Board and +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Robert Greenberg +Chairman of the Board and Chief Executive Officer +February 28, 2025 +Robert Greenberg +(Principal Executive Officer) +/s/ Michael Greenberg +President and Director +February 28, 2025 +Michael Greenberg +/s/ David Weinberg +Executive Vice President, Chief Operating Officer, +February 28, 2025 +David Weinberg +and Director +/s/ John Vandemore +Chief Financial Officer +February 28, 2025 +John Vandemore +(Principal Financial and Accounting Officer) +/s/ Katherine Blair +Director +February 28, 2025 +Katherine Blair +/s/ Morton D. Erlich +Director +February 28, 2025 +Morton D. Erlich +/s/ Zulema Garcia +Director +February 28, 2025 +Zulema Garcia +/s/ Yolanda Macias +Director +February 28, 2025 +Yolanda Macias +/s/ Richard Siskind +Director +February 28, 2025 +Richard Siskind +59 \ No newline at end of file diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/filing_metadata.csv b/raw/filings/0001065837/2024/0000950170-25-030016/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..bd9c03a2f9a0c6b10f8f19aaf42e2d964db0f566 --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001065837,SKX,SKECHERS USA INC,10-K,2025-02-28,2024-12-31,2025-02-28T21:15:28.000Z,0000950170-25-030016,skx-20241231.htm,10-K,16422979,1,1,https://www.sec.gov/Archives/edgar/data/1065837/000095017025030016/skx-20241231.htm,https://www.sec.gov/Archives/edgar/data/1065837/000095017025030016/,2024,2024,1 diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/item1.txt b/raw/filings/0001065837/2024/0000950170-25-030016/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..661a80a35eef5535884cb10187fb92f2ebe400e3 --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/item1.txt @@ -0,0 +1,73 @@ +Item 1. Business +DESCRIPTION OF BUSINESS +Skechers U.S.A., Inc., designs, develops and markets a diverse range of footwear, apparel, and accessories. Our company was incorporated in California in 1992 and reincorporated in Delaware in 1999. For over 30 years, we have expanded our product offering and grown our sales while substantially increasing the breadth of our consumer and customer base. Our objective is to profitably grow our operations worldwide by delivering stylish, comfortable, innovative and high-quality products at a reasonable price. +Skechers is the third largest athletic footwear company in the world due to our innovative comfort technology products, supported by impactful marketing, as well as a diverse distribution strategy, a dedicated global employee base and a loyal network of partners. +In this annual report on Form 10-K for the fiscal year ended December 31, 2024, Skechers U.S.A., Inc., its consolidated subsidiaries and certain variable interest entities (“VIEs”) of which it is the primary beneficiary, are referred to as “Skechers,” “the Company,” “we,” “us,” or “our.” Reference in this annual report to “sales” refers to Skechers net sales reported under U.S. generally accepted accounting principles. +SEGMENTS +We have two reportable segments: Wholesale and Direct-to-Consumer. +Wholesale . Our Wholesale segment is comprised of sales to a network of partners including: +• +Skechers-branded stores operated by third-party franchisees and licensees; +• +Family shoe stores, specialty athletic and sporting goods retailers, department stores and big box club stores; +• +E-commerce retailers; and +• +Distributors in select international markets. +Growth in the Wholesale segment is expected to derive from adding new partners, more third-party Skechers-branded stores, as well as expanding our existing shelf space with current partners from the introduction of new products. +Direct-to-Consumer . Our Direct-to-Consumer segment comprises sales by us directly to consumers through a combination of channels including: +• +Company-owned Skechers-branded stores; +• +Company-owned e-commerce sites; and +• +Leading third-party marketplaces and digital platforms. +Growth in the Direct-to-Consumer segment is expected to derive from expanding our footprint, leveraging third-party digital marketplaces and platforms and introducing new products. +PRODUCTS +Skechers is a product-driven company with comfort and innovation at the core of our design process. We offer footwear and accessories for men, women and kids, as well as apparel for men and women. We market our products at multiple price points and provide consumers with what we believe is an offering with superior comfort technology. +Product design and development is essential to our success and is driven by our ability to recognize trends and to design products that anticipate and accommodate consumers’ evolving preferences. Lifestyle trend information is compiled and analyzed by our designers in various ways, including reviewing and analyzing pop culture, and fashion media. We also consult with our customers on current retail selling trends and collaborate with partners and ambassadors to ensure that our products are designed to address the intended market opportunity and convey the distinctive perspective and lifestyle associated with our brand. A key component of our design philosophy is to continually reinterpret and improve our most successful styles. +Footwear. We offer a comprehensive line of Skechers-branded performance and lifestyle footwear for men, women, and kids – with the Company’s signature comfort features and innovations. We develop footwear for athletes at all levels, everyday comfort needs, as well as occupational requirements. Our footwear categories include the following: +• +Lifestyle – Forward, innovative and on trend, the brand’s fashion, athleisure, and casual collections inspire millions to enjoy the style, comfort and quality synonymous with Skechers. Our lifestyle offering delivers comfort technologies such as Skechers Hands Free Slip-ins®, Skechers Arch Fit®, and Skechers Air-Cooled Memory Foam®, among others. With a street, fashion and court classic range, Skechers is able to reach a younger demographic. +2 +• +Performance – Winner of numerous awards, the Skechers Performance collection offers elite athletes and enthusiasts innovative technologies for soccer/football, basketball, golf, pickleball, running and walking, as well as cricket in India in 2024. The Skechers Performance division develops footwear utilizing the latest advancements in materials and works with its athletes to develop superior designs. Signature technologies include Skechers Hyper Burst®, Goodyear ® Resagrip Technology, Skechers Hands Free Slip-ins® and Skechers Arch Fit®. To support and market our Performance footwear, we have a roster of elite athletes, including Harry Kane, Europe’s top football scorer for 2023 and captain of the England national team; NBA players Julius Randle, Terance Mann, Joel Embiid, Jabari Walker and WNBA player Rickea Jackson; Major golfers Matt Fitzpatrick and Brooke Henderson; pickleball pros Tyson McGuffin and Catherine Parenteau; and cricketers Ishan Kishan and Yastika Bhatia. +• +Kids – Skechers appeals to kids with bright and bold colors and designs and are made with the latest comfort features specific to growing children’s feet. Along with unique styles for children like S-Lights, Skechers Kids also includes take-downs of our most popular products, including Skech-Air, Foamies, Skechers Hands Free Slip-ins®, Skechers Stretch Fit, and Skechers Street. +• +Work – A leading work brand in the United States and other international markets, Skechers Work is made to last – offering service and occupational employees style, comfort and industry-certified quality for all-day protection. Available for men and women, the Skechers Work line includes slip-resistant and safety-toe shoes and boots for professionals who use protective footwear in their work environments with safety and durability features such as steel, composite and lightweight safety toes, high-abrasion soles, puncture resistance, waterproofing and electrostatic-dissipative technology. +• +Earth-Friendly – Skechers Our Planet Matters line is made with recycled materials to help reduce our environmental impact. An important part of our product innovation process includes seeking out new material and textile technologies to improve upon the recycled content in Skechers Our Planet Matters products. +Apparel . We offer the latest trends in athletic and lifestyle apparel. Our collections are designed to complement our footwear products, by offering apparel that is stylish, high-quality and comfortable all at a reasonable price. +Accessories . Skechers licenses a variety of Skechers-branded products including socks, eyewear, medical scrubs, undergarments, fitness and yoga accessories, and cold weather products. +TRADEMARKS, PATENTS AND LICENSING +We own and utilize a variety of trademarks, including the Skechers trademark. We consider our Skechers trademark a significant factor in building our brand image and in distinguishing our products from those of others. We vigorously protect our trademarks against infringement, including through the use of cease-and-desist letters, administrative proceedings and lawsuits. We have a significant number of both registrations and pending applications for our U.S. trademarks. In addition, we have trademark registrations and trademark applications in 165 foreign countries. Further, we have design patents and pending design and utility patent applications in both the U.S. and a myriad of foreign countries. We continuously look to increase the number of our patents and trademarks both domestically and internationally. +We believe that selective licensing of the Skechers brand name to manufacturers broadens and enhances the brand without requiring incremental capital investments or operating expenses. As of December 31, 2024, we had 25 active licensing agreements in which we are the licensor. We license a variety of Skechers-branded products including apparel and accessories. +MARKETING +Brand recognition is an important element for success in the footwear business. Senior management is directly involved in shaping our image and the conception, development and implementation of our advertising and marketing activities. We aggressively market our brands through comprehensive marketing campaigns. The Skechers brand is supported by television, digital, print, radio, outdoor, and press campaigns. To further drive recognition, we enlist numerous celebrities, athletes, and influencers to appear in our campaigns. We strategically select ambassadors who we believe work well with the Company to promote the brand and support the product. In 2024, our brand ambassadors included television personalities and entertainers Martha Stewart, Snoop Dogg, Amanda Kloots, Brooke Burke, Howie Mandel, Myleene Klass, Andy Reid and Vanessa Mai, and former athletes Sugar Ray Leonard, Tony Romo, Howie Long, Jamie Redknapp, Fabio Cannavaro, Ruud, Gullet and Frank Leboeuf. +Additionally, athletes supporting our performance footwear included elite golfers Matt Fitzpatrick and Brooke Henderson, professional pickleball players Tyson McGuffin and Catherine Parenteau, and Major League Baseball players Clayton Kershaw, Chris Taylor, Brendan Donovan, Aaron Nola and Wade Miley. Skechers Football launched at the start of the 2023/24 season when the Company signed Bayern Munich striker Harry Kane as the first professional to compete in the boot. Skechers expanded its roster with a number of Premier League athletes including Mohammed Kudus, Oleksandr Zinchenko and Anthony Elanga, as well as Indian Super League all-time top scorer Sunil Chhetri and Turkey’s Super Lig and national team player Baris Alper Yilmaz. Skechers Basketball launched at the start of the 2023/24 season with NBA pros Julius Randle and Terance Mann. The roster expanded in 2024 with gold-medal winner Joel Embiid, Jabari Walker and Rickea Jackson, our first WNBA athlete. For the 2024 launch of Skechers Cricket, we signed Mumbai Indian cricketers Ishan Kishan and Yastika Bhatia. We identify athletes who benefit from the comfort and technologies that our brand has to offer, and whose performance on the field, court, pitch, or course is augmented through the product. +3 +SOURCING AND MANUFACTURING +Our suppliers are integral partners in delivering stylish, high-quality footwear and apparel to our consumers worldwide. Our products are produced by independent contract manufacturers located primarily in Asia. We do not own or operate any manufacturing facilities. We believe that the use of independent manufacturers substantially increases our production flexibility and capacity, while reducing capital expenditures and avoiding the costs of managing a large production workforce. To minimize disruption of our product supply due to potential political instability, civil unrest, economic instability, changes in government policies or regulations, natural and manmade disasters, and other risks, we source product from multiple facilities across multiple countries. We believe that the existing production capacity at our third-party manufacturers’ facilities is sufficient to handle our expected volume in the foreseeable future. +To safeguard product quality and consistency, we monitor the key aspects of production from initial prototype manufacturing, through initial production runs, to final manufacturing. Monitoring of production is performed in the U.S. by our in-house production department and in Asia by staff working from our offices in China and Vietnam. We believe that our Asia presence allows us to negotiate supplier and manufacturer arrangements more effectively, decrease product turnaround time, and ensure timely delivery of finished footwear. +We believe quality control is an important and effective means of maintaining the quality and reputation of our products and brand. Our quality control program is designed to ensure finished goods meet our established design specifications and goods bearing our trademarks meet our standards for quality. Our quality control personnel located in China and Vietnam perform an array of inspection procedures at various stages of the production process, including examination and testing of prototypes of key raw materials prior to manufacture, samples and materials at various stages of production and final products prior to shipment. Our employees are on-site at each of our major manufacturers to oversee production and ensure that manufacturers comply with our Supplier Code of Conduct. +OUR MARKET +Our collections are available in approximately 180 countries and territories and can be accessed in digital or physical stores. We are continually expanding and enhancing our distribution and logistics facilities and systems to support our omni-channel capabilities and provide greater access to merchandise selection and faster delivery. Our company-owned e-commerce business enables consumers to shop, browse, find store locations, socially interact, post reviews, and immerse themselves in our brands. Additionally, the e-commerce business provides an efficient and effective direct-to-consumer distribution channel, which continues to improve our customer service and brand experience. We manage our international business through a network of wholly-owned subsidiaries, joint venture partners, and distributors. Our joint venture interests include China, Malaysia, Vietnam and Singapore (50%), Thailand (51%), Mexico (60%), South Korea (65%) and Israel (75%). Where we do not sell directly through our international subsidiaries and joint ventures, our footwear is distributed through a network of distributors and licensees who sell our products to department, athletic and specialty stores, and digital stores, as well as in Skechers-branded retail stores. +COMPETITION +The global footwear industry is a competitive business. Although we believe that we do not compete directly with any single company with respect to our entire range of products, our products compete with other branded products within their product category as well as with private label products sold by retailers, including some of our customers. We also compete with numerous manufacturers, importers, and distributors of footwear for the limited shelf space available for displaying such products to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of our competitors are larger, have been in existence longer, have strong brand recognition, have captured greater market share and/or have substantially greater financial, distribution, marketing and other resources than we do. We believe, however, that we have competitive advantages because of our brand recognition, our quality comfort technology products, and our application of pricing and distribution strategies, among other factors. +HUMAN CAPITAL +Skechers employees are central to our success. We are a family brand at the core, and our commitment to family extends to our diverse team of global employees. We believe our unique backgrounds and experiences have made us stronger, inspired new ideas, and driven our innovative spirit. From our corporate offices to our retail stores and our distribution centers, we aim to build a workplace that supports each employee’s well-being and encourages everyone to grow in their careers and give back to their community. We are focused on creating a positive, supportive work environment where our team can work and feel their best every day. +Employees . As of December 31, 2024, we employed approximately 20,100 persons worldwide, of whom approximately 10,100 were employed on a full-time basis and approximately 10,000 were employed on a part-time basis, primarily in our retail stores. +Compensation and Benefits. We seek to provide market-competitive compensation and benefits that attract and retain the best talent. We offer a broad range of benefits including medical, prescription, dental and vision plans, flexible spending accounts, company-provided disability insurance, pet insurance, paid sick and vacation time, employee assistance program, childcare subsidies, parental leave and tuition reimbursement. Additional benefits for certain employees include a 401(k) plan, 529 college savings plan and pensions. +4 +Workplace Culture. Skechers was founded on inclusivity, diversity, respect, and entrepreneurial spirit with the philosophy of putting people first. In conjunction with our corporate policy against discrimination, Skechers emphasizes that every employee, applicant, contractor, and customer is entitled to be treated with dignity and respect. Human rights are a core value at the heart of how we conduct our business, at every level of the Company – including our factories and suppliers. Our Code of Ethics, Corporate Code of Conduct and Supplier Code of Conduct codify our commitment to these values. These codes are in the Corporate Governance section of the Investor Relations page of our corporate information website located at investors.skechers.com/corporate-governance/governance-documents. We intend to post any amendment to, or waivers of, these codes on our website. +CORPORATE RESPONSIBILITY +Despite the dynamic growth we have seen over the years, we remain firmly rooted in the same community where we began while dedicated to serving the people around the world. In so doing, we take seriously our position as a steward of the many communities and stakeholders we impact in our daily business activities. This increasingly involves considering multiple ways we can evolve our business practices and processes to improve the health of our planet, the lives of our people and our communities. Corporate responsibility is a top priority for our leadership, who are investing in plans to further our environmental, social and governance ("ESG") efforts. +Sustainability. We believe it is our responsibility as a family-focused footwear and apparel brand to create and implement sustainable strategies across our operations to minimize our impact on the environment and support our customers, employees, and partners. Environmental advancements are a top priority in the development of our corporate offices as well as logistic centers. Many of our facilities are designed and operated with sustainability in mind, including one of America’s largest LEED Gold certified facilities at our North America distribution center in Southern California. Our European Distribution Center in Liege, Belgium, has both a BREEAM Very Good rating and a Lean and Green certification. Additionally, our China Distribution Center in Taicang incorporates sustainable features such as natural lighting, LED motion detectors and temperature controllers; and our recently opened India Distribution Center outside Mumbai is designed as a LEED building with certification pending. Now under construction, our corporate offices in Manhattan Beach remain future-focused as we incorporate our earth-friendly philosophy into our growing footprint. All four new buildings are being designed to receive LEED Gold certification upon completion. +In 2021, we introduced Our Planet Matters, a collection for men and women that utilizes recycled materials. We partnered with a global conservation organization to help fund its organization’s global efforts which align with our interests and commitment to reduce tree harvesting and emissions through packaging. These efforts represent our growing focus on more environmentally sustainable manufacturing, packaging, distribution, product development, corporate processes, and activities. +Human Rights. We require our manufacturers to operate in a manner consistent with the Skechers Supplier Code of Conduct posted on our corporate website. We partner with factories that ensure humane conditions for their employees and we engage in routine auditing and monitoring procedures to ensure that those who contribute to our product are treated with civility and respect. This code outlines our policies and expectations on topics including discrimination, harassment and abuse, forced labor, freedom of association, compensation and benefits, and health and safety, among others. +Community. Skechers encourages active participation in the greater community, with annual charity walks for children near our corporate offices and in select global markets. We promote charitable giving and volunteering by sponsoring community service days along with blood drives, food drives and shoe drives. Additionally, we regularly donate product to not-for-profit organizations and for humanitarian relief. In 2024, we donated $1.6 million to Petco Love Foundation to help save the lives of animals in need in the U.S. and Canada. In addition, in 2024, we donated $2.0 million to the Skechers Foundation which is dedicated to ensuring the well-being of youth around the world. +For additional information on Skechers value creation and global impact, refer to our Impact Report which can be found on our website at about.skechers.com/social-responsibility. +AVAILABLE INFORMATION +We file annual, quarterly, and current reports, proxy statements and other documents with the Securities and Exchange Commission (“SEC”). The SEC maintains an internet site at sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Our internet address is www.skechers.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information are also made available, free of charge, on our investor relations website at investors.skechers.com as soon as reasonably practicable after we file or furnish with the SEC. The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of this annual report on Form 10-K or our other filings with the SEC. +5 \ No newline at end of file diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/item13.txt b/raw/filings/0001065837/2024/0000950170-25-030016/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..4fbc68e2d021ca0951506fede4596604460cd6c2 --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2024 fiscal year. \ No newline at end of file diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/item9a.txt b/raw/filings/0001065837/2024/0000950170-25-030016/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..51cea6392566c9a61462bcaf01414d803e423172 --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/item9a.txt @@ -0,0 +1,46 @@ +Item 9A. Controls and Procedures +Attached as exhibits to this annual report on Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of disclosure controls and procedures +We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods and that such information is accumulated and communicated to allow timely decisions regarding required disclosures. As of the end of the period covered by this annual report on Form 10-K, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective, at the reasonable assurance level as of such time, and that the previously disclosed material weakness has been remediated. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. +With the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management has concluded that our internal control over financial reporting is effective as of December 31, 2024. We reviewed the results of management’s assessment with the Audit Committee of our Board. +As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023, we identified a material weakness in our internal control over financial reporting related to the information technology general controls related to segregation of duties within an information system relevant to the preparation of the Company’s consolidated financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +We have completed the execution of our remediation plan and to address the material weakness, our management designed and implemented internal control measures, which included: +• +Rationalizing user access roles and privileges; +• +Implementing user activity monitoring; and +• +Formalizing additional control activities over the completeness and accuracy of data provided by the affected system. +During the quarter ended December 31, 2024, management performed adequate testing to conclude that the material weakness has been remediated. +Our independent registered public accountants, BDO USA, P.C., who audited the consolidated financial statements included in this annual report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2024, which is set forth below. +50 +Inherent Limitations on Effectiveness of Controls +Our management does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Assessments of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements as a result of error or fraud may occur and not be detected. +Changes in internal control over financial reporting +Other than the remediation efforts described above, there were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the fourth quarter of 2024. +51 +Report of Independent Registered Public Accounting Firm +Shareholders and Board of Directors +Skechers U.S.A., Inc. +Manhattan Beach, California +Opinion on Internal Control over Financial Reporting +We have audited Skechers U.S.A., Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2024 and 2023, the related consolidated statements of earnings, comprehensive income, stockholders' equity and redeemable noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2024, and the related notes and financial statement schedule listed in the accompanying index and our report dated February 28, 2025 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ BDO USA, P.C. +Los Angeles, California +February 28, 2025 +52 \ No newline at end of file diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/rp_note.txt b/raw/filings/0001065837/2024/0000950170-25-030016/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001065837/2024/0000950170-25-030016/rpt_disclosure.txt b/raw/filings/0001065837/2024/0000950170-25-030016/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..b66af9de53f6acf90f68f72c2cb19364d3146f0f --- /dev/null +++ b/raw/filings/0001065837/2024/0000950170-25-030016/rpt_disclosure.txt @@ -0,0 +1,16 @@ +TRANSACTIONS WITH RELATED PERSONS +Policies and Procedures +As provided in our Audit Committee Charter, the Audit Committee shall review (i) at least annually a summary of directors’ and executive officers’ related party transactions and potential conflicts of interest and our policies relating to the avoidance of conflicts of interest (which is discussed in the section entitled “ Code of Business Conduct and Ethics and Corporate Code of Conduct ” in this Proxy Statement), (ii) past and proposed transactions between our company, on the one hand, and any of our directors or executive officers, on the other hand, and (iii) policies and procedures as well as audit results associated with directors’ and executive officers’ expense accounts and perquisites, including the use of corporate assets. +Our Policies and Procedures for Related Person Transactions (the “Policy”), which was adopted by the Board of Directors as of March 8, 2007, covers any transaction, arrangement or relationship, or series of similar transactions, arrangements or relationships, (including any indebtedness or guarantee of indebtedness) in which (i) the aggregate amount involved will or may be expected to exceed $100,000 in any calendar year, (ii) we are a participant, and (iii) any Related Person has or will have a direct or indirect interest (other than solely as a result of being a director or a less than ten percent beneficial owner of another entity). A “Related Person” is (a) any person who is or was (since the beginning of the last fiscal year for which we have filed a Form 10-K and Proxy Statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director of Skechers, (b) a greater than five percent beneficial owner of our Class A Common Stock or Class B Common Stock or (c) an immediate family member of either of the foregoing. +Certain categories of transactions with Related Persons (such as transactions involving competitive bids) have been reviewed and pre-approved by the Audit Committee under the Policy. The Audit Committee shall review the material facts of all other transactions with Related Persons that require the Committee’s approval. If advance approval by the Audit Committee of a transaction with a Related Person is not feasible, then the transaction will be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. Factors that the Audit Committee will take into account include whether the transaction with a Related Person is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction. No Audit Committee member will participate in any discussion or approval of a transaction with a Related Person pursuant to which he is a Related Person except for providing material information concerning the transaction. For those transactions with a Related Person that are ongoing, the Audit Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Person to determine that the transaction with the Related Person remains appropriate. +We have adopted changes to our policies and procedures to identify and report employees who, pursuant to Item 404 of Regulation S-K under the Exchange Act, are related to a Related Person and earned annual compensation equal to or greater than $120,000. +The following list of transactions with Related Persons includes all such transactions equal to or greater than $120,000 that took place since January 1, 2024. Each of these transactions was reviewed, and either approved or ratified, by the Audit Committee, pursuant to the policies and procedures discussed herein. +50 +Related Person Transactions +During 2024, we paid $267,488 and $135,000 to The BeachLife Festival and The BeachLife Ranch Festival for Skechers marketing and sponsorship. The BeachLife Festival is owned and operated by BeachLife Festival, LLC, of which Michael Greenberg owns a 10% beneficial ownership interest. The BeachLife Ranch Festival is owned and operated by BeachLife Festival 2, LLC, of which Michael Greenberg owns a 10% beneficial ownership interest. Skechers had no outstanding accounts receivable or payable with any of these music festivals or their operating entities as of December 31, 2024. +During 2024, we paid $399,566 to the Redondo Beach Hospitality Company, LLC ("RBHC") for lodging, food and events, including the Company's 2024 holiday party at the Shade Hotel in Redondo Beach, which is owned and operated by RBHC. In addition, we made payments of $495,028, $597,063 and $126,534 to RBHC for lodging, food and events in 2023, 2022 and 2021, respectively, that were not previously reported. Michael Greenberg owns a 9% beneficial ownership interest in RBHC, and three other officers, directors and senior vice presidents of Skechers own in aggregate an additional 7% beneficial ownership in RBHC. Skechers had no outstanding accounts receivable or payable with RBHC or the Shade Hotel in Redondo Beach at December 31, 2024. +On July 29, 2010, we formed the Skechers Foundation (the “Foundation”), which is a 501(c)(3) non-profit entity that does not have any shareholders or members. The Foundation is not a subsidiary of, and is not otherwise affiliated with us, and we do not have a financial interest in the Foundation. However, Michael Greenberg and David Weinberg are officers and directors of the Foundation. During the year ended December 31, 2024, we made cash contributions of $2,000,000 to the Foundation and provided support services with a value of $300,000. +As of December 31, 2024, Robert Greenberg and Michael Greenberg owed unreimbursed expenses of $144,948 and $3,099, respectively, to Skechers. These amounts have since been repaid in the ordinary course of our reimbursement practices, which occurs on a regular cadence. +Jason Greenberg, Jeffrey Greenberg, Joshua Greenberg and Jennifer Greenberg Messer, who are the children of Robert Greenberg and also the siblings of Michael Greenberg, are non-executive employees of Skechers, and they earned total compensation of $6,183,967, $122,903, $5,476,325 and $331,289, respectively, in 2024. Marlene Greenberg, who is Robert Greenberg’s sister, is a non-executive employee of Skechers, and she earned total compensation of $400,472 in 2024. Chase Greenberg, who is the son of Michael Greenberg, is a non-executive employee of Skechers, and he earned total compensation of $1,519,331 in 2024. Andrew Bronstein, who is Michael Greenberg’s brother-in-law, is a non-executive employee of Skechers, and he earned total compensation of $196,910 in 2024. Danielle Coates, a personal acquaintance of Robert Greenberg, is a non-executive employee of Skechers, and she earned compensation of $135,544 in 2024. Miguel Escobar, who is Robert Greenberg’s brother-in-law, and who provided services as a consultant to Skechers, earned compensation of $165,000 in 2024. +Andrew Weinberg and Jeffrey Weinberg, who are the sons of David Weinberg, are non-executive employees of Skechers, and they earned total compensation of $943,260 and $663,424, respectively, in 2024. +During 2024, we paid $120,000 to El Camino Media Services, which provides music procurement services to Skechers. El Camino Media Services is owned by Jennifer Greenberg Messer's husband, Matthew Messer, who is the son-in-law of Robert Greenberg and the brother-in-law of Michael Greenberg. In addition, for each of the years from 2016 through 2023, we paid $120,000 to El Camino Media Services, which were not previously reported. \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/filing.txt b/raw/filings/0001532286/2017/0001564590-18-007130/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..238dfb57bb0f11fb221504d7cd55edc97a15f3f6 --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/filing.txt @@ -0,0 +1,5327 @@ +10-K +1 +nine-10k_20171231.htm +10-K +nine-10k_20171231.DOCX.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +FORM 10-K +(Mark One) +☐ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017 +OR +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE TRANSITION PERIOD FROM TO +Commission File Number: 001-38347 +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +Delaware +80-0759121 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston, TX 77019 +(Address of principal executive offices) +(281) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, par value $0.01 per share +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ +Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☐ No ☒ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act +Large accelerated filer +☐ +Accelerated filer +☐ +Non-accelerated filer +☒ +(Do not check if a smaller reporting company) +Smaller reporting company +☐ +Emerging growth company +☒ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The Company was not a public company as of the last business day of its most recently completed second quarter and therefore cannot calculate the aggregate market value of its voting and non-voting common equity held by non-affiliates at such date. +The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding at March 21, 2018, was 23,873,583. +DOCUMENTS INCORPORATED BY REFERENCE: NONE +TABLE OF CONTENTS +PART I +1 +Item 1. +Business +2 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +34 +Item 2. +Properties +34 +Item 3. +Legal Proceedings +35 +Item 4. +Mine Safety Disclosures +35 +PART II +36 +Item 5. +Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities +36 +Item 6. +Selected Financial Data +40 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +42 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +60 +Item 8. +Financial Statements and Supplementary Data +61 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +62 +Item 9A. +Controls and Procedures +62 +Item 9B. +Other Information +63 +PART III +64 +Item 10. +Directors, Executive Officers and Corporate Governance +64 +Item 11. +Executive Compensation +69 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters +76 +Item 13. +Certain Relationships and Related Transactions, and Director Independence Related Persons Transactions +77 +Item 14. +Principal Accounting Fees and Services +83 +PART IV +84 +Item 15. +Exhibits, Financial Statement Schedules +84 +Item 16. +None +PAR T I +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K for the year ended December 31, 2017 (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact included in this Annual Report, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +Forward-looking statements may include statements about: +• +the volatility of future oil and natural gas prices; +• +our ability to successfully manage our growth, including risks and uncertainties associated with integrating and retaining key employees of the businesses we acquire; +• +availability of skilled and qualified labor and key management personnel; +• +our ability to accurately predict customer demand and implement price increases for our services; +• +competition in our industry; +• +governmental regulation and taxation of the oil and natural gas industry; +• +environmental liabilities; +• +political and social issues affecting the countries in which we do business; +• +our ability to implement new technologies and services; +• +availability and terms of capital; +• +general economic conditions; +• +benefits of our acquisitions; +• +operating hazards inherent in our industry; +• +the continued influence of SCF-VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”); +• +our ability to establish and maintain effective internal controls over financial reporting; +• +our ability to operate effectively as a publicly traded company; +• +our financial strategy, budget, projections, operating results, cash flows and liquidity; and +• +our plans, business strategy and objectives, expectations and intentions that are not historical; and +• +other factors disclosed in Item 1A. “Risk Factors” and elsewhere in this Annual Report. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law and we caution you not to place undue reliance on them. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. We disclose important factors that could cause our actual results to differ materially from our expectations under Item 1A. “Risk factors” and Item 7. “Management’s discussion and analysis of financial condition and results of operations” in this Annual Report. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +Item 1. +Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us” and “our”) is a Delaware corporation that was incorporated in February 2013 through a combination of three service companies owned by SCF. Nine is a leading North American onshore completion and production services provider that targets unconventional oil and gas resource development. We partner with our exploration and production (“E&P”) customers across all major onshore basins in both the U.S. and Canada to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery (“EUR”) per lateral foot and a superior return on investment, which make them attractive to operators despite their associated increased well cost. We compete with a limited number of service companies for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well and increased proppant loading per lateral foot. As stage counts per well increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and drilling out plugs and performing associated remedial work as production comes online. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. We provide customers with plug-and-perf or pinpoint frac sleeve system technology to complete the remaining stages of the well. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our pinpoint frac sleeve system involves packers, either hydraulic or swellable, to isolate sections of the wellbore and frac sleeves to provide access to each stage for stimulation and production. Our equipment also includes high-specification coiled tubing units and workover rigs that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. Once a well is producing, we are able to offer a range of production enhancement and well workover services through our fleet of well service rigs and ancillary equipment. +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017 (“Combination”), the Company merged with Beckman Production Services, Inc. (“Beckman”) and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc., other than 1.6% of Beckman shares paid in cash. Prior to the Combination, SCF-VII, L.P. controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the combined Company was accounted for using reorganization accounting (i.e., “as if” pooling of interests) for entities under common control. +2 +Our Segments +We operate in two segments: Completion Solutions and Production Solutions. Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. +Completion Solutions +The following is a description of the primary service offerings and deployment methods within the Completion Solutions business segment: +Cementing services : Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently have three high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to API specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps and two electrical systems. This significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment, and since 2012, we have deployed only new equipment for use in the fields. As of December 31, 2017, we operated a total of 28 twin-pumping units, each of which has 1,000 horsepower, which we believe is the highest in the industry. +From January 2014 through December 2017, we completed approximately 11,100 cementing jobs, with an on-time rate of approximately 90%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 90% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants and our service-driven culture. In order to further improve punctuality, respond to customers’ demands for providers near their acreage, and gain access to an additional customer base, we built a bulk plant and lab facility in Hobbs, New Mexico, with close proximity to the Delaware Basin. We believe this location will reduce operating expenses due to improved logistics as well as provide cross-selling opportunities for other service lines. +Completion tools : We provide unconventional and conventional downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, fully-composite and dissolvable frac plugs and specialty open hole float equipment and centralizers. Our completion tools provide pinpoint frac sleeve system technologies that enable comparable rates per stage while providing more control over fracture initiation. A few examples of our innovative portfolio of completion tools are: (i) the Scorpion Fully-Composite Plug TM , a patented packer-style fully-composite plug designed to provide zonal isolation in a multi-stage well completion; we offer a diverse product group of fully-composite plugs designed for 3.5” to 5.5” well casings as well as a unique Scorpion Extended Range plug, which is used in demanding well applications where operators have to negotiate through internal diameter restrictions, (ii) the Scorpion Dissolvable Plug, a high performance plug designed to provide zonal isolation, is made entirely from proprietary materials that dissolve over time, leaving the wellbore unobstructed for production and eliminating the risk and costs of conventional plug removal, (iii) the SmartStart PLUS TM , an interventionless time-delayed pressure-activated sleeve that we have the exclusive distribution rights to in the northeastern U.S. and with certain customers in other regions, that eliminates the need for tubing or pipe-conveyed perforating when completing the toe stage of horizontal wells, (iv) the Storm Re-Frac Packer TM , a system that allows our customers to re-stimulate their existing wells using standard size plug-and-perf procedures to extend and enhance their production profiles with minimal flow restriction during stimulation, (v) the FlowGun TM , a stage one interventionless casing-conveyed perforating technology that eliminates the need to run wireline or coil tubing and requires no electronic detonation allowing our customers to perform a maximum pressure test and perforate stage one more efficiently with less risk and with no lateral length limitations, (vi) the Coil Frac Sleeve System, a system that utilizes coiled tubing to deploy a resettable +3 +frac packer, that we have the exclusive distribution rights to in the U.S., which is used to open and isolate frac sleeves that have been installed as an integral part of the casing, and (vii) the EON Ball Drop s ystem, an interventionless single-size ball activated pinpoint frac sleeve system, that we have exclusive distributions rights to in the U.S. and Canada. Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. From March 2011 through December 2017, we deployed approximately 65,000 swell and hydro-mechanical packers and approximately 18,000 frac sleeves for downhole completions. +Additionally, we offer a portfolio of completion technologies used for completing the toe stage of a horizontal well, as well as fully-composite, dissolvable and extended-range frac plugs to isolate stages during plug-and-perf operations. +Wireline services : Our wireline services involve the use of a wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations, with 37 wireline units in the U.S. and 14 wireline units in Canada. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools and addressable switches. We currently have wireline units equipped with customized drums to hold up to 40,000 feet of Enviroline. Enviroline is a coated wireline that significantly reduces injector oil use requiring only 5% of the amount needed with standard wireline. Offering a lower dynamic coefficient of friction, Enviroline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite frac plugs through our wireline units. From January 2014 through December 2017, we completed approximately 70,000 wireline stages in the U.S. with a success rate of approximately 99%. +Coiled tubing services : Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 25,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift installation, cementing, stimulation and restimulation services. In addition, our units are also used in conjunction with pinpoint hydraulic fracturing operations. +We currently operate 16 coiled tubing units serving the Permian Basin, SCOOP/STACK region and Haynesville markets. Each of our coiled tubing units carries data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Of the 16 coiled tubing units, we consider 11 to be “extended reach” units capable of reaching the toe of wells with total measured depths of 21,500 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8’’ and 2 5/8’’) applications, we also offer 2’’ and 1 1/4’’ diameter solutions to our customers. From April 2014 through December 2017, we have performed approximately 5,900 jobs and deployed more than 115 million running feet of coiled tubing, with a success rate of over 99%. +Production Solutions +The following is a description of the primary service offerings conducted within the Production Solutions business segment: +Well services : Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to plugging and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the +4 +production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. Activities performed wi th our well servicing rigs can range from the milling of plugs following a plug-and-perf completion, to the installation and repair of artificial lift, to the ultimate plug and abandonment of a depleted well. Key components of our well services success inc lude our geographic footprint, employee culture, fleet of rigs and inventory of equipment. Our operations extend across six major onshore U.S. basins, and our employee culture fosters local relationships within this expansive geographic footprint through e xcellent customer service and basin-level expertise. +We utilize a fleet of more than 100 rigs, approximately 40% of which are capable of performing completion-oriented work. This fleet of rigs and the inventory of equipment maintained at each of our regional locations are tailored to the needs of our customers in each particular basin. The high-specification rigs we utilize are engineered to perform in the most demanding laterals being drilled in the U.S. today. In addition, we also own and operate auxiliary equipment necessary to support the activities of our rigs, swabbing units, hot oilers, high pressure pump trucks, cementers, vacuum trucks and transport tankers in the basins in which we operate. These complementary services facilitate the production enhancement of existing wells or are called upon to plug and abandon a well at the end of its life. From January 2014 through December 2017, we operated more than 900,000 rig hours. According to the Association of Energy Service Companies (“AESC”), only 52% of industry reported well service rigs were active or available from January 2015 through December 2017. In contrast, 66% of our rigs have remained utilized in the same period. +Geographic Areas of Operation +We operate in all major onshore basins in both the U.S. and Canada, including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, SCOOP / STACK Formation, Bakken Formation, Haynesville Formation and Western Canada Sedimentary Basin. We provide our services through strategically placed operating facilities located in-basin throughout North America. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion and production trends and technology across all divisions and geography. +We believe that our strategic geographic positioning will benefit us as activity increases in our core operating areas. Our broad geographic footprint provides us with exposure to the ongoing recovery in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +For disclosures regarding financial statements about segment information and geographic area, see Part II, Item 8. “Financial Statements and Supplementary Data” of this Annual Report. +Seasonality +Our operations are subject to seasonal factors and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. Additionally, our operations are directly affected by weather conditions. During the winter months (first and fourth quarters) and periods of heavy snow, ice or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Lastly, throughout the year heavy rains adversely affect activity levels, as well locations and dirt access roads can become impassible in wet conditions. +Weather conditions also affect the demand for, and prices of, oil and natural gas and, as a result, demand for our services. Demand for oil and natural gas is typically higher in the fourth and first quarters, resulting in higher prices in these quarters. +5 +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location and economic viability. Direction of the sales team is conducted through weekly meetings and daily communication. The Completion Solutions and Production Solutions teams are led by the segment presidents. Our marketing activities are performed internally with input and guidance from a third party marketing agency. Our strategy is based on building a strong North American brand though multiple media outlets including our website, select social media accounts, print, billboard advertisements, press releases and various industry-specific conferences, publications and lectures. We have a technical sales organization with expertise and focus within their specific service line. We focus on organic growth through selling of services and marketing excellence through brand service quality, technology and metrics of success. We accomplish this through communication across sales and operations departments and regions to share best practices and leverage existing customer relationships. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2017, our top five customers collectively accounted for approximately 29% of our revenues. For the year ended December 31, 2017, no single customer accounted for 10% or more of our revenues. +Competition +We provide our services and products across the United States and Canada and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force competency, efficiency, safety record, reputation and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance and quality of crews, equipment and services, we believe we are equipped for continued growth and success in a competitive market. +Our major competitors for our completion solutions include Halliburton Company, Schlumberger Limited, Baker Hughes Incorporated, Weatherford International Ltd., C&J Energy Services, Inc. and a significant number of locally oriented businesses. Our major competitors for our production solutions include Pioneer Energy Services Corp., Key Energy Services, Inc., Basic Energy Services, Inc., Superior Energy Services, Inc. and a significant number of locally oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts and components that are manufactured and supplied for our operations from various suppliers. We are not dependent on any single supplier for those parts, supplies or materials. During the year ended December 31, 2017, one supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages and our results of operations, prospects and financial condition could be adversely affected. +6 +Research & Technology, Intellectual Property +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins. We have dedicated resources focused on the internal development of new technology and equipment, as well as resources focused on sourcing and commercializing new technologies through strategic partnerships. Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. +We have developed a suite of proprietary downhole tools, products and techniques through both internal resources, as well as strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. Examples of our technology includes: +• +Scorpion Fully-Composite Plug TM : Our patented packer-style fully-composite plug is designed to provide zonal isolation in a multi-stage well completion. We offer a diverse product group of fully-composite plugs for the use in 3.5” to 5.5” well casings used today, as well as a unique Scorpion Extended Range plug offering. Our Extended Range plugs are used in demanding well applications where operators have to negotiate tough mechanical casing internal diameter restrictions. With the Scorpion plug’s shorter length, nonmetallic casing anchor slips and robust engineered design, our plugs provide superior reliability and greatly reduced drill-out times. +• +Scorpion Dissolvable Plug: We developed and completed successful trials of our Scorpion Dissolvable Plug, a high performance plug designed to provide zonal isolation that is made entirely from proprietary materials that dissolve over time based on temperature and salinity. The Dissolvable plug has a large ID to assist immediate flowback, while ultimately leaving the wellbore unobstructed for production and eliminating the risk and costs of conventional plug removal. +• +SmartStart PLUS TM : We currently have exclusive distribution rights in the northeastern U.S. and with certain customers in other regions for the SmartStart frac valve. The SmartStart frac valve is an interventionless time-delayed pressure-activated frac sleeve that eliminates the need for tubing or pipe conveyed perforating when completing the toe stage of horizontal wells. The SmartStart frac valve is deployed on production string and allows operators to achieve a maximum casing pressure test and begin frac operations up to nine times faster, greatly cutting cost and reducing risk during toe stage completions. +• +Storm Re-Frac Packer TM : We currently have an exclusive North American arrangement to deploy the Storm Re-Frac Packer, a system that allows our customers to re-stimulate their existing wells using standard size plug-and-perf procedures to extend and enhance their production profiles with minimal flow restriction during stimulation. Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. +• +FlowGun TM : Our patented FlowGun technology is a stage one interventionless casing-conveyed perforating technology that eliminates the need to run wireline or coil tubing and requires no electronic detonation. This technology allows customers to perform a maximum pressure test, perforate stage one more efficiently with less risk and with no lateral length limitations. The FlowGun manages several downhole jobs with one tool and one crew, increasing efficiency with the entire process taking no more than one hour. +• +EON Ball Drop System: We have an exclusive North American arrangement to provide the EON Single Size Ball Drop Sleeve System. This completely interventionless completion tool system can be used in both cemented and non-cemented applications and utilizes a single-size ball to activate pinpoint frac sleeves run downhole on the well casing. This system enables operators to reduce their footprint and time on the well site creating efficiencies and reducing costs. +• +Coil Frac Sleeve System: We currently have an agreement to be the exclusive provider of a Coil Frac Sleeve System in the United States. This system utilizes coiled tubing to deploy a resettable frac packer which is used to open and isolate frac sleeves that have been installed as an integral part of the casing. This frac packer can also be used where no frac sleeves have been installed by abrasive cutting perforations in the casing. +7 +We strike strategic alliances with manufacturing and technology companies to be the exclusive distributor and service provider of downhole technology across a variety of basins in North America. In these partnerships, we ha ve exclusive rights to market and sell technology unavailable to any other service providers in the designated regions. With these partnerships, we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. +We currently hold seven U.S. and two Canadian patents and two pending U.S. and three pending Canadian patent applications relating to our Scorpion Fully-Composite Plug TM . We also have five U.S. patents, one Canadian patent, two pending U.S. and one pending Canadian patent application relating to our FlowGun TM completion tool. In addition, we have entered into strategic partnerships with respect to the SmartStart PLUS TM toe valve, QuickStart TM frac valve, Coil Frac Sleeve System, EON Ball Drop System, and the Storm TM , Force TM , Centurion TM completion product line for the frac and re-frac market. Although in the aggregate our patents, licenses and strategic partnerships are important to us, we do not regard any single patent, license or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service oriented culture and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +We believe we have become a “go-to” service provider for piloting new technologies across North America because of our service quality, execution at the wellsite and scale. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators. This also allows us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing R&D internally. Our internal resources are focused on evolving our existing proprietary tools to stay on trend and ensure quicker, lower completion and production costs for our customers. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills and hazardous materials spills. These conditions can cause: +• +personal injury or loss of life; +• +damage to, or destruction of property, the environment and wildlife; and +• +the suspension of our or our customers’ operations. +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs and insurability, and our relationship with customers, employees and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance, and could have other material adverse effects on our financial condition and results of operations. +8 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobi le and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our cu rrent arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our MSAs. We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire or blowout. +The summary of MSAs set forth above is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2017, we had 1,772 employees (all of which were full time). Of our total employees, 1,685 were in the United States and 87 were in Canada. We are not a party to any collective bargaining agreements. +Government Regulations and Environmental, Health and Safety Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state and local levels governing the release, disposal or discharge of materials into the environment, health and safety aspects of our operations, or otherwise relating to environmental protection. In addition, due to our operations in Canada, we are also subject to Canadian environment statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil and criminal penalties, imposition of remedial or corrective action requirements and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +The following is a summary of some of the existing laws, rules and regulations to which we are subject. +9 +Hazardous substances and waste handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain E&P related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If the EPA proposes rulemaking for revised oil and gas regulations, the Consent Decree requires that the EPA take final action following notice and comment rulemaking no later than July 15, 2021. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of its customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred, and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several, strict liability for the costs of cleaning up the hazardous substances that have been released into the environment, and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable state statutes requires maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities and citizens. The Federal Motor Carrier Safety Administration regulating and providing safety oversight of commercial motor vehicles, the EPA establishing requirements to protect human health and the environment, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishing requirements for the safe use and storage of explosives, and the federal Nuclear Regulatory Commission establishing requirements for the protection against ionizing radiation. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with these laws and regulations. +10 +Transportation safety and compliance +Operating a fleet in excess of 1,100 commercial motor vehicles, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for Interstate travel, and comparable state regulations for Intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, a new EPA and U.S. Army Corps of Engineers (the “Corps”) rule defining the scope of federal jurisdiction over wetlands and other waters became effective (the “Clean Water Rule”). The Clean Water Rule was previously stayed nationwide to determine whether federal district or appellate courts had jurisdiction to hear cases challenging the rule. The EPA and the Corps issued a proposed rulemaking in June 2017 to repeal the Clean Water Rule, and announced their intent to issue a new rule defining the Clean Water Act’s jurisdiction. Recently, in January 2018, the U.S. Supreme Court issued a decision finding that jurisdiction resides with the federal district courts to hear challenges to the Clean Water Rule; following which, the previously-filed district court cases have been allowed to proceed. Following the Supreme Court’s decision, the EPA and the Corps issued a final rule in January 2018 staying implementation of the 2015 rule for two years while the agencies reconsider the rule. Multiple states and environmental groups have challenged the stay. As a result, future implementation of the rule is uncertain at this time. To the extent the rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +The federal Clean Air Act (“CAA”), and comparable state laws, regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. These regulations change frequently. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air permit requirements or utilize specific equipment or technologies to control emissions of certain pollutants. For example, in May 2016, the EPA finalized rules regarding criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, thereby triggering more stringent air permitting requirements. In addition, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”) for ozone from 75 to 70 parts per billion. In November 2017, the EPA published a list of areas that are in compliance with the new ozone standard and, separately in December 2017, issued responses to state recommendations for designating non-attainment areas. States have the opportunity to submit new air quality monitoring to the EPA prior to the EPA finalizing any non-attainment designations. The EPA intends to issue final attainment status designations during the first half of 2018. State implementation of the revised NAAQS could result in stricter permitting requirements, which in turn could delay or impair our or our +11 +customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrati ve, civil and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +The EPA has determined that emissions of greenhouse gases, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established greenhouse gas emission reporting requirements for sources in the oil and gas sector, and has also promulgated rules requiring certain large stationary sources of greenhouse gases to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to greenhouse gas emissions permitting and best available control technology requirements because none of our facilities are presently major sources of greenhouse gas emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition and results of operations. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and many states have already have established regional greenhouse gas “cap- and-trade” programs. The adoption of any legislation or regulation that restricts emissions of greenhouse gases from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, some scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, over the past year the EPA has taken several steps to delay implementation of its methane standards, and the agency proposed a rulemaking in June 2017 to stay the requirements for a period of two years and revisit implementation of the 2016 methane standards in their entirety. The EPA has not yet published a final rule but, as a result of these developments, future implementation of the 2016 standards is uncertain at this time. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. The U.S. Bureau of Land Management (“BLM”) previously finalized similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but proposed to repeal those standards in February 2018. Several states have announced their intent to file judicial challenges against any attempt to repeal the BLM methane rules. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remain a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. In addition, the BLM had previously issued final rules in March 2015 imposing stringent standards for performing hydraulic fracturing on federal and Native American lands; however, the agency finalized a separate rulemaking in December 2017 repealing its hydraulic fracturing rules. Several states and environmental groups have challenged the repeal in federal court. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +12 +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For e xample, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking wate r resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturi ng in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various s tate, federal, and local laws. +Some states, counties and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce our business by making it more difficult or costly for their customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition and results of operations. +Item 1A. +Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition or future results. If any of these risks were actually to occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline and you could lose all or part of your investment. +Risks Related to our Business and our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry in North America, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• +the level of prices, and expectations about future prices, for oil and natural gas; +• +the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• +the level of global and domestic oil and natural gas production; +• +the supply of and demand for hydraulic fracturing and other oilfield services and equipment in North America; +13 +• +governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• +the cost of exploring for, developing, producing and delivering oil and natural gas; +• +available pipeline, storage and other transportation capacity; +• +worldwide political, military and economic conditions; +• +lead times associated with acquiring equipment and products and availability of qualified personnel; +• +the discovery rates of new oil and natural gas reserves; +• +federal, state and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• +economic and political conditions in oil and natural gas producing countries; +• +actions of the Organization of the Petroleum Exporting Countries, its members and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• +advances in exploration, development and production technologies or in technologies affecting energy consumption; +• +activities by non-governmental organizations to restrict the exploration, development and production of oil and natural gas so as to minimize emissions of carbon dioxide, a greenhouse gas; +• +the price and availability of alternative fuels and energy sources; +• +global weather conditions and natural disasters; and +• +uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +A decline in oil and natural gas commodity prices may adversely affect the demand for our services and the rates we are able to charge. +The demand for our services and the rates we are able to charge are primarily influenced by current and anticipated oil and natural gas commodity prices and the related level of capital spending and drilling and completion activity in the areas in which we have operations. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. For example, between the third quarter of 2014 and the first quarter of 2016, oil and natural gas commodity prices declined significantly, which resulted in most of our customers reducing their exploration, development and production activities, which in turn resulted in a reduction in the demand for our services, as well as the rates we were able to charge and the utilization of our assets, during this period as compared to levels in mid-2014. Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +14 +Historically, oil and natural gas commodity prices have been extremely volatile. During the past six years, the posted price for West Texas Intermediate oil has ranged from a low of $26.19 per Bbl in February 2016 to a high of $113.39 per Bbl in April 2011, and the Henry Hub spot market price of gas has ranged from a low of $1.49 per MMBtu in March 2016 to a high of $7.51 per MMBtu in January 2010. Oil and natural gas commodity prices are expected to continue to be volatile. For example, in 2017, oil prices increased to a high of $60.46 in December 2017, following a low of $4 2.48 in June 2017. This environment could cause prices to remain at current levels or fall to lower levels. If the prices of oil and natural gas reverse their recent increases, our business, financial condition, results of operations, cash flows and prospe cts may be materially and adversely affected. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry. +A prolonged economic slowdown or recession in North America, adverse events relating to the energy industry or regional, national and global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas and decreased prices for oil and natural gas. +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work. Our ability to be profitable and productive will depend upon our ability to employ and retain skilled workers. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. In addition, the shortage of fixed housing and the lack of employee housing in certain areas where we operate could make it difficult for us to attract and retain quality, long-term personnel. The right-sizing of our and our competitors’ labor force over the recent sustained period of commodity price declines, as well as a significant decrease in the wages paid by us or our competitors as a result of reduced industry demand, has resulted in a reduction of the available skilled labor force to service the energy industry, and there is no assurance that the availability of skilled labor will improve following a subsequent increase in demand for our services or an increase in wage rates. If any of these events were to occur, our capacity and profitability could be diminished and our growth potential could be impaired. +We may be unable to implement price increases or maintain existing prices on our services. +We periodically seek to increase the prices on our services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising, or maintaining, our existing prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset such rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations and cash flows. +15 +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption and damage to, or destruction of, property, equipment and the environment. Such risks may include, but are not limited to: +• +equipment defects; +• +liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• +explosions and uncontrollable flows of gas or well fluids; +• +unusual or unexpected geological formations or pressures and industrial accidents; +• +blowouts; +• +fires; +• +cratering; +• +loss of well control; +• +collapse of the borehole; and +• +damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our completion and production services could become a source of spills or releases of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages and could result in a variety of claims, losses and remedial obligations that could have an adverse effect on our business and results of operations. For example, on August 31, 2017, an incident occurred at a wellsite operated by Pioneer Natural Resources resulting in the death of an employee of one of our subsidiaries. The subsidiary is a defendant in a lawsuit related to this incident. The existence, frequency and severity of such incidents could affect operating costs, insurability and relationships with customers, employees and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose customers and substantial revenue, and any litigation or claims, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +Historically, we have experienced periods of low demand for our services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur further operating losses and experience negative operating cash flow. +16 +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +We made term loan borrowings of $125 million under our credit facility concurrently with the consummation of our initial public offering (our “IPO”). The operating and financial restrictions and covenants in our credit facility and any future financing agreements could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our credit facility restricts or limits our ability to: +• +pay dividends and move cash; +• +grant liens; +• +incur additional indebtedness; +• +engage in a merger, consolidation or dissolution; +• +enter into transactions with affiliates; +• +sell or otherwise dispose of assets, businesses and operations; +• +materially alter the character of our business as conducted at the closing of our IPO; and +• +make acquisitions and investments. +Furthermore, our credit facility contains certain other operating covenants. Our ability to comply with the covenants and restrictions contained in our credit facility, and, as of the end of each quarter, compliance with a leverage ratio, an asset coverage ratio and a fixed charge coverage ratio, may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. Any violation of the restrictions, covenants, or ratio tests in our credit facility could result in an event of default, which may cause a significant portion of our indebtedness becoming immediately due and payable, and our lenders’ commitment to provide further loans to us may terminate. We might not have, or be able to obtain, sufficient funds to make these accelerated payments. Any subsequent replacement of our credit facility or any new indebtedness could have similar or greater restrictions. For more information about our credit facility, please read “Management’s discussion and analysis of financial condition and results of operations—Our credit facilities—Our credit facility.” +We may incur additional indebtedness or issue additional equity securities to execute our long-term growth strategy, which may reduce our profitability or result in significant dilution to our stockholders. +We may require additional capital in the future to develop and execute our long-term growth strategy. For the years ended December 31, 2016 and 2017, we incurred approximately $9.1 million and $45.2 million, respectively, in capital expenditures and our capital expenditure budget for 2018, excluding possible acquisitions, is expected to be between $53 million and $57 million. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors including expected industry activity levels and company initiatives. We believe the net proceeds from our IPO and borrowings under our credit facility, together with cash flows from operations, should be sufficient to fund our capital requirements for the next twelve months. If we incur additional indebtedness or issue additional equity securities, our profitability may be reduced and our stockholders may experience significant dilution. +We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under applicable debt instruments, which may not be successful. +Our ability to make scheduled payments on or to refinance our indebtedness obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. For example, as of December 31, 2017, we had $119.9 million of debt outstanding under the Former Nine Credit Facility and $122.3 million of debt outstanding under the Former Beckman Credit Facility. As of +17 +December 31, 2016, we had $120. 6 million of debt outstanding under the Former Nine Credit Facility that was then scheduled to mature on January 1, 2018, which was within twelve months of the date of the issuance of our audited financial statements and thereby resulted in a “going concer n” paragraph being included in our independent registered public accounting firm’s audit report. Delivery of audited financial statements including a going concern qualification would result in an event of default under the Former Nine Credit Facility abse nt an amendment or waiver. On March 23, 2017, we received the requisite waiver from the lenders under the Former Nine Credit Facility with respect to this potential event of default. On August 2, 2017, we also entered into an amendment to the Former Nine C redit Facility, which extended the maturity to May 31, 2018. We repaid the Former Nine Credit Facility and the Former Beckman Credit Facility in full with a portion of the proceeds from our IPO and $125 million of term loan borrowings under our new credit facility. However, our ability to satisfy our liquidity requirements going forward will depend on our future operating performance, which is affected by prevailing economic and competitive conditions, the level of drilling and completions activities in the North American E&P industry, and financial, business and other factors, many of which are beyond our control. +If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to reduce or delay investments and capital expenditures, sell assets, seek additional capital or restructure or refinance indebtedness. Our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. In the absence of sufficient cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet debt service and other obligations. We may not be able to consummate those dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of services. Some of our competitors may also be able to devote greater resources to the research and development, promotion and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +18 +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the recent industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services. Any significant future increase in overall market capacity for completion and production services may adversely affect our business, financial condition and results of operations. +Fuel conservation measures may reduce oil and natural gas demand. +Fuel conservation measures, alternative fuel requirements and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, results of operations, cash flows and prospects. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells and biofuels) could reduce demand for hydrocarbons and therefore for our services, which would lead to a reduction in our revenues. +Our success may be affected by our ability to implement new technologies and services. Additionally, we rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +Our success may be affected by the ongoing development and implementation of new product designs, methods and improvements, and our ability to protect, obtain and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide services to our customers. Though other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense and delay. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result or termination of our manufacturing relationships, could have a material adverse effect on our financial condition, business and results of operations. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing and marketing resources to research and development of new systems, services and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of such proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements and other +19 +protective measures to protect intellectual property rights per taining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may e nter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how or other intellectual property in the event of any unauthorized use, misappropriation or disclosure. We cannot assure you that competitors will not infringe upon, misappropriate, violate or challenge our intellectual property rights in the future. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution proceedings, a defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute or otherwise violate another party’s intellectual property rights. We may not prevail in any such dispute resolution proceedings, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute or otherwise violate the intellectual property rights of others. The results or costs of any such dispute resolution proceedings may have an adverse effect on our business, operating results and financial condition. Any dispute resolution proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable and could have an adverse effect on our business, regardless of its outcome. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects and/or results of operations. In the course of our business we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our services. +20 +Our assets require capital for maintenance, upgrades and refurbishment, and we may require capital expenditu res for new equipment. +Our equipment requires capital investment in maintenance, upgrades and refurbishment to maintain their competitiveness. For the years ended December 31, 2016 and 2017, we spent approximately $3.8 million and $9.6 million, respectively, on capital expenditures related to maintenance. Our equipment typically does not generate revenue while it is undergoing maintenance, refurbishment or upgrades. Any maintenance, upgrade or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects and results of operations and may increase costs. +We may record losses or impairment charges related to idle assets or assets that we sell. +Prolonged periods of low utilization, changes in technology or the sale of assets below their carrying value may cause us to experience losses. These events could result in the recognition of impairment charges that increase our net loss. In 2015, we recognized $35.5 million of goodwill impairment charges for two operating units. In 2016, we recognized $12.2 million of goodwill impairment in one of our operating units due to persistent low completions activity in the market where the unit operates. In 2017, we recognized $31.5 million of goodwill impairment and $3.8 million of impairment to intangible assets in one of our operating units, due to a general decline in activity coupled with a methodology transition from open hole to cemented completions. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our results of operations in future periods. +Competition among oilfield service and equipment providers is affected by each provider’s reputation for safety and quality. +Our activities are subject to a wide range of national, state and local occupational health and safety laws and regulations. In addition, customers maintain their own compliance and reporting requirements. Failure to comply with these health and safety laws and regulations, or failure to comply with our customers’ compliance or reporting requirements, could tarnish our reputation for safety and quality and have a material adverse effect on our competitive position. +Seasonal and adverse weather conditions adversely affect demand for services and operations. +Weather can have a significant impact on demand as consumption of energy is seasonal, and any variation from normal weather patterns, cooler or warmer summers and winters, can have a significant impact on demand. Adverse weather conditions, such as hurricanes, tropical storms and severe cold weather, may interrupt or curtail operations, or customers’ operations, cause supply disruptions and result in a loss of revenue and damage to our equipment and facilities, which may or may not be insured. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. Additionally, our operations are directly affected by weather conditions. During the winter months (first and fourth quarters) and periods of heavy snow, ice or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For the years ended December 31, 2016 and 2017, we generated approximately 4.4% and 4.0%, respectively, of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels, as well locations and dirt access roads can become impassible in wet conditions. +21 +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects and results of operations. +The growth of our business through acquisitions may expose us to various risks, including those relating to difficulties in identifying suitable, accretive acquisition opportunities and integrating businesses, assets and personnel, as well as difficulties in obtaining financing for targeted acquisitions and the potential for increased leverage or debt service requirements. +As a component of our business strategy, we have pursued and intend to continue to pursue selected, accretive acquisitions of complementary assets, businesses and technologies. Acquisitions involve numerous risks, including: +• +unanticipated costs and assumption of liabilities and exposure to unforeseen liabilities of acquired businesses, including, but not limited to, environmental liabilities; +• +difficulties in integrating the operations and assets of the acquired business and the acquired personnel; +• +limitations on our ability to properly assess and maintain an effective internal control environment over an acquired business, in order to comply with public reporting requirements; +• +potential losses of key employees and customers of the acquired businesses; +• +inability to commercially develop acquired technologies; +• +risks of entering markets in which we have limited prior experience; and +• +increases in our expenses and working capital requirements. +The process of integrating an acquired business may involve unforeseen costs and delays or other operational, technical and financial difficulties and may require a disproportionate amount of management attention and financial and other resources. Our failure to achieve consolidation savings, to incorporate the acquired businesses and assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our financial condition and results of operations. Furthermore, there is intense competition for acquisition opportunities in our industry. Competition for acquisitions may increase the cost of, or cause us to refrain from, completing acquisitions. +In addition to potential future acquisitions, the ongoing integration of our business in connection with the Combination present a number of risks that could affect our results of operations. In particular, integrating the businesses from the Combination is difficult and involves a number of special risks, including the diversion of management’s attention to the assimilation of the operations, the unpredictability of costs related to the Combination and the difficulty of integration of the businesses, products, services, technology and employees. The ability to achieve the anticipated benefits of the Combination will depend, in part, upon whether the integration of the various businesses, products, services, technology and employees is accomplished in an efficient and effective manner, and there can be no assurance that this will occur. +22 +Furthermore, we may not have sufficient capital resources to complete additional acquisitions. Historically, we have financed acquisitions primarily with funding from our equity investors, cash generated by operations and borrowings under debt facilities. We may incur substantial indebtedness to finance future acquisitions and also may issue equity, debt or convertible securities in connection with such acquisitions. Debt service requirements could represent a significant burden on our results o f operations and financial condition and the issuance of additional equity or convertible securities could be dilutive to our existing stockholders. Furthermore, we may not be able to obtain additional financing on satisfactory terms. Even if we have acces s to the necessary capital, we may be unable to continue to identify additional suitable acquisition opportunities, negotiate acceptable terms or successfully acquire identified targets. +Our ability to grow through acquisitions and manage growth will require us to continue to invest in operational, financial and management information systems and to attract, retain, motivate and effectively manage our employees. The inability to effectively manage the integration of acquisitions could reduce our focus on current operations and subsequent acquisitions, which, in turn, could negatively impact our earnings and growth. Our financial position and results of operations may fluctuate significantly from period to period, based on whether or not significant acquisitions are completed in particular periods. +We are subject to federal, state and local laws and regulations regarding issues of health, safety and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, greenhouse gasses, nonattainment areas, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills onto or into surface or subsurface soils, surface water or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects and results of operations. Additionally, an increase in regulatory requirements, limitations, restrictions or moratoria on oil and natural gas exploration and completion activities at a federal, state or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the EPA, the U.S. Department of Transportation (the “DOT”), U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA and state regulatory agencies that regulate operations to prevent air, soil and water pollution. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects or financial condition. +23 +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the federal Clean Air Act’s (“CAA”) Tier 4 emission standards. The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regu lations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, over the past year the EPA has taken several steps to delay implementation of its methane standards, and the agency proposed a rulemaking in June 2017 to stay the requirements for a period of two years and revisit implementation of the 2016 methane standards in their entirety. The EPA has not yet published a final rule but, as a result of these developments, future implementation of the 2016 standards is uncertain at this time. Various industry and environmental groups have separately challenged both the original standards and EPA’s attempts to delay implementation of the rule. The BLM previously finalized similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but proposed to repeal those standards in February 2018. Several states have announced their intent to file judicial challenges against any attempt to repeal the BLM methane rules. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remain a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. In addition, the BLM had previously issued final rules in March 2015 imposing stringent standards for performing hydraulic fracturing on federal and Native American lands; however, the agency finalized a separate rulemaking in December 2017 repealing its hydraulic fracturing rules. Several states and environmental groups have challenged the repeal in federal court. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal and local laws. +24 +Some states, counties and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordina nces, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturin g are adopted, such laws could reduce our business by making it more difficult or costly for their customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs an d process prohibitions, which could have an adverse effect on our business, financial condition and results of operations. +Existing or future laws and regulations related to greenhouse gases and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture and use of greenhouse gasses that could have a material adverse effect on our business, results of operations, prospects and financial condition. +Changes in environmental requirements related to greenhouse gas emissions and climate change may negatively impact demand for our services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns. Federal, state and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of greenhouse gases in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to greenhouse gases and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration and use of greenhouse gasses that could have a material adverse effect on our business, results of operations, prospects and financial condition. Finally, some scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Studies by both state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our services and have a material adverse effect on our business. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment or the environment or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +25 +We maintain what we believe is customary and reasonable insurance to protect our business against m ost potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material unins ured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Federal Labor Standards Act, in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation. The frequency and significance of wage- or other employment-related claims may affect expenses, costs and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects or results of operations. +Our operations are subject to cyber security risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cyber security risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, or customer data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cyber security attacks. These risks could have a material adverse effect on our business, financial condition and result of operations. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license, and effective December 2017, the Federal Motor Carrier Safety Administration has mandated electronic logging devices in all interstate commercial trucks. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency and greenhouse gas emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, +26 +including routing and weight restrictions, c ould be affected by road construction, road repairs, detours and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regul atory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects and results of operations. +Our customers are engaged in the oil and natural gas E&P business in North America, which has been historically volatile. For the year ended December 31, 2017, our five largest customers, collectively accounted for approximately 29% of total revenues, and no single customer accounted for 10% or more of our revenue. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations and prospects. +Our executive officers and certain key personnel are critical to our business and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the President of our Completion Solutions segment, David Crombie. These individuals possess extensive expertise, talent and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future. This may impact our ability to successfully integrate or operate the assets we acquire. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the United States or other countries, anti-terrorist efforts and other armed conflicts involving the United States or other countries, including continued hostilities in the Middle East, may adversely affect the United States and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors or disruptions of fuel supplies and markets if wells, operations sites or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital or otherwise adversely impact our ability to realize certain business strategies. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking +27 +operations. The requ irements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued and the conditions which may be imposed in connection with the granting of the permit. In Texas, rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribe s to conduct such drilling and completion activities. Permitting, authorization or renewal delays, the inability to obtain new permits or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on ou r business, financial condition, prospects or results of operations. +Our Canadian operations subject us to currency translation risk, which could cause our results to fluctuate significantly from period to period. +A portion of our revenues are derived from our Canadian activities and operations. As a result, we translate the results of our operations and financial condition of our Canadian operations into U.S. dollars. Therefore, our reported results of operations and financial condition are subject to changes in the exchange rate between the two currencies. Fluctuations in foreign currency exchange rates could affect our revenue, expenses and operating margins. Currently, we do not hedge our exposure to changes in foreign exchange rates. +Risks Related to our Common Stock +SCF controls a significant percentage of our voting power. +SCF owns approximately 38% of our outstanding common stock. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents and approval of acquisition offers and other significant corporate transactions. This concentration of ownership will limit your ability to influence corporate matters, and as a result, actions may be taken that you may not view as beneficial. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with a controlling stockholder. +Certain of our directors may have conflicts of interest because they are also directors or officers of SCF. The resolution of these conflicts of interest may not be in our or your best interests. +Certain of our directors, namely David C. Baldwin and Andrew L. Waite, are currently officers of L.E. Simmons & Associates, Incorporated, a Delaware corporation (“LESA”), SCF’s ultimate general partner. In addition, Mr. Baldwin and Mr. Waite are both directors of Forum Energy Technology, a corporation in which SCF and its affiliates own an approximate 21% equity interest as of December 31, 2017. These positions may conflict with such individuals’ duties as one of our directors or officers regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in the best interest of the Company or its stockholders. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates and its portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our +28 +charter further provides that no such person or party shall be liable to us b y reason of the fact that such person pursues any such business opportunity, or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or other wise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approv ed by the holders of at least 80% of the voting power of the outstanding stock of the corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. +The requirements of being a public company, including compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the requirements of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the New York Stock Exchange (“NYSE”), may strain our resources, increase our costs and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner. +As a newly public company, we need to comply with new laws, regulations and requirements, certain corporate governance provisions of the Sarbanes-Oxley Act, related regulations of the Securities and Exchange Commission (the “SEC”) and the requirements of the NYSE, with which we are not required to comply as a private company. We are currently evaluating these rules, regulations and requirements, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. +Complying with these statutes, regulations and requirements will occupy a significant amount of time of our board of directors and management and will significantly increase our costs and expenses. Among other things, we will need to: +• +institute a more comprehensive compliance function; +• +comply with rules promulgated by the NYSE; +• +continue to prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws; +• +establish new internal policies, such as those relating to insider trading; +• +involve and retain to a greater degree outside counsel and accountants in the above activities; and +• +implement an internal audit function. +In addition, beginning with our annual report on Form 10-K for the fiscal year ending December 31, 2018, we will be required to comply with certain provisions of Section 404 of the Sarbanes-Oxley Act that requires that we document and test our internal control over financial reporting and issue management’s assessment of our internal control over financial reporting in such annual report. Section 404 of the Sarbanes-Oxley Act also requires that our independent registered public accounting firm opine on those internal controls upon becoming a large accelerated filer, as defined in the SEC rules, or otherwise ceasing to qualify as an emerging growth company under the JOBS Act. We are evaluating our existing controls against the standards adopted by the Committee of Sponsoring Organizations of the Treadway Commission. During the course of our ongoing evaluation and integration of the internal control over financial reporting, we may identify areas requiring improvement, and we may have to design enhanced processes and controls to address issues and prevent fraud identified through this review. For example, we anticipate the need to hire additional administrative and accounting personnel to conduct our financial reporting. We cannot be certain at this time that we will be able to successfully complete the procedures, certification and attestation requirements of Section 404. +29 +Moreover, we e xpect that being a public company subject to these rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur su bstantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. +We have identified material weaknesses in our internal control over financial reporting, with regard to the reporting of income tax expense (benefit), related balance sheet accounts and other comprehensive income and also with regard to segregation of certain accounting duties. We may identify additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to meet our reporting obligations. +In connection with a review of our financial statements for the three months ended March 31, 2017, we identified a material weakness in our internal control over the reporting of income tax expense (benefit), the related balance sheet accounts and other comprehensive income. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +During the first quarter of 2017, we hired a tax professional as our tax director, who performed a detailed review of our deferred taxes and our tax provision and identified certain immaterial errors in our income tax expense (benefit) and deferred tax balance for the years ended December 31, 2016 and 2015. Upon review of our internal controls in connection with the identification of these errors, we determined that we did not design and maintain an effective control environment with formal accounting policies and controls, and with trained professionals with an appropriate level of income tax knowledge and experience, to properly analyze, record and disclose the accounting matters commensurate with our financial reporting requirements related to income taxes. Specifically, we did not have controls designed to address the accuracy of income tax expense (benefit) and related combined balance sheet accounts, including deferred income taxes, as well as adequate procedures and controls to review the work of external experts engaged to assist in income tax matters or to monitor the presentation and disclosure of income taxes. +This material weakness resulted in the need to correct misstatements in our combined financial statements as of and for the years ended December 31, 2016 and 2015 prior to their issuance. The misstatements were not material to either 2016 or 2015. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +As described above, during the first quarter of 2017, we hired a tax professional as our tax director, who identified the misstatements described above and will be responsible for performing a detailed review of our deferred taxes and our annual and quarterly tax provision for all future periods. Further, we have implemented additional review procedures within the accounting and finance department. These actions are subject to ongoing management review and the oversight of our board of directors. +In addition, in connection with the preparation of our financial statements for the nine months ended September 30, 2017, we identified a material weakness in our internal control over financial reporting, specifically as it related to segregation of certain accounting duties stemming from our decentralized accounting structure and limited number of accounting personnel. We did not design and maintain adequate controls to address segregation of certain accounting duties related to journal entries, account reconciliations and other accounting functions. Certain accounting personnel have the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy and completeness. Immaterial misstatements have been identified related to the inadequate segregation of accounting duties. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +30 +We have begun to remediate and plan to further remediate this material weakness r elating to segregation of certain accounting duties. We have replaced the less sophisticated accounting systems used by our newly-acquired subsidiaries with the enterprise resource planning system used by the majority of our subsidiaries. Also, we are work ing with third party consultants to identify internal control risks and implement remedies. These actions are subject to ongoing management review and the oversight of our board of directors. +The material weaknesses described above or any newly identified material weakness could limit our ability to prevent or detect a misstatement of our accounts or disclosures that could result in a material misstatement of our annual or interim financial statements. We cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to remediate the control deficiencies that led to the material weaknesses in our internal control over financial reporting described above or to avoid potential future material weaknesses. In addition, neither our management nor an independent registered public accounting firm has ever performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act because no such evaluation has been required. Had we or our independent registered public accounting firm performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act, additional material weaknesses may have been identified. +Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. If we are unable to successfully remediate our existing or any future material weakness in our internal control over financial reporting, or identify any additional material weaknesses that may exist, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, we may be unable to prevent fraud, investors may lose confidence in our financial reporting, and our stock price may decline as a result. Additionally, our reporting obligations as a public company could place a significant strain on our management, operational and financial resources and systems for the foreseeable future and may cause us to fail to timely achieve and maintain the adequacy of our internal control over financial reporting. +If securities or industry analysts do not publish research reports or publish unfavorable research about our business, the price and trading volume of our common stock could decline. +The trading market for our common stock depends in part on the research reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our securities, the price of our securities would likely decline. If one or more of these analysts ceases to cover us or fails to publish regular reports on us, interest in the purchase of our securities could decrease, which could cause the price of our common stock and other securities and their trading volume to decline. +Our charter and bylaws contain provisions that could delay, discourage or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our +31 +stockholders’ ability to obtain a favorable judicial fo rum for disputes with us or our directors, officers, employees or agents. +Our charter provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our charter described in the preceding sentence. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations. +We do not intend to pay dividends on our common stock, and we expect that our debt agreements will place certain restrictions on our ability to do so. Consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our credit facility places certain restrictions on our ability to pay cash dividends. Consequently, unless we revise our dividend policy, your only opportunity to achieve a return on your investment in us will be if you sell your common stock at a price greater than you paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which you purchased your shares of common stock. +Future sales of our common stock in the public market could reduce our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us. +We may sell additional shares of common stock in subsequent public offerings. We may also issue additional shares of common stock or convertible securities. We have 23,873,583 shares of our common stock outstanding (all shares reflect the 8.0256 for 1 stock split that took place in connection with the IPO in January 2018 – Note 2) and SCF-VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) own 9,086,888 shares of our common stock or approximately 38% of our total outstanding shares, all of which are restricted from immediate resale under the federal securities laws and are subject to lock-up agreements with the underwriters in our IPO but may be sold into the market in the future. SCF and certain of our other stockholders are parties to the Amended Stockholders Agreement (as defined and described in Item 13. “Certain Relationships and Related Transactions, and Director Independence—Transactions with our Significant Stockholders and our Directors and Executive Officers—Stockholders Agreement”), which will require us to effect the registration of their shares in certain circumstances no earlier than the expiration of the lock-up period contained in the underwriting agreement entered into in connection with our IPO. Additionally, 7,097,491 shares held by our employees and others will be eligible for sale at various times and subject to a 180 day lock-up agreement contained in the Existing Stockholders Agreement, including shares eligible for sale upon exercise of vested options. +In connection with our IPO, we filed a registration statement with the SEC on Form S-8 providing for the registration of shares of our common stock issued or reserved for issuance under our equity incentive plan. Subject to the satisfaction of vesting conditions, the expiration of lock-up agreements and the requirements of Rule 144, shares registered under the registration statement on Form S-8 will be available for resale immediately in the public market without restriction. +We cannot predict the size of future issuances of our common stock or securities convertible into common stock or the effect, if any, that future issuances and sales of shares of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares issued in connection with +32 +an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices of our common stock. +The underwriters of our IPO may waive or release parties to the lock-up agreements entered into in connection with our IPO, which could adversely affect the price of our common stock. +In connection with our IPO, we, all of our directors and executive officers and SCF entered into lock-up agreements with respect to their common stock, pursuant to which they are subject to certain resale restrictions for a period of 180 days following the date of the underwriting agreement entered into in connection with our IPO. J.P. Morgan Securities LLC, Goldman Sachs & Co. LLC and Wells Fargo Securities, LLC may, at any time and without notice, release all or any portion of the common stock subject to the foregoing lock-up agreements. If the restrictions under the lock-up agreements are waived, then common stock will be available for sale into the public markets, which could cause the market price of our common stock to decline and impair our ability to raise capital. +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. Upon the expiration or earlier waiver of the lock-up restrictions on transfers or sales of our securities following the completion of our IPO, SCF will not be subject to any obligation to maintain its ownership interest in us and may elect at any time thereafter to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that are expected to serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies which could adversely affect our cash flows or results of operations. +Taking advantage of the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors. +We are an “emerging growth company” as defined in the JOBS Act. An emerging growth company may take advantage of certain reduced reporting and other requirements that are otherwise applicable generally to public companies. Pursuant to these reduced disclosure requirements, emerging growth companies are not required to, among other things, comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, provide certain disclosures regarding executive compensation, holding stockholder advisory votes on executive compensation or obtain stockholder approval of any golden parachute payments not previously approved. In addition, emerging growth companies have longer phase-in periods for the adoption of new or revised financial accounting. We would cease to be an emerging growth company if we have more than $1.07 billion in annual revenue, have more than $700 million in market value of our common stock held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period. +We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards under Section 107 of the JOBS Act, until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our common stock price may be more volatile. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. +We may not be able to utilize a portion of our net operating loss carryforwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2017, the Company had federal and state income tax NOLs of approximately $168.1 million, which will begin to expire between 2023 and 2033. Utilization of these NOLs depends on many factors, +33 +including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), gen erally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and h ighly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest owner ship percentage within a rolling three-year period. In the event that an ownership change has occurred—or were to occur—with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation unde r Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under cert ain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL general ly may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in our IPO, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382 and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +Item 1B. +Unresolved Staff Comments +None. +Item 2. +Properties +The following table describes the material facilities owned or leased by us as of December 31, 2017. +Segment +Location +Basin/ Region +Leased or owned +Principal/most +significant use +Headquarters +Houston, TX +— +Leased +Corporate Headquarters / Administrative +Headquarters +Houston, TX +— +Leased +Corporate Headquarters / Administrative +Completion +Athens, TX +— +Leased +Operations +Completion +Baker, MT +Bakken +Owned +Operations/Administrative +Completion +Calgary, AB, Canada +— +Leased +Administrative +Completion +Cheyenne, WY +Rockies +Leased +Operations +Completion +Dickinson, ND +Bakken +Leased +Operations/Administrative +Completion +Enid, OK +SCOOP/STACK +Leased +Operations/Administrative +Completion +Fort St. John, BC, Canada +WCSB +Leased +Operations +Completion +Fort Worth, TX +— +Leased +Administrative +Completion +Grand Prairie, AB, Canada +WCSB +Leased +Operations +Completion +Hobbs, NM +Permian +Leased +Operations +Completion +Jacksboro, TX +Barnett +Leased +Operations +Completion +Kilgore, TX +Haynesville +Leased +Operations/Administrative +Completion +Marietta, OH +Marcellus/Utica +Leased +Operations +Completion +Midland, TX +Permian +Leased +Operations +Completion +Midland, TX +Permian +Owned +Operations/Administrative +Completion +Midland, TX +Permian +Leased +Administrative +Completion +Monahans, TX +Permian +Leased +Operations/Administrative +Completion +Pleasanton, TX +Eagle Ford +Leased +Operations +Completion +Poolville, TX +— +Owned +Operations +Completion +Red Deer, AB, Canada +WCSB +Leased +Operations +Completion +Shawnee, OK +SCOOP/STACK +Leased +Operations +Completion +Sweetwater, TX +Permian +Leased +Operations +34 +Completion +Ulster, PA +Marcellus/Utica +Leased +Operations +Completion +Washington, PA +Marcellus/Utica +Leased +Operations +Completion +Whitecourt, AB, Canada +WCSB +Leased +Operations +Completion +Williston, ND +Bakken +Owned +Operations +Completion +Williston, ND +Bakken +Owned +Operations/Administrative +Production +Big Lake, TX +Permian +Owned +Operations/Administrative +Production +Casper, WY +Rockies +Owned +Operations/Administrative +Production +Douglas, WY +Rockies +Owned +Operations/Administrative +Production +Edgerton, WY +Rockies +Owned +Operations/Administrative +Production +Gaylord, MI +Antrim +Owned +Operations +Production +Gillette, WY +Rockies +Leased +Operations/Administrative +Production +Harrison, MI +Antrim +Owned +Operations +Production +Hennessey, OK +SCOOP/STACK +Owned +Operations +Production +Kalkaska, MI +Antrim +Owned +Operations/Administrative +Production +Mesick, MI +Antrim +Owned +Operations +Production +Midland, TX +Permian +Owned +Operations/Administrative +Production +Powell, WY +Rockies +Owned +Operations/Administrative +Production +Thermopolis, WY +Rockies +Leased +Operations/Administrative +Production +Tioga, ND +Bakken +Leased +Operations +Production +Worland, WY +Rockies +Leased +Operations +Item 3. +Legal Proceedings +From time to time, we have various claims, lawsuits and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters and other matters. Although no assurance can be given with respect to the outcome of these and the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results or financial condition. +We have been named in the following proceeding: +Christina Sparks, et al v. Pioneer Natural Resources, et al., Filed in the District Court, 142nd Judicial District, Midland County, Texas. On August 31, 2017, an accident occurred while a five-employee crew of Big Lake Services, LLC, a subsidiary of Nine (“Big Lake Services”), was performing workover services at an oil and gas wellsite near Midland, Texas, operated by Pioneer Natural Resources, resulting in the death of a Big Lake Services employee, Juan De La Rosa. On December 7, 2017, a lawsuit was filed on behalf of Mr. De La Rosa’s minor children in the Midland County District Court against Pioneer Natural Resources, Big Lake Services, and Phillip Hamilton related to this accident. The petition alleges, among other things, that the defendants acted negligently, resulting in the death of Mr. De La Rosa. The plaintiffs are seeking money damages, including punitive damages. +We maintain insurance coverage against liability for, among other things, personal injury (including death), which coverage is subject to certain exclusions and deductibles. We tendered this matter to our insurance company for defense and indemnification of Big Lake Services and the other defendants. While we maintain such insurance policies with insurers in amounts and with coverage and deductibles that we, with the advice of our insurance advisors and brokers, believe are reasonable and prudent, we cannot assure you that this insurance will be adequate to protect us from all material expenses related to current or potential future claims for personal and property damage or that these levels of insurance will be available in the future at economical prices. +Item 4. +Mine Safety Disclosures +Not applicable. +35 +PART II +Item 5. +Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities +Market Information +In connection with our IPO, our common stock began trading on the NYSE under the symbol “NINE” on January 19, 2018. Prior to that, there was no public market for our common stock. As a result we have not set forth quarterly information with respect to the high and low prices for our common stock for the two most recent fiscal years. From January 19, 2018, our first day of trading on NYSE, to March 21, 2018, the high and low prices for our common stock were $29.00 and $22.23, respectively. +Holders +As of March 21, 2018, we had approximately 23,873,583 shares of common stock outstanding and 112 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements and investment opportunities. In addition, our credit facility places restrictions on our ability to pay cash dividends. +Securities Authorized for Issuance under Equity Compensation Plans +For disclosures regarding securities authorized for issuance under equity compensation plans, see Part III, Item 12. “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this report. +Recent Sales of Unregistered Securities +During the year ended December 31, 2017, we have issued unregistered securities to a limited number of persons, as described below. None of these transactions involved any underwriters, underwriting discounts or commissions or any public offering, and we believe that each of these transactions was exempt from the registration requirements pursuant to Section 4(a)(2) of the Securities Act, Regulation D or Regulation S promulgated thereunder or Rule 701 of the Securities Act. The recipients of these securities represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the share certificates and instruments issued in these transactions. +36 +The following table sets forth information on the restricted stock awards issued by us and common stock issued pursuant to the exercise of stock options during the year ended December 31, 2017. +Person or class of person +Date of issuance/ +option exercise +Total shares of +restricted stock +Common stock +issued pursuant +to options/warrants +exercises +Total consideration +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +4,807 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Director +March 20, 2017 +3,210 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +4,815 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +3,210 +* +Nine Employee +March 20, 2017 +6,412 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +9,622 +* +Nine Executive Officer +March 20, 2017 +5,609 +* +Nine Executive Officer +March 20, 2017 +8,017 +* +Former Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +802 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +6,412 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +6,412 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Director +March 20, 2017 +3,210 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Executive Officer +March 20, 2017 +80,256 +* +Nine Employee +March 20, 2017 +1,605 +* +Nine Employee +March 20, 2017 +3,210 +* +Nine Employee +March 20, 2017 +3,210 +* +Nine Director +March 20, 2017 +9,622 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Executive Officer +March 20, 2017 +22,447 +* +Nine Employee +March 20, 2017 +2,407 +* +Nine Employee +March 20, 2017 +2,568 +* +Nine Employee +March 20, 2017 +4,815 +* +Nine Employee +March 20, 2017 +2,568 +* +Nine Director +March 20, 2017 +3,210 +* +Nine Employee +March 20, 2017 +3,210 +* +Nine Executive Officer +March 31, 2017 +72,230 +* +* +No cash consideration was paid to us by any recipient of any restricted stock award. +37 +The following table sets forth information on the stock options issued by us during the year ended December 31, 2017. +Date of issuance +Number of +options granted +Grant date +exercise price +($/sh) +January 17, 2017 +13,242 +$ +22.63 +March 20, 2017 +260,583 +$ +31.18 +March 21, 2017 +101,323 +$ +31.18 +March 31, 2017 +96,307 +$ +31.18 +No cash consideration was paid to us by any recipient of any of the foregoing options for the grant of such options. All of the stock options described above issued prior to the completion of the Combination were granted under the Stock Plan, to the officers, employees and consultants of the Company. +Pursuant to a Subscription Agreement dated January 17, 2017, three Nine Employees subscribed to each purchase 4,414 shares of our common stock in exchange for cash payments of $99,891.00 each. +On January 31, 2017, we issued 24,157 shares of common stock to the former members of Pat Greenlee Builders, LLC as deferred consideration for the G8 Oil Tool Acquisition. +On February 28, 2017, we completed the Combination, through which Nine Energy Service, Inc. and Beckman Production Services, Inc. were combined. In the Combination, Nine Energy Service, Inc. was the surviving entity, all of the outstanding shares held by each of the former Beckman Production Services, Inc. shareholders in Beckman Production Services, Inc. were acquired in exchange for 5,371,293 of our shares. +In connection with the Combination and pursuant to subscription agreements dated March 10, 2017, we offered each of our stockholders (our existing stockholders and the Beckman stockholders) who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of our common stock worth $20 million in the aggregate, up to their pro-rata ownership of the Company in the Combined Nine Subscription Offer). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $20 million of shares of our common stock, the eligible purchasers that elected to participate in the Combined Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $20 million in the aggregate. In connection with Combined Nine Subscription Offer, 55 stockholders, including some of our executive officers and directors, subscribed to purchase 641,357 shares of our common stock in exchange for aggregate cash payments of approximately $20 million. The proceeds from the Combined Nine Subscription Offer were used to (i) to finance the purchase of non-accredited investors’ shares in the Combination and pay fees and expenses related to the Combination and (ii) for general corporate purposes, including ensuring compliance with our financial covenants under the Existing Nine Credit Facility. In connection with the Combined Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Combined Nine Subscription Offer, resulting in warrants issued to purchase an aggregate of 320,582 shares of our common stock. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated March 10, 2017, we offered each of our existing stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of our common stock worth $5 million in the aggregate, up to their pro-rata ownership of the Company (the “Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $5 million of shares of our common stock, the eligible purchasers that elected to participate in the Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $5 million in the aggregate. In connection with Nine Subscription Offer, 41 stockholders, including some of our executive officers and directors, subscribed to purchase 160,335 shares of our common stock in exchange for aggregate cash payments of approximately $5 million. The proceeds from the Nine Subscription Offer were retained by us to ensure compliance with our financial covenants under the Existing Nine Credit Facility. In connection with the Nine Subscription Offer, we issued to those +38 +stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every t wo shares purchased in the Nine Subscription Offer, resulting in warrants issued to purchase an aggregate of 80,095 shares of our common stock. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer and the Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated February 10, 2017, Beckman offered each of its stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of its common stock worth $15 million in the aggregate, up to their pro-rata ownership of Beckman (the “Beckman Subscription Offer” and with the Combined Nine Subscription Offer and the Nine Subscription Offer, the “Subscription Offers”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $15 million of shares of its common stock, the eligible purchasers that elected to participate in the Beckman Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of its common stock worth $15 million in the aggregate. In connection with Beckman Subscription Offer, 15 stockholders, including some of our executive officers and directors, subscribed to purchase 105,680 shares of Beckman common stock in exchange for aggregate cash payments of approximately $15 million (481,030 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock). The proceeds from the Beckman Subscription Offer were used to pay outstanding indebtedness under the Existing Beckman Credit Facility. In connection with the Beckman Subscription Offer, Beckman issued to those stockholders who purchased shares of its common stock a warrant to purchase additional shares of its common stock on the basis of one warrant share for every two shares purchased in the Beckman Subscription Offer, resulting in warrants issued to purchase an aggregate of 240,438 shares of our common stock based on the exchange ratio used with respect to the combination. Beckman shares of common stock issued in the Beckman Subscription Offer and warrants purchased in the Beckman Subscription Offer converted into shares and warrants of our common stock based on the exchange ratio used with respect to the Combination. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +Pursuant to a Subscription Agreement dated March 31, 2017, a former Company employee subscribed to purchase 32,102 shares of our common stock in exchange for a cash payment of approximately $1.0 million. +On July 25, 2017, we provided notice to all existing holders of the Company’s common stock that we were offering for sale up to approximately $20 million of the Company’s common stock at $18.69 per share to those stockholders who were accredited investors. We closed the July 2017 Subscription Offer on August 23, 2017. +Pursuant to the Employment Agreement dated November 20, 2017, as amended by the First Amendment thereto dated December 20, 2017, Clinton Roeder, the Senior Vice President and Chief Financial Officer of the Company, purchased $300,000 of our common stock on January 23, 2018, at the Fair Market Value (as defined in the Nine Energy Service, Inc. 2011 Stock Incentive Plan (the “Stock Plan”)). Pursuant to such Employment Agreement, the Company granted (i) options to purchase 4,000 shares of our common stock with an exercise price equal to the Fair Market Value (as defined in the Stock Plan) and (ii) $600,000 of shares of restricted stock at a price per share equal to the Fair Market Value (as defined in the Stock Plan), to Mr. Roeder under the Stock Plan. +Use of Proceeds from Registered Securities +In January 2018, we completed our IPO of 8,050,000 shares of common stock (including 1,050,000 shares pursuant to an over-allotment option) at a price to the public of $23.00 per share pursuant to our registration statement on Form S‑1 (File 333‑217601), as amended and declared effective by the SEC on January 18, 2018 (the “Registration Statement”). J.P. Morgan Securities LLC, Goldman Sachs & Co. LLC and Wells Fargo Securities, LLC acted as joint book-running managers and representatives of the underwriters in our IPO. +The aggregate gross proceeds of our IPO were $185.2 million. After subtracting underwriting discounts and commissions of $12.5 million and offering expenses of approximately $3.2 million, we received net proceeds of approximately $169.5 million. We used a portion of these net proceeds, together with $125.0 million of term loan borrowings under our credit facility, to fully repay the outstanding indebtedness under our former credit +39 +facilities. Further, our credit agreement required that we use a portion of the proceeds from the over-allotment option to make a prepayment of the term loan borrowings of $9.7 million. The remainder of the net proceeds were used for general corporate purposes. No payments, fees or expenses have been paid, directly or indirectly, to any of our officers, directors or their asso ciates, holders of 10% or more of any class of our equity securities or other affiliates. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +Item 6. +Selected Financial Data +This section presents our selected consolidated financial data for the periods and as of the dates indicated. The financial data set forth below, as well as our audited financial statements and related notes give effect to the Combination and represent the consolidated results of Nine and Beckman and their respective subsidiaries. The selected historical consolidated financial data presented below is not intended to replace our historical consolidated financial statements. The following selected consolidated financial data should be read in conjunction with both Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 8. “Financial Statements and Supplementary Data” of this Annual Report in order to fully understand those factors which may affect the comparability of the information presented below. +40 +Year ended December 31, +2017 +2016 +2015 +(in thousands, except share +and per share information) +Statement of operations data: +Revenues +$ +543,660 +$ +282,354 +$ +478,522 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown +separately below) +448,467 +246,109 +373,191 +General and administrative expenses +49,552 +39,387 +42,862 +Depreciation +53,422 +55,260 +58,894 +Impairment of goodwill +31,530 +12,207 +35,540 +Impairment of intangibles +3,800 +— +— +Amortization of intangibles +8,799 +9,083 +8,650 +Loss on equity method investment +368 +— +— +Loss on sale of property and equipment +4,688 +3,320 +2,004 +Loss from operations +(56,966 +) +(83,012 +) +(42,619 +) +Other expense +Interest expense +15,703 +14,185 +9,886 +Total other expense +15,703 +14,185 +9,886 +Loss from continuing operations before income taxes +(72,669 +) +(97,197 +) +(52,505 +) +Benefit for income taxes +(4,987 +) +(26,286 +) +(14,323 +) +Loss from continuing operations, net of tax +(67,682 +) +(70,911 +) +(38,182 +) +Loss from discontinued operations, net of tax of $0, $0 and $513 +— +— +(935 +) +Net loss +(67,682 +) +(70,911 +) +(39,117 +) +Other comprehensive income, net of tax +Foreign currency translation adjustments, net of tax of $0, $0, and $0 +(198 +) +210 +(4,067 +) +Total other comprehensive income (loss), net of tax +(198 +) +210 +(4,067 +) +Total comprehensive loss +$ +(67,880 +) +$ +(70,701 +) +$ +(43,184 +) +Historical earnings per share data: +Weighted average shares outstanding—basic +14,887,006 +13,268,540 +13,193,380 +Loss from continuing operations per share—basic +$ +(4.55 +) +$ +(5.34 +) +$ +(2.89 +) +Loss from discontinued operations per share—basic +$ +- +$ +- +$ +(0.07 +) +Loss per share—basic +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +Weighted average shares outstanding—fully diluted +14,887,006 +13,268,540 +13,193,380 +Loss from continuing operations per share— fully diluted +$ +(4.55 +) +$ +(5.34 +) +$ +(2.89 +) +Loss from discontinued operations per share—fully diluted +$ +- +$ +- +$ +(0.07 +) +Loss per share—fully diluted +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +Balance sheet data at period end: +Cash and cash equivalents +$ +17,513 +$ +4,074 +$ +18,877 +Property and equipment, net +259,039 +273,210 +325,894 +Total assets +578,859 +576,094 +658,434 +Long-term debt +241,509 +244,262 +249,641 +Total stockholders’ equity +287,358 +288,186 +352,676 +Statement of Cash Flows data: +Net cash (used in) provided by operating activities +$ +5,671 +$ +(3,290 +) +$ +140,367 +Net cash used in investing activities +(44,464 +) +(4,176 +) +(19,251 +) +Net cash (used in) provided by financing activities +52,342 +(7,315 +) +(126,878 +) +All shares and per share data reflect the 8.0256 for 1 stock split that took place in January 2018. +41 +Item 7. +Management’s Discussion and Analysis o f Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected financial data” and our financial statements and related notes included under Item 8 of this Annual Report on Form 10-K (“Annual Report”). This discussion contains forward-looking statements based on our current expectations, estimates and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described in this Annual Report under “Cautionary note regarding forward-looking statements” and “Risk factors.” We assume no obligation to update any of these forward-looking statements. +Overview +We are a leading North American onshore completion and production services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +On February 28, 2017, we completed the Combination, pursuant to which all of the issued and outstanding shares of Beckman common stock were converted into shares of our common stock, other than 1.6% of Beckman shares paid in cash. Prior to the Combination, Beckman, a growth-oriented oilfield services company that provides a wide range of well service and coiled tubing services, was also an SCF Partners portfolio company. As a result, the Combination was accounted for using the reorganization accounting method for entities under common control. Under this method of accounting, the financial statements and the discussions herein include the operating results of Nine and Beckman. In this Annual Report, unless the context otherwise requires, the terms “Nine,” “we,” “us,” “our” and the “Company” refer to (i) Nine Energy Service, Inc. and its subsidiaries together with Beckman prior to the Combination and (ii) Nine Energy Service, Inc. and its subsidiaries after the Combination. For more information on the Combination, see Note 3—“Acquisitions and Combinations” in our audited financial statements. +We operate in two segments: +• +Completion Solutions : Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Through our Completion Solutions segment, we provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies, which enable comparable rates per stage while providing more control over fracture initiation, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 25,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +• +Production Solutions : Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to ultimate plug and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. +42 +For more information on our services and segments, see Item 1. “Business—Our Segments.” +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion and production services to E&P customers across all major onshore basins in both the U.S. and Canada. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into a Master Service Agreement (“MSA”) with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting both our Completion Solutions and Production Solutions segments are labor costs, materials and freight, the costs of maintaining our equipment and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +How We Evaluate Our Operations +We manage our operations through two business segments, Completion Solutions and Production Solutions, as described above. We evaluate the performance of these segments based on a number of financial and non-financial measures, including the following: +• +Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of each of our segments compared to historical revenue drivers or market metrics applicable to that service. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• +Adjusted gross profit (excluding depreciation and amortization) and adjusted gross profit margin : Adjusted gross profit (excluding depreciation and amortization) is a key metric that we use to evaluate segment operating performance and to determine resource allocation between segments. We define segment adjusted gross profit (excluding depreciation and amortization) as segment revenues less segment direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost and other miscellaneous expenses. Adjusted gross profit margin is calculated by dividing adjusted gross profit (excluding depreciation and amortization) by revenue. Our management continually evaluates our adjusted gross margin percentage and our adjusted gross margin percentage by segment to determine how each segment is performing. This metric aids management in capital resource allocation and pricing decisions. See Item 6. “Selected Financial Data.” +• +Adjusted EBITDA : Adjusted EBITDA is a supplemental non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies. We define Adjusted EBITDA as net income (loss) before interest expense, taxes and depreciation and amortization, further adjusted for (i) impairment of goodwill and other intangible assets, (ii) transaction expenses related to acquisitions or the Combination (iii) loss from discontinued operations, (iv) loss or gains from the revaluation of contingent liabilities, (v) non-cash stock-based compensation expense, (vi) loss or gains on sale of assets, (vii) inventory write-down, and (viii) adjustment for expenses or charges, to exclude certain items which we believe are not reflective of ongoing performance of our business, such as costs related to our IPO, legal expenses and settlement costs related to litigation outside the ordinary course of business, and restructuring costs. Our management believes Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. See Item 6. “Selected Financial Data.” +43 +• +Safety : We measure safety by tracking the total recordable incid ent rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal oc cupational illness and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Factors Affecting the Comparability of our Future Results of Operations to our Historical Results of Operations +Our future results of operations may not be comparable to our historical results of operations for the periods presented, primarily for the reasons described below: +• +Public company expenses : We expect to incur direct, incremental G&A expenses as a result of being a publicly traded company, including, but not limited to, costs associated with hiring new personnel, annual and quarterly reports to stockholders, quarterly tax provision preparation, independent auditor fees, expenses relating to compliance with the rules and regulations of the SEC, listing standards of the NYSE and the Sarbanes-Oxley Act of 2002, investor relations activities, registrar and transfer agent fees, incremental director and officer liability insurance costs and independent director compensation. These direct, incremental G&A expenses are not included in our historical results of operations. +• +The Combination : The historical financial statements included in this Annual Report are based on the separate businesses of Nine and Beckman. As a result, the historical financial data may not give you an accurate indication of what our actual results would have been if the Combination, which was completed on February 28, 2017, had been completed at the beginning of the periods presented, or of what our future results of operations are likely to be. We anticipate the Combination will provide potential benefits, including enhancing our ability to serve customers and our growth potential through broader product lines and basin diversification, enabling us to cross-sell our products and compete with larger companies. +• +Decreased leverage : As of December 31, 2017, on a pro forma basis giving effect to (i) the entry into our credit facility and (ii) our IPO and the use of a portion of the net proceeds therefrom, together with term loan borrowings under our credit facility, to fully repay all outstanding borrowings under the Former Nine Credit Facility and the Former Beckman Credit Facility, we would have had $125.0 million of outstanding total indebtedness, compared to the actual outstanding indebtedness of $242.0 million as of December 31, 2017. For more information on our credit facility, under which we made term loan borrowings concurrently with the consummation of our IPO, see “—Our Credit Facilities—Our Credit Facility.” +Industry Trends and Outlook +Our business depends to a significant extent on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. Oil and natural gas prices declined significantly between the third quarter of 2014 and the first quarter of 2016. However, oil and natural gas prices have since gradually increased, a positive trend that was bolstered in the fourth quarter of 2016 when members of the Organization of Petroleum Exporting Countries and certain other oil-producing nations agreed to reduce their oil output. This price recovery has stimulated an increase in onshore North American completions activity, and if the current price environment holds or continues to improve, we expect a further increase in demand for our services. As the demand for our services and complexity of our jobs increase, we anticipate the ability to increase prices for our services, creating more favorable margins for the services we provide. +The increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete with a limited number of service companies for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing and cluster spacing and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. +44 +Results of Operations +Year Ended December 31, 2017 Compared to Year Ended December 31, 2016 +Year ended +December 31, +2017 +2016 +(in thousands) +Revenues +Completion Solutions +$ +465,773 +$ +221,468 +Production Solutions +77,887 +60,886 +543,660 +282,354 +Cost of revenues(1) +Completion Solutions +384,641 +194,436 +Production Solutions +63,826 +51,673 +448,467 +246,109 +Adjusted gross profit (excluding depreciation and amortization) +Completion Solutions +81,132 +27,032 +Production Solutions +14,061 +9,213 +95,193 +36,245 +General and administrative expenses +49,552 +39,387 +Depreciation +53,422 +55,260 +Impairment of goodwill +31,530 +12,207 +Impairment of intangibles +3,800 +— +Amortization of intangibles +8,799 +9,083 +Loss on equity method investment +368 +— +Loss on sale of property and equipment +4,688 +3,320 +Loss from operations +(56,966 +) +(83,012 +) +Interest expense +15,703 +14,185 +Loss from operations before income taxes +(72,669 +) +(97,197 +) +Provision (benefit) for income taxes +(4,987 +) +(26,286 +) +Net loss +$ +(67,682 +) +$ +(70,911 +) +(1) +Excludes depreciation and amortization, shown separately below. +Revenue +Total revenue is comprised of revenue from Completion Solutions and Production Solutions. Revenue for the year ended December 31, 2017 increased by $261.3 million, or 93%, to $543.7 million, from $282.4 million for the year ended December 31, 2016. Both segments’ businesses depend to a significant extent on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America, which in turn are strongly influenced by current and expected oil and natural gas prices, which were low during most of 2016, but showed improvement during 2017. During 2016, the closing price of oil reached a 12-year low of $26.19 per barrel and the closing price of natural gas reached an 18-year low of $1.49 per MMBtu. During 2017, the closing price of oil reached a high of $60.46 per barrel and the closing price of natural gas reached a high of $3.71 per MMBtu. The increase in revenue by reportable segment is discussed below. +Completion Solutions : Completion Solutions segment revenue increased by $244.3 million, or 110%, to $465.8 million for the year ended December 31, 2017 from $221.5 million for the year ended December 31, 2016 due to a significant increase in completions activity and increased pricing in 2017 in response to the improvement of industry conditions. The increase in demand and price for our services resulted from our customers increasing their North American capital expenditures and drilling and completing more new wells in the year ended December 31, 2017 as compared to the year ended December 31, 2016. Wireline revenue increased 67% from the year ended December 31, 2016 to the year ended December 31, 2017; total wireline stages completed increased 65% due to the increase in +45 +overall market activity. Completion tools revenue increased 173%, reflecting a 243% increase in stages. Revenue per stage fell 20% due to transition from a higher volume of plugs sold from sleeves reflective of the market change. Cementing r evenue increased by 154% on a 75% increase in job count and improved pricing from the year ended December 31, 2016 to the year ended December 31, 2017. Coiled Tubing Services revenue increased 107%, with total jobs increasing 48%. +Production Solutions : Production Solutions segment revenue increased by $17.0 million, or 28%, to $77.9 million for the year ended December 31, 2017 from $60.9 million for the year ended December 31, 2016. Hours worked for the Production Solutions segment increased approximately 26%. The increases were primarily attributable to our customers’ increase in well maintenance and increased well completions activity, which was in response to the improvement of industry conditions described above. Production Solutions average pricing increased by 1% for the year ended December 31, 2017 compared to the year ended December 31, 2016. +Cost of Revenues +Cost of revenues for the year ended December 31, 2017 increased by $202.4 million, or 82%, compared to the year ended December 31, 2016. The increase was a result of an increase in revenue-generating activity related to improvement in the oil and gas market. Activity-driven costs were primarily responsible for the increase; materials installed in wells and consumed while performing services increased by $94.5 million and other activity-driven costs were $43.5 million higher. Compensation and benefits increased by $60.5 million. +Completion Solutions : Completion Solutions segment cost of services for the year ended December 31, 2017 increased by $190.2 million, or 98%, when compared to the year ended December 31, 2016. The increase was driven primarily by the increased level of activity. Costs related to materials installed in wells and consumed while performing services increased by $93.4 million, and other activity-driven costs increased by $39.7 million. Additionally, compensation and benefits were $54.4 million higher, as headcount was increased in response to the increase in revenue and forecasted activity increases. +Production Solutions : Production Solutions segment cost of services for the year ended December 31, 2017 increased by $12.2 million, or 24%, when compared to the year ended December 31, 2016. The increase was due to the increase in revenue-generating activity. Compensation and benefits increased by $6.1 million and other activity-driven costs increased by $5.9 million. +Adjusted Gross Profit (Excluding Depreciation and Amortization) +Completion Solutions : Adjusted gross profit (excluding depreciation and amortization) increased $54.1 million to $81.1 million for the year ended December 31, 2017 compared to adjusted gross profit (excluding depreciation and amortization) of $27.0 million for the year ended December 31, 2016 as a result of the factors described above under “Revenue” and “Cost of revenues.” +Production Solutions : Adjusted gross profit (excluding depreciation and amortization) increased $4.9 million to $14.1 million for the year ended December 31, 2017 compared to $9.2 million for the year ended December 31, 2016 as a result of the factors described above under “Revenue” and “Cost of revenues.” +General and Administrative Expenses +General and administrative expenses increased by $10.2 million, to $49.6 million, for the year ended December 31, 2017 from $39.4 million for the year ended December 31, 2016. The increase was partly due to a $3.2 million increase in legal, audit and other professional fees incurred in connection with the combination of Nine with Beckman, and related to preparations for our IPO. Compensation and benefits, including stock-based compensation, increased by $6.8 million, and other general and administrative expenses increased in order to support the company’s increased level of activity. These increases were partly offset by a $1.3 million decline in the revaluation of the contingent liability related to the purchase of Scorpion. General and administrative expenses as a percentage of revenue were 9% for the year ended December 31, 2017, compared with 14% for the year ended December 31, 2016. +46 +Depreci ation +Depreciation expense for the year ended December 31, 2017 decreased by $1.8 million, to $53.4 million, from $55.3 million for the year ended December 31, 2016. The decrease resulted primarily from sales of fixed assets during 2016 and 2017. +Impairment of Goodwill and Intangible Assets +For the year ended December 31, 2017, we recognized $31.5 million of goodwill impairment and $3.8 million of impairment of intangible assets in one of our Completions Solutions segment operating units, which resulted from declining profitability and deteriorating market conditions. In the year ended December 31, 2016, we recognized $12.2 million of goodwill impairment in another operating unit in the Completion Solutions segment due to persistently low completions activity in the market where the unit operates. +The December 31, 2017 goodwill impairment test for the Production Solutions segment indicated that the estimated fair value calculation provided only 11% of cushion in relation to carrying value. Fair value was determined using both an income and market value approach. In the income approach, discounted cash flows were based on estimated equipment utilization, revenue, operating expenses and capital expenditures. In the market value approach, fair value was estimated using financial information from comparable entities. As a result of the limited cushion, this segment’s goodwill, which totals $13.0 million, is susceptible to impairment risk from adverse economic conditions in the future. +Amortization of Intangibles +Amortization of intangibles decreased by $0.3 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. +Interest Expense +Interest expense was $15.7 million during the year ended December 31, 2017, an increase of $1.5 million from the year ended December 31, 2016. Higher interest rates accounted for an increase of approximately $2.4 million, which was partly offset by a $0.9 million decrease due to lower amortization and write-off of deferred financing costs. +Taxes +The effective tax rate for the year ended December 31, 2017 was 7%, compared with 27% for the year ended December 31, 2016. The Company’s tax position changed during the fourth quarter of 2016 when a valuation allowance was recorded against the net deferred tax asset. We have excluded deferred tax liabilities related to certain indefinite life intangibles when calculating the amount of valuation allowance needed as these liabilities cannot be considered a source of income when determining the realizability of the net deferred tax assets. A full valuation allowance typically results in an effective rate of 0%, but the underlying tax amortization of the indefinite life intangibles, along with the rate change impact of tax reform, resulted in the effective rate of 7% for the year ended December 31, 2017. +Adjusted EBITDA +Adjusted EBITDA was $59.6 million for the year ended December 31, 2017 as compared with $9.8 million for the year ended December 31, 2016, an increase of 506%. The Adjusted EBITDA increase is primarily due to the changes in revenues and expenses discussed above. See “Non-GAAP financial measures” below for further explanation. +47 +Year Ended December 31, 2016 Compared to Year Ended December 31, 2015 +Year ended +December 31, +2016 +2015 +(in thousands) +Revenues +Completion Solutions +$ +221,468 +$ +380,174 +Production Solutions +60,886 +98,348 +282,354 +478,522 +Cost of revenues(1) +Completion Solutions +194,436 +295,969 +Production Solutions +51,673 +77,222 +246,109 +373,191 +Adjusted gross profit (excluding depreciation and amortization) +Completion Solutions +27,032 +84,205 +Production Solutions +9,213 +21,126 +36,245 +105,331 +General and administrative expenses +39,387 +42,862 +Depreciation +55,260 +58,894 +Impairment of goodwill +12,207 +35,540 +Amortization of intangibles +9,083 +8,650 +Loss on sale of property and equipment +3,320 +2,004 +Loss from operations +(83,012 +) +(42,619 +) +Interest expense +14,185 +9,886 +Loss from operations before income taxes +(97,197 +) +(52,505 +) +Benefit for income taxes +(26,286 +) +(14,323 +) +Loss from continuing operations +(70,911 +) +(38,182 +) +Loss from discontinued operations, net of tax +— +(935 +) +Net loss +$ +(70,911 +) +$ +(39,117 +) +(1) +Excludes depreciation and amortization, shown separately below. +Revenue +Total revenue is comprised of revenue from Completion Solutions and Production Solutions. Revenue for the year ended December 31, 2016 decreased by $196.2 million, or 41%, to $282.4 million from $478.5 million for the year ended December 31, 2015. Both segments’ businesses depend to a significant extent on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America, which in turn are strongly influenced by current and expected oil and natural gas prices, which were low during most of 2016. In the first quarter of 2016, the closing price of oil reached a 12-year low of $26.19 per barrel and the closing price of natural gas reached an 18-year low of $1.49 per MMBtu. The decrease in revenue by reportable segment is discussed below. +Completion Solutions : Completion Solutions segment revenue decreased by $158.7 million, or 42%, to $221.5 million for the year ended December 31, 2016 from $380.2 million for the year ended December 31, 2015 due to the significant decline in completions activity and lowered pricing in 2016 in response to the weak industry conditions. This reduction in demand and price for our services resulted from our customers reducing North American capital expenditures and drilling and completing fewer new wells in 2016 as compared to 2015. In our U.S. Wireline service, although our total stages completed increased slightly by approximately 6% due to increased market share, our revenue was down approximately 38% year over year due to pricing decreases. U.S. Cementing revenue was down approximately 44% with job count dropping approximately 19% year-over-year. Coiled Tubing services revenue dropped approximately 15% although total jobs increased 10% year-over-year. Demand for our pinpoint frac sleeve systems declined most significantly in the Bakken region, which had a rig count decline over 70% coupled with a methodology transition from open hole to cemented completions. +48 +Production Sol utions : Production Solutions segment revenue decreased by $37.5 million, or 38%, to $60.9 million for the year ended December 31, 2016 from $98.3 million for the year ended December 31, 2015. Hours worked for the Production Solutions segment decreased by 27% for the year ended December 31, 2016 compared to the year ended December 31, 2015. Such decreases were primarily attributable to our customers’ deferred well maintenance and decreased well completions activity, which was in response to the weak industr y conditions described above. Production Solutions average pricing decreased by 15% for the year ended December 31, 2016 compared to the year ended December 31, 2015. +Cost of Revenues +Cost of revenues for the year ended December 31, 2016 decreased by $127.1 million, or 34%, when compared to the year ended December 31, 2015. This decrease was a result of a decline in revenue-generating activity related to the generally depressed oil and natural gas market. Activity-driven costs were the largest contributors to the decline in expenses. Materials installed in wells and consumed while performing services at the well decreased by $51 million. Other activity-related expenses fell by more than $15 million. Additionally, compensation and benefits were reduced by $53 million as the organization was sized to meet the lower levels of activity. Cost of revenues as a percentage of total revenue for the year ended December 31, 2016 was 87%, which represented an increase of 9% from 78% for the year ended December 31, 2015. The change in costs of revenues by reportable segment is further discussed below. +Completion Solutions : Completion Solutions segment cost of services for the year ended December 31, 2016 decreased by $101.5 million, or 34%, to $194.4 million when compared to the year ended December 31, 2015. The decrease in cost of revenues was due to the decline in revenue-generating activity, which was a result of the generally depressed oil and natural gas market. Activity-driven costs were the largest contributors to the decline in expenses. Materials installed in wells and consumed while performing services at the well decreased by $50 million. Other activity-driven costs fell by more than $10 million. In addition, compensation and benefits were reduced by $34 million in response to the decline in activity. +Production Solutions : Production Solutions segment cost of revenues for the year ended December 31, 2016 decreased by $25.5 million, or 33%, to $51.7 million when compared to the year ended December 31, 2015. The decrease in cost of revenues was due to the decline in revenue-generating activity, which was a result of a generally depressed oil and natural gas market. Compensation and benefits were reduced by $19 million in response to the drop in activity, and activity-related costs fell by more than $6 million. +Adjusted Gross Profit (Excluding Depreciation and Amortization) +Completion Solutions : Adjusted gross profit (excluding depreciation and amortization) decreased $57.2 million to $27.0 million for the year ended December 31, 2016 compared to adjusted gross profit (excluding depreciation and amortization) of $84.2 million for the year ended December 31, 2015 as a result of the factors described above under “Revenue” and “Cost of revenues.” +Production Solutions : Adjusted gross profit (excluding depreciation and amortization) decreased $11.9 million to $9.2 million for the year ended December 31, 2016 compared to $21.1 million for the year ended December 31, 2015 as a result of the factors described above under “Revenue” and “Cost of revenues.” +General and Administrative Expenses +General and administrative (“G&A”) expense, which represents costs associated with managing and supporting our operations, decreased by $3.5 million, or 8%, to $39.4 million for the year ended December 31, 2016 from $42.9 million for the year ended December 31, 2015. The decrease in G&A expense is primarily a result of a reduction in compensation and benefits, which declined $3.9 million due to headcount and salary reductions. G&A as a percentage of total revenue was 14% for the year ended December 31 2016 compared with 9% for the year ended December 31, 2015, which was primarily a result of decreased revenue, which is described under “—Revenues.” +49 +Depreciation +Depreciation expense for the year ended December 31, 2016 decreased $3.6 million to $55.3 million from $58.9 million for the year December 31, 2015. The decline resulted from sales of fixed assets during both 2015 and 2016. +Impairment of Goodwill +For the year ended December 31, 2016, we recognized $12.2 million of goodwill impairment in one of the operating units in our Completion Solutions segment due to persistently low completions activity in the market where the unit operates. In 2015, we recognized goodwill impairment charges of $30.4 million and $5.1 million for two of the operating units in our Completion Solutions segment as a result of the decline in completions activity and forecasted activity declines. +Amortization of Intangibles +Intangible assets, acquired in business acquisitions, are amortized over 3 to 15 years. Amortization expense increased by $0.4 million during 2016, primarily due to a full year of amortization expense on intangible assets acquired during 2015. +Interest Expense +We incurred $14.2 million of interest expense during the year ended December 31, 2016, an increase of $4.3 million, or 43%, from the year ended December 31, 2015. Higher interest rates accounted for approximately $3.3 million of the increase; $1.0 million of the increase was due to the write-off of a portion of deferred financing costs as a result of amending debt agreements. +Taxes +Tax expense includes current income taxes expected to be due based on taxable income to be reported during the applicable period in the various jurisdictions in which we conduct business, and deferred income taxes based on changes in the tax effect of temporary differences between the bases of assets and liabilities for financial reporting and tax purposes at the beginning and end of the applicable period. The effective tax rate, calculated by dividing provision for income tax expense by income from continuing operations before income taxes, was 27% and 27% for the years ended December 31, 2016 and 2015, respectively. +Adjusted EBITDA +Adjusted EBITDA was $9.8 million for the year ended December 31, 2016 as compared with $73.9 million for the year ended December 31, 2015, a decrease of 87%. The Adjusted EBITDA decrease is primarily due to the changes in revenues and expenses discussed above. See “Non-GAAP financial measures” below for further explanation. +Non-GAAP Financial Measures +EBITDA and Adjusted EBITDA +EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are used by management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies. +We define EBITDA as net income (loss) before interest expense, depreciation, amortization and income tax expense. EBITDA is not a measure of net income or cash flows as determined by GAAP. +We define Adjusted EBITDA as EBITDA further adjusted for (i) impairment of goodwill and other intangible assets, (ii) transaction expenses related to acquisitions or the Combination, (iii) loss from discontinued operations, (iv) loss or gains from the revaluation of contingent liabilities, (v) non-cash stock-based compensation expense, (vi) loss or gains on sale of assets, (vii) inventory write-down and (viii) adjustment for other expenses or charges, to exclude certain items which we believe are not reflective of ongoing performance of our business, such as costs related to this offering, legal expenses and settlement costs related to litigation outside the ordinary course of business, and restructuring costs. +50 +Management believes EBITDA and Adjusted EBITDA are useful because they allow for a more effective evaluation of our operating performance and compare th e results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income in arriving at these measures because these amounts can vary substantially from company to com pany within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. These measures should not be considered as an alternative to, or more meaningful than, net income as determined in accordance with GAAP or as an indicator of our operating performance. Certain items excluded from these measures are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of these measures. Our computations of these measures may not be comparable to other similarly titled measures of other companies. We believe that these ar e widely followed measures of operating performance. +The following table presents a reconciliation of the non-GAAP financial measures of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year ended December 31, +2017 +2016 +2015 +(in thousands) +EBITDA reconciliation: +Net loss +$ +(67,682 +) +$ +(70,911 +) +$ +(39,117 +) +Interest expense +15,703 +14,185 +9,886 +Depreciation +53,422 +55,260 +58,894 +Amortization +8,799 +9,083 +8,650 +Provision (benefit) from income taxes +(4,987 +) +(26,286 +) +(14,323 +) +EBITDA +$ +5,255 +$ +(18,669 +) +$ +23,990 +Adjusted EBITDA reconciliation: +EBITDA +$ +5,255 +$ +(18,669 +) +$ +23,990 +Impairment of goodwill and other intangible assets +35,330 +12,207 +35,540 +Transaction expenses +3,622 +— +208 +Loss from discontinued operations +— +— +935 +Loss or gains from the revaluation of contingent liabilities(1) +415 +1,735 +(293 +) +Loss on equity investment +368 +— +— +Non-cash stock-based compensation expense +7,568 +5,711 +5,473 +Loss or gains on sale of assets +4,688 +3,320 +2,004 +Legal fees and settlements(2) +974 +4,145 +— +Inventory write-down +1,359 +287 +2,772 +Restructuring costs +— +1,088 +3,272 +Adjusted EBITDA +$ +59,579 +$ +9,824 +$ +73,901 +(1) +Loss or gain related to the revaluation of liability for contingent consideration relating to our acquisition of Scorpion to be paid in shares of Company common stock and in cash, contingent upon quantities of Scorpion Composite Plugs sold during 2016 and gross margin related to the product sales for three years following the acquisition. +(2) +Amount represents fees and legal settlements associated with legal proceedings brought pursuant to the Fair Labor Standards Act and/or similar state laws. +Return on invested capital +ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit, divided by average total capital. We define after-tax net operating profit as income (loss) from continuing operations (net of tax) plus interest expense, less taxes on interest. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We then take the average of the current and prior year-end total capital for use in this analysis. +51 +Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation o f ROIC may not be comparable to other similarly titled measures of other companies. +The following table provides an explanation of our calculation of ROIC: +Year ended December 31, +2017 +2016 +2015 +(in thousands) +Loss from continuing operations, net of tax +$ +(67,682 +) +$ +(70,911 +) +$ +(38,182 +) +Add back: +Interest Expense +15,703 +14,185 +9,886 +Taxes on interest +(5,496 +) +(3,836 +) +(2,697 +) +After-tax net operating profit (loss) +$ +(57,475 +) +$ +(60,562 +) +$ +(30,993 +) +Total capital as of prior year end: +Total stockholders' equity +$ +288,186 +$ +352,676 +$ +389,644 +Total debt +245,888 +252,378 +379,658 +Less cash and cash equivalents +(4,074 +) +(18,877 +) +(24,236 +) +Total capital +$ +530,000 +$ +586,177 +$ +745,066 +Total capital as of year-end: +Total stockholders' equity +$ +287,358 +$ +288,186 +$ +352,676 +Total debt +242,235 +245,888 +252,378 +Less cash and cash equivalents +(17,513 +) +(4,074 +) +(18,877 +) +Total capital +$ +512,080 +$ +530,000 +$ +586,177 +Average total capital +$ +521,040 +$ +558,089 +$ +665,622 +ROIC +-11 +% +-11 +% +-5 +% +Adjusted gross profit (excluding depreciation and amortization) +GAAP defines gross profit as revenues less cost of revenues, and includes in costs of revenues depreciation and amortization. We define adjusted gross profit (excluding depreciation and amortization) as revenues less cost of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (excluding depreciation and amortization) to evaluate operating performance and to determine resource allocation between segments. We prepare adjusted gross profit (excluding depreciation and amortization) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (excluding depreciation and amortization) should not be considered as an alternative to gross profit (loss), operating income (loss) or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (excluding depreciation and amortization) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (excluding depreciation and amortization) or similarly titled measures in the same manner as we do. +52 +The following table presents a reconciliation of adjusted gross profit (excluding depreciation and amortization) to GAAP gross profit (l oss). +Year ended December 31, +2017 +2016 +2015 +(in thousands) +Calculation of gross profit (loss) +Revenues +$ +543,660 +$ +282,354 +$ +478,522 +Cost or revenue (exclusive of depreciation and amortization) +448,467 +246,109 +373,191 +Depreciation (related to cost of revenues) +52,536 +54,344 +58,042 +Amortization +8,799 +9,083 +8,650 +Gross profit (loss) +$ +33,858 +$ +(27,182 +) +$ +38,639 +Adjusted gross profit (excluding depreciation and amortization) reconciliation: +Gross profit (loss) +$ +33,858 +$ +(27,182 +) +$ +38,639 +Depreciation (related to cost of revenues) +52,536 +54,344 +58,042 +Amortization +8,799 +9,083 +8,650 +Adjusted gross profit (excluding depreciation and amortization) +$ +95,193 +$ +36,245 +$ +105,331 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash flows from operating activities, external borrowings and capital contributions. Our principal uses of cash are to fund capital expenditures and acquisitions, to service our outstanding debt and to fund our day to day operations. We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. +At December 31, 2017, we had $17.5 million of cash and cash equivalents and $3.5 million of availability under our former credit facilities, which resulted in a total liquidity position of $21.0 million. +On January 23, 2018, we completed our IPO of 7,000,000 shares of common stock at a price to the public of $23.00 per share. After subtracting underwriting discounts and commissions of $10.9 million and the estimated offering expenses, we received net proceeds of approximately $150.1 million. On January 24, 2018, we sold an additional 1,050,000 shares of common stock at the IPO price of $23.00 per share pursuant to the underwriters’ over-allotment option. After subtracting underwriting discounts and commissions of approximately $1.6 million and the estimated offering expenses, we received net proceeds of approximately $22.5 million. We used a portion of these net proceeds, together with $125.0 million of term loan borrowings under our new credit facility (which was funded upon the closing of the IPO), to fully repay the outstanding indebtedness under our former credit facilities. Further, our credit agreement required that we use a portion of the proceeds from the over-allotment option to make a prepayment of the term loan borrowings of $9.7 million. The remainder of the net proceeds are being used for general corporate purposes. On an “as adjusted” basis, our cash and cash equivalents increased by $43.4 million, to $60.9 million, and we had $49.4 million available under our credit facility compared to $3.5 million under our former credit facilities, resulting in a total liquidity position of $110.3 million as of December 31, 2017 on an as adjusted basis. +As discussed in Note 7 in our audited financial statements, as of December 31, 2017 we had $119.9 million of debt under the Former Nine Credit Facility and $122.3 million of debt under the Former Beckman Credit Facility that were scheduled to mature on May 31, 2018 and June 30, 2018, respectively. As discussed above, we repaid in full the Former Nine Credit Facility and the Former Beckman Credit Facility prior to their respective maturities with the proceeds of our IPO and term loan borrowings under our credit facility +53 +Our ability to satisfy our liquidity requirements depends on our future operating performance, which is affected by prevailing economic conditions, the level of drilling, completion and production activity for North American onshore oil a nd natural gas resources, and financial and business and other factors, many of which are beyond our control. +Our total 2017 capital expenditure budget, excluding possible acquisitions, was $45.0 million and the actual amount of capital expenditures incurred in 2017 was $45.2 million. Our capital expenditure budget for 2018, excluding possible acquisitions, is expected to be between $53 million and $57 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors including expected industry activity levels and company initiatives. We believe the net proceeds from our IPO and borrowings under our credit facility, together with cash flows from operations, should be sufficient to fund our capital requirements for the next twelve months. +Although we do not budget for acquisitions, pursuing growth through acquisitions is a significant part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +Our cash flows for the year ended December 31, 2017 and 2016 are presented below: +Year ended +December 31, +2017 +2016 +(in thousands) +Net cash provided by operating activities +$ +5,671 +$ +(3,290 +) +Net cash used in investing activities +(44,464 +) +(4,176 +) +Net cash provided by (used in) financing activities +52,342 +(7,315 +) +Impact of foreign exchange rate on cash +(110 +) +(22 +) +Net change in cash and cash equivalents +$ +13,439 +$ +(14,803 +) +Net cash provided by operating activities +Net cash provided by operating activities was $5.7 million for the year ended December 31, 2017 compared to $3.3 million used in operating activities for the year ended December 31, 2016. The $9.0 million increase in cash provided by operating activities was due to the general improvement in profitability and the receipt of a $14.6 million tax refund, mostly offset by increases in accounts receivable and inventories less increases in accounts payable and accrued liabilities, all related to business growth. +Net cash flows used in Investing Activities +Net cash used in investing activities was $44.5 million for the year ended December 31, 2017, an increase of $40.3 million from the year ended December 31, 2016. The increase was mainly attributable to a $36.1 million increase in purchases of property and equipment, a $1.0 million equity investment, and decreases in proceeds from sales of equipment and in proceeds from repayment of notes receivable. +Net cash Provided by (Used in) Financing Activities +Net cash provided by financing activities totaled $52.3 million for the year ended December 31, 2017 compared with $7.3 million used in financing activities for the year ended December 31, 2016, an increase of $59.7 million. Proceeds from share issuances of $61.4 million and a $1.7 million increase in borrowings in excess of debt payments, partly offset by distributions to shareholders and payment of deferred financing costs, were responsible for the increase. +54 +Our cash flows for the years ended December 31, 2016 and 2015 are presented below: +Year ended December 31, +2016 +2015 +(in thousands) +Net cash (used in) provided by operating activities +$ +(3,290 +) +$ +140,367 +Net cash used in investing activities +(4,176 +) +(19,251 +) +Net cash used in financing activities +(7,315 +) +(126,878 +) +Impact of foreign exchange rate on cash +(22 +) +403 +Net change in cash and cash equivalents +$ +(14,803 +) +$ +(5,359 +) +Net Cash (Used in) Provided by Operating Activities +Net cash used in operating activities was $3.3 million for the year ended December 31, 2016 compared to net cash provided by operating activities of $140.4 million for the year ended December 31, 2015. The decrease in operating net cash flows was primarily attributable to the overall decline in completions activity and well services activity, as described in “—Results of operations.” The increase in net operating losses in 2016 and a decline of $89 million in accounts receivable balances in 2015 were primarily responsible for the unfavorable swing in cash provided by operating activities. +Our operating cash flows are sensitive to a number of variables, the most significant of which is the level of drilling, completion and production activity for North American onshore oil and natural gas resources. These activity levels are in turn impacted by the volatility of oil and natural gas prices, regional and worldwide economic activity and its effect on demand for hydrocarbons, weather, infrastructure capacity to reach markets and other variable factors. These factors are beyond our control and are difficult to predict. For additional information on the impact of changing prices on our financial position, see “—Quantitative and qualitative disclosures about market risk” below. +Net Cash Flows Used in Investing Activities +Net cash used in investing activities was $4.2 million and $19.3 million for the years ended December 31, 2016 and December 31, 2015, respectively, a $15.1 million decrease, which was primarily attributable to lower equipment purchases. +Net Cash Used in Financing Activities +Net cash used in financing activities was $7.3 million and $126.9 million for the years ended December 31, 2016 and December 31, 2015, respectively, a $119.6 million decrease, which was primarily attributable to net repayments of debt during 2015. +Our Credit Facilities +We used a portion of the net proceeds from our IPO and term loan borrowings under our credit facility to fully repay and terminate the Former Nine Credit Facility and the Former Beckman Credit Facility (Note 7). +Former Nine Credit Facility +As of June 30, 2014, Nine and its wholly-owned Canadian subsidiary, Nine Energy Canada Inc. (“Nine Canada”), entered into the Amended and Restated Credit Agreement, dated June 30, 2014 and amended May 13, 2016 (as amended, the “Former Nine Credit Facility”) with HSBC Bank USA, N.A., as U.S. administrative agent, HSBC Bank Canada, as Canadian agent, and certain other financial institutions. Pursuant to the Former Nine Credit Facility, as of December 31, 2017, Nine had a $35.2 million term loan, and Nine was entitled to borrow up to $75.0 million (including letters of credit) under the U.S. revolving commitments (the “Former Nine U.S. Revolving Credit Facility”) and Nine Canada was entitled to borrow up to $10.0 million (including letters of credit) under the Canadian revolving commitments (the “Former Nine Canadian Revolving Credit Facility”). As of December 31, 2017, we had $75.0 million of outstanding revolving borrowings (including letters of credit) under the Former Nine U.S. Revolving Credit Facility and $9.8 million of outstanding revolving borrowings (including letters of credit) +55 +under the Former Nine Canadian Revolving Credit Facility. All loans and other obligations under the Former Nine Credit Facility were scheduled to mature on May 31, 2018 . +As of December 31, 2016, we had $120.6 million of debt under the Former Nine Credit Facility that was scheduled to mature on January 1, 2018, which was within twelve months of the date of the issuance of our audited financial statements and thereby resulted in a “going concern” paragraph being included in our independent registered public accounting firm’s audit report. Delivery of audited financial statements including a going concern paragraph would result in an event of default under the Former Nine Credit Facility absent an amendment or waiver. On March 23, 2017, we received the requisite waiver from the lenders under the Former Nine Credit Facility with respect to this potential event of default. The maturity date for the Former Nine Credit Facility was extended to May 31, 2018. +We used a portion of the net proceeds from our IPO and term loan borrowings under our credit facility to fully repay the outstanding borrowings under the Former Nine Credit Facility and terminate the Former Nine Credit Facility in connection with the closing of our IPO. +We were in compliance with all financial covenants as of December 31, 2017. +Former Beckman Credit Facility +Beckman entered into a Credit Agreement, dated May 2, 2014 (as amended, the “Former Beckman Credit Facility” and, together with the “Former Nine Credit Facility, “our former credit facilities”), with Wells Fargo Bank, National Association, as administrative agent, and certain other financial institutions pursuant to which Beckman obtained a $145 million senior credit facility. A portion of the commitments up to $132.5 million were available on a revolving basis, and $12.5 million of the commitments were extended as term advances. The amount available to be borrowed under the revolving portion was further limited by a borrowing base determined monthly based upon a formula calculated by reference to Beckman’s eligible accounts receivable, equipment, inventory and real estate. As of December 31, 2016, the borrowing base was $120.8 million and $114.3 million was outstanding under revolving loans. As of December 31, 2016, $11.0 million was outstanding under the term loan. +On February 10, 2017, pursuant to Agreement and Amendment No. 5 to the Former Beckman Credit Facility, the above-described facility was amended to consist of (i) a $6.0 million term loan tranche (the “Former Beckman Tranche B Term Loan”), (ii) a $106.3 million term loan tranche (the “Former Beckman Tranche C Term Loan” and together with the Former Beckman Tranche B Term Loan, the “Former Beckman Term Loans”), and (iii) a $15.0 million revolving facility (subject to a borrowing base that is determined monthly and was $15 million as of February 28, 2017) (the “Former Beckman Revolving Facility”). The actual amount available to be borrowed under the Former Beckman Revolving Facility was limited by a borrowing base that was determined monthly based upon a formula calculated by reference to Beckman’s eligible accounts receivable and inventory. As of December 31, 2017, the borrowing base was $15.0 million. As of December 31, 2017, we had $6.0 million outstanding under the Former Beckman Tranche B Term Loan, $104.8 million outstanding under the Former Beckman Tranche C Term Loan and $11.5 million of outstanding revolving borrowings under the Former Beckman Revolving Facility. All loans and other obligations under the Former Beckman Credit Facility were scheduled to mature on June 30, 2018. +We used a portion of the net proceeds from our IPO and term loan borrowings under our credit facility to repay the outstanding borrowings under the Former Beckman Credit Facility and terminate the Former Beckman Credit Facility in connection with the closing of our IPO. +Beckman and its restricted subsidiaries were in compliance with such covenants and ratios as of December 31, 2017. +Our Credit Facility +Concurrently with the consummation of our IPO, our credit facility became effective, consisting of $125 million of term loan commitments and $50 million of revolving credit commitments. Upon consummation of our IPO, we borrowed $125 million of term loans and had approximately $49.4 million of undrawn revolver capacity under our credit facility. Borrowings under our credit facility may vary significantly from time to time depending on our cash needs at any given time. +56 +Our credi t facility is evidenced by a credit agreement dated as of September 14, 2017, with JPMorgan Chase Bank, N.A., as administrative agent, and certain other financial institutions, as amended by the First Amendment to Credit Agreement dated as of November 20, 2017 (as amended, the “Credit Agreement”). The Company was not permitted to borrow under the Credit Agreement, and the covenants of the Credit Agreement were not binding on the Company, until the consummation of our IPO on January 23, 2018. Pursuant to the Credit Agreement, Nine and its domestic restricted subsidiaries are entitled to borrow $125 million of term loans and up to $50 million (including letters of credit) as revolving credit loans under the revolving commitments. At no time will the maximum pr incipal amount of revolving credit loans, together with the face amount of letters of credit, under the Credit Agreement be permitted to exceed $50 million, absent Nine obtaining additional commitments from existing or new lenders. On January 24, 2018, in connection with the closing of the over-allotment option, the Company used a portion of the proceeds from the closing of the over-allotment option to make a mandatory prepayment of the term loan borrowings of $9.7 million. After giving effect to such prepa yment, the Company had $115.3 million of outstanding term loans under the credit facility. +All of the obligations under the Credit Agreement are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Nine and its domestic restricted subsidiaries (including Beckman and its subsidiaries), excluding certain assets. Nine Canada is not be a borrower or guarantor under the Credit Agreement. +Loans to Nine and its domestic restricted subsidiaries under the Credit Agreement may be base rate loans or LIBOR loans. The applicable margin for base rate and prime rate loans will vary from 1.50% to 2.75%, and the applicable margin for LIBOR loans will vary from 2.50% to 3.75%, in each case depending on Nine’s leverage ratio. Nine is permitted to repay any amounts borrowed prior to the maturity date without any premium or penalty other than customary LIBOR breakage costs. +In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. Such commitment fee is payable quarterly in arrears. +The term loans are payable on a quarterly basis in amounts equal to 2.5% of the original principal balance. The term loans and revolving loans mature in July 2020. +The Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. The Credit Agreement does not contain any financial covenants, other than a total leverage ratio, an asset coverage ratio and a fixed charge coverage ratio, each of which will be tested on a quarterly basis. +Contractual Obligations +In the normal course of business, we enter into various contractual obligations that impact or could impact our liquidity. The table below contains our known contractual commitments at December 31, 2017. +Payments due by period for the year ended December 31, +2018 +2019 +2020 +2021 +2022 +Thereafter +Total +(in thousands) +Former credit facilities(1) +$ +242,235 +$ +- +$ +- +$ +- +$ +- +$ +- +$ +242,235 +Interest expense +6,604 +- +- +- +- +- +$ +6,604 +Operating leases +6,799 +4,027 +2,992 +2,604 +2,277 +12,738 +$ +31,437 +Total +$ +255,638 +$ +4,027 +$ +2,992 +$ +2,604 +$ +2,277 +$ +12,738 +$ +280,276 +(1) +The table above does not reflect our use of a portion of the net proceeds from our IPO and term loan borrowings under our credit facility to fully repay and terminate our former credit facilities (the Former Nine Credit Facility and the Former Beckman Credit Facility). +Please see “—Our credit facilities—Our credit facility” for information regarding our credit facility. +57 +Off-Balance Sheet Arrangements +We had no off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, as of December 31, 2017. +Critical Accounting Policies +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Certain accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. We provide expanded discussion of our more significant accounting policies, estimates and judgments below. We believe that most of these accounting policies reflect our more significant estimates and assumptions used in preparation of our financial statements. +Emerging Growth Company Status +We are an “emerging growth company” as defined in the JOBS Act. Under Section 107 of the JOBS Act, as an emerging growth company, we can take advantage of an extended transition period for the adoption of new or revised financial accounting standards. We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards, until we are no longer an emerging growth company. Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Revenue Recognition +The Company recognizes revenue for products and services based upon purchase orders, contracts or other persuasive evidence of an arrangement with the customer that include fixed or determinable prices and that do not include right of return or other similar provisions or other post-delivery obligations. Revenue is recognized for services when they are rendered and collectability is reasonably assured. Revenue for products is recognized upon delivery, customer acceptance and when collectability is reasonably assured. +Property and Equipment +Property and equipment are recorded at cost or valuation, less applicable depreciation. Equipment held under capital leases is stated at the present value of minimum lease payments. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, which range from one to 15 years, except for buildings which have lives up to 39 years (see Note 4—“Property and Equipment” to our audited financial statements for further information). Equipment held under capital leases is amortized straight-line over the shorter of the lease term or estimated useful life of the asset. Maintenance and repairs are charged to operating expense as incurred; significant renewals and betterments are capitalized. +Definite-lived Intangible Assets +Definite-lived intangible assets that are acquired in connection with business acquisitions are amortized utilizing the estimated pattern of the consumption of the economic benefit over their estimated useful lives, which range from 3 to 15 years. +58 +Impairment of Long-lived assets, Goodwill and Other Intangible Assets +Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable. For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets are less than their carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value. The costs of assets that are sold or retired and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income. +Goodwill is tested for impairment annually and when indicators of impairment exist. In the first step, the Company determines the fair value of its individual operating units by blending two valuation approaches: the income and market value approach. The income approach uses the Company’s own market assumptions, including projections of future cash flows, determinations of appropriate discount rates, and other assumptions which are considered reasonable and inherent in the discounted cash flow analysis. The projections are based on historical performance and future estimated results. The market value approach uses financial information from comparable entities. If the carrying amount exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the goodwill is estimated as the fair value of the operating unit used in the first step less the fair values of all other net tangible and intangible assets of the operating unit. If the carrying amount of the goodwill exceeds its implied fair market value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. Legal costs are expensed as incurred. +Share-based Compensation +We account for awards of share-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Fair value of the share-based compensation was measured using the Black-Scholes model for all of the options outstanding. These models require assumptions and estimates for inputs, especially the estimate of the volatility in the value of the underlying share price, that affect the resultant values and hence the amount of compensation expense recognized. We determine the estimate of volatility periodically based on the averages for the stocks of comparable publicly traded companies. Forfeitures are recorded as they occur. All stock based compensation expense is recorded using the straight-line method and is included in general and administrative expenses in the Consolidated Statements of Income and Comprehensive Income (Loss). +Determining Fair Market Value +Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our share-based compensation expense could be materially different in the future. We estimate the fair value of each option grant using the Black-Scholes option-pricing model. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected volatility —We developed our expected volatility by using the historical volatilities of our peer group of public companies. +59 +Risk-free interest rate —The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term —The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +Expected dividend yield —We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Recent Accounting Pronouncements +See Note 2—“Summary of Significant Accounting Policies” to our audited financial statements for a discussion of recently issued accounting pronouncements. +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +At December 31, 2016 and 2017, we held no significant derivative instruments that materially increased our exposure to market risks for interest rates, foreign currency rates, commodity prices or other market price risks. +Interest Rate Risk +We have interest rate exposure arising from our variable interest rate borrowings. These variable interest rate borrowings are impacted by changes in short-term interest rates. A hypothetical one-percentage point increase in interest rates on our long-term debt outstanding as of December 31, 2017 would increase our annual interest expense by $1.1 million. +Commodity Price Risk +Our fuel purchases expose us to commodity price risk. Our fuel costs consist primarily of diesel fuel used by our various trucks and other motorized equipment. The prices for fuel are volatile and are impacted by changes in supply and demand, as well as market uncertainty and regional shortages. Recently we have been able to pass along price increases to our customers; however, we may be unable to do so in the future. We generally do not engage in commodity price hedging activities. +Non-U.S. Currency Exchange Rates +We operate in the U.S. and Canadian markets, and as a result our primary exposure to fluctuations in currency exchange rates relates to fluctuations between the U.S. dollar and the Canadian dollar. In Canada, the effects of currency fluctuations are largely mitigated because local expenses of such operations are also generally denominated in the local currency. However, there may be instances in which costs and revenue will not be matched with respect to currency denomination and we may experience economic loss and a negative impact on earnings or net assets solely as a result of foreign currency exchange rate fluctuations. We do not hedge our exposure to changes in foreign exchange rates. See Item 1A. “Risk Factors—Our Canadian operations subject us to currency translation risk, which could cause our results to fluctuate significantly from period to period.” +Assets and liabilities for which the functional currency is the local currency are translated using the exchange rates in effect at the balance sheet date, resulting in translation adjustments that are reflected as accumulated other comprehensive income in the stockholders’ equity section on our balance sheet. We recorded adjustments of approximately $0.2 million to our equity account for each of the years ended December 31, 2017 and 2016 to reflect the net impact of the changes in the strength of the Canadian dollar against the U.S. dollar. +60 +Item 8. +Financial Statemen ts and Supplementary Data +Index to Consolidated Financial Statements +Reports of Independent Registered Public Accounting Firms +F-1 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-3 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016 and 2015 +F-4 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2017, 2016 and 2015 +F-5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015 +F-6 +Notes to Consolidated Financial Statements +F-7 +61 +Report of Independent Regist ered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of income and comprehensive income (loss), of stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2017, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, based on our audits and the report of other auditors with respect to the consolidated financial statements as of and for the year ended December 21, 2015, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. +We did not audit the consolidated financial statements of Beckman Production Services, Inc., a wholly owned subsidiary, as of and for the year ended December 31, 2015, which statements reflect total assets of $321.9 million as of December 31, 2015 and total revenues of $176.4 million for the year then ended. Those statements were audited by other auditors whose report thereon has been furnished to us and our opinion expressed herein, insofar as it relates to the amounts included for Beckman Production Services, Inc. as of and for the year ended December 31, 2015, is based solely on the report of the other auditors. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +March 29, 2018 +We have served as the Company's auditor since 2011. +F-1 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Nine Energy Services, Inc. +Houston, Texas +We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of Beckman Production Services, Inc. (the “Company”) for the year ended December 31, 2015. These financial statements (not presented herein) are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Beckman Production Services, Inc. for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. +/s/BDO USA, LLP +Houston, TX +March 21, 2017 +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +December 31 , 2017 and 2016 +2017 +2016 +(in thousands of dollars except shares) +Assets +Current assets +Cash and cash equivalents +$ +17,513 +$ +4,074 +Accounts receivable, net +99,565 +47,366 +Inventories +22,230 +15,169 +Income taxes receivable +— +14,620 +Prepaid expenses and other +7,929 +9,485 +Total current assets +147,237 +90,714 +Property and equipment, net +259,039 +273,210 +Goodwill +93,756 +125,286 +Intangible assets, net +63,545 +76,144 +Other long-term assets +4,806 +364 +Notes receivable from shareholders +10,476 +10,376 +Total assets +$ +578,859 +$ +576,094 +Liabilities and Stockholders’ Equity +Current liabilities +Long-term debt, current portion +$ +241,509 +$ +17,975 +Accounts payable +29,643 +18,823 +Accrued expenses +14,687 +12,417 +Income taxes payable +581 +— +Notes payable—insurance premium financing +— +272 +Total current liabilities +286,420 +49,487 +Long-term liabilities +Long-term debt +— +226,287 +Deferred taxes +5,017 +10,637 +Other long term liabilities +64 +1,497 +Total liabilities +291,501 +287,908 +Commitments and contingencies (Note 10) +Stockholders’ equity +Common stock (120,000,000 shares authorized at $.01 par value; 15,810,540 and 13,386,986 shares issued and outstanding at December 31, 2017 +and 2016, respectively) +158 +134 +Additional paid-in capital +384,965 +317,937 +Accumulated other comprehensive income (loss) +(3,684 +) +(3,486 +) +Retained earnings (accumulated deficit) +(94,081 +) +(26,399 +) +Total stockholders’ equity +287,358 +288,186 +Total liabilities and stockholders’ equity +$ +578,859 +$ +576,094 +All share data reflect the 8.0256 for 1 stock split that took place in January 2018 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +Years ended December 31, 2017, 2016 and 2015 +2017 +2016 +2015 +(in thousands of dollars, +except share and per share data) +Revenues +$ +543,660 +$ +282,354 +$ +478,522 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown +separately below) +448,467 +246,109 +373,191 +General and administrative expenses +49,552 +39,387 +42,862 +Depreciation +53,422 +55,260 +58,894 +Amortization of intangibles +8,799 +9,083 +8,650 +Impairment of goodwill +31,530 +12,207 +35,540 +Impairment of intangibles +3,800 +— +— +Loss on equity method investment +368 +— +— +Loss on sale of property and equipment +4,688 +3,320 +2,004 +Loss from operations +(56,966 +) +(83,012 +) +(42,619 +) +Other expense +Interest expense +15,703 +14,185 +9,886 +Total other expense +15,703 +14,185 +9,886 +Loss from continuing operations before income taxes +(72,669 +) +(97,197 +) +(52,505 +) +Benefit for income taxes +(4,987 +) +(26,286 +) +(14,323 +) +Loss from continuing operations, net of tax +(67,682 +) +(70,911 +) +(38,182 +) +Loss from discontinued operations, net of tax of $0, $0 and $513 +— +— +(935 +) +Net loss +$ +(67,682 +) +$ +(70,911 +) +$ +(39,117 +) +Loss per share from continuing operations—basic and diluted +$ +(4.55 +) +$ +(5.34 +) +$ +(2.89 +) +Loss per share from discontinued operations—basic and diluted +$ +— +$ +— +$ +(0.07 +) +Loss per share—basic and diluted +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +Weighted average shares outstanding +14,887,006 +13,268,540 +13,193,380 +Other comprehensive income, net of tax +Foreign currency translation adjustments, net of tax of $0, $0 and $0 +$ +(198 +) +$ +210 +$ +(4,067 +) +Total other comprehensive income (loss), net of tax +(198 +) +210 +(4,067 +) +Total comprehensive loss +$ +(67,880 +) +$ +(70,701 +) +$ +(43,184 +) +All share data reflect the 8.0256 for 1 stock split that took place in January 2018 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +Years ended December 31, 2017, 2016 and 2015 +Common stock +Additional +paid-in +Accumulated +other +comprehensive +Retained +earnings +(accumulated +Total +stockholders’ +Shares +Amounts +capital +income (loss) +deficit) +equity +(in thousands of dollars, except shares) +Stockholders’ equity as of December 31, 2014 +13,197,031 +$ +132 +$ +305,512 +$ +371 +$ +83,629 +$ +389,644 +Issuance of common stock +53,819 +1 +199 +— +— +200 +Stock-based compensation expense +30,031 +— +5,266 +— +— +5,266 +Exercise of stock options +15,593 +— +219 +— +— +219 +Issuance of shares for Scorpion acquisition +24,157 +— +1,000 +— +— +1,000 +Cancellation of shares in conjunction with repayment of notes receivable +(20,417 +) +— +(675 +) +— +— +(675 +) +Excess tax benefit on share based compensation +— +— +206 +— +— +206 +Other comprehensive loss +— +— +— +(4,067 +) +— +(4,067 +) +Net loss +— +— +— +— +(39,117 +) +(39,117 +) +Stockholders’ equity as of December 31, 2015 +13,300,214 +133 +311,727 +(3,696 +) +44,512 +352,676 +Issuance of common stock +86,772 +1 +499 +— +— +500 +Stock-based compensation expense +— +— +5,711 +— +— +5,711 +Other comprehensive income +— +— +— +210 +— +210 +Net loss +— +— +— +— +(70,911 +) +(70,911 +) +Stockholders’ equity as of December 31, 2016 +13,386,986 +$ +134 +$ +317,937 +$ +(3,486 +) +$ +(26,399 +) +$ +288,186 +Issuance of common stock +2,501,643 +25 +61,897 +— +— +61,922 +Distribution to non-accredited investors +(78,089 +) +(1 +) +(2,437 +) +— +— +(2,438 +) +Stock-based compensation expense +— +— +7,568 +— +— +7,568 +Other comprehensive income +— +— +— +(198 +) +— +(198 +) +Net loss +— +— +— +— +(67,682 +) +(67,682 +) +Stockholders’ equity as of December 31, 2017 +15,810,540 +$ +158 +$ +384,965 +$ +(3,684 +) +$ +(94,081 +) +$ +287,358 +All share data reflect the 8.0256 for 1 stock split that took place in January 2018 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +December 31, 2017, 2016 and 2015 +2017 +2016 +2015 +(in thousands of dollars) +Cash flows from operating activities +Net loss +$ +(67,682 +) +$ +(70,911 +) +$ +(39,117 +) +Adjustments to reconcile net loss to net cash (used in) provided by +operating activities +Depreciation +53,422 +55,260 +58,894 +Amortization of intangibles +8,799 +9,083 +8,650 +Amortization of deferred financing costs +1,615 +2,355 +1,027 +Provision for doubtful accounts +176 +— +1,170 +Deferred tax benefit +(5,815 +) +(12,159 +) +(15,836 +) +Impairment of goodwill +31,530 +12,207 +35,540 +Impairment of intangibles +3,800 +— +— +Provision for inventory obsolescence +1,359 +287 +2,772 +Stock-based and deferred compensation expense +7,568 +5,711 +5,473 +Loss on sales of assets +4,688 +3,320 +2,004 +Loss (gain) on revaluation of contingent consideration +415 +1,735 +(293 +) +Loss on equity method investment +368 +— +— +Changes in operating assets and liabilities, net of effects from acquisitions +Accounts receivable +(52,180 +) +2,073 +88,880 +Inventories +(8,212 +) +(558 +) +3,524 +Prepaid expenses and other current assets +1,472 +(3,172 +) +1,259 +Accounts payable and accrued expenses +12,530 +(2,396 +) +(24,141 +) +Income taxes receivable/payable +15,158 +(5,848 +) +10,495 +Other assets and liabilities +(3,340 +) +(277 +) +66 +Net cash (used in) provided by operating activities +5,671 +(3,290 +) +140,367 +Cash flows from investing activities +Entity acquisitions, no cash acquired +— +— +(397 +) +Proceeds from sales of assets +1,452 +2,918 +5,241 +Proceeds from property and equipment casualty losses +300 +262 +2,388 +Proceeds from notes receivable payments +- +1,774 +243 +Purchases of property and equipment +(45,216 +) +(9,130 +) +(26,726 +) +Equity method investment in DIT +(1,000 +) +— +— +Net cash used in investing activities +(44,464 +) +(4,176 +) +(19,251 +) +Cash flows from financing activities +Borrowings on revolving credit facilities +56,481 +75,136 +15,641 +Payments on revolving credit facilities +(38,287 +) +(61,956 +) +(134,351 +) +Payments on term loans +(22,475 +) +(19,725 +) +(8,500 +) +Proceeds from notes payable—insurance premium financing +— +1,127 +— +Payments on notes payable—insurance premium financing +(272 +) +(855 +) +— +Payment of contingent liability on Scorpion purchase +(1,325 +) +(297 +) +— +Payments on capital lease obligations +— +— +(70 +) +Proceeds from share issuances +61,374 +500 +419 +Distribution to shareholders +(2,438 +) +— +— +Deferred financing costs +(716 +) +(1,245 +) +(17 +) +Net cash used in financing activities +52,342 +(7,315 +) +(126,878 +) +Net increase (decrease) in cash and cash equivalents +13,549 +(14,781 +) +(5,762 +) +Impact of foreign currency exchange on cash +(110 +) +(22 +) +403 +Cash and cash equivalents +Beginning of year +4,074 +18,877 +24,236 +End of year +$ +17,513 +$ +4,074 +$ +18,877 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Description of business and organization +Nine Energy Service, Inc. (the “Company”, “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies, and provides a range of production enhancement and well workover services. The Company is headquartered in Houston, Texas. +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017 (“Combination”) the Company merged with Beckman Production Services, Inc., (“Beckman”) and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc. Prior to the Combination, SCF-VII, L.P. had controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the combined Company was accounted for using reorganization accounting (i.e., “as if” pooling of interest) for entities under common control. +As of December 31, 2017, the Company had $119.9 million of debt scheduled to mature on May 31, 2018 and $122.3 million of debt scheduled to mature on June 30, 2018. The Company did not have sufficient liquidity and capital resources to repay the outstanding debt on its maturity dates. The accompanying consolidated financial statements have been prepared on a basis which assumes that the Company will continue as a going concern and which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. The Company performed an evaluation of its ability to continue as a going concern within one year after the date that the consolidated financial statements are issued and concluded that, due to the Company’s initial public offering of stock in January 2018 and subsequent funding of a new credit agreement, the Company will continue as a going concern. With the proceeds of the IPO and the new debt agreement, the Company paid all of the debt outstanding at December 31, 2017 during January 2018 (Note 7). +2. Significant accounting policies +Basis of presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). +Principles of consolidation +The consolidated financial statements as of December 31, 2017, 2016 and 2015, and for the years then ended, include the accounts of Nine Energy Service, Inc. and Beckman Production Services, Inc. and their wholly owned subsidiaries since the date of their respective acquisition (Note 1). The Company’s historical financial information was recast to combine the financial statements of the Company with those of Beckman as if the combination had been in effect since inception of common control. All inter-company balances and transactions have been eliminated in the consolidation. +Use of estimates +The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include but are not limited to fair value assumptions used in purchase accounting and in analyzing goodwill, other intangibles and long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, stock based compensation fair value, estimated realizable value on excess and obsolete inventories, deferred taxes and income tax contingencies and losses on accounts receivable. It is at least reasonably possible that the estimates used will change within the next year +F-7 +Revenue recognition +The Company recognizes revenue for equipment, products and services based upon purchase orders, contracts or other persuasive evidence of an arrangement with the customer that include fixed or determinable prices and that do not include right of return or other similar provisions or other post-delivery obligations. Revenue is recognized for products upon delivery, customer acceptance and when collectability is reasonably assured. Revenue is recognized for services when they are rendered and collectability is reasonably assured. +Cash and cash equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances on the Consolidated Balance Sheets. +Foreign currency +The Company’s functional currency is the U.S. Dollar (“USD”). The financial position and results of operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the consolidated balance sheet date. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the accompanying Consolidated Statements of Income and Comprehensive Income (Loss) and changes in stockholders’ equity. +Accounts receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices, industry and customer historical experience as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +Bad debt expense was $0.2 million for the year ended December 31, 2017, and $1.2 million for the year ended December 31, 2015. There was no bad debt expense for the year ended December 31, 2016. The allowance for doubtful accounts was $0.6 million and $0.4 million at December 31, 2017 and 2016, respectively. +Concentration of credit risk +The majority of the Company’s customers operate in the oil and gas industry. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development and production activity as well as the entire health of the oil and natural gas industry, and can therefore negatively impact spending by the Company’s customers. +Revenues for the years ended December 31, 2016 and 2015 each included sales to one customer that individually represented 10% or more of total revenue. No customer accounted for at least 10% of revenues for the year ended December 31, 2017. +F-8 +Inventories +Inventories, classified as finished goods, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserves for obsolescence were $2.9 million and $3.3 million at December 31, 2017 and 2016, respectively. +2017 +2016 +(in thousands of dollars) +Raw Materials +$ +939 +$ +605 +Finished Goods +21,291 +14,564 +Total +$ +22,230 +$ +15,169 +Concentration of supplier risk +Purchases during the years ended December 31, 2017 and 2016 included purchases from one supplier that individually represented more than 10% of total operating purchases. The accounts payable to this vendor totaled 17% and 11% of total accounts payable at December 31, 2017 and 2016, respectively. No supplier accounted for more than 10% of operating purchases during the year ended December 31, 2015. +Equity method investment +The Company accounts for investments, which it does not control but has the ability to significantly influence, using the equity method of accounting. Under this method, the investment is carried originally at cost, increased by any allocated share of the investee’s net income and contributions made, and decreased by any allocated share of the investee’s net losses and distributions received. The investee’s allocated share of income and losses is based on the rights and priorities outlined in the equity investment agreement. +On March 13, 2017, the Company entered into an agreement to acquire shares of the Series B Preferred Stock of Deep Imaging Technologies (“DIT”) for $1.0 million. DIT provides an advanced electromagnetic fracture monitoring service which will allow our customers to make on-site decisions regarding efficiencies. The Company’s investment in DIT is accounted for as an equity method investment, as the Company has a non-controlling interest in DIT but has the ability to exercise significant influence. +From the date of the investment through December 31, 2017, the Company’s share of DIT’s net loss was $0.4 million, and is reported as “loss on equity method investment” in the Consolidated Statements of Income and Comprehensive Income (Loss) and as a reduction of the investment in DIT, which is reported within “other long-term assets” in the Consolidated Balance Sheets. +Property and equipment +Property and equipment are recorded at cost, less applicable depreciation. Equipment held under capital leases is stated at the present value future minimum lease payments. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Equipment held under capital leases is amortized over the shorter of the lease term or the estimated useful life of the asset. Maintenance and repairs are charged to operating expense as incurred; significant renewals and betterments are capitalized. +Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable. For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets are less than their carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value. The costs of assets that are sold or retired and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income. +F-9 +Goodwill and intangible assets +For goodwill and indefinite lived intangibles, an assessment for impairment is performed annually or when there is an indication an impairment may have occurred. The Company completes its annual impairment test for goodwill using an assessment date as of December 31 for each of the Company’s seven operating units. Through 2016, Beckman’s goodwill was tested for impairment as of October 31. The testing date was changed to December 31 in 2017 in order to align the timing of the assessment with the Company’s planning and forecasting process. This is not considered a material change in accounting principle. +In the first step of the impairment test, the Company determines the fair value of its individual operating units by blending two valuation approaches: the income and market value approach. The income approach uses the Company’s own market assumptions, including projections of future cash flows, determinations of appropriate discount rates, and other assumptions which are considered reasonable and inherent in the discounted cash flow analysis. The projections are based on historical performance and future estimated results. The market value approach uses financial information from comparable entities. If the carrying amount exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the goodwill is estimated as the fair value of the operating unit used in the first step less the fair values of all other net tangible and intangible assets of the operating unit. If the carrying amount of the goodwill exceeds its implied fair market value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. +Intangible assets with finite lives, including customer relationships, technology, and non-compete agreements are amortized on a straight-line basis over the life of the intangible assets, for three to fifteen years. These assets are tested for impairment whenever events or changes in circumstances indicated that their carrying amount may not be recoverable. +Equity +In January 2018, there was an 8.0256 for 1 stock split immediately preceding the IPO. All shares and per share data reflect the effect of the stock split. +Share-based compensation +The Company measures employee share-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. The Company has stock-based compensation plans for certain of its employees. Compensation expense is recorded for restricted stock over the applicable vesting period based on the fair value of the stock on the date of grant. Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options, and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. +Fair value of the share-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +Expected life +The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected volatility +Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. Since the Company’s stock is not publicly traded, the Company determines volatility based on an analysis of the PHLX Oil Service Index that tracks publicly traded oilfield service stocks. +F-10 +Dividend yield +At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +Risk-free interest rate +The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Forfeitures +As a result of the adoption of ASC No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Fair value of common stock +The value of the Company’s stock at the time of each option grant used to establish the strike price is estimated by management in accordance with an internal valuation model, and approved by the Company’s Board of Directors. The valuation model is based upon an average of cash flow and book value multiples of comparable companies. The comparable companies selected reflect the market’s view on key sector, geographic, and product type exposure that are similar to those that impact the Company’s business. The value is further subject to judgmental factors such as prevailing market conditions, changes in the stock prices of other oilfield service companies and the overall outlook for the Company and its products in general. +Going forward, the stock value will be the publicly traded share price. +Income taxes +The Company follows the asset and liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date, and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +Deferred financing costs +Deferred financing costs are amortized over the life of the related debt using the effective interest method. The Company expensed approximately $1.6 million, $2.4 million and $1.0 million of deferred financing costs during the years ended December 31, 2017, 2016 and 2015, respectively, which amounts are included in interest expense in the statements of comprehensive income. The expense included the write-off of approximately $0.1 million and $1.0 million of deferred financing costs for the years ended December 2017 and 2016. The amount written off represents the portion of the deferred financing costs related to the reduction in the amount available in the revolving credit facilities during 2017 and 2016 (Note 7). +Deferred financing costs of $0.7 million and $1.6 million at December 31, 2017 and 2016, respectively, are reported as a reduction of long-term debt (Note 7). +F-11 +Fair value of financial instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. The book values of other financial instruments, such as the Company’s debt under its Credit Facilities (Note 7), approximates fair value because interest rates charged are similar to other financial instruments with similar terms and maturities and the rates vary in accordance with a market index. +For the financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• +Level 1—inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• +Level 2—inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• +Level 3—inputs are unobservable for the asset or liability, which reflect the best judgment of management. +The financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +Earnings per share +Basic income per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. The diluted income per share computation is calculated by dividing net income by the weighted-average number of common shares outstanding during the period, taking into effect, if any, of shares that would be issuable upon the exercise of outstanding stock options, reduced by the number of shares purchased by the Company at cost, when such amounts are dilutive to the earnings per share calculation. There is no dilutive effect for 2017, 2016 or 2015 since the company is in a net loss position. +Recently issued accounting pronouncements +In May 2014, the Financial Accounting Standards Board (‘‘FASB’’) issued Accounting Standards Update (‘‘ASU’’) No. 2014-09, Revenue from Contracts with Customers , which supersedes the current revenue recognition guidance. The ASU is based on the principle that revenue is recognized to depict the transfer of goods and services to customers in the amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and asset recognized from costs incurred to obtain or fulfill a contract. The new standard will be effective for the Company for the fiscal years beginning after December 31, 2018 using one of two retrospective application methods. The Company is currently evaluating the impacts of adoption of this guidance. +In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory , which requires companies to measure inventory at the lower of cost or net realizable value rather than at the lower of cost or market. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The Company adopted this ASU in the first quarter of 2017 and the adoption of this ASU did not have a material impact on the consolidated financial statements and related disclosures. +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Upon adoption of the new guidance, lessees are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective +F-12 +approach. Although the new guidance will be generally effective for fiscal years beginning after Dec ember 15, 2018, the Company plans to adopt for fiscal years beginning after December 31, 2019 as an emerging growth company. The Company is currently evaluating the impacts of adoption of this guidance. +In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business , in an effort to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this standard provide a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the integrated set of assets and activities is not a business. Although the new guidance is generally effective for fiscal years beginning after December 15, 2017, the Company plans to adopt for the fiscal years beginning after December 31, 2018 as an emerging growth company. Early adoption is allowed for transactions for which the acquisition date occurs before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance and for transactions in which a subsidiary is deconsolidated or a group of assets is derecognized before the issuance date or effective date of the amendments. Entities will be required to apply the guidance prospectively when adopted. The Company is evaluating the impact this new pronouncement will have on the consolidated financial statements. +In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other which simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the new standard, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of an operating unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the operating unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that operating unit. An entity still has the option to perform the qualitative assessment for an operating unit to determine if the quantitative impairment test is necessary. The new guidance should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is evaluating the financial statement implications of adopting ASU 2017-04. +In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230)—Classification of Certain Cash Receipts and Cash Payment . This new guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice, including: debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is evaluating the financial statement implications of adopting ASU 2016-15. +3. Acquisitions and combinations +Beckman combination +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017, the Company merged with Beckman and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc. Beckman shares were converted at a ratio of 0.567154 Nine shares per Beckman share. Prior to the Combination, SCF-VII, L.P. had controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the Company was accounted for using reorganization accounting (i.e., “as if” pooling of interest) for entities under common control. +F-13 +In conjunction with the Combination, other events occurred, including: +• +The conversion of certain Beckman shares into cash at the price of $17.69 per Beckman share. These shares were owned by non-accredited shareholders of Beckman at the time of the Combination; +• +Payment of cash for a certain number of Beckman shares that converted into fractional Nine shares at the price of $31.18 per Nine share; +• +The conversion of Beckman options to purchase Beckman common stock into options to purchase Nine shares; +• +The conversion of Beckman restricted shares into Nine restricted shares; +• +The conversion of Beckman warrants to purchase Beckman common stock in warrants to purchase Nine shares; +• +The issuance of options to purchase Nine common stock; +• +The issuance, on a pro-rata basis, to the Company’s shareholders, of Nine common stock based on a subscription amount equal to the number of common shares issued at a price of $31.18. The subscription was offered to all shareholders on record at the time of the Combination. Any unsubscribed shares were reallocated among the shareholders; and +• +The issuance, to the Company’s shareholders, of Nine warrants equal to one half of the amount of shares issued related to the subscription described above. +4. Property and equipment +The following is a summary of property and equipment as of December 31, 2017 and 2016: +Estimated +useful lives +2017 +2016 +(in thousands of dollars) +Operating equipment +1 to 12 years +$ +397,802 +$ +370,153 +Autos and trucks +1 to 7 years +32,973 +33,892 +Furniture, fixtures and equipment +2 to 12 years +3,179 +2,913 +Shop equipment +3 to 15 years +13,463 +7,535 +Buildings +7 to 39 years +14,260 +14,901 +Leasehold improvements +3 to 10 years +963 +936 +Land +indefinite +2,087 +1,777 +464,727 +432,107 +Less: Accumulated depreciation +(205,688 +) +(158,897 +) +$ +259,039 +$ +273,210 +Depreciation expense was $53.4 million, $55.3 million and $58.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. Depreciation expense related to cost of revenues but reported separately as part of depreciation expense, was $52.5 million, $54.3 million and $58.0 million for the years ended December 31, 2017, 2016 and 2015, respectively. +F-14 +5. Goodwill and intangible assets +The changes in the net carrying amount of the components of goodwill and intangible assets for the years ended December 31, 2017 and 2016 were as follows: +Goodwill +Gross value +Accumulated impairment loss +Net +(in thousands of dollars) +Balances as of December 31, 2015 +$ +173,033 +$ +(35,540 +) +$ +137,493 +Impairment +— +(12,207 +) +(12,207 +) +Balance as of December 31, 2016 +$ +173,033 +$ +(47,747 +) +$ +125,286 +Impairment +— +(31,530 +) +(31,530 +) +Balance as of December 31, 2017 +$ +173,033 +$ +(79,277 +) +$ +93,756 +Intangible assets +Gross value +Accumulated amortization +Net +(in thousands of dollars) +Balances as of December 31, 2015 +$ +105,464 +$ +(20,237 +) +$ +85,227 +Amortization expense +— +(9,083 +) +(9,083 +) +Impairment +— +— +— +Balance as of December 31, 2016 +$ +105,464 +$ +(29,320 +) +$ +76,144 +Amortization expense +— +(8,799 +) +(8,799 +) +Impairment +(12,000 +) +8,200 +(3,800 +) +Balance as of December 31, 2017 +$ +93,464 +$ +(29,919 +) +$ +63,545 +The Company performs its annual impairment tests of goodwill as of December 31. Prior to 2017, Beckman performed its annual impairment tests as of October 31. The impairment test date was changed to December 31 in order to align more closely with the Company’s planning and forecasting process. +At December 31, 2017, the Company performed its annual impairment test on each of its operating units and concluded that there was impairment at one operating unit in our Completion Solutions segment because its carrying value exceeded its estimated fair value, which resulted from declining profitability and deteriorating market conditions. The Company recognized a goodwill impairment loss of $31.5 million. At December 31, 2016, the annual impairment test indicated impairment in another operating unit in the Completion Solutions segment on which impairment was also recognized during 2015, because its carrying value exceeded its estimated fair value, which resulted from continued deterioration of market conditions. The Company recognized an impairment loss of $12.2 million. +The December 31, 2017 impairment test for the Production Solutions segment indicated that the estimated fair value calculation provided only 11% of cushion in relation to carrying value. As a result, this segment’s goodwill, which totals $13.0 million, is susceptible to impairment risk from adverse economic conditions in the future. +At the time of the acquisition of one of the Completion Solutions operating units, a customer relationships intangible was recorded, based on revenue from existing customers. During 2017, the completions methodology in the area where the operating unit is located continued to evolve from open hole completions to significantly less profitable cemented liners. Due to declining revenue and profitability, the Company considered whether the operating unit’s asset group, which includes the intangible asset, should be tested for recoverability. Based on the significance of the events or changes in circumstances, the Company concluded that the carrying amounts of these assets were not recoverable. Fair value was determined by estimating the net present value of the future cash flows over the life of the assets. Using Level 3 inputs of the fair value hierarch, critical assumptions for those valuations include estimated activity levels, revenue and operating expenses. The Company incurred $3.8 million of intangible asset impairments for the year ended December 31, 2017. This impairment was recorded as “Impairment of Intangibles” in the Consolidated Statement of Income and Comprehensive Income (loss). +F-15 +Amortization expense of $8.8 million, $9.1 million and $8.7 million for the years ended December 31, 2017, 2016 and 2015, respectively, is related to cost of revenues, but report ed separately. +Goodwill by segment for the years ended December 31, 2017 and 2016 was as follows: +Completion Solutions +Production Solutions +Total +(in thousands of dollars) +2017 +2016 +2017 +2016 +2017 +2016 +Balances as of January 1 +$ +112,300 +$ +124,507 +$ +12,986 +$ +12,986 +$ +125,286 +$ +137,493 +Impairment +(31,530 +) +(12,207 +) +- +- +(31,530 +) +(12,207 +) +Balances as of December 31 +$ +80,770 +$ +112,300 +$ +12,986 +$ +12,986 +$ +93,756 +$ +125,286 +Intangible assets arising from business acquisitions consisted of the following: +December 31, 2016 +Amortization +period +Gross +Accumulated +amortization +Net +(in thousands of dollars) +Customer relationships +8 to 15 years +$ +76,040 +$ +(24,896 +) +$ +51,144 +Noncompete agreements +3 to 5 years +4,966 +(3,452 +) +1,514 +Technology +6 years +1,870 +(415 +) +1,455 +Trademarks +Indefinite +22,020 +— +22,020 +Other intangible assets +4 years +550 +(539 +) +11 +$ +105,446 +$ +(29,302 +) +$ +76,144 +December 31, 2017 +Amortization +period +Gross +Accumulated +amortization +Net +(in thousands of dollars) +Customer relationships +8 to 15 years +$ +64,040 +$ +(24,395 +) +$ +39,645 +Noncompete agreements +3 to 5 years +4,966 +(4,241 +) +725 +Technology +6 years +1,870 +(726 +) +1,144 +Trademarks +Indefinite +22,020 +— +22,020 +Other intangible assets +4 years +550 +(539 +) +11 +$ +93,446 +$ +(29,901 +) +$ +63,545 +The weighted average remaining useful life of the intangible assets as of December 31, 2017 was 7.5 years. Future estimated amortization expense is as follows: +(in thousands of dollars) +Year Ending December 31, +2018 +$ +7,431 +2019 +6,925 +2020 +6,604 +2021 +6,253 +2022 +3,603 +Thereafter +10,709 +$ +41,525 +F-16 +6. Accrued expenses +Accrued expenses consisted of the following as of December 31, 2017 and 2016: +2017 +2016 +(in thousands of dollars) +Accrued compensation and benefits +$ +6,923 +$ +4,922 +Accrued management bonus +1,351 +- +Sales tax payable +767 +820 +Accrued expenses +3,685 +4,031 +Accrued property tax +83 +764 +Accrued interest +148 +96 +Scorpion contingent liability +1,730 +1,784 +$ +14,687 +$ +12,417 +7. Long-term debt +Long-term debt consists of the following as of December 31, 2017 and 2016: +2017 +2016 +(in thousands of dollars) +Nine US revolving credit facility +$ +75,000 +$ +55,500 +Nine US term loan +35,175 +56,150 +Nine Canada revolving credit facility +9,760 +8,938 +Beckman revolving credit facility +110,800 +114,300 +Beckman term loan +11,500 +11,000 +Total debt before deferred financing costs +$ +242,235 +$ +245,888 +Deferred financing costs +(726 +) +(1,626 +) +Total +$ +241,509 +$ +244,262 +Less Current portion +(241,509 +) +(17,975 +) +Long-term debt +$ +- +$ +226,287 +Nine credit facilities +In conjunction with the Crest Pumping Technologies (“Crest”) acquisition on June 30, 2014, the Company entered into a $300 million credit facility arrangement with several major financial institutions, secured by substantially all of the Company’s assets. Under the credit facility arrangement, $270 million could be borrowed in the U.S., consisting of an $85 million 5-year Term Loan and a $185 million Revolving Credit Facility, and $30 million could be borrowed in Canada under a Revolving Credit Facility. The maturity date was June 30, 2019. Interest rates were based on prime rate, the federal funds rate or the London Interbank Offered Rate (LIBOR), plus a margin determined by the funded debt to EBITDA ratio. There was also a standby fee of 0.375% to 0.5%. Interest rates ranged from 2.2% to 3.4% during 2015 and were approximately 2.7% in 2016 through May 13, 2016 when the Company entered into an amendment to the credit facility (see below). The debt covenants required that the ratio of debt to Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) be no higher than 3.5 to 1 during the period from inception of the loan through December 31, 2014, 3.25 to 1 from January through June 2015 and 3 to 1 thereafter. +On May 13, 2016, the Company entered into an amendment to the credit facility (“Amended Credit Facility”) described above. The Amended Credit Facility reduced the borrowing capacity of the Revolving Credit Facility to $75 million in the US and $13 million in Canada, with a new maturity date of January 1, 2018 and increased interest rates and standby fees. The amendment waived all previous covenants through 2016, established minimum 12-month EBITDA targets for the quarter ended June 30, 2016 through the quarter ended June 30, 2017 and limited the amount of capital expenditures in 2016 and 2017. The amendment established a debt to EBITDA ratio of 4.5 starting +F-17 +subsequent to June 30, 2017, and EBITDA to fixed charge ratios of 1.0 0 for the quarters ended March 31 and June 30, 2017 and a ratio of 1.25 for the quarter ended September 30, 2017 and thereafter. (Fixed charges include interest, term loan payments, capital expenditures and income tax payments.) The amendment also required that all future income tax refunds resulting from net operating losses be used to prepay term loan advances in reverse order of maturity. +On August 2, 2017, the Company amended the Existing Nine Credit Facility (“Amended Existing Nine Credit Facility”) and secured approval of the amendment by Legacy Nine’s existing lenders. Under the Amended Existing Nine Credit Facility, the current maturity date of January 1, 2018 was extended to May 31, 2018 and certain covenants, such as fixed charge coverage ratio, total leverage ratio and minimum EBITDA were modified to coincide with the extended maturity date. +The Company was in compliance with all debt covenants as of December 31, 2017. +Beckman credit facilities +On May 2, 2014, the Company entered into a new senior secured credit agreement with several major financial institutions (“2014 Credit Facility”). The senior secured credit financing consisted of a revolving credit facility in an aggregate amount of $170 million with an accordion feature of up to $50 million in the aggregate. The 2014 Credit Facility was secured by first priority perfected security interest in all equity interests of domestic subsidiaries, 65% of the voting equity of directly owned foreign subsidiaries, and substantially all of the tangible and intangible assets of the Company. Interest only is due monthly and calculated at 2.50% above the London Interbank Offered Rate (LIBOR) or 1.50% above the Alternate Base Rate. The credit agreement was to mature on May 2, 2019. As a requirement of the credit agreement, on May 2, 2014 the Company paid the outstanding balance under a 2012 credit agreement of $31.5 million revolving credit and the term loan of $28.1 million. +The credit agreement contained certain financial covenants which, among other things, limited Beckman’s spending for capital expenditures and required that certain financial ratios be maintained. During 2014, the credit agreement was amended three times, primarily to increase the aggregate amount of the credit facility. +On January 12, 2016, Beckman entered into Amendment No. 4 to the 2014 Credit Facility. The amendment reduced the total aggregate commitments of the lenders from $235 million to $145 million, limited borrowing availability subject to a new borrowing basic mechanic, and amended certain covenant compliance and reporting requirements of the Company. Effective with the amendment date, $12.5 million of the outstanding revolver was converted to a term advance. Repayment of $1.5 million was required in 2016, $3.1 million is required in 2017 and the remainder is due on June 30, 2018. +The amended credit agreement contained certain financial covenants which, among other things, limited spending on capital expenditures and required that certain financial ratios be maintained. Beckman was required to provide a monthly borrowing base certificate which calculates the available borrowing base and reports compliance commencing January 2016. The Company was to provide a cash availability report each week commencing in January 2016 whereby cash on hand at the beginning of the week could not exceed $3.0 million. The leverage ratio was waived through the quarter ending March 31, 2017 and could not be more than 3.50 to 1.00 commencing with the quarter ending June 30, 2017. The fixed charge coverage as of the last day of each quarter, commencing with the quarter ending March 31, 2016, was to be less than 1.15 to 1.00 for each fiscal quarter ending on or prior to March 31, 2017 and 1.25 to 1.00 for each fiscal quarter ending after March 31, 2017. Capital expenditures in the fiscal year ended December 31, 2016, were not to exceed $15 million, and in each year ending after December 31, 2016, were not to exceed 75% of EBITDA for the immediately preceding year. Beckman was in compliance with all covenants during 2017 and 2016. +On February 10, 2017, Beckman entered into Amendment No. 5 to the 2014 Credit Facility. The amendment reduces the total aggregate commitments of the lenders from $145 million to $127.3 million, limits borrowing availability subject to a new borrowing basic mechanic, and amends certain covenant compliance and reporting requirements. As a requirement of this amendment, immediately prior to the amendment date, Beckman received $15.0 million of equity proceeds from certain of its shareholders. Effective with the amendment date, these proceeds were used to prepay the outstanding revolver $10.0 million and the term advance $5 million, of which $3.9 million was applied as prepayment of the scheduled amortization payments that were due March 31, 2017 through March +F-18 +31, 2018 and $106.3 million of the outstanding revolver was converted to a second term advance. The amendment provides for a $15 million revolver of which $2.5 million was drawn on the date of the amendment. Required repayment s of the original term advance are $1.5 million in 2017, $0.8 million by March 31, 2018 and the remainder on June 30, 2018. +The amended credit agreement contains certain financial covenants which, among other things, limit spending on capital expenditures and require that certain financial ratios be maintained. Certain of the requirements are: +Beckman must provide a monthly borrowing base certificate which calculates the available borrowing base and reports compliance commencing February 2017; +Beckman must provide a cash availability report each month commencing in February 2017 whereby cash on hand on the last business day of the month cannot exceed $6.0 million; +The leverage ratio is waived through the quarter ending September 30, 2017 and cannot be more than 3.50 to 1.00 commencing with the quarter ending December 31, 2017; +The interest coverage ratio remains waived; +The fixed charge coverage as of the last day of each quarter, commencing with the quarter ending March 31, 2016, to be a) less than 1.15 to 1.00 for each fiscal quarter ending on or prior to June 30, 2017 and b) 1.25 to 1.00 for each fiscal quarter ending after June 30, 2017; and +Capital expenditures in the fiscal year ended December 31, 2017 must not exceed $20.0 million, and in each year ending after December 31, 2017 must not exceed 75% of EBITDA for the immediately preceding year. +As of December 31, 2017, $6.0 million was outstanding under the original term advance, $104.8 million was outstanding under the second term advance, $11.5 million was outstanding under the revolver and $0.7 million was outstanding under a letter of credit. As of December 31, 2017, the Company had $2.9 million available under the revolver. The Company was in compliance with all covenants as of December 31, 2017. +Nine and Beckman combined +All of the Company’s debt is payable during 2018. In accordance with ASC 2015-4, Going Concern, the Company evaluated whether there are conditions and events that raise substantial doubt about the Company’s ability to continue as a going concern for a period of one year after the date that the financial statements are issued. The Company had $119.9 million of debt outstanding, under the revolving credit facility and term loan discussed above, as of December 31, 2017 that is scheduled to mature on May 31, 2018, and $122.3 million that is scheduled to mature on June 30, 2018. At December 31, 2017 Company did not expect to have sufficient liquidity and capital resources to repay the debt outstanding in full on its maturity date. This condition raised substantial doubt about the Company’s ability to continue as a going concern for a period of one year after the date that the consolidated financial statements are issued. However, the substantial doubt about the Company’s ability to continue as a going concern has been alleviated, as proceeds from the IPO and new debt facility, described below, were used to pay the debt that was outstanding at December 31, 2017, and the only debt outstanding now is related to the new debt facility, on which no payments are due until 2019. +As explained in Note 2, the Company completed its initial public offering of stock on January 23, 2018. On September 15, 2017, in anticipation of the IPO, the Company completed negotiations of terms for a new Credit Facility (the “New Facility”) that became effective upon the consummation of the IPO. Under this New Facility, all balances owed under the Legacy Nine and Legacy Beckman entities’ Credit Facilities (“the Legacy Facilities”) were paid in full immediately following funding of the IPO, and are no longer in effect. The New Facility aggregates the Company’s collateral and security and recognizes the Company as a single combined entity. The New Facility consists of a Term Loan Facility of up to $125 million, but in any event no less than $100 million, amortizable at a quarterly rate of 2.5%, and a $50 million Revolving Credit Facility. The New Facility has a maturity date of 2.5 years from the date of the consummation of the IPO. The Company incurred $0.3 million of legal fees in connection with the New Facility during the year ended December 31, 2017, which are reported within “Prepaid expenses and +F-19 +other” in the Consolidated Balance Sheets as of December 31, 2017 pending consummation of the IPO and funding of the New Facility. +Fair value of debt +The fair value (level 2) of debt approximates book value, as its interest rates are variable and based on market rates. +8. Defined contribution plans +Nine and Beckman both sponsor defined contribution plans under Section 401(k) of the Internal Revenue Code for all qualified employees. +Under Nine’s plan, employee contributions are matched by the Company at 100% of the first 3% and 50% of the remaining up to 5% of compensation that a participant contributes to the Plan. Contributions were $1.3 million during 2015, but contributions were suspended for part of 2015 and no contributions were made in 2016 or 2017. +Under Beckman’s plan, employee contributions are matched by the Company at 50% of the first 5% of compensation that a participant contributes to the Plan. The Company contributed $0.4 million during 2015. The Company made no contributions during 2016, but incurred a liability of $0.4 million for contributions that were made in 2017. During 2017, the Company incurred a liability of $0.6 million for contributions to be made in 2018. +9. Stock based compensation +Nine +Stock options +Information about stock option activity during the years ended December 31, 2017 and 2016 is as follows: +2017 Activity +Number of +shares in +underlying +options +Weighted +average +exercise price +Remaining +weighted avg +contractual life +in years +Intrinsic value +(in thousands) +Beginning balance +656,646 +$ +31.26 +6.9 +$ +2,863 +Beckman options converted to Nine options +78,714 +27.03 +5.9 +360 +Granted +471,456 +30.94 +9.2 +113 +Exercised +— +— +— +— +Forfeited +(138,025 +) +31.38 +8.6 +55 +Total outstanding +1,068,791 +$ +30.79 +7.6 +$ +3,282 +Options exercisable +347,225 +$ +23.77 +6.1 +$ +2,571 +2016 Activity +Number of +shares in +underlying +options +Weighted +average +exercise price +Remaining +weighted avg +contractual life +in years +Intrinsic value +(in thousands) +Beginning balance +604,745 +$ +32.50 +7.6 +$ +502 +Granted +81,002 +22.70 +9.7 +— +Exercised +— +— +— +— +Forfeited +(29,101 +) +32.75 +7.8 +14 +Total outstanding +656,646 +$ +31.26 +7.9 +$ +502 +Options exercisable +169,003 +$ +39.51 +8.2 +$ +- +F-20 +The intrinsic value at December 31, 2017 and 2016 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2017 and 2016, respectively. +The assumptions used in the Black-Scholes pricing model to estimate the fair value of the options granted in 2017, 2016 and 2015 are as follows: +2017 +2016 +2015 +Weighted average fair value +$ +14.70 +$ +10.44 +$ +17.21 +Assumptions +Expected life (in years) +6.0 +6.0 +6.0 +Volatility +47.1 +% +47.0 +% +49.6 +% +Dividend yield +0.0 +% +0.0 +% +0.0 +% +Risk free interest rate +2.16 +% +1.46 +% +1.86 +% +Compensation expense recorded was approximately $3.3 million, $2.7 million and $1.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. As of December 31, 2017, the Company expects to record compensation expense of approximately $5.7 million over the remaining options term of approximately 2.4 years. Future stock option grants will result in additional compensation expense. +Restricted stock +Information about restricted stock activity during the years ended December 31, 2017 and 2016 is as follows: +2017 +2016 +2015 +Nonvested at the beginning of the year +131,179 +146,074 +45,200 +Beckman restricted stock converted to Nine restricted stock +91,961 +— +— +Granted +302,797 +24,157 +200,680 +Vested +(77,093 +) +(39,052 +) +(12,568 +) +Cancelled +(74,983 +) +— +(87,238 +) +Nonvested at the end of the year +373,861 +131,179 +146,074 +The weighted-average grant date fair value of the restricted stock was $31.18, $22.63 and $38.00 during the years ended December 31, 2017, 2016 and 2015, respectively. The total amount of compensation expense related to the restricted stock awards recorded was approximately $4.3 million, $1.7 million and $1.1 million for the years ended December 31, 2017, 2016 and 2015, respectively. As of December 31, 2017, the Company expects to record compensation expense of approximately $7.0 million over the remaining restricted stock term of approximately 2.3 years. +Beckman +Stock options +During 2017, concurrent with the combination of Nine and Beckman, all Beckman stock options were converted to Nine stock options. Information about stock option activity during the years ended December 31, 2017 and 2016 follows: +F-21 +2017 Activity +Number of +shares in +underlying +options +Weighted +average +exercise price +Remaining +weighted avg +contractual life +in years +Intrinsic value +(in thousands) +Beginning balance +17,313 +$ +123.02 +5.9 +$ +- +Beckman options converted to Nine options +(17,313 +) +123.02 +5.9 +- +Granted +- +- +- +- +Exercised +- +- +- +- +Forfeited +- +- +- +- +Total outstanding +- +$ +- +- +$ +- +Options exercisable +- +$ +- +- +$ +- +2016 Activity +Number of +shares in +underlying +options +Weighted +average +exercise Price +Remaining +weighted avg +contractual life +in years +Intrinsic value +(in thousands) +Beginning balance +16,235 +$ +125.00 +6.8 +$ +- +Granted +1,078 +86.00 +9.3 +6.00 +Exercised +- +- +- +- +Forfeited +- +- +- +- +Total outstanding +17,313 +$ +123.02 +6.9 +$ +- +Options exercisable +12,051 +$ +120.54 +6.5 +$ +- +The intrinsic value at December 31, 2017 and 2016 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2017 and 2016, respectively. +The assumptions used in the Black-Scholes pricing model to estimate the fair value of the options granted in 2017, 2016 and 2015 are as follows: +2017 +2016 +2015 +Weighted average fair value +$ +- +$ +86.18 +$ +150.00 +Assumptions +Expected life (in years) +- +7.0 +7.0 +Volatility +0.0 +% +98.6 +% +30.0 +% +Dividend yield +0.0 +% +0.0 +% +0.0 +% +Risk free interest rate +0.00 +% +2.00 +% +1.00 +% +Compensation expense recorded was approximately $0, $0.2 million and $0.5 million for the years ended December 31, 2017, 2016 and 2015, respectively. +Restricted stock +During 2017, concurrent with the combination of Nine and Beckman, all Beckman restricted stock was converted to Nine restricted stock. Information about restricted stock activity during the years ended December 31, 2017, 2016 and 2015 is as follows: +F-22 +2017 +2016 +2015 +Nonvested at the beginning of the year +20,225 +17,576 +23,512 +Beckman restricted stock converted to Nine restricted stock +(20,225 +) +Granted +- +9,092 +- +Vested +- +(5,631 +) +(5,707 +) +Cancelled +- +(812 +) +(229 +) +Nonvested at the end of the year +- +20,225 +17,576 +The weighted average grant date fair value of the restricted stock was $77.00 during the year 2016. The total amount of compensation expense related to the restricted stock awards was approximately $0, $1.0 million and $0.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. +Other share based compensation +During 2015, 4,000 shares were issued to a Beckman officer for services provided, at the market value of $150 per share, and $0.6 million of compensation expense was recognized. +During 2015, certain Beckman officers and one member of Beckman’s board of directors were issued 2,598 common shares in lieu of cash compensation. Of these shares, 1,763 were issued at $100 per share and 835 were issued at $117 per share, and $0.3 million of compensation expense was recognized. +10. Commitments and contingencies +Litigation +From time to time, we have various claims, lawsuits and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters and other matters. Although no assurance can be given with respect to the outcome of these and the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results or financial condition. +We have been named in the following proceeding: +Christina Sparks, et al v. Pioneer Natural Resources, et al., Filed in the District Court, 142nd Judicial District, Midland County, Texas. On August 31, 2017, an accident occurred while a five-employee crew of Big Lake Services, LLC, a subsidiary of Nine (“Big Lake Services”), was performing workover services at an oil and gas wellsite near Midland, Texas, operated by Pioneer Natural Resources, resulting in the death of a Big Lake Services employee, Juan De La Rosa. On December 7, 2017, a lawsuit was filed on behalf of Mr. De La Rosa’s minor children in the Midland County District Court against Pioneer Natural Resources, Big Lake Services, and Phillip Hamilton related to this accident. The petition alleges, among other things, that the defendants acted negligently, resulting in the death of Mr. De La Rosa. The plaintiffs are seeking money damages, including punitive damages. +We maintain insurance coverage against liability for, among other things, personal injury (including death), which coverage is subject to certain exclusions and deductibles. We tendered this matter to our insurance company for defense and indemnification of Big Lake Services and the other defendants. While we maintain such insurance policies with insurers in amounts and with coverage and deductibles that we, with the advice of our insurance advisors and brokers, believe are reasonable and prudent, we cannot assure you that this insurance will be adequate to protect us from all material expenses related to current or potential future claims for personal and property damage or that these levels of insurance will be available in the future at economical prices. +F-23 +Leases +The Company leases equipment, vehicles, office space, yard facilities and employee housing in the United States and in Canada where the Company operates, under leases classified as operating. The original lease terms require monthly rental payments and expire from 2018 through 2029. Other leases for various equipment and facilities are on a month-to-month basis or have expired during 2017. Total rent expense for all operating leases was approximately $7.2 million, $6.3 million and $8.8 million for the years ended December 31, 2017, 2016 and 2015, respectively. +The following schedule shows the future total minimum lease payments under these non-cancelable leases as of December 31, 2017: +(in thousands +of dollars) +Year ending December 31, +2018 +$ +6,799 +2019 +4,027 +2020 +2,992 +2021 +2,604 +2022 +2,277 +Thereafter +12,738 +$ +31,437 +Self-insurance +The Company uses a combination of third party insurance and self-insurance for health insurance clams. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $1.3 million and $0.8 million at December 31, 2017 and 2016, respectively, and is included under the caption “Accrued liabilities” on the Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Scorpion contingent liability +In connection with the acquisition of Scorpion in 2015, the Company recorded a liability for contingent consideration to be paid in shares of Company common stock and in cash, contingent upon quantities of Scorpion Composite Plugs TM sold during 2016 and gross margin related to the product sales for three years following the acquisition. +The contingent consideration related to the Scorpion acquisition is reported at fair value, based on discounted cash flows. Significant inputs used in the fair value measurement include estimated gross margin related to forecasted sales of the plugs, term of the agreement, and a risk adjusted discount factor. +The shares of common stock underlying the contingent liability were valued at $41.39 at the acquisition date but revalued to $29.27 at December 31, 2015, resulting in a gain of $0.3 million. A cash payment of $0.3 million was made during 2016 based on the gross margin on sales of Scorpion plugs during the first year following the acquisition. The forecasted quantities of plug sales and the related gross margin increased significantly at December 31, 2016 and the shares underlying the contingent liability were revalued at $22.63, resulting in a revaluation loss of $1.7 million. A cash payment of $1.3 million was made during 2017 and common stock was issued based on gross margin on sales of Scorpion plugs in the second year following acquisition. The forecasted quantities of plug sales and the related gross margin increased again during the year ended December 31, 2017, resulting in a revaluation loss of $0.4 million. +F-24 +The revaluation losses are included in “General and administr ative expenses” in the Consolidated Statements of Income and Comprehensive Income (Loss). The following is a reconciliation of the beginning and ending amounts of contingent consideration obligation (level 3) related to the Scorpion acquisition for the yea rs ended December 31, 2017 and 2016: +2017 +2016 +(in thousands of dollars) +Balance at beginning of year +$ +3,187 +$ +1,749 +Common stock issuance +(547 +) +— +Payment +(1,325 +) +(297 +) +Revaluation +415 +1,735 +Balance at end of the year +$ +1,730 +$ +3,187 +Contingent liabilities related to the Scorpion acquisition include $1.7 million and $1.8 million reported in “Accrued expenses” at December 2017 and 2016, respectively, and $0 and $1.4 million reported in “Other long term liabilities” at December 2017 and 2016, respectively, in the Consolidated Balance Sheets. +11. Taxes +On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (the “Tax Act”) with some provisions effective as early as 2017 while others are delayed until 2018. This change in U.S. tax law included a reduction in the federal corporate tax rate from 35% to 21% for years beginning after 2017, which resulted in the remeasurement of our U.S. net deferred income tax liabilities. Our 2017 income tax provision includes a $3.0 million net income tax benefit related to the remeasurement of our U.S. net deferred income tax liabilities. Although the $3.0 million income tax benefit represents a reasonable estimate of the impact of the Tax Act on our Consolidated Financial Statements as of December 31, 2017, it should be considered provisional. The impact of the Tax Act may differ from this reasonable estimate due to additional guidance that may be issued, changes in assumptions made, and the finalization of certain U.S. income tax positions with the filing of our 2017 U.S. income tax return, which will allow for the ability to conclude whether any further adjustments are necessary to our deferred tax assets and liabilities. Any adjustments to these provisional amounts will be reported as a component of income tax expense in the reporting period in which any such adjustments are identified, which will be no later than the fourth quarter of 2018. We will continue to analyze the Tax Act to determine the full effects of the new law. +The components of the provision (benefit) for income taxes for the years ended December 31, 2017, 2016 and 2015 were as follows: +2017 +2016 +2015 +(in thousands of dollars) +Current +US Federal +$ +(50 +) +$ +(14,295 +) +$ +21 +US State +878 +168 +1,524 +Canada +— +— +(32 +) +Total current provision (benefit) +828 +(14,127 +) +1,513 +Deferred +US Federal +(5,455 +) +(14,206 +) +(14,924 +) +US State +(360 +) +2,047 +(924 +) +Canada +— +— +12 +Total deferred benefit +(5,815 +) +(12,159 +) +(15,836 +) +Total benefit for income taxes +$ +(4,987 +) +$ +(26,286 +) +$ +(14,323 +) +The provision (benefit) for income taxes for the years ended December 31, 2017, 2016 and 2015 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +F-25 +2017 +2016 +2015 +(in thousands of dollars) +Tax benefit at statutory rate +$ +(25,434 +) +$ +(33,689 +) +$ +(18,240 +) +Foreign rate differential +241 +367 +602 +State income taxes, net of federal benefit +70 +766 +151 +Impact on deferred taxes from Combination +(2,025 +) +— +— +Effect of Tax Act +Effect of tax rate reduction on deferred tax +6,649 +— +— +Effect of tax rate reduction on deferred tax valuation +(9,668 +) +— +— +Nondeductible expenses +1,559 +1,660 +595 +Loss of tax benefits due to carryback +— +998 +— +Valuation allowance +24,066 +2,804 +2,226 +Adoption of ASU 2016-09 +— +141 +— +Other +(445 +) +667 +343 +$ +(4,987 +) +$ +(26,286 +) +$ +(14,323 +) +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2017 and 2016 were as follows: +2017 +2016 +(in thousands of dollars) +Deferred income tax assets: +Inventories +$ +500 +$ +792 +Goodwill and intangible assets +8,837 +6,761 +Deferred tax benefit from net losses +31,112 +37,453 +Stock based compensation +3,129 +2,418 +Tax credit carryforwards +677 +1,091 +Accrued expenses +1,390 +691 +Other +86 +— +Total deferred income tax assets +45,731 +49,206 +Less: Valuation allowance +(18,950 +) +(4,277 +) +Net deferred income tax assets +26,781 +44,929 +Deferred income tax liabilities: +Property and equipment +(31,798 +) +(55,398 +) +Prepaid expenses and other +— +(168 +) +Total deferred income tax liabilities +(31,798 +) +(55,566 +) +Net deferred income tax liability +$ +(5,017 +) +$ +(10,637 +) +As of December 31, 2017, the Company had federal and state net operating losses of approximately $168.1 million. The federal net operating loss can be used for a 20-year period and, if unused, will begin to expire in 2033. The state net operating losses can be used from 10 to 20 years and vary by state. A small portion of state net operating losses will begin to expire in 2023. The Company has recognized domestic carryforwards of approximately $0.2 million of AMT credit which are refundable over the next four years as a result of the Tax Act +We evaluate our deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. We assess whether a valuation allowance should be established based on our determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of our NOL and tax credit carryforwards. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results and goodwill impairments recorded during 2017 and 2016, we are in a three-year cumulative loss position for the year ending December 31, 2017. According to FASB ASC 740, Income Taxes, cumulative losses in recent years represent significant negative evidence in considering whether deferred tax assets are realizable. Therefore, during 2016 we recorded a valuation allowance against our domestic deferred tax assets. We have excluded the deferred tax liabilities related to certain indefinite life intangibles when calculating the +F-26 +amount of valuation allowance needed as these liabilities cannot be considered as a source of income when determining the realizability of the net deferred tax assets. During 2017 we removed the valuation allowance against the Company’s federal AMT credit carryforwards as these were made refundable as part of the Tax Act. The 2017 results also include an increase in our valuation allowance of $24.1 million primar ily related to the increase in net operating loss generated during the year. If we are able to generate sufficient taxable income in the future, and it becomes more likely than not that we will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a potential decrease to our effective tax rate. +The Company is subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of Federal income tax returns by the Internal Revenue Service is 2014. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +The Company accounts for uncertain tax positions in accordance with guidance in FASB ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2017 +(in thousands of dollars) +Balance at January 1, 2017 +$ +- +Additional based on tax positions related to prior years +568 +Additional based on tax positions related to current year +- +Reduction based on tax positions related to prior years +- +Lapse of statute of limitations +- +Balance at December 31, 2017 +$ +568 +The total amount of unrecognized tax benefits at December 31, 2017 was $0.6 million. The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in the consolidated statement of income. As of December 31, 2017, no interest and penalties have been accrued. +12. Earnings per share +The diluted earnings per share calculation excludes all stock options and unvested restricted stock for 2017, 2016 and 2015 because there is a net loss for each period as their inclusion would be anti-dilutive. +2017 +2016 +2015 +(in thousands of dollars except for +share and per share data) +Net income (loss) attributable to common stockholders +$ +(67,682 +) +$ +(70,911 +) +$ +(39,117 +) +Average shares outstanding +14,887,006 +13,268,540 +13,193,380 +Loss per share (basic and diluted) +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +13. Related party transactions +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, promissory notes totaling $2.5 million were issued to both a former executive officer of the Company in 2015, and to a current manager of the Company. The principal is due on June 30, 2019 (the “Maturity Date”). Interest of 4% per annum is due and payable on the Maturity Date. At December 31, 2017 and 2016, the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and $2.8 million, respectively. Unpaid interest at December 31, 2017 and 2016 totaled $0.4 million and $0.3 million, respectively. +As part of the acquisition of Crest in 2014, promissory notes totaling $9.4 million were issued to former owners of Crest, including Mr. Crombie, who is an executive of the Company. The principal is due on June 30, 2019. The interest rate is based on the prime rate, the federal funds rate or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement, and is due quarterly. Mr. Crombie paid $1.8 million during 2016 +F-27 +to pay his promissory note in full. At December 31, 2017 and 2016, the outstanding principal balance of the notes totaled $7.6 million. Unpaid interest, included in “Prepaid expenses and other” in the Consolidated Balance Sheets, totaled $8,000 and $19,000 at December 31, 2017 and 2016, respectively. +The Company leases office space, yard facilities and equipment, and purchases building maintenance services from Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million, $0.7 million and $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. There were payables of $13,000 and $0 at December 31, 2017 and 2016, respectively. +As part of the Tripoint acquisition on October 3, 2011, promissory notes totaling $1.1 million were issued to former owners of Tripoint who were members of management. The principal was due on September 15, 2015. Interest of 4% was due quarterly, but could be deferred and added to the outstanding principal balance at the election of the Company. In 2015, the outstanding balance of the notes, $0.9 million, including accrued interest, was repaid in full using a combination of $0.2 million of cash and common stock redemption valued at $0.7 million. The value attributed to common stock, as agreed between the Company and the former owners of Tripoint, was $33.11 per share, resulting in the cancellation of 20,417 shares. +The Company entered into a shared services agreement with a related party, whose manager, Benjamin Winston, is a stockholder of the Company, and was a member of Beckman’s board of directors from 2014 through the consummation of the Combination. The related party provides office space, personnel and certain general and administrative services to the Company. The Company paid the related party $0.7 million, $0.2 million and $0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $13,000 and $8,000 as of December 31, 2017 and 2016, respectively. +The Company leases facilities and buildings in Monahans, Texas and Enid, Oklahoma, from an entity owned by Mr. Winston. The Company incurred rent expense of $0.5 million, $0.6 million and $0.5 million to this entity for the years ended December 31, 2017, 2016 and 2015, respectively. There were no payables to or receivables from this related party at December 31, 2017 and December 31, 2016. +The Company utilizes a related party, whose manager is Mr. Winston, to transport equipment, chemicals, and supplies. The Company incurred expense of $1.2 million, $0.7 million and $0.7 million, for these services during the years ended December, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $0.1 million at December 31, 2017. There was no payable related to this party at December 31, 2016. +The Company facilitates pass-through billings on behalf of an entity owned by Mr. Winston. The Company recognizes no revenue or expense related to this activity. During the year ended December 31, 2017, the related entity billed the Company $40,000, and the Company billed respective customers the same amount. The Company collected cash for and reimbursed to the related entity $0.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $11,000 of pass-through billings to customers remained uncollected as of December 31, 2017. During the year ended December 31, 2016, the related entity billed the Company $0.8 million, and the Company rebilled respective customers the same amount. The Company collected cash for and reimbursed to the related entity $1.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $0.1 million of pass-through billings to customers remained uncollected as of December 31, 2016. During 2015, the related entity billed Beckman $2.2 million. Beckman rebilled respective customers of this related entity $2.2 million, and Beckman collected cash for and reimbursed to the related entity approximately $2.1 million. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million, $0.4 million and $0.5 million for services provided to this entity during the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding receivable due of $0.2 million and $0.1 million as of December 31, 2017 and 2016, respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas acts as the President of EOG Resources, Inc. The Company generated revenue from EOG Resources, Inc. of $34.4 million, $13.7 million and $24.9 million in 2017, 2016 and 2015, respectively. +F-28 +14. Discontinued operations +The Company’s Tripoint subsidiary, acquired in October of 2011, was focused primarily on conventional completions, and did not fit with the future strategy of the Company. During 2014, the Company created a plan to fully dispose of the subsidiary. Tripoint operations ceased in the fourth quarter of 2014 and substantially all of its employees were released. Assets held for sale at December 31, 2014 were written down to net realizable value and were fully disposed of during the first quarter of 2015. The pretax loss for the year ended December 31, 2015 reflects expenses related to the disposal of the business. There were no assets or liabilities as of December 31, 2015 and no expenses during 2017 and 2016. +Summarized results of the Company’s discontinued operations for the year ended December 31, 2015 are as follows: +2015 +(in thousands of +dollars) +Income Statement +Revenue +$ +— +Expenses +1,494 +Loss (gain) on disposal +(46 +) +Pretax loss +(1,448 +) +Income tax benefit +513 +Net loss +$ +(935 +) +15. Supplemental disclosures of cash flow information +Year ended +December 31, +2017 +Year ended +December 31, +2016 +Year ended December 31, 2015 +(in thousands of dollars) +Supplemental disclosures +Cash paid for interest +$ +(14,987 +) +$ +(12,442 +) +$ +(8,957 +) +Cash refunds for income taxes, net +14,344 +8,716 +9,140 +Noncash investing and financing activities +Decrease in accounts payable and accrued liabilities for +additions to property and equipment +$ +(135 +) +$ +(497 +) +$ +(4,245 +) +Issuance of common stock warrants +2,687 +— +— +Exercise and cancellation of common stock warrants +(2,687 +) +— +— +Increase (decrease) in long term liabilities for additions to +property and equipment +— +(182 +) +182 +Issuance of common stock in acquisitions +547 +— +1,000 +Unpaid costs related to public offering +276 +— +— +Contingent consideration for Scorpion acquisition +— +— +2,042 +Cancellation of shares in conjunction with repayment of notes receivable +— +— +(675 +) +16. Segment information +Beginning with the first quarter of 2017, the Company realigned its segments due to the acquisition of Beckman. This change is reflected on a retrospective basis in accordance with GAAP. The Company is reporting its results of operations in the following two reportable segments: Completion Solutions and Production Solutions. +The Completion Solutions segment consists primarily of cementing, completion tools, wireline and coiled tubing services, while the Production Solutions consists of rig-based well maintenance and workover services. +The Company’s reportable segments are strategic units that offer distinct products and services. They are managed separately since each business segment requires different marketing strategies. Operating segments have not been +F-29 +aggregated as part of a reportable segment. The Company evaluates the performance of its reportable segments based on gross profit. This segmentation is representative of the manner in which our Chief Operating Decision Maker and our Board of Director s view the business. We consider the Chief Operating Decision Maker to be the Chief Executive Officer. +F-30 +Summary financial data by segment follows. The amounts labeled “Corporate” relate to assets not allocated to the reportable segments. +2017 +2016 +2015 +(in thousands of dollars) +Revenues +Completion Solutions +$ +465,773 +$ +221,468 +$ +380,174 +Production Solutions +77,887 +60,886 +98,348 +$ +543,660 +$ +282,354 +$ +478,522 +Adjusted gross profit (1) +Completion Solutions +$ +81,132 +$ +27,032 +$ +84,205 +Production Solutions +14,061 +9,213 +21,126 +$ +95,193 +$ +36,245 +$ +105,331 +General and administrative expenses +49,552 +39,387 +42,862 +Depreciation +53,422 +55,260 +58,894 +Impairment of goodwill +31,530 +12,207 +35,540 +Impairment of intangibles +3,800 +— +— +Amortization of intangibles +8,799 +9,083 +8,650 +Loss on equity method investment +368 +— +— +Loss on sale of assets +4,688 +3,320 +2,004 +Loss from operations +$ +(56,966 +) +$ +(83,012 +) +$ +(42,619 +) +Capital expenditures +Completion Solutions +$ +40,626 +$ +7,358 +$ +24,636 +Production Solutions +4,590 +1,772 +2,090 +$ +45,216 +$ +9,130 +$ +26,726 +Assets +Completion Solutions +$ +428,702 +$ +433,721 +$ +478,879 +Production Solutions +119,607 +131,046 +148,919 +Corporate +30,550 +11,327 +30,636 +$ +578,859 +$ +576,094 +$ +658,434 +(1) +Excludes depreciation and amortization, shown separately below. +Revenues by country were as follows: +Year ended December 31, +Year ended December 31, +Year ended December 31, +2017 +2016 +2015 +(in thousands of dollars) +Revenues +United States +$ +521,914 +96.0 +% +$ +269,893 +95.6 +% +$ +460,232 +96.2 +% +Canada +21,746 +4.0 +% +12,461 +4.4 +% +18,290 +3.8 +% +$ +543,660 +100.0 +% +$ +282,354 +100.0 +% +$ +478,522 +100.0 +% +Long-lived assets by country were as follows: +2017 +2016 +(in thousands of dollars) +Long-lived assets: +United States +$ +426,858 +$ +479,691 +Canada +4,764 +5,689 +$ +431,622 +$ +485,380 +F-31 +17. Selected Quarterly Financial Data (Unaudited) +Summarized quarterly financial data for the years ended December 31, 2017 and 2016 are presented below (in thousands, except per share amounts). +March 31, 2017 +June 30, 2017 +September 30, 2017 +December 31, 2017 +Revenue +$ +105,353 +$ +135,860 +$ +148,167 +$ +154,280 +Operating loss +(14,790 +) +(8,141 +) +(193 +) +(33,842 +) +Loss before income taxes +(18,548 +) +(12,070 +) +(4,286 +) +(37,765 +) +Net loss +(20,714 +) +(12,105 +) +(5,052 +) +(29,811 +) +Net loss per common share +Basic and diluted +$ +(1.50 +) +$ +(0.82 +) +$ +(0.34 +) +$ +(1.89 +) +March 31, 2016 +June 30, 2016 +September 30, 2016 +December 31, 2016 +Revenue +$ +65,970 +$ +62,803 +$ +73,595 +$ +79,986 +Operating loss +(18,578 +) +(17,555 +) +(17,362 +) +(29,517 +) +Loss before income taxes +(21,939 +) +(21,361 +) +(20,876 +) +(33,021 +) +Net loss +(15,361 +) +(15,170 +) +(14,628 +) +(25,752 +) +Net loss per common share +Basic and diluted +$ +(1.16 +) +$ +(1.14 +) +$ +(1.10 +) +$ +(1.94 +) +18. Subsequent Events +In January 2018, we completed our IPO of 8,050,000 shares of common stock (including 1,050,000 shares pursuant to an over-allotment option) at a price to the public of $23.00 per share pursuant to our registration statement on Form S‑1 (File 333‑217601), as amended and declared effective by the SEC on January 18, 2018 (the “Registration Statement”). J.P. Morgan Securities LLC, Goldman Sachs & Co. LLC and Wells Fargo Securities, LLC acted as joint book-running managers and representatives of the underwriters in our IPO. +The aggregate gross proceeds of our IPO were $185.2 million. After subtracting underwriting discounts and commissions of $12.5 million and offering expenses of approximately $3.2 million, we received net proceeds of approximately $169.5 million. We used a portion of these net proceeds, together with $125.0 million of term loan borrowings under our credit facility, to fully repay the outstanding indebtedness under our former credit facilities. Further, our credit agreement required that we use a portion of the proceeds from the over-allotment option to make a prepayment of the term loan borrowings of $9.7 million. The remainder of the net proceeds were used for general corporate purposes. No payments, fees or expenses have been paid, directly or indirectly, to any of our officers, directors or their associates, holders of 10% or more of any class of our equity securities or other affiliates. +F-32 +Item 9. Changes in and Disagreements with Acc ountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures . The Company’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is accumulated and communicated to its management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. As required by Rule 13a-15(b) under the Exchange Act, the Company’s management, with the participation of its principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2017. Based upon that evaluation, the Company’s principal executive officer and principal financial officer concluded that its disclosure controls and procedures were not effective as of December 31, 2017. +Material Weaknesses in Internal Control over Financial Reporting. In connection with a review of our financial statements for the three months ended March 31, 2017, we identified a material weakness in our internal control over the reporting of income tax expense (benefit), the related balance sheet accounts and other comprehensive income. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +During the first quarter of 2017, we hired a tax professional as our tax director, who performed a detailed review of our deferred taxes and our tax provision and identified certain immaterial errors in our income tax expense (benefit) and deferred tax balance for the years ended December 31, 2016 and 2015. Upon review of our internal controls in connection with the identification of these errors, we determined that we did not design and maintain an effective control environment with formal accounting policies and controls, and with trained professionals with an appropriate level of income tax knowledge and experience, to properly analyze, record and disclose the accounting matters commensurate with our financial reporting requirements related to income taxes. Specifically, we did not have controls designed to address the accuracy of income tax expense (benefit) and related consolidated balance sheet accounts, including deferred income taxes, as well as adequate procedures and controls to review the work of external experts engaged to assist in income tax matters or to monitor the presentation and disclosure of income taxes. +This material weakness resulted in the need to correct misstatements in our combined financial statements as of and for the years ended December 31, 2016 and 2015 prior to their issuance. The misstatements were not material to either 2016 or 2015. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +In addition, in connection with the preparation of our financial statements for the nine months ended September 30, 2017, we identified a material weakness in our internal control over financial reporting, specifically as it related to segregation of certain accounting duties stemming from our decentralized accounting structure and limited number of accounting personnel. We did not design and maintain adequate controls to address segregation of certain accounting duties related to journal entries, account reconciliations and other accounting functions. Certain accounting personnel have the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy and completeness. Immaterial misstatements have been identified related to the inadequate segregation of accounting duties. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +62 +Management’s Report Regarding Internal Control; Attestation report of the registered public accounting firm . This Annual Report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the SEC for newly public companies. +Changes in Internal Control over Financial Reporting . As described above, during the first quarter of 2017, we hired a tax professional as our tax director, who identified the misstatements related to deferred taxes and our tax provision as described above and will be responsible for performing a detailed review of our deferred taxes and our annual and quarterly tax provision for all future periods. Further, in the fourth quarter of 2017, we implemented additional review procedures within the accounting and finance department. These actions are subject to ongoing management review and the oversight of our board of directors. +During the fourth quarter of 2017, we began to remediate and plan to further remediate the material weakness relating to segregation of certain accounting duties. We have replaced the less sophisticated accounting systems used by our newly-acquired subsidiaries with the enterprise resource planning system used by the majority of our subsidiaries. Also, we are working with third party consultants to identify internal control risks and implement remedies. These actions are subject to ongoing management review and the oversight of our board of directors. +Item 9B. +Other Information +None. +63 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +Information About Our Directors and Executive Officers +Set forth below are the names, ages and positions of our executive officers and directors as of the date of this report. All directors are elected for a term of one year or serve until their successors are elected and qualified or upon earlier of death, disability, resignation or removal. All executive officers hold office until their successors are elected and qualified or upon earlier of death, disability, resignation or removal. There are no family relationships among any of our directors or executive officers, except that David Baldwin and Mark Baldwin are brothers. The address of each director and executive officer is: 2001 Kirby Drive, Suite 200, Houston, TX 77019. +Name +Age +Position +Ann G. Fox +40 +President, Chief Executive Officer, Secretary and Director +David Crombie +44 +Executive Vice President and President, Completion Solutions +Clinton Roeder +47 +Senior Vice President and Chief Financial Officer +Edward Bruce Morgan +50 +President, Production Solutions +Theodore R. Moore +40 +Senior Vice President and General Counsel +Ernie L. Danner +62 +Chairman of the Board +David C. Baldwin +54 +Director +Mark E. Baldwin +64 +Director +Curtis F. Harrell +53 +Director +Scott E. Schwinger +52 +Director +Gary L. Thomas +67 +Director +Andrew L. Waite +56 +Director +Directors . Biographical information for each director of the Company is set forth below. +Ernie L. Danner, Chairman of the Board . Mr. Danner has served as the Company’s Chairman of the Board since the consummation of the Combination on February 28, 2017. From 1998 until his retirement in October 2011, Mr. Danner was employed by Universal Compression Holdings, Inc., which became Exterran Holdings, Inc. following a merger with Hanover Compressor Company in August 2007. Mr. Danner joined Universal Compression Holdings in 1998 as its Chief Financial Officer and served in various positions of increasing responsibility, including as Chief Operating Officer from July 2006 through August 2007. From August 2007 to October 2011, Mr. Danner served as a director of Exterran Holdings and of Exterran GP, LLC, and beginning in July 2009, he also served as President and Chief Executive Officer of both companies. Mr. Danner served as a director at Copano Energy, L.L.C. from 2004 to 2013. Mr. Danner holds a Bachelor of Arts degree and a Master of Arts degree in Accounting from Rice University. In 2011, Mr. Danner joined Beckman where he served as the President, Chief Executive Officer and Chairman until the merger of the Company in February 2017. We believe that Mr. Danner’s extensive leadership, financial and operational experience in the energy industry, particularly with respect to his leadership involvement in Beckman, make him well qualified to serve as our Chairman of the Board. +David C. Baldwin, Director . Mr. Baldwin has served as a Director of the Company since the consummation of the Combination on February 28, 2017 and served on Beckman’s board of directors prior to the Combination. Mr. David C. Baldwin serves as Co-President of SCF Partners since April 2014 and has served as its Managing Director since 1999. Mr. Baldwin is responsible for overseeing U.S. based investments and creating investment platforms around emerging energy trends. Mr. Baldwin joined SCF in 1991. From September 2002 to April 2004, he served as President and Chief Executive Officer of Integrated Production Services, Ltd. He served as Chief Financial Officer and Vice President of ION Geophysical Corporation from June 1999 to January 2000. He started his career as a Drilling and Production Engineer with Union Pacific Resources. He later went on to start an energy consulting business and worked for General Atlantic Partners. He currently serves on the Board of Directors of Forum Energy Technologies (NYSE: FET), Select Energy Services, Inc. (NYSE: WTTR), and Oil Patch Group, Inc. Additionally he is a Trustee of The Center, The Center Foundation, The Baylor College of Medicine, and Baylor St. Lukes +64 +Medical Center Hospital. Mr. Baldwin received both a B.S. degree in Petroleum Engineering in 1980, and M.B.A. degree from the University of Texas at Austin. We believe that Mr. Baldwin’s experience in the private equity industry, board experience and overall knowledge of our business and operational strategy, make him well qualified to serve as a Director on our board of dir ectors. Further, his service as a Co-President of the ultimate general partner of our largest stockholder provides a valuable perspective into its insights and interests. +Mark E. Baldwin, Director . Mr. Baldwin has served as a Director of the Company since May 10, 2013. Mr. Baldwin has been a Director of KBR, Inc. since October 3, 2014 and Director of TETRA Technologies, Inc. since January 16, 2014. He served as a Director of Seahawk Drilling, Inc. from 2009 to 2011. He served as the Chief Financial Officer and Executive Vice President of Dresser-Rand Group Inc. from 2007 to 2013 and as the Chief Financial Officer, Executive Vice President and Treasurer of Veritas DGC Inc. from 2004 to 2007. From 2003-2004 he was an Operating Partner of First Reserve Corporation. He served as the Chief Financial Officer and Executive Vice President of Nextiraone, LLC from 2001 to 2002. He served as Chairman of the Board of Pentacon, Inc. from November 1997 to 2001 and served as its Chief Executive Officer from September 1997 to 2001. From 1980 to 1997, he served in a variety of finance and operations positions with Keystone International Inc., including Treasurer, Chief Financial Officer and President of the Industrial Valves and Controls Group. For the three years ending in 1980, he served as an Accountant with a national accounting firm. Mr. Baldwin holds a B.S. in Mechanical Engineering from Duke University and an MBA from Tulane University. We believe that Mr. Baldwin’s financial and operational experience with public companies and his extensive knowledge of the energy industry make him well qualified to serve as a Director on our board of directors. +Curtis F. Harrell, Director . Mr. Harrell has served as a Director of the Company since the consummation of the Combination on February 28, 2017. Mr. Harrell currently serves as President and Chief Executive Officer of Citation Oil & Gas Corp. Curtis joined Citation in 2002 where he took on the position of Executive Vice President and Chief Financial Officer. In 2004, Curtis was promoted to President, Chief Operating and Financial Officer. Then in 2008, Curtis was named President and Chief Executive Officer. Citation Oil & Gas Corp. is one of the largest privately-held independent oil & gas acquisition, development and production companies in the United States. Founded in 1981, Citation has built a significant portfolio of mature, long-life producing properties through a combination of disciplined acquisitions, focused operations and subsequent development. He served as the Chief Financial Officer of Brigham Exploration Company from August 1999 to July 2002 and served as its Executive Vice President since August 2000. Mr. Harrell joined Citation in 2002. From 1997 to August 1999, Mr. Harrell served as Executive Vice President and Partner at R. Chaney & Company, Inc., where he managed R. Chaney & Company, Inc.’s investment origination efforts in the U.S., focusing on investments in corporate equity securities of energy companies in the exploration and production and oilfield service industry segments. From 1995 to 1997, Mr. Harrell served as Director of Domestic Corporate Finance for Enron Capital & Trade Resources, Inc. from 1995 to 1997, where he was responsible for initiating and executing a variety of debt and equity financing transactions for independent exploration and production companies. Before Enron Capital & Trade Resources, Mr. Harrell spent eight years working in corporate finance and reservoir engineering positions for two public independent exploration and production companies, Kelley Oil & Gas Corporation and Pacific Enterprises Oil Company, Inc. He serves as a Director of Carlile Bancshares, Inc. Mr. Harrell has over fifteen years of experience in corporate finance and management. He served as a Director of Brigham Exploration Co. since August 1999. He was a Member of Yellowstone Academy Board of Directors. Mr. Harrell holds a B.S. in Petroleum Engineering from the University of Texas at Austin and M.B.A. from Southern Methodist University. We believe that Mr. Harrell’s extensive experience as an executive officer of other oil and natural gas companies, and his strategic, operational and financial expertise in the oil and natural gas industry make him well qualified to serve as a Director on our board of directors. +Scott E. Schwinger, Director . Mr. Schwinger was appointed as a director of Nine on May 25, 2017. Mr. Schwinger is the President and CEO of the McNair Group and the Chief Financial Officer for the Houston Texans, a National Football League franchise. For the past plus 20 years, Mr. Schwinger has held positions with various companies owned, directly or indirectly, by Robert C. McNair including President of Palmetto Partners Ltd., RCM Financial Services, L.P., and Vice President of Cogen Technologies. In April 2010, he was named the CEO of The McNair Group. In his role, he oversees the investment and management activities for The McNair Group of companies which include portfolios of public and private equities, a private trust company, several foundations and various other operating companies. Mr. Schwinger serves on the board of directors of The Make-A-Wish Foundation and the Salient Capital complex of mutual funds. Mr. Schwinger received an M.B.A. from the University of Texas at Austin and a B.A. in mathematics from Vanderbilt University. We believe that Mr. Schwinger’s broad experience as an executive officer and proven financial expertise make him well qualified to serve as a Director on our board of directors. +65 +Gary L. Thomas, Director . Mr. Thomas has served as a Director of the Company since March 15, 2013. Mr. Gary L. Thomas is President of EOG Resources, Inc. Mr. Thomas served as a Senior Executive Vice President of Operations at EOG Resources, Inc. from February 2007 to September 2011. He served as an Executive Vice President, North America Operations of EOG Resources Inc. since May 1998 and served as its Executive Vice President, Operations from May 1998 to February 26, 2007. Previously, he served as Senior Vice President and General Manager of EOG’s Midland Di vision. Mr. Thomas joined a predecessor of EOG in July 1978. He holds a Petroleum Engineering degree from The University of Texas at Austin and a Master’s degree in Engineering Management from The University of Tulsa. We believe that Mr. Thomas’ experience in the oil and gas industry, the perspective he brings as a result of his long tenure as an executive of a public company, and his valuable insight as a result of his long history as a customer for the oilfield services industry make him well qualified to serve as a Director on our board of directors. +Andrew L. Waite, Director . Mr. Waite has served as a director of Nine since February 28, 2013. He served as Chairman of Nine from February 2013 until the consummation of the Combination. Mr. Waite is Co-President of LESA, the ultimate general partner of SCF, and has been an officer of that company since October 1995. He was previously Vice President of Simmons & Company International, where he served from August 1993 to September 1995. From 1984 to 1991, Mr. Waite held a number of engineering and project management positions with the Royal Dutch/Shell Group, an integrated energy company. Mr. Waite currently serves on the board of directors of Forum Energy Technologies, Inc. (NYSE: FET), a position he has held since August 2010, is on the board of directors of Atlantic Navigation Holdings (Singapore) Limited (SGX: 5UL), a position he has held since January 2016. Mr. Waite previously served on the board of directors of Complete Production Services, Inc., a provider of specialized oil and gas completion and production services from 2007 to 2009, Hornbeck Offshore Services, Inc., a provider of marine services to exploration and production oilfield service, offshore construction and military customers from 2000 to 2006, and Oil States International, Inc., a diversified oilfield services and equipment company from August 1995 through April 2006. Mr. Waite received an M.B.A. with High Distinction from the Harvard University Graduate School of Business Administration, an M.S. degree in Environmental Engineering Science from California Institute of Technology and a BSc degree with First Class Honours in Civil Engineering from England’s Loughborough University of Technology. We believe that Mr. Waite’s extensive public company experience in the energy sector, in particular in the oilfield services industry, and his experience in identifying strategic growth trends in the energy industry and evaluating potential transactions make him well qualified to serve on our board of directors. Further, his service as a Co-President of the ultimate general partner of our largest stockholder provides a valuable perspective into its insights and interests. +Ann G. Fox, President, Chief Executive Officer, Secretary and Director . Ms. Fox has served as the President, Chief Executive Officer and Secretary of the Company since July 2015, and from February 2013 to July 2015, Ms. Fox served the Company as Chief Financial Officer and Vice President, Strategic Development. In addition, Ms. Fox served as the Interim Chief Financial Officer of the Company from September 2017 to December 2017 and previously served in such capacity from July 2015 through April 2017. From December 2008 to February 2013, Ms. Fox served in various positions with SCF Partners, focusing on the evaluation of potential investment opportunities. Ms. Fox became a Managing Director of SCF Partners in December 2012. Prior to joining SCF Partners, Ms. Fox served in the United States Marine Corps. During her service, Ms. Fox worked with a small team embedded in the South of Iraq in order to ensure Iraqi Security Force combat operations were consistent with the application of US counterinsurgency tactics. Ms. Fox has also served as an Investment Banking Analyst for both Prudential Securities and Warburg Dillon Read in New York. Ms. Fox holds a Bachelors of Science in Diplomacy and Security in World Affairs from Georgetown University’s Walsh School of Foreign Service and an M.B.A. from the Harvard Business School and is currently a member of the Harvard Business School Alumni Board. We believe that Ms. Fox’s leadership experience, industry experience and deep knowledge of our business and our customers make her well qualified to serve as our President, Chief Executive Officer and Director. +66 +Executive Officers . Biographical information for the Company’s executive officers who do not serve on the Board of Directors is set forth below. +David Crombie, Executive Vice President and President, Completion Solutions . Mr. Crombie currently serves as the President, Completion Solutions and as an Executive Vice President of the Company. Prior to serving in this position, Mr. Crombie served as President, US Wireline and Cementing and was an EVP of the Company from December 2013 to February 2017. Mr. Crombie joined the Company from Crest Pumping Technologies, LLC, which he founded and guided to success as President. Before starting Crest, Mr. Crombie was Vice President of Operations and Sales for Pumpco Energy Services, a wholly-owned subsidiary of Complete Production Services (now part of Superior Energy Services) from 2000 to 2012. At Pumpco, he oversaw stimulation and cementing services in prolific, unconventional plays throughout the continental United States. Prior to Pumpco, Mr. Crombie was employed by Halliburton Energy Services from 1994 to 2000. Since 1994, Mr. Crombie has worked in both cementing and stimulation operations in the areas of domestic and international operations, including the Permian Basin, the Fort Worth Basin, Oklahoma, the Gulf of Mexico and Saudi Arabia. +Clinton Roeder, Senior Vice President and Chief Financial Officer . Mr. Roeder has served as the Company’s Senior Vice President and Chief Financial Officer since December 16, 2017. Prior to joining the Company, Mr. Roeder served as the Chief Financial Officer of Total Safety US, Inc. from December 2013 to December 2017. Prior to that, Mr. Roeder served as the Chief Financial Officer of Vopak America, from February 2013 to December 2013. He also served as Chief Financial Officer of Vopak North America from February 2009 to February 2013. Mr. Roeder graduated from St. Mary’s University with a B.B.A. in accounting and received an M.B.A. from the Tulane A.B. Freeman School of Business. +Edward Bruce Morgan, President, Production Solutions . Mr. Morgan currently serves as the Company’s President, Production Solutions. Prior to serving in this position, Mr. Morgan served as an Operations Manager for the Company since August 2013. Mr. Morgan joined the Company from Peak Pressure Control, LLC, which he founded in 2010. Peak Pressure Control was acquired by Nine in August 2013. Before founding Peak, Mr. Morgan was the regional manager at STS Rental and Supply from 2005 to 2010 overseeing operations in West Texas and Williston, North Dakota. Prior to Peak, Mr. Morgan held various positions at Schlumberger from 1990 to 2004, including positions handling all onshore and offshore wireline for Union Pacific Resources, serving as location manager in Natchez, Mississippi; managing all wireline operations for Unocal in Lafayette, Louisiana, before transferring to Houston and serving as operations manager for West Texas, where he oversaw all wireline operations in the Permian Basin. Mr. Morgan holds a Bachelor of Science degree in Engineering from Mississippi State University. +Theodore R. Moore, Senior Vice President and General Counsel . Mr. Moore currently serves as the Company’s Senior Vice President and General Counsel. Prior to joining the Company, Mr. Moore served as the Executive Vice President, General Counsel and Chief Risk Officer of C&J Energy Services, Inc. from March 2015 to June, 2016, Executive Vice President from October 2012 and Vice President, General Counsel and Corporate Secretary from February 2011. Prior to that time, Mr. Moore practiced corporate law at Vinson & Elkins L.L.P. from 2002 through January 2011. Mr. Moore represented public and private companies and investment banking firms in capital markets offerings, mergers and acquisitions and corporate governance matters, primarily in the oil and gas industry. Mr. Moore graduated magna cum laude from Tulane University with a B.A. in Political Economy and a J.D. from Tulane Law School. +Corporate Governance +Board of Directors +The number of members of our board of directors is determined from time-to-time by resolution of the board of directors. Currently, our board of directors consists of eight persons. We expect our board of directors will be increased to nine persons within one year of the time of our IPO. +67 +Our board of directors is di vided into three classes of directors, with each class as equal in number as possible, serving staggered three-year terms. Class I, Class II and Class III directors will serve until our annual meetings of stockholders in 2019, 2020 and 2021, respectively. David C. Baldwin and Curtis F. Harrell are assigned to Class I; Scott E. Schwinger, Gary L. Thomas and Andrew L. Waite are assigned to Class II; and Mark E. Baldwin, Ernie L. Danner and Ann G. Fox are assigned to Class III. At each annual meeting of stockh olders held after the initial classification, directors will be elected to succeed the class of directors whose terms have expired. This classification of our board of directors could have the effect of increasing the length of time necessary to change the composition of a majority of the board of directors. In general, at least two annual meetings of stockholders will be necessary for stockholders to effect a change in a majority of the members of the board of directors. Our directors are removable only fo r “cause.” +In evaluating director candidates, we will assess whether a candidate possesses the integrity, judgment, knowledge, experience, skills and expertise that are likely to enhance the board of directors’ ability to manage and direct our affairs and business, including, when applicable, to enhance the ability of the committees of the board of directors to fulfill their duties. +Our board of directors has determined that Mark E. Baldwin, Curtis F. Harrell and Scott E. Schwinger are independent under NYSE listing standards. +Committees of the Board of Directors +Our board of directors established an audit committee and a nominating, governance and compensation committee, and we may have such other committees as the board of directors shall determine from time to time. We anticipate that each of the standing committees of the board of directors will have the composition and responsibilities described below. +Audit Committee +Our audit committee consists of Mark E. Baldwin, Curtis F. Harrell and Scott E. Schwinger, each of whom is independent under SEC rules and NYSE listing standards. As required by the SEC rules and NYSE listing standards, the audit committee consists solely of independent directors. SEC rules also require that a public company disclose whether or not its audit committee has an “audit committee financial expert” as a member. An “audit committee financial expert” is defined as a person who, based on his or her experience, possesses the attributes outlined in such rules. Our board of directors determined that Mark E. Baldwin satisfies the definition of “audit committee financial expert.” +This committee oversees, reviews, acts on and reports on various auditing and accounting matters to our board of directors, including: the selection of our independent accountants, the scope of our annual audits, fees to be paid to the independent accountants, the performance of our independent accountants and our accounting practices. In addition, the audit committee will oversee our compliance programs relating to legal and regulatory requirements. We adopted an audit committee charter defining the committee’s primary duties in a manner consistent with the rules of the SEC and the listing standards of the NYSE. +Nominating, Governance and Compensation Committee +Our nominating, governance and compensation committee consists of Mark E. Baldwin, Curtis F. Harrell and Scott E. Schwinger, each of whom are “independent” under the NYSE listing standards. This committee identifies, evaluates and recommends qualified nominees to serve on our board of directors; develops and oversees our internal corporate governance processes; and maintains a management succession plan. This committee establishes salaries, incentives and other forms of compensation for officers and other employees and administers our incentive compensation and benefit plans. We adopted a nominating, governance and compensation committee charter defining the committee’s primary duties in a manner consistent with the rules of the SEC and the listing standards of the NYSE. +68 +Compensation Committee Interlocks and Insider Participation +None of our executive officers serve on the board of directors or compensation committee of a company that has an executive officer that serves on our board or nominating, governance and compensation committee. No member of our board is an executive officer of a company in which one of our executive officers serves as a member of the board of directors or compensation committee of that company. +Executive Sessions of our Board of Directors +Our independent directors are provided the opportunity to meet in executive session at each regularly scheduled meeting of our board. +Risk Oversight +The board is actively involved in oversight of risks that could affect us. This oversight function is conducted primarily through committees of our board, but the full board retains responsibility for general oversight of risks. The audit committee is charged with oversight of our system of internal controls and risks relating to financial reporting, legal, regulatory and accounting compliance. Our board will continue to satisfy its oversight responsibility through full reports from the audit committee chair regarding the committee’s considerations and actions, as well as through regular reports directly from officers responsible for oversight of particular risks within our Company. +Code of Business Conduct and Ethics +Our board of directors has adopted a corporate code of business conduct and ethics (the “Code of Business Conduct and Ethics”) applicable to our employees, directors and officers (including our principal executive officer, principal financial officer and principal accounting officer), in accordance with applicable U.S. federal securities laws and the corporate governance rules of the NYSE. The Code of Business Conduct and Ethics can be found on our website located at http://www.nineenergyservice.com. Any stockholder may request a printed copy of the Code of Business Conduct and Ethics by submitting a written request to our Secretary, 2001 Kirby Drive, Suite 200, Houston, TX 77019. Any amendment to, or waiver from, the Code of Business Conduct and Ethics may be made only by our board of directors, and any amendment or waiver that apply to our principal executive officer, principal financial officer, principal accounting officer or controller and are required to be disclosed will be promptly disclosed on our website as required by applicable U.S. federal securities laws and the corporate governance rules of the NYSE. +Corporate Governance Guidelines +Our board of directors has adopted corporate governance guidelines in accordance with the corporate governance rules of the NYSE. +Item 11. Execut ive Compensation +The tables and narrative disclosure below provide compensation disclosure that satisfies the requirements applicable to emerging growth companies, as defined in the JOBS Act. +In this section, we provide disclosure relating to the compensation of our named executive officers as of December 31, 2017, and, in accordance with Instruction 1 to Item 402(n) of Regulation S-K, we are also presenting information on historic executive compensation paid to our named executive officers during fiscal year 2016. The tables and narrative disclosure below provide compensation information for Ann G. Fox, our President and Chief Executive Officer, David Crombie, Executive Vice President and President, Completion Solutions, Theodore R. Moore, Senior Vice President and General Counsel, and Edward Bruce Morgan, President, Production Solutions. We refer to Ms. Fox, and Messrs. Crombie, Moore and Morgan herein collectively as our “Named Executive Officers.” +69 +Summary Compensation Table +The following table summarizes the compensation paid to our Named Executive Officers for the fiscal years ended December 31, 2017 and 2016. +Name and principal position +Year +Salary +($)(1) +Bonus +($)(2) +Stock +awards +($)(3) +Option +awards +($)(4) +All other +compensation +($)(5) +Total($) +Ann G. Fox +2017 +$ +476,923 +$ +500,000 +$ +2,502,700 +$ +459,645 +$ +40,672 +$ +3,979,940 +(President and Chief Executive Officer)(6) +2016 +$ +297,500 +$ +— +$ +— +$ +— +$ +36,439 +$ +333,939 +David Crombie +2017 +$ +438,462 +$ +300,000 +$ +700,005 +$ +141,602 +$ +16,485 +$ +1,596,554 +(Executive Vice President and President— Completions Solutions) +2016 +$ +325,000 +$ +50,000 +$ +— +$ +— +$ +16,488 +$ +391,488 +Theodore R. Moore +2017 +$ +230,769 +$ +150,000 +$ +250,020 +$ +117,982 +$ +— +$ +748,771 +(Senior Vice President and General Counsel)(7) +Edward Bruce Morgan +2017 +$ +260,732 +$ +125,500 +$ +174,939 +$ +47,240 +$ +3,403 +$ +611,814 +(President—Production Solutions) +2016 +$ +157,500 +$ +— +$ +— +$ +— +$ +22,113 +$ +179,613 +(1) +For 2017, our Named Executive Officers’ annualized base salaries were $500,000, $400,000, $300,000 and $250,000 for Ms. Fox, Mr. Crombie, Mr. Moore and Mr. Morgan, respectively. Please see below for more information. In 2016, Ms. Fox’s and Mr. Morgan’s annualized base salaries were reduced by approximately 15% and 10%, respectively, in light of general market conditions. +(2) +Bonus amounts for 2017 represent discretionary bonus amounts paid to our Named Executive Officers with respect to the 2017 fiscal year, as approved by our board of directors on January 26, 2018. For Mr. Crombie, bonus compensation for 2016 and 2017 includes Mr. Crombie’s annual guaranteed bonus amount under his employment agreement. No discretionary bonuses were provided to our Named Executive Officers in 2016. +(3) +The amounts reflected in the “Stock awards” column represent the grant date fair value of restricted stock awards granted to our Named Executive Officers in March 2017 pursuant to the Stock Plan (as defined below), as computed in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 718. See Note 9 to our consolidated financial statements for additional detail regarding assumptions underlying the value of these awards. +(4) +The amounts reflected in the “Option awards” column represent the grant date fair value of stock option awards granted to our Named Executive Officers in March 2017 pursuant to the Stock Plan, as computed in accordance with FASB ASC Topic 718. See Note 9 to our consolidated financial statements for additional detail regarding assumptions underlying the value of these awards. +(5) +Amounts reported in the “All other compensation” column for 2017 include costs of $15,117 for Ms. Fox, $16,483 for Mr. Crombie and $2,500 for Mr. Morgan for the Company to lease vehicles for use by those Named Executive Officers. Ms. Fox currently participates in health benefit plans maintained by SCF. The Company reimburses SCF for the costs associated with the participation of Ms. Fox, her spouse and her eligible dependents in such plans. The aggregate amount of the reimbursement to SCF for providing these benefits to Ms. Fox in 2017 was $25,555. In 2017, the Company reimbursed a portion of Mr. Morgan’s employee premiums associated with coverage under the Company’s health benefit plans for Mr. Morgan, his spouse and his eligible dependents. The aggregate amount of such premiums reimbursed by the Company in 2017 was $903. +(6) +Ms. Fox also served as Interim Chief Financial Officer during the fiscal year ended December 31, 2016. +(7) +Mr. Moore’s employment with the Company began on March 20, 2017. +70 +Narrative Disclosure to the Summary Compensation Table and Grants of Plan-Based Awards for the 2016 Fiscal Year +2017 Base Salary Adjustments and Annual Bonus Awards +In 2017, Ms. Fox’s and Messrs. Crombie’s and Morgan’s annualized base salaries were increased to $500,000, $400,000 and $250,000 for Ms. Fox, Mr. Crombie and Mr. Morgan, respectively, in order to more appropriately align our Named Executive Officers’ base salaries with current market practice. Mr. Moore began his employment with the Company on March 20, 2017, and his Employment Agreement provides for an annualized base salary of $300,000. In addition, for the 2017 fiscal year, our Named Executive Officers were eligible to earn target annual bonuses of up to $500,000 for Ms. Fox, up to $400,000 for Mr. Crombie, up to $300,000 for Mr. Moore and up to $250,000 for Mr. Morgan. In addition to the target annual bonus described above, Mr. Crombie was eligible to receive an annual guaranteed bonus of $50,000. +Employment Agreements +All of our executive officers have entered into employment agreements with the Company or one of our affiliates, which we refer to herein, collectively, as the “Employment Agreements.” In 2017, we entered into a new employment agreement with Mr. Morgan, which superseded his prior employment agreement in effect as of 2016 fiscal year-end. Messrs. Roeder and Moore also entered into employment agreements with the Company in 2017 in connection with the commencement of their employment. While Mr. Roeder was not a Named Executive Officer for the 2017 fiscal year, his Employment Agreement is included in the discussions of our executive officers’ Employment Agreements below. +The Employment Agreements have a three-year initial term, which is automatically extended for successive, additional one-year periods, unless either the executive or the Company provides 60 days’ prior written notice that no such automatic extension will occur. Ms. Fox’s and Messrs. Moore’s and Crombie’s Employment Agreements provide for annualized base salaries of $350,000, $300,000 and $250,000, respectively, which amounts may be decreased by up to 10% as part of similar base salary reductions applicable to the Company’s other executive officers. Mr. Crombie’s Employment Agreement provides for an annualized base salary of $250,000 and an annual guaranteed bonus equal to $50,000. In December 2015, Mr. Crombie’s annualized base salary was increased to $350,000 in connection with a change in his title and an increase in his duties and responsibilities. In addition, subject to the satisfaction of certain performance criteria established by our board of directors, the Employment Agreements provide for the opportunity to receive an annual incentive bonus under the terms of Company’s annual cash incentive bonus program based on criteria determined in the discretion of our board of directors. No annual incentive bonuses were provided to our Named Executive Officers for fiscal year 2016 other than the annual guaranteed bonus paid to Mr. Crombie. While employed under the Employment Agreements, the executives are eligible for certain additional benefits, including reimbursement of reasonable business expenses, paid vacation, and participation in the Company’s benefit plans, programs or arrangements. +The Employment Agreements provide for certain severance benefits upon a resignation by the applicable executive for “good reason” or upon a termination by the Company without “cause.” Please see the section entitled “Additional narrative disclosure—Potential payments upon termination or change in control” below for more details regarding the severance benefits provided to our Named Executive Officers under the Employment Agreements. +The Employment Agreements also contain certain restrictive covenants, including provisions that create restrictions, with certain limitations, on our Named Executive Officers competing with the Company and its affiliates, soliciting any customers, or soliciting or hiring Company employees or inducing them to terminate their employment. These restrictions are intended to generally apply during the term of the executives’ employment with the Company and for the one-year period following termination of employment for Ms. Fox and Messrs. Roeder, Moore and Morgan and the two-year period following termination of employment for Mr. Crombie. +2011 Stock Incentive Plan +We provide grants of stock options and restricted stock to our employees (including our Named Executive Officers) and our non-employee directors pursuant to our 2011 Stock Incentive Plan, which we refer to herein as the “Stock Plan,” in order to align their interests with those of our stockholders. No awards were provided to our Named Executive Officers under the Stock Plan in the 2016 fiscal year. +71 +During 2017, our board of directors granted awards under the Stock Plan to certain of our employees (including our Named Executive Officers) and non-employee directors with respect to 761,012 shares of our common stock. Generally, these awards either vest in full on the third anniversary of the applicable date of gr ant or vest in three equal installments on each of the first three anniversaries of the applicable date of grant in each case, so long as the employee remains employed by us through the applicable vesting date. +Other Compensation Elements +We offer participation in broad-based retirement, health and welfare plans to all of our employees. We currently maintain a retirement plan intended to provide benefits under Section 401(k) of the Internal Revenue Code. Under the 401(k) plan, eligible employees, including our Named Executive Officers, are allowed to contribute portions of their base compensation to a tax-qualified retirement account. Given recent market conditions, we did not provide matching contributions to participants in our 401(k) plan for the 2016 or 2017 plan years. See “Additional narrative disclosure—Retirement benefits” for more information. In addition, minimal perquisites have historically been provided to our Named Executive Officers, including company-provided vehicles for our Named Executive Officers and reimbursements for certain healthcare costs. Ms. Fox currently participates in the healthcare plans maintained by SCF, and we reimburse SCF for the costs associated with the participation of Ms. Fox, her spouse and her eligible dependents in such plans. In 2016 and a portion of 2017, the Company reimbursed Mr. Morgan for his employee premiums associated with medical coverage for him, his spouse and his eligible dependents under the Company’s health benefit plans. +Outstanding Equity Awards at 2017 Fiscal Year-End +The following table reflects information regarding outstanding equity-based awards held by our Named Executive Officers as of December 31, 2017. +Option awards(1) +Stock awards +Name +Grant date +Number of +securities +underlying +unexercised +options +exercisable (#) +Number of +securities +underlying +unexercised +options +unexercisable (#) +Option exercise +price ($) +Option +expiration date +Number of +shares or units +of stock that +have not vested +(#)(2) +Market value of +shares or units +of stock that +have not vested +($)(3) +Ann G. Fox +3/21/2017 +— +31,235 +$ +31.18 +3/21/2027 +— +— +3/21/2017 +— +— +— +— +80,256 +$ +1,725,504 +7/15/2015 +111,716 +55,858 +$ +41.39 +2/15/2025 +— +— +7/15/2015 +— +— +— +— +4,020 +$ +86,430 +2/28/2013 +6,284 +— +$ +23.86 +2/28/2023 +— +— +David Crombie +3/21/2017 +— +9,622 +$ +31.18 +3/21/2027 +— +— +3/21/2017 +— +— +— +— +22,447 +$ +482,611 +8/31/2015 +— +— +— +— +20,064 +$ +431,376 +Theodore R. Moore +3/21/2017 +— +8,017 +$ +31.18 +3/21/2027 +— +— +3/21/2017 +— +— +— +— +8,017 +$ +172,366 +Edward Bruce Morgan +3/21/2017 +— +3,210 +$ +31.18 +3/21/2027 +— +— +3/21/2017 +— +— +— +— +5,609 +$ +120,613 +8/30/2013 +20,064 +— +$ +23.86 +8/30/2023 +— +— +(1) +The option awards reported in these columns are subject to time-based vesting conditions. The option awards vest in three equal installments on the first three anniversaries of the date of grant of such awards. The option awards granted to each of the Named Executive Officers on March 21, 2017 will vest in equal installments on March 21 of each of 2018, 2019 and 2020, subject to the applicable executive’s continued employment through each such vesting date. The remaining unvested installment of the stock options granted to Ms. Fox on July 15, 2015 will vest on July 15, 2018, subject to Ms. Fox’s continued employment through such vesting date. +(2) +The restricted stock awards reported in this column are subject to time-based vesting conditions. The restricted stock awards granted to each of the Named Executive Officers on March 21, 2017 vest on the third anniversary of the date of grant, or +72 +March 21, 2020, subject to the applicable Named Executive Officer’s continued employment through such vesting date. The restricted stock awards granted to Ms. Fox on July 15, 2015 vest in three equal installments on the first three anniversaries of the date of grant of such awards, and the remaining unvested installment of such awards will vest on July 15, 2018, subject to Ms. Fox’s continued employment through such vesting date. The restricted stock awards granted to Mr. Crombie on August 31, 2015 vest on the third anniversary of the date of grant, or August 31, 2018, subject to Mr. Crombie’s continued employment through such vesting date. +(3) +Calculated based on the fair market value of our common stock on December 31, 2017, which was determined by adjusting the midpoint of the estimated price of our IPO, or $21.50. +Retirement Benefits +We have not maintained, and do not currently maintain, a defined benefit pension plan or nonqualified deferred compensation plan. We currently maintain a retirement plan intended to provide benefits under section 401(k) of the Internal Revenue Code where employees, including our Named Executive Officers, are allowed to contribute portions of their base compensation to a tax-qualified retirement account. We did not provide any matching contributions in the 2017 or 2016 fiscal years. As of January 1, 2018, the Company provides matching contributions equal to 100% of elective deferrals up to 3% of eligible compensation and 50% of elective deferrals from 3% to a maximum of 5% of eligible compensation, subject to the applicable contributions limits. Matching contributions are immediately fully vested. +Potential Payments upon Termination or Change in Control +The Employment Agreements provide for potential severance benefits in connection with certain terminations of employment. The Employment Agreements provide that upon a resignation by the applicable executive for “good reason” or upon a termination by the Company without “cause,” then, subject to the applicable executive’s execution and non-revocation of a release within the time provided to do so, the applicable executive will be eligible to receive the following benefits: (i) in the case of Ms. Fox and Messrs. Roeder, Moore and Morgan, an amount equal to the sum of (x) one year annualized base salary at the time of termination and (y) the applicable executive’s then-current target annual bonus, payable in 12 equal monthly installments, which, in the case of Messrs. Roeder, Moore and Morgan, shall not be less than 100% of the executive’s base salary for the year in which such termination occurs; (ii) in the case of Mr. Crombie, 18 months of Mr. Crombie’s annualized base salary at the time of termination, payable in 18 equal installments; (iii) in the case of Mr. Moore, accelerated vesting of all outstanding time-based equity awards held by Mr. Moore on the date of termination (and vested stock options, after giving effect to the foregoing, shall remain exercisable through the original expiration date applicable to such stock options); provided, however, that equity awards subject to performance requirements shall not accelerate and shall remain subject to the terms and conditions set forth in the applicable award agreement; (iv) in the case of Messrs. Roeder and Morgan, accelerated vesting of a prorated amount of all outstanding time-based equity awards on the date of termination, prorated based on the number of days that have elapsed in the vesting period applicable to such awards on the date of such termination (and vested stock options, after giving effect to the foregoing, shall remain exercisable through the original expiration date applicable to such stock options); provided, however, that equity awards subject to performance requirements shall not accelerate and shall remain subject to the terms and conditions set forth in the applicable award agreement; and (v) if the applicable executive elects COBRA continuation coverage, monthly reimbursement for the amount paid by such executive to continue such coverage for up to 12 months in the case of Ms. Fox and Messrs. Roeder, Moore and Morgan and 18 months in the case of Mr. Crombie following the date of termination. If any of our executive officers’ employment is terminated for any reason other than those described above, the applicable executive will continue to receive the compensation and benefits to be provided by the Company until the date of termination, and the applicable executive’s compensation and benefits will terminate contemporaneously with such executive’s termination of employment. The Employment Agreements do not provide for any enhanced benefits in connection with a termination of employment at or following a change in control. +73 +Ms. Fox’s and Messrs. Roeder, Moore and Morgan’s Employment Agreements provide that “cause” m eans that the applicable executive has: (i) engaged in gross negligence or willful misconduct in the performance of his or her duties; (ii) breached any material provision of his or her Employment Agreement, any other agreement between the Company and the applicable executive or any of the Company’s corporate policies or codes of conduct; (iii) willfully engaged in conduct that is injurious to the Company; or (iv) committed, pleaded no contest to or received deferred adjudication with respect to a felony or any crime involving fraud, dishonesty or moral turpitude, in the case of Messrs. Roeder, Moore and Morgan, that results in material harm to the Company. Ms. Fox’s and Messrs. Roeder, Moore and Morgan’s Employment Agreements provide that “good reason” mean s: (a) a material diminution in the applicable executive’s base salary, other than a decrease of up to 10% of the base salaries of all executive officers; (b) the relocation of the applicable executive’s principal place of employment by more than 75 miles from his or her principal place of employment as of the effective date of his or her Employment Agreement; or, (c) in the case of Messrs. Moore and Morgan only, a material diminution in the applicable executive’s authority, duties or responsibilities; prov ided, that, upon written notice from the applicable executive of the existence of any such condition, the Company will have 30 days to cure such condition. Generally, a disability will exist under Ms. Fox’s and Messrs. Roeder, Moore’s and Morgan’s Employme nt Agreements if the applicable executive is unable to perform his or her duties or fulfill his or her obligations under the applicable executive’s Employment Agreement by reason of any physical or mental impairment for a continuous period of not less than three months. +Mr. Crombie’s Employment Agreement provides that “cause” means that Mr. Crombie has: (i) engaged in gross negligence or willful misconduct in the performance of his duties; (ii) willfully refused to perform his duties for a period of more than 30 days following written notice from the Company; (iii) breached any material provision of his Employment Agreement or any other agreement between Mr. Crombie and the Company, which breach is not remedied within 30 days of written notice from the Company; (iv) materially violated a material corporate policy or code of conduct established by the Company; (v) committed an act of theft, fraud, embezzlement, or misappropriation against the Company; (vi) been convicted of (or pleaded no contest to) a crime involving fraud, dishonesty or moral turpitude or any felony; or (vii) willfully and knowingly violated any material legal requirement applicable to the Company. Mr. Crombie’s Employment Agreement provides that “good reason” means: (a) Mr. Crombie’s reassignment to a position not commensurate with his current position and level of seniority; (b) a reduction in his annual base salary of more than 10%; (c) the Company’s material breach of Mr. Crombie’s Employment Agreement; or (d) the relocation of Mr. Crombie’s principal place of work outside a 50-mile radius of Tarrant County, Texas; provided that, upon written notice from Mr. Crombie of the existence of any of the foregoing conditions, the Company will have 30 days to cure such condition. Generally, a disability will exist under Mr. Crombie’s Employment Agreement if he is incapacitated by accident, sickness or other circumstance that renders him mentally or physically incapable of performing his duties under his Employment Agreement for a period of at least 120 consecutive days or for a period of at least 180 days (whether or not consecutive) during any 12-month period. +Other than described above for Messrs. Roeder, Moore and Morgan, any shares of restricted stock subject to forfeiture restrictions held by our executive officers are forfeited for no consideration upon any termination of employment. In addition, other than described above for Messrs. Roeder, Moore and Morgan, stock options held by our executive officers may only be exercised to the extent vested while such executive officer remains employed by the Company or one of our affiliates; however, our executive officers may exercise vested stock options for a period of 30 days following a termination of employment other than for “cause” (as defined in the applicable stock option agreement) or for a period of one year following a termination of employment due to death or disability. Other than the foregoing, we do not currently maintain any other severance or change in control agreements with any of our Named Executive Officers. +Director Compensation +In 2017, our non-employee directors received quarterly cash payments of $7,500 for their service on our board of directors with an additional quarterly retainer of $3,750 for the Chairman of the Board. Our non-employee directors received restricted stock awards covering 3,202 shares of common stock under the Stock Plan in 2017. In addition, Mr. Danner received additional awards of restricted stock and options in recognition of his significant efforts in connection with the Combination. Directors that also provide services to the Company or its affiliates as employees, including Ms. Fox, and directors employed by or affiliated with SCF do not receive compensation for their service on our board of directors. +74 +The fo llowing table summarizes the compensation awarded or paid to the members of our board of directors for the fiscal year ended December 31, 2017. +Name +Fees earned or +paid in cash +($)(1) +Stock awards +($)(2) +Option awards +($)(3) +Total +($) +Ernie L. Danner +$ +45,000 +$ +300,074 +$ +353,946 +$ +699,019 +Mark E. Baldwin +$ +30,000 +$ +99,858 +$ +— +$ +129,858 +Gary L. Thomas +$ +30,000 +$ +99,858 +$ +— +$ +129,858 +Curtis F. Harrell +$ +30,000 +$ +99,858 +$ +— +$ +129,858 +Scott E. Schwinger(4) +$ +22,500 +$ +— +$ +— +$ +22,500 +(1) +Amounts reported in this column reflect annual cash retainer amounts received by our non-employee directors for service on our board of directors. As described above, in 2017, our directors received quarterly payments of $7,500, and the Chairman of the Board received an additional quarterly retainer of $3,750. +(2) +In 2017, our non-employee directors received restricted stock awards covering 3,202 shares of common stock with a grant date fair value equal to approximately $100,000 for their service on our board of directors. As discussed above, Mr. Danner received an additional restricted stock award in recognition of his significant contributions in connection with the Combination. The amounts reflected in the “Stock awards” column represent the grant date fair value of restricted stock awards granted to our non-employee directors in March 2017 pursuant to the Stock Plan, as computed in accordance with FASB ASC Topic 718. See Note 9 to our consolidated financial statements for additional detail regarding assumptions underlying the value of these awards. +(3) +As discussed above, Mr. Danner received an additional stock option award in recognition of his significant contributions in connection with the Combination. The amounts reflected in the “Option awards” column represent the grant date fair value of stock option awards granted to Mr. Danner in March 2017 pursuant to the Stock Plan, as computed in accordance with FASB ASC Topic 718. See Note 9 to our consolidated financial statements for additional detail regarding assumptions underlying the value of these awards. +(4) +Mr. Schwinger was appointed to our board of directors on May 25, 2017 and did not receive a restricted stock award in 2017. Mr. Schwinger was granted a restricted stock award in January 2018 in connection with the completion of our IPO in recognition of his services on our board of directors. +2018 Non-employee Director Compensation Program +In connection with our IPO, we adopted a compensation policy for our non-employee directors (the “Non-Employee Director Compensation Policy”). Under the Non-Employee Director Compensation Policy, our non-employee directors will be entitled to receive compensation for services they provide to us consisting of retainers and equity compensation as described below. Each non-employee director will be eligible to receive the following for their service on our board of directors pursuant to the Non-Employee Director Compensation Policy: +• +A quarterly retainer of $17,500; +• +An additional quarterly retainer of $7,500 for the Chairman of the Board; +• +An additional quarterly retainer of $2,500 for the non-employee directors serving as chairs of the audit committee and the nominating, governance and compensation committee; +In addition to cash compensation, our non-employee directors are eligible to receive annual equity-based compensation consisting of restricted stock awards with an aggregate grant date value equal to $100,000 or, in the case of the Chairman of the Board, $150,000. However, the Non-Employee Director Compensation Policy provides that in the first calendar year in which non-employee directors are appointed or elected to our board of directors, they will be eligible to receive an initial restricted stock award with an aggregate grant date value equal to $125,000 in lieu of such annual restricted stock award. Generally, the forfeiture restrictions applicable to the restricted stock awards lapse on the one-year anniversary of the date of grant of such awards. The restricted stock awards granted to our non-employee directors are subject to the terms and conditions of the Stock Plan and the award agreements pursuant to which such awards are granted. +75 +Item 12. +Security Ownership of Certain Beneficial O wners and Management and Related Shareholder Matters +Beneficial Ownership Information +The following table sets forth information with respect to the beneficial ownership of our common stock as of March 21, 2018 by: +• +each of our Named Executive Officers; +• +each of our directors; +• +all of our directors and executive officers as a group; and +• +each person known to us to beneficially own 5% or more of our outstanding common stock. +Except as otherwise indicated, the persons or entities listed below have sole voting and investment power with respect to all shares of our common stock beneficially owned by them, except to the extent this power may be shared with a spouse. All information with respect to beneficial ownership has been furnished by the respective directors, executive officers, or 5% or more stockholders, as the case may be. Unless otherwise noted, the mailing address of each listed beneficial owner is 2001 Kirby Drive, Suite 200, Houston, Texas 77019. +Shares of common stock beneficially owned +Name and address of beneficial owner +Number +%(1) +5% or more Stockholders: +SCF(2) +9,086,888 +38.1 +% +Directors and Named Executive Officers: +Ann G. Fox +243,488 +* +David Crombie +192,733 +* +Edward Bruce Morgan +122,670 +* +Theodore R. Moore +10,690 +* +Ernie L. Danner +123,489 +* +David C. Baldwin +— +— +Mark E. Baldwin +13,105 +* +Curtis F. Harrell +43,497 +* +Scott E. Schwinger +5,435 +* +Gary L. Thomas +13,450 +* +Andrew L. Waite +— +— +All directors and executive officers as a group (11 persons) +768,557 +3.2 +% +* +less than 1%. +(1) +Based upon an aggregate of 23,873,583 shares outstanding as of March 21, 2018, 2018. For each stockholder, in accordance with Rule 13d-3 promulgated under the Exchange Act, this percentage is determined by assuming the named stockholder exercises all options and other instruments pursuant to which the stockholder has the right to acquire shares of our common stock within 60 days of March 21, 2018, but that no other person exercises any options or other purchase rights (except with respect to the calculation of the beneficial ownership of all directors and executive officers as a group, for which the percentage assumes that all directors and executive officers exercise all such options or other purchase rights). +(2) +L. E. Simmons is the natural person who has voting and investment control over the securities owned by SCF. Mr. Simmons serves as the President and sole member of the board of directors of LESA, the ultimate general partner of SCF. Because SCF-VII, L.P. and SCF-VII(A), L.P. are controlled by LESA, these entities may be considered to be a group for purposes of Section 13(d)(3) under the Exchange Act. As a group, SCF beneficially owns 9,086,888 shares of our common stock in the aggregate. This beneficial ownership includes 7,528,518 shares of our common stock held by SCF-VII, L.P. and 1,558,370 shares of our common stock held by SCF-VII(A), L.P. The address for SCF-VII, L.P. and SCF-VII(A), L.P. is 600 Travis Street, Suite 6600, Houston, Texas 77002. +76 +Securities Authorized for Issuance under Equity Compensation Plans +The following table summarizes information about our equity compensation plans as of December 31, 2017: +(a) +(b) +(c) +Number of +securities +to be issued +upon exercise +of outstanding +options, warrants +and rights (1) +Weighted-average +exercise price +of outstanding +options, warrants +and rights (2) +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders +1,068,791.00 +$ +30.79 +2,269,708.00 +Equity compensation plans not approved by security holders +— +$ +— +— +Total +1,068,791.00 +$ +30.79 +2,269,708.00 +(1) +This column reflects all shares of common stock subject to outstanding options granted under the Nine Energy Service, Inc. 2011 Stock Incentive Plan (the “Stock Plan”) as of December 31, 2017. +(2) +The weighted average exercise price reflected in this column is calculated based solely on the exercise prices of outstanding options. +Our only equity compensation plan is the Stock Plan, which was approved by our stockholders prior to our initial public offering. Please see Note 9 to our consolidated and consolidated financial statements for a description of our equity compensation plan. In addition, a detailed description of the terms of the Stock Plan is available in the Company’s Amendment No. 6 to Registration Statement on Form S-1 (File No. 333-217601), filed by the Company with the SEC on January 9, 2018, under the heading “Executive Compensation—Amended and Restated 2011 Stock Incentive Plan.” +Item 13. +Certain Relationships and Related Transactions, and Director Independence +On February 28, 2017, we closed the Combination with Beckman, a growth-oriented oilfield services company that provides a wide range of well and coiled tubing services. Pursuant to the Combination, all of the issued and outstanding shares of Beckman common stock were converted into shares of our common stock, except 1.6% of Beckman shares paid in cash. In addition to the conversion of all of the shares of outstanding common stock of Beckman to shares of our common stock, all of the restricted stock and outstanding stock options of Beckman were also converted to restricted stock and stock options of Nine. Options exercisable for approximately 17,313 shares of Beckman common stock with a weighted average exercise price of $123.02 per share and 20,225 shares of restricted stock of Beckman outstanding as of December 31, 2016 converted to options exercisable for approximately 78,715 shares of our common stock with a weighted average exercise price of $27.03 per share and 91,961 shares of restricted stock of Nine. +Prior to the Combination, Beckman was also an SCF Partners portfolio company. A key strategic rationale for the Combination was to enhance our ability to serve customers and our growth potential through broader product lines and basin diversification, enabling us to cross-sell our products and compete with larger companies. The Combination was a means of achieving these objectives and created various synergistic opportunities, including greater ability to raise capital for expansion, opportunity to develop broader and more diversified product lines, ability to compete with larger companies and opportunity to leverage internal initiatives. +Immediately prior to the Combination and the Subscription Offers (described below), SCF owned 615,525 shares of Beckman common stock or 56.4%. +77 +Immed iately following the completion of the transactions contemplated by the Combination and the Subscription Offers, SCF beneficially owned a total of 8,753,271 shares of our common stock (calculated pursuant to Rule 13d-3 under the Exchange Act). This benefic ial ownership consisted of (1) 7,528,526 shares of common stock issued to SCF in connection with the Combination, (2) 804,502 shares of common stock issued to SCF in connection with the Subscription Offers, and (3) warrants to purchase 402,243 shares of ou r common stock issued to SCF in connection with the Subscription Offers. For a discussion of the Combination, please see Note 1 to our consolidated financial statements, and for a discussion of the Subscription Offers, and related issuance of warrants to S CF, please see “—Subscription and warrant agreements.” +Transactions with our Significant Stockholders and our Directors and Executive Officers +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, promissory notes totaling $2.5 million were issued to both a former executive officer of the Company in 2015, and to a current manager of the Company. The principal is due on June 30, 2019 (the “Maturity Date”). Interest of 4% per annum is due and payable on the Maturity Date. At December 31, 2017 and 2016, the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and $2.8 million, respectively. Unpaid interest at December 31, 2017 and 2016 totaled $0.4 million and $0.3 million, respectively. +As part of the acquisition of Crest in 2014, promissory notes totaling $9.4 million were issued to former owners of Crest, including Mr. Crombie, who is an executive of the Company. The principal is due on June 30, 2019. The interest rate is based on the prime rate, the federal funds rate or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement, and is due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At December 31, 2017 and 2016, the outstanding principal balance of the notes totaled $7.6 million. Unpaid interest, included in “Prepaid expenses and other” in the Consolidated Balance Sheets, totaled $8,000 and $19,000 at December 31, 2017 and 2016, respectively. +The Company leases office space, yard facilities and equipment, and purchases building maintenance services from Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million, $0.7 million and $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. There were payables of $13,000 and $0 at December 31, 2017 and 2016, respectively. +As part of the Tripoint acquisition on October 3, 2011, promissory notes totaling $1.1 million were issued to former owners of Tripoint who were members of management. The principal was due on September 15, 2015. Interest of 4% was due quarterly, but could be deferred and added to the outstanding principal balance at the election of the Company. In 2015, the outstanding balance of the notes, $0.9 million, including accrued interest, was repaid in full using a combination of $0.2 million of cash and common stock redemption valued at $0.7 million. The value attributed to common stock, as agreed between the Company and the former owners of Tripoint, was $33.11 per share, resulting in the cancellation of 20,417 shares. +The Company entered into a shared services agreement with a related party, whose manager, Benjamin Winston, is a stockholder of the Company, and was a member of Beckman’s board of directors from 2014 through the consummation of the Combination. The related party provides office space, personnel and certain general and administrative services to the Company. The Company paid the related party $0.7 million, $0.2 million and $0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $13,000 and $8,000 as of December 31, 2017 and 2016, respectively. +The Company leases facilities and buildings in Monahans, Texas and Enid, Oklahoma, from an entity owned by Mr. Winston. The Company incurred rent expense of $0.5 million, $0.6 million and $0.5 million to this entity for the years ended December 31, 2017, 2016 and 2015, respectively. There were no payables to or receivables from this related party at December 31, 2017 and December 31, 2016. +The Company utilizes a related party, whose manager is Mr. Winston, to transport equipment, chemicals, and supplies. The Company incurred expense of $1.2 million, $0.7 million and $0.7 million, for these services during the years ended December, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $0.1 million at December 31, 2017. There was no payable related to this party at December 31, 2016. +78 +The Company facilitates pass-through billings on behalf of an entity owned by Mr. Winston. The Company recognizes no revenue or expense related to this activity. During the year ended December 31, 2017, the related entity billed the Company $40,000 , and the Company billed respective customers the same amount. The Company collected cash for and reimbursed to the related entity $0.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $11,000 of pass-through billings to customers remained uncollected as of December 31, 2017. During the year ended December 31, 2016, the related entity billed the Company $0.8 million, and the Company rebilled respective customers the same amount. The Company collected cash for and reimburse d to the related entity $1.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $0.1 million of pass-through billings to customers remained uncollected as of December 31, 2016. During 2015, the related entity billed Beckman $2.2 million. Beckman rebilled respective customers of this related entity $2.2 million, and Beckman collected cash for and reimbursed to the related entity approximately $2.1 million. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million, $0.4 million and $0.5 million for services provided to this entity during the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding receivable due of $0.2 million and $0.1 million as of December 31, 2017 and 2016, respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas acts as the President of EOG Resources, Inc. The Company generated revenue from EOG Resources, Inc. of $34.4 million, $13.7 million and $24.9 million in 2017, 2016 and 2015, respectively. +Subscription and Warrant Agreements +In connection with the Combination and pursuant to subscription agreements dated March 10, 2017, we offered each of our stockholders (our existing stockholders and the Beckman stockholders) who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under Securities Act) the opportunity to purchase shares of our common stock worth $20 million in the aggregate, up to their pro-rata ownership of the Company (the “Combined Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $20 million of shares of our common stock, the eligible purchasers that elected to participate in the Combined Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $20 million in the aggregate. The proceeds from the Combined Nine Subscription Offer were used to (i) to finance the purchase of non-accredited investors’ shares in the Combination and pay fees and expenses related to the Combination and (ii) for general corporate purposes, including ensuring compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Combined Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Combined Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated March 10, 2017, we offered each of our existing stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of our common stock worth $5 million in the aggregate, up to their pro-rata ownership of the Company (the “Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $5 million of shares of our common stock, the eligible purchasers that elected to participate in the Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $5 million in the aggregate. The proceeds from the Nine Subscription Offer were retained by us to ensure compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer and the Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated February 10, 2017, Beckman offered each of its stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of its common stock worth $15 million in +79 +the aggregate, up to their pro-rata ownership of Beckman (the “Beckman Subscription Offer” and with the Combined Nine Subscription Offer and the Nine Subscription Offer, the “Subscription Offers”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $15 million of shares of its common stock, the eligible purchasers that elected to participate in the Beckman Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of its common stock worth $15 million in the aggregate. The proceeds from the Beckman Subscription Offer were used to pay outstanding indebtedness under the Fo rmer Beckman Credit Facility. In connection with the Beckman Subscription Offer, Beckman issued to those stockholders who purchased shares of its common stock a warrant to purchase additional shares of its common stock on the basis of one warrant share for every two shares purchased in the Beckman Subscription Offer. Beckman shares of common stock issued in the Beckman Subscription Offer and warrants purchased in the Beckman Subscription Offer converted into shares and warrants of our common stock based on the exchange ratio used with respect to the Combination. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +The following table identifies each related person who participated in the Combined Nine and Nine Subscription Offers. +Related person +No. of shares +purchased +$ amount +purchased +No. of warrant +shares(1) +Mark Baldwin +698 +$ +21,774 +345 +David Crombie(2) +10,344 +$ +322,598 +5,168 +Ernie L. Danner(3) +4,004 +$ +124,884 +1,998 +Ann G. Fox +239 +$ +59,815 +955 +Curtis F. Harrell(4) +1,388 +$ +43,297 +690 +Gary L. Thomas +698 +$ +21,774 +345 +(1) +The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +(2) +Amounts reported include 10,344 shares purchased at a purchase price of $322,598 and 5,168 warrants by DKM Investments, LP of which Mr. Crombie is a member. +(3) +Amounts reported include 1,380 shares purchased at a purchase price of $43,046 and 690 warrants by Autumn Plecher, LP of which Mr. Danner is a limited partner of the general partner. +(4) +Amounts reported include 1,388 shares purchased at a purchase price of $43,297 and 690 warrants by Harrell Ventures, LLC of which Mr. Harrell is the managing member . +In connection with the Beckman Subscription Agreement, Mr. Danner subscribed to purchase 1,850 shares of Beckman common stock (8,418 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Danner also received 925 warrants to purchase Beckman shares of common stock, which were converted into 4,205 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In connection with the Beckman Subscription Agreement, Mr. Harrell subscribed to purchase 672 shares of Beckman common stock (3,057 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Harrell also received 336 warrants to purchase Beckman shares of common stock, which were converted into 1,524 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +Pursuant to a Subscription Agreement dated March 31, 2017, Douglas S. Aron, who acted as the Executive Vice President and Chief Financial Officer of the Company from April 2017 until September 8, 2017, subscribed to purchase 32,102 shares of our common stock in exchange for a cash payment of $1 million. +80 +On July 25, 2017, we provided notice to all existing holders of the Company’s common stock that we are offering for sale up to approximately $20 million of the Company ’s common stock for $18.69 per share to those stockholders that were accredited investors. We closed the July 2017 Subscription Offer on August 23, 2017. Pursuant to this subscription offer, the following related persons purchased, directly or indirectly, more than $120,000 of our common stock: Mr. Crombie - $227,250, Mr. Danner - $163,650, Mr. Morgan - $121,650 and SCF-VII, L.P. - $14,039,100. We received consent from all the lenders under the Former Nine Credit Facility for the cash proceeds from the July 2017 Subscription Offer to be deposited in a segregated account that does not constitute collateral for the indebtedness thereunder. +Pursuant to the Employment Agreement dated November 20, 2017, as amended by the First Amendment thereto dated December 20, 2017, Clinton Roeder, the Senior Vice President and Chief Financial Officer of the Company, agreed to purchase $300,000 of our common stock during the 10-day period beginning on the earlier of (i) the closing of our IPO and (ii) February 22, 2018 (the date of such purchase, the “Funding Date”), at the Fair Market Value (as defined in the Stock Plan). Such purchase was completed on January 23, 2018. Pursuant to such Employment Agreement on January 23, 2018, the Company granted (i) options to purchase 32,102 shares of our common stock (as adjusted by the Stock Split and any other splits or adjustments determined by our board of directors) with an exercise price equal to the Fair Market Value (as defined in the Stock Plan) and (ii) $600,000 of shares of restricted stock at a price per share equal to the Fair Market Value (as defined in the Stock Plan), to Mr. Roeder under the Stock Plan. +Stockholders Agreement +In connection with the Combination, on February 28, 2017, we, SCF and substantially all of the holders of our common stock and warrants entered into the Second Amended and Restated Stockholders Agreement, which was further amended on July 24, 2017 (as amended, the “Existing Stockholders Agreement”). The Existing Stockholders Agreement contained provisions related to, among other things, stock transfer restrictions, tag-along and drag-along rights, preemptive rights, registration rights and board composition. +The Existing Stockholders Agreement, other than the provisions relating registration rights and certain miscellaneous provisions, terminated upon the consummation of our IPO on January 23, 2018. Following the consummation of our IPO, we will amend and restate the Existing Stockholders Agreement (the “Amended Stockholders Agreement”) to eliminate all terminated provisions. The registration rights provisions that will be contained in the Amended Stockholders Agreement are described below. +Demand Registration Rights +Under the Amended Stockholders Agreement, from and after 180 days following our IPO, SCF (and its permitted transferees) will have the right to demand (a “Demand Request”) on five occasions that we register all or any portion of the SCF Registrable Securities (as such term is defined in the Amended Stockholders Agreement) (a “Demand Registration”) so long as the SCF Registrable Securities proposed to be sold on an individual registration statement have an aggregate gross offering price of at least $10.0 million or at least $1.0 million if we are then eligible to register such sale on a Form S-3 registration statement (or any comparable or successor form) and provided that we are not required to effect more than one Demand Registration in any six-month period. After such time that we become eligible to use Form S-3 (or comparable form) for the registration under the Securities Act of any of our securities, any Demand Request with a reasonably anticipated aggregate offering price of $100.0 million may be for a “shelf” registration statement pursuant to Rule 415 under the Securities Act. +We may delay the filing of a registration statement pursuant to a Demand Request until a date not later than 60 days after the required filing date if (i) we are engaged in confidential negotiations or other confidential business activities that would require disclosure in the registration statement and our board of directors determines in good faith that such disclosure would be materially detrimental to us or (ii) we have experienced some other material non-public event or is in possession of material non-public information concerning the Company. We may also delay the filing if, prior to receiving a Demand Request, we are already proceeding with another offering for its own account or for the account of another requesting holder. +81 +Piggyback Registration Rights +If we propose to file a registration statement under the Securities Act relating to an offering of our common stock for our own account or for the account of any common stockholder (other than certain registration statements, including those relating to securities offered in connection with benefit plans or acquisitions), the holders of Registrable Securities (as defined in the Amended Stockholders Agreement) will have customary piggyback registration rights that allow them to include the Registrable Securities that they own in any such registration statement, and any related underwriting. We will provide written notice to holders of Registrable Securities of such filing as soon as practicable (but in no event less than 15 days prior to the anticipated filing). +If the managing underwriter of a proposed underwritten offering advises us that in its opinion the total amount of securities to be included in such offering is sufficiently large to materially and adversely affect the price or success of the offering, then the securities to be included in such offering will be allocated first to the requesting holders if the registration statement is pursuant to a Demand Request or, if not, then to us, and then pro rata among the holders of piggyback securities on the basis of the number of Registrable Securities then held by each such holder. +Holdback Agreements +Each holder of Registrable Securities will be subject to certain lock-up provisions that restrict transfer during the period beginning 14 days prior to, and continuing for a period not to exceed 180 days after, the date of our IPO final prospectus, or 90 days for any subsequent underwritten public offering of equity securities of the Company, except as part of such registration (subject to an extension of such lock-up period by up to 35 days in certain circumstances). +Registration Procedures and Expenses +The Amended Stockholders Agreement will contain customary procedures relating to underwritten offerings and the filing of registration statements. We will agree to pay all registration expenses incurred in connection with any registration, including all registration, qualification and filing fees, printing expenses, accounting fees, escrow fees, legal fees of the Company, reasonable fees of one counsel to the holders of Registrable Securities, blue sky fees and expenses and the expense of any special audits incident to or required by any such registration. All underwriting discounts and selling commissions and stock transfer taxes applicable to securities registered by holders and fees of counsel to any such holder (other than as described above) will be payable by holders of Registrable Securities. +Indemnification and Contribution +The Amended Stockholders Agreement will contain customary indemnification and contribution provisions by the Company for the benefit of holders participating in any registration. Each holder participating in any registration will also agree to indemnify the Company in respect of information provided by such holder to the Company for use in connection with such registration; provided that such indemnification will be limited to the net proceeds actually received by such indemnifying holder from the sale of Registrable Securities. +Procedures for Approval of Related Person Transactions +A “Related Party Transaction” is a transaction, arrangement or relationship in which we or any of our subsidiaries was, is or will be a participant, the amount of which involved exceeds $120,000, and in which any related person had, has or will have a direct or indirect material interest. A “Related Person” means: +• +any person who is, or at any time during the applicable period was, one of our executive officers or one of our directors; +• +any person who is known by us to be the beneficial owner of more than 5.0% of our common stock; +82 +• +any immediate family member of any of the foregoing persons, which means any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law of a director, executive o fficer or a beneficial owner of more than 5.0% of our common stock, and any person (other than a tenant or employee) sharing the household of such director, executive officer or beneficial owner of more than 5.0% of our common stock; and +• +any firm, corporation or other entity in which any of the foregoing persons is a partner or principal or in a similar position or in which such person has a 10.0% or greater beneficial ownership interest. +Our board of directors adopted a written related party transactions policy prior to the completion of our IPO. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Party Transactions and either approve or disapprove entry into the Related Party Transaction, subject to certain limited exceptions. In determining whether to approve or disapprove entry into a Related Party Transaction, the Audit Committee expects to take into account, among other factors, the following: (1) whether the Related Party Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and (2) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Party Transactions required to be disclosed in our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +Item 14. Principal Accounting Fees and Services +Audit and Other Fee Information +Set forth below is a summary of certain fees paid to PricewaterhouseCoopers for services related to the fiscal years ended December 31, 2017 and December 31, 2016. +2017 +2016 +(in millions of dollars) +Audit fees +$ +1.3 +$ +0.9 +Audit related fees +0.8 +- +Tax fees +0.2 +0.2 +All other fees +- +- +Total +$ +2.3 +$ +1.1 +Audit Fees +Audit fees consist of the aggregate fees billed for professional services rendered for (a) the audit of our annual financial statements included in our Annual Report on Form 10-K, (b) the filing of our registration statements for equity securities offerings, (c) services that are normally provided in connection with statutory and regulatory filings or engagements for those years, and (d) accounting consultations. +Audit Related Fees +Audit related fees consisted of amounts incurred in connection with the IPO. +Tax Fees +Tax fees consisted of services provided for income tax. +All Other Fees +None +83 +PART IV +Item 15. Exhibits, Financial Statement Schedules +(a) Documents Filed With This Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this report: +Reports of Independent Registered Public Accounting Firms +F-1 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-3 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016 and 2015 +F-4 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2017, 2016 and 2015 +F-5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015 +F-6 +Notes to Consolidated Financial Statements +F-7 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this report required to be filed pursuant to Item 15(b) are listed below in the “Index to Exhibits” attached hereto and are incorporated herein by reference. +Exhibit +number +Description +2.1† +Combination Agreement, dated as of February 3, 2017, by and among Nine Energy Service, Inc., Beckman Production Services, Inc. and Beckman Merger Sub, Inc. (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +84 +Exhibit +number +Description +4.3 +Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +10.1 +Credit Agreement, dated as of September 14, 2017, among Nine Energy Service, Inc. and certain of its subsidiaries listed therein, Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Amendment No. 4 to Registration Statement on Form S-1 filed on November 14, 2017). +10.2 +First Amendment to Credit Agreement, dated as of November 20, 2017, among Nine Energy Service, Inc. and certain of its subsidiaries listed therein, Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.22 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +10.3 +Amended and Restated Credit Agreement, dated as of June 30, 2014, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., HSBC Bank USA, N.A., HSBC Bank Canada and certain other financial institutions listed therein (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.4 +First Amendment to Amended and Restated Credit Agreement and US Pledge and Security Agreement, dated as of May 13, 2016, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., HSBC Bank USA, N.A., HSBC Bank Canada and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.5 +Second Amendment to Amended and Restated Credit Agreement and Limited Consent, dated as of August 2, 2017, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., HSBC Bank USA, N.A., HSBC Bank Canada and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +10.6 +Credit Agreement, dated as of May 2, 2014, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions listed therein (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.7 +Agreement and Amendment No. 1 to Credit Agreement, dated as of August 26, 2014, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.8 +Master Assignment, Agreement and Amendment No. 2 to Credit Agreement, dated as of October 16, 2014, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.9 +Agreement and Amendment No. 3 to Credit Agreement, dated as of November 21, 2014, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.6 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +85 +Exhibit +number +Description +10.10 +Agreement and Amendment No. 4 to Credit Agreement, dated as of January 12, 2016, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.7 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.11 +Agreement and Amendment No. 5 to Credit Agreement, dated as of February 10, 2017, by and among Beckman Production Services, Inc., Wells Fargo Bank, National Association and certain other financial institutions and guarantors listed therein (Incorporated by reference to Exhibit 10.8 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.12+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.13+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.14+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.11 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.15+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.12 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.16+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.13 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.17+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.14 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.18+ +Employment Agreement between Ann Fox and Nine Energy Service, LLC, dated as of July 6, 2015 (Incorporated by reference to Exhibit 10.15 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.19+ +Employment Agreement between David Crombie and Crest Pumping Technologies, LLC, dated as of June 30, 2014 (Incorporated by reference to Exhibit 10.16 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.20+ +Employment Agreement between Edward Bruce Morgan, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of April 6, 2017 (Incorporated by reference to Exhibit 10.18 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.21+ +Employment Agreement between Theodore R. Moore, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of March 12, 2017 (Incorporated by reference to Exhibit 10.19 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.22+ +Employment Agreement between Clinton Roeder, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of November 20, 2017 (Incorporated by reference to Exhibit 10.21 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +10.23+ +First Amendment to Employment Agreement between Clinton Roeder, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of December 20, 2017 (Incorporated by reference to Exhibit 10.23 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +86 +Exhibit +number +Description +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP +23.2* +Consent of BDO USA, LLP +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +* +Filed herewith. +** +Furnished herewith. +† +The schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K and will be provided to the Securities and Exchange Commission upon request. ++ +Management contract or compensatory plan or arrangement +87 +SIGNA TURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: +/s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 29, 2018 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 29, 2018. +Signature +Title +/s/ Ann G. Fox +President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Clinton Roeder +Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Clinton Roeder +/s/ Richard S. Woolston +Chief Accounting Officer (Principal Accounting Officer) +Richard S. Woolston +/s/ Ernie L. Danner +Chairman of the Board +Ernie L. Danner +/s/ David C. Baldwin +Director +David C. Baldwin +/s/ Mark E. Baldwin +Director +Mark E. Baldwin +/s/ Curtis F. Harrell +Director +Curtis F. Harrell +/s/ Gary L. Thomas +Director +Gary L. Thomas +/s/ Scott E. Schwinger +Director +Scott E. Schwinger +/s/ Andrew L. Waite +Director +Andrew L. Waite +88 \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/filing_metadata.csv b/raw/filings/0001532286/2017/0001564590-18-007130/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..23d0c37e9b7b993fb33f0cc4dd379f6738ee028b --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2018-03-29,2017-12-31,2018-03-29T20:12:53.000Z,0001564590-18-007130,nine-10k_20171231.htm,10-K,4734643,0,0,https://www.sec.gov/Archives/edgar/data/1532286/000156459018007130/nine-10k_20171231.htm,https://www.sec.gov/Archives/edgar/data/1532286/000156459018007130/,2017,2017,1 diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/item1.txt b/raw/filings/0001532286/2017/0001564590-18-007130/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..8c9701467478c6958a074fc2e8103096e14102b6 --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/item1.txt @@ -0,0 +1,115 @@ +Item 1. +Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us” and “our”) is a Delaware corporation that was incorporated in February 2013 through a combination of three service companies owned by SCF. Nine is a leading North American onshore completion and production services provider that targets unconventional oil and gas resource development. We partner with our exploration and production (“E&P”) customers across all major onshore basins in both the U.S. and Canada to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery (“EUR”) per lateral foot and a superior return on investment, which make them attractive to operators despite their associated increased well cost. We compete with a limited number of service companies for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well and increased proppant loading per lateral foot. As stage counts per well increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and drilling out plugs and performing associated remedial work as production comes online. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. We provide customers with plug-and-perf or pinpoint frac sleeve system technology to complete the remaining stages of the well. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our pinpoint frac sleeve system involves packers, either hydraulic or swellable, to isolate sections of the wellbore and frac sleeves to provide access to each stage for stimulation and production. Our equipment also includes high-specification coiled tubing units and workover rigs that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. Once a well is producing, we are able to offer a range of production enhancement and well workover services through our fleet of well service rigs and ancillary equipment. +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017 (“Combination”), the Company merged with Beckman Production Services, Inc. (“Beckman”) and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc., other than 1.6% of Beckman shares paid in cash. Prior to the Combination, SCF-VII, L.P. controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the combined Company was accounted for using reorganization accounting (i.e., “as if” pooling of interests) for entities under common control. +2 +Our Segments +We operate in two segments: Completion Solutions and Production Solutions. Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. +Completion Solutions +The following is a description of the primary service offerings and deployment methods within the Completion Solutions business segment: +Cementing services : Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently have three high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to API specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps and two electrical systems. This significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment, and since 2012, we have deployed only new equipment for use in the fields. As of December 31, 2017, we operated a total of 28 twin-pumping units, each of which has 1,000 horsepower, which we believe is the highest in the industry. +From January 2014 through December 2017, we completed approximately 11,100 cementing jobs, with an on-time rate of approximately 90%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 90% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants and our service-driven culture. In order to further improve punctuality, respond to customers’ demands for providers near their acreage, and gain access to an additional customer base, we built a bulk plant and lab facility in Hobbs, New Mexico, with close proximity to the Delaware Basin. We believe this location will reduce operating expenses due to improved logistics as well as provide cross-selling opportunities for other service lines. +Completion tools : We provide unconventional and conventional downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, fully-composite and dissolvable frac plugs and specialty open hole float equipment and centralizers. Our completion tools provide pinpoint frac sleeve system technologies that enable comparable rates per stage while providing more control over fracture initiation. A few examples of our innovative portfolio of completion tools are: (i) the Scorpion Fully-Composite Plug TM , a patented packer-style fully-composite plug designed to provide zonal isolation in a multi-stage well completion; we offer a diverse product group of fully-composite plugs designed for 3.5” to 5.5” well casings as well as a unique Scorpion Extended Range plug, which is used in demanding well applications where operators have to negotiate through internal diameter restrictions, (ii) the Scorpion Dissolvable Plug, a high performance plug designed to provide zonal isolation, is made entirely from proprietary materials that dissolve over time, leaving the wellbore unobstructed for production and eliminating the risk and costs of conventional plug removal, (iii) the SmartStart PLUS TM , an interventionless time-delayed pressure-activated sleeve that we have the exclusive distribution rights to in the northeastern U.S. and with certain customers in other regions, that eliminates the need for tubing or pipe-conveyed perforating when completing the toe stage of horizontal wells, (iv) the Storm Re-Frac Packer TM , a system that allows our customers to re-stimulate their existing wells using standard size plug-and-perf procedures to extend and enhance their production profiles with minimal flow restriction during stimulation, (v) the FlowGun TM , a stage one interventionless casing-conveyed perforating technology that eliminates the need to run wireline or coil tubing and requires no electronic detonation allowing our customers to perform a maximum pressure test and perforate stage one more efficiently with less risk and with no lateral length limitations, (vi) the Coil Frac Sleeve System, a system that utilizes coiled tubing to deploy a resettable +3 +frac packer, that we have the exclusive distribution rights to in the U.S., which is used to open and isolate frac sleeves that have been installed as an integral part of the casing, and (vii) the EON Ball Drop s ystem, an interventionless single-size ball activated pinpoint frac sleeve system, that we have exclusive distributions rights to in the U.S. and Canada. Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. From March 2011 through December 2017, we deployed approximately 65,000 swell and hydro-mechanical packers and approximately 18,000 frac sleeves for downhole completions. +Additionally, we offer a portfolio of completion technologies used for completing the toe stage of a horizontal well, as well as fully-composite, dissolvable and extended-range frac plugs to isolate stages during plug-and-perf operations. +Wireline services : Our wireline services involve the use of a wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations, with 37 wireline units in the U.S. and 14 wireline units in Canada. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools and addressable switches. We currently have wireline units equipped with customized drums to hold up to 40,000 feet of Enviroline. Enviroline is a coated wireline that significantly reduces injector oil use requiring only 5% of the amount needed with standard wireline. Offering a lower dynamic coefficient of friction, Enviroline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite frac plugs through our wireline units. From January 2014 through December 2017, we completed approximately 70,000 wireline stages in the U.S. with a success rate of approximately 99%. +Coiled tubing services : Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 25,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift installation, cementing, stimulation and restimulation services. In addition, our units are also used in conjunction with pinpoint hydraulic fracturing operations. +We currently operate 16 coiled tubing units serving the Permian Basin, SCOOP/STACK region and Haynesville markets. Each of our coiled tubing units carries data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Of the 16 coiled tubing units, we consider 11 to be “extended reach” units capable of reaching the toe of wells with total measured depths of 21,500 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8’’ and 2 5/8’’) applications, we also offer 2’’ and 1 1/4’’ diameter solutions to our customers. From April 2014 through December 2017, we have performed approximately 5,900 jobs and deployed more than 115 million running feet of coiled tubing, with a success rate of over 99%. +Production Solutions +The following is a description of the primary service offerings conducted within the Production Solutions business segment: +Well services : Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to plugging and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the +4 +production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. Activities performed wi th our well servicing rigs can range from the milling of plugs following a plug-and-perf completion, to the installation and repair of artificial lift, to the ultimate plug and abandonment of a depleted well. Key components of our well services success inc lude our geographic footprint, employee culture, fleet of rigs and inventory of equipment. Our operations extend across six major onshore U.S. basins, and our employee culture fosters local relationships within this expansive geographic footprint through e xcellent customer service and basin-level expertise. +We utilize a fleet of more than 100 rigs, approximately 40% of which are capable of performing completion-oriented work. This fleet of rigs and the inventory of equipment maintained at each of our regional locations are tailored to the needs of our customers in each particular basin. The high-specification rigs we utilize are engineered to perform in the most demanding laterals being drilled in the U.S. today. In addition, we also own and operate auxiliary equipment necessary to support the activities of our rigs, swabbing units, hot oilers, high pressure pump trucks, cementers, vacuum trucks and transport tankers in the basins in which we operate. These complementary services facilitate the production enhancement of existing wells or are called upon to plug and abandon a well at the end of its life. From January 2014 through December 2017, we operated more than 900,000 rig hours. According to the Association of Energy Service Companies (“AESC”), only 52% of industry reported well service rigs were active or available from January 2015 through December 2017. In contrast, 66% of our rigs have remained utilized in the same period. +Geographic Areas of Operation +We operate in all major onshore basins in both the U.S. and Canada, including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, SCOOP / STACK Formation, Bakken Formation, Haynesville Formation and Western Canada Sedimentary Basin. We provide our services through strategically placed operating facilities located in-basin throughout North America. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion and production trends and technology across all divisions and geography. +We believe that our strategic geographic positioning will benefit us as activity increases in our core operating areas. Our broad geographic footprint provides us with exposure to the ongoing recovery in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +For disclosures regarding financial statements about segment information and geographic area, see Part II, Item 8. “Financial Statements and Supplementary Data” of this Annual Report. +Seasonality +Our operations are subject to seasonal factors and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. Additionally, our operations are directly affected by weather conditions. During the winter months (first and fourth quarters) and periods of heavy snow, ice or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Lastly, throughout the year heavy rains adversely affect activity levels, as well locations and dirt access roads can become impassible in wet conditions. +Weather conditions also affect the demand for, and prices of, oil and natural gas and, as a result, demand for our services. Demand for oil and natural gas is typically higher in the fourth and first quarters, resulting in higher prices in these quarters. +5 +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location and economic viability. Direction of the sales team is conducted through weekly meetings and daily communication. The Completion Solutions and Production Solutions teams are led by the segment presidents. Our marketing activities are performed internally with input and guidance from a third party marketing agency. Our strategy is based on building a strong North American brand though multiple media outlets including our website, select social media accounts, print, billboard advertisements, press releases and various industry-specific conferences, publications and lectures. We have a technical sales organization with expertise and focus within their specific service line. We focus on organic growth through selling of services and marketing excellence through brand service quality, technology and metrics of success. We accomplish this through communication across sales and operations departments and regions to share best practices and leverage existing customer relationships. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2017, our top five customers collectively accounted for approximately 29% of our revenues. For the year ended December 31, 2017, no single customer accounted for 10% or more of our revenues. +Competition +We provide our services and products across the United States and Canada and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force competency, efficiency, safety record, reputation and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance and quality of crews, equipment and services, we believe we are equipped for continued growth and success in a competitive market. +Our major competitors for our completion solutions include Halliburton Company, Schlumberger Limited, Baker Hughes Incorporated, Weatherford International Ltd., C&J Energy Services, Inc. and a significant number of locally oriented businesses. Our major competitors for our production solutions include Pioneer Energy Services Corp., Key Energy Services, Inc., Basic Energy Services, Inc., Superior Energy Services, Inc. and a significant number of locally oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts and components that are manufactured and supplied for our operations from various suppliers. We are not dependent on any single supplier for those parts, supplies or materials. During the year ended December 31, 2017, one supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages and our results of operations, prospects and financial condition could be adversely affected. +6 +Research & Technology, Intellectual Property +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins. We have dedicated resources focused on the internal development of new technology and equipment, as well as resources focused on sourcing and commercializing new technologies through strategic partnerships. Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. +We have developed a suite of proprietary downhole tools, products and techniques through both internal resources, as well as strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. Examples of our technology includes: +• +Scorpion Fully-Composite Plug TM : Our patented packer-style fully-composite plug is designed to provide zonal isolation in a multi-stage well completion. We offer a diverse product group of fully-composite plugs for the use in 3.5” to 5.5” well casings used today, as well as a unique Scorpion Extended Range plug offering. Our Extended Range plugs are used in demanding well applications where operators have to negotiate tough mechanical casing internal diameter restrictions. With the Scorpion plug’s shorter length, nonmetallic casing anchor slips and robust engineered design, our plugs provide superior reliability and greatly reduced drill-out times. +• +Scorpion Dissolvable Plug: We developed and completed successful trials of our Scorpion Dissolvable Plug, a high performance plug designed to provide zonal isolation that is made entirely from proprietary materials that dissolve over time based on temperature and salinity. The Dissolvable plug has a large ID to assist immediate flowback, while ultimately leaving the wellbore unobstructed for production and eliminating the risk and costs of conventional plug removal. +• +SmartStart PLUS TM : We currently have exclusive distribution rights in the northeastern U.S. and with certain customers in other regions for the SmartStart frac valve. The SmartStart frac valve is an interventionless time-delayed pressure-activated frac sleeve that eliminates the need for tubing or pipe conveyed perforating when completing the toe stage of horizontal wells. The SmartStart frac valve is deployed on production string and allows operators to achieve a maximum casing pressure test and begin frac operations up to nine times faster, greatly cutting cost and reducing risk during toe stage completions. +• +Storm Re-Frac Packer TM : We currently have an exclusive North American arrangement to deploy the Storm Re-Frac Packer, a system that allows our customers to re-stimulate their existing wells using standard size plug-and-perf procedures to extend and enhance their production profiles with minimal flow restriction during stimulation. Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. +• +FlowGun TM : Our patented FlowGun technology is a stage one interventionless casing-conveyed perforating technology that eliminates the need to run wireline or coil tubing and requires no electronic detonation. This technology allows customers to perform a maximum pressure test, perforate stage one more efficiently with less risk and with no lateral length limitations. The FlowGun manages several downhole jobs with one tool and one crew, increasing efficiency with the entire process taking no more than one hour. +• +EON Ball Drop System: We have an exclusive North American arrangement to provide the EON Single Size Ball Drop Sleeve System. This completely interventionless completion tool system can be used in both cemented and non-cemented applications and utilizes a single-size ball to activate pinpoint frac sleeves run downhole on the well casing. This system enables operators to reduce their footprint and time on the well site creating efficiencies and reducing costs. +• +Coil Frac Sleeve System: We currently have an agreement to be the exclusive provider of a Coil Frac Sleeve System in the United States. This system utilizes coiled tubing to deploy a resettable frac packer which is used to open and isolate frac sleeves that have been installed as an integral part of the casing. This frac packer can also be used where no frac sleeves have been installed by abrasive cutting perforations in the casing. +7 +We strike strategic alliances with manufacturing and technology companies to be the exclusive distributor and service provider of downhole technology across a variety of basins in North America. In these partnerships, we ha ve exclusive rights to market and sell technology unavailable to any other service providers in the designated regions. With these partnerships, we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. +We currently hold seven U.S. and two Canadian patents and two pending U.S. and three pending Canadian patent applications relating to our Scorpion Fully-Composite Plug TM . We also have five U.S. patents, one Canadian patent, two pending U.S. and one pending Canadian patent application relating to our FlowGun TM completion tool. In addition, we have entered into strategic partnerships with respect to the SmartStart PLUS TM toe valve, QuickStart TM frac valve, Coil Frac Sleeve System, EON Ball Drop System, and the Storm TM , Force TM , Centurion TM completion product line for the frac and re-frac market. Although in the aggregate our patents, licenses and strategic partnerships are important to us, we do not regard any single patent, license or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service oriented culture and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +We believe we have become a “go-to” service provider for piloting new technologies across North America because of our service quality, execution at the wellsite and scale. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators. This also allows us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing R&D internally. Our internal resources are focused on evolving our existing proprietary tools to stay on trend and ensure quicker, lower completion and production costs for our customers. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills and hazardous materials spills. These conditions can cause: +• +personal injury or loss of life; +• +damage to, or destruction of property, the environment and wildlife; and +• +the suspension of our or our customers’ operations. +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs and insurability, and our relationship with customers, employees and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance, and could have other material adverse effects on our financial condition and results of operations. +8 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobi le and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our cu rrent arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our MSAs. We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire or blowout. +The summary of MSAs set forth above is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2017, we had 1,772 employees (all of which were full time). Of our total employees, 1,685 were in the United States and 87 were in Canada. We are not a party to any collective bargaining agreements. +Government Regulations and Environmental, Health and Safety Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state and local levels governing the release, disposal or discharge of materials into the environment, health and safety aspects of our operations, or otherwise relating to environmental protection. In addition, due to our operations in Canada, we are also subject to Canadian environment statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil and criminal penalties, imposition of remedial or corrective action requirements and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +The following is a summary of some of the existing laws, rules and regulations to which we are subject. +9 +Hazardous substances and waste handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain E&P related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If the EPA proposes rulemaking for revised oil and gas regulations, the Consent Decree requires that the EPA take final action following notice and comment rulemaking no later than July 15, 2021. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of its customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred, and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several, strict liability for the costs of cleaning up the hazardous substances that have been released into the environment, and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable state statutes requires maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities and citizens. The Federal Motor Carrier Safety Administration regulating and providing safety oversight of commercial motor vehicles, the EPA establishing requirements to protect human health and the environment, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishing requirements for the safe use and storage of explosives, and the federal Nuclear Regulatory Commission establishing requirements for the protection against ionizing radiation. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with these laws and regulations. +10 +Transportation safety and compliance +Operating a fleet in excess of 1,100 commercial motor vehicles, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for Interstate travel, and comparable state regulations for Intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, a new EPA and U.S. Army Corps of Engineers (the “Corps”) rule defining the scope of federal jurisdiction over wetlands and other waters became effective (the “Clean Water Rule”). The Clean Water Rule was previously stayed nationwide to determine whether federal district or appellate courts had jurisdiction to hear cases challenging the rule. The EPA and the Corps issued a proposed rulemaking in June 2017 to repeal the Clean Water Rule, and announced their intent to issue a new rule defining the Clean Water Act’s jurisdiction. Recently, in January 2018, the U.S. Supreme Court issued a decision finding that jurisdiction resides with the federal district courts to hear challenges to the Clean Water Rule; following which, the previously-filed district court cases have been allowed to proceed. Following the Supreme Court’s decision, the EPA and the Corps issued a final rule in January 2018 staying implementation of the 2015 rule for two years while the agencies reconsider the rule. Multiple states and environmental groups have challenged the stay. As a result, future implementation of the rule is uncertain at this time. To the extent the rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +The federal Clean Air Act (“CAA”), and comparable state laws, regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. These regulations change frequently. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air permit requirements or utilize specific equipment or technologies to control emissions of certain pollutants. For example, in May 2016, the EPA finalized rules regarding criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, thereby triggering more stringent air permitting requirements. In addition, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”) for ozone from 75 to 70 parts per billion. In November 2017, the EPA published a list of areas that are in compliance with the new ozone standard and, separately in December 2017, issued responses to state recommendations for designating non-attainment areas. States have the opportunity to submit new air quality monitoring to the EPA prior to the EPA finalizing any non-attainment designations. The EPA intends to issue final attainment status designations during the first half of 2018. State implementation of the revised NAAQS could result in stricter permitting requirements, which in turn could delay or impair our or our +11 +customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrati ve, civil and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +The EPA has determined that emissions of greenhouse gases, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established greenhouse gas emission reporting requirements for sources in the oil and gas sector, and has also promulgated rules requiring certain large stationary sources of greenhouse gases to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to greenhouse gas emissions permitting and best available control technology requirements because none of our facilities are presently major sources of greenhouse gas emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition and results of operations. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and many states have already have established regional greenhouse gas “cap- and-trade” programs. The adoption of any legislation or regulation that restricts emissions of greenhouse gases from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, some scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, over the past year the EPA has taken several steps to delay implementation of its methane standards, and the agency proposed a rulemaking in June 2017 to stay the requirements for a period of two years and revisit implementation of the 2016 methane standards in their entirety. The EPA has not yet published a final rule but, as a result of these developments, future implementation of the 2016 standards is uncertain at this time. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. The U.S. Bureau of Land Management (“BLM”) previously finalized similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but proposed to repeal those standards in February 2018. Several states have announced their intent to file judicial challenges against any attempt to repeal the BLM methane rules. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remain a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. In addition, the BLM had previously issued final rules in March 2015 imposing stringent standards for performing hydraulic fracturing on federal and Native American lands; however, the agency finalized a separate rulemaking in December 2017 repealing its hydraulic fracturing rules. Several states and environmental groups have challenged the repeal in federal court. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +12 +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For e xample, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking wate r resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturi ng in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various s tate, federal, and local laws. +Some states, counties and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce our business by making it more difficult or costly for their customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition and results of operations. \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/item13.txt b/raw/filings/0001532286/2017/0001564590-18-007130/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a7f3cb7a657409d327815d9283200eb6cc40deb --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/item13.txt @@ -0,0 +1,105 @@ +Item 13. +Certain Relationships and Related Transactions, and Director Independence +On February 28, 2017, we closed the Combination with Beckman, a growth-oriented oilfield services company that provides a wide range of well and coiled tubing services. Pursuant to the Combination, all of the issued and outstanding shares of Beckman common stock were converted into shares of our common stock, except 1.6% of Beckman shares paid in cash. In addition to the conversion of all of the shares of outstanding common stock of Beckman to shares of our common stock, all of the restricted stock and outstanding stock options of Beckman were also converted to restricted stock and stock options of Nine. Options exercisable for approximately 17,313 shares of Beckman common stock with a weighted average exercise price of $123.02 per share and 20,225 shares of restricted stock of Beckman outstanding as of December 31, 2016 converted to options exercisable for approximately 78,715 shares of our common stock with a weighted average exercise price of $27.03 per share and 91,961 shares of restricted stock of Nine. +Prior to the Combination, Beckman was also an SCF Partners portfolio company. A key strategic rationale for the Combination was to enhance our ability to serve customers and our growth potential through broader product lines and basin diversification, enabling us to cross-sell our products and compete with larger companies. The Combination was a means of achieving these objectives and created various synergistic opportunities, including greater ability to raise capital for expansion, opportunity to develop broader and more diversified product lines, ability to compete with larger companies and opportunity to leverage internal initiatives. +Immediately prior to the Combination and the Subscription Offers (described below), SCF owned 615,525 shares of Beckman common stock or 56.4%. +77 +Immed iately following the completion of the transactions contemplated by the Combination and the Subscription Offers, SCF beneficially owned a total of 8,753,271 shares of our common stock (calculated pursuant to Rule 13d-3 under the Exchange Act). This benefic ial ownership consisted of (1) 7,528,526 shares of common stock issued to SCF in connection with the Combination, (2) 804,502 shares of common stock issued to SCF in connection with the Subscription Offers, and (3) warrants to purchase 402,243 shares of ou r common stock issued to SCF in connection with the Subscription Offers. For a discussion of the Combination, please see Note 1 to our consolidated financial statements, and for a discussion of the Subscription Offers, and related issuance of warrants to S CF, please see “—Subscription and warrant agreements.” +Transactions with our Significant Stockholders and our Directors and Executive Officers +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, promissory notes totaling $2.5 million were issued to both a former executive officer of the Company in 2015, and to a current manager of the Company. The principal is due on June 30, 2019 (the “Maturity Date”). Interest of 4% per annum is due and payable on the Maturity Date. At December 31, 2017 and 2016, the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and $2.8 million, respectively. Unpaid interest at December 31, 2017 and 2016 totaled $0.4 million and $0.3 million, respectively. +As part of the acquisition of Crest in 2014, promissory notes totaling $9.4 million were issued to former owners of Crest, including Mr. Crombie, who is an executive of the Company. The principal is due on June 30, 2019. The interest rate is based on the prime rate, the federal funds rate or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement, and is due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At December 31, 2017 and 2016, the outstanding principal balance of the notes totaled $7.6 million. Unpaid interest, included in “Prepaid expenses and other” in the Consolidated Balance Sheets, totaled $8,000 and $19,000 at December 31, 2017 and 2016, respectively. +The Company leases office space, yard facilities and equipment, and purchases building maintenance services from Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million, $0.7 million and $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. There were payables of $13,000 and $0 at December 31, 2017 and 2016, respectively. +As part of the Tripoint acquisition on October 3, 2011, promissory notes totaling $1.1 million were issued to former owners of Tripoint who were members of management. The principal was due on September 15, 2015. Interest of 4% was due quarterly, but could be deferred and added to the outstanding principal balance at the election of the Company. In 2015, the outstanding balance of the notes, $0.9 million, including accrued interest, was repaid in full using a combination of $0.2 million of cash and common stock redemption valued at $0.7 million. The value attributed to common stock, as agreed between the Company and the former owners of Tripoint, was $33.11 per share, resulting in the cancellation of 20,417 shares. +The Company entered into a shared services agreement with a related party, whose manager, Benjamin Winston, is a stockholder of the Company, and was a member of Beckman’s board of directors from 2014 through the consummation of the Combination. The related party provides office space, personnel and certain general and administrative services to the Company. The Company paid the related party $0.7 million, $0.2 million and $0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $13,000 and $8,000 as of December 31, 2017 and 2016, respectively. +The Company leases facilities and buildings in Monahans, Texas and Enid, Oklahoma, from an entity owned by Mr. Winston. The Company incurred rent expense of $0.5 million, $0.6 million and $0.5 million to this entity for the years ended December 31, 2017, 2016 and 2015, respectively. There were no payables to or receivables from this related party at December 31, 2017 and December 31, 2016. +The Company utilizes a related party, whose manager is Mr. Winston, to transport equipment, chemicals, and supplies. The Company incurred expense of $1.2 million, $0.7 million and $0.7 million, for these services during the years ended December, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $0.1 million at December 31, 2017. There was no payable related to this party at December 31, 2016. +78 +The Company facilitates pass-through billings on behalf of an entity owned by Mr. Winston. The Company recognizes no revenue or expense related to this activity. During the year ended December 31, 2017, the related entity billed the Company $40,000 , and the Company billed respective customers the same amount. The Company collected cash for and reimbursed to the related entity $0.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $11,000 of pass-through billings to customers remained uncollected as of December 31, 2017. During the year ended December 31, 2016, the related entity billed the Company $0.8 million, and the Company rebilled respective customers the same amount. The Company collected cash for and reimburse d to the related entity $1.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $0.1 million of pass-through billings to customers remained uncollected as of December 31, 2016. During 2015, the related entity billed Beckman $2.2 million. Beckman rebilled respective customers of this related entity $2.2 million, and Beckman collected cash for and reimbursed to the related entity approximately $2.1 million. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million, $0.4 million and $0.5 million for services provided to this entity during the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding receivable due of $0.2 million and $0.1 million as of December 31, 2017 and 2016, respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas acts as the President of EOG Resources, Inc. The Company generated revenue from EOG Resources, Inc. of $34.4 million, $13.7 million and $24.9 million in 2017, 2016 and 2015, respectively. +Subscription and Warrant Agreements +In connection with the Combination and pursuant to subscription agreements dated March 10, 2017, we offered each of our stockholders (our existing stockholders and the Beckman stockholders) who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under Securities Act) the opportunity to purchase shares of our common stock worth $20 million in the aggregate, up to their pro-rata ownership of the Company (the “Combined Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $20 million of shares of our common stock, the eligible purchasers that elected to participate in the Combined Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $20 million in the aggregate. The proceeds from the Combined Nine Subscription Offer were used to (i) to finance the purchase of non-accredited investors’ shares in the Combination and pay fees and expenses related to the Combination and (ii) for general corporate purposes, including ensuring compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Combined Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Combined Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated March 10, 2017, we offered each of our existing stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of our common stock worth $5 million in the aggregate, up to their pro-rata ownership of the Company (the “Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $5 million of shares of our common stock, the eligible purchasers that elected to participate in the Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $5 million in the aggregate. The proceeds from the Nine Subscription Offer were retained by us to ensure compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer and the Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated February 10, 2017, Beckman offered each of its stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of its common stock worth $15 million in +79 +the aggregate, up to their pro-rata ownership of Beckman (the “Beckman Subscription Offer” and with the Combined Nine Subscription Offer and the Nine Subscription Offer, the “Subscription Offers”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $15 million of shares of its common stock, the eligible purchasers that elected to participate in the Beckman Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of its common stock worth $15 million in the aggregate. The proceeds from the Beckman Subscription Offer were used to pay outstanding indebtedness under the Fo rmer Beckman Credit Facility. In connection with the Beckman Subscription Offer, Beckman issued to those stockholders who purchased shares of its common stock a warrant to purchase additional shares of its common stock on the basis of one warrant share for every two shares purchased in the Beckman Subscription Offer. Beckman shares of common stock issued in the Beckman Subscription Offer and warrants purchased in the Beckman Subscription Offer converted into shares and warrants of our common stock based on the exchange ratio used with respect to the Combination. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +The following table identifies each related person who participated in the Combined Nine and Nine Subscription Offers. +Related person +No. of shares +purchased +$ amount +purchased +No. of warrant +shares(1) +Mark Baldwin +698 +$ +21,774 +345 +David Crombie(2) +10,344 +$ +322,598 +5,168 +Ernie L. Danner(3) +4,004 +$ +124,884 +1,998 +Ann G. Fox +239 +$ +59,815 +955 +Curtis F. Harrell(4) +1,388 +$ +43,297 +690 +Gary L. Thomas +698 +$ +21,774 +345 +(1) +The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +(2) +Amounts reported include 10,344 shares purchased at a purchase price of $322,598 and 5,168 warrants by DKM Investments, LP of which Mr. Crombie is a member. +(3) +Amounts reported include 1,380 shares purchased at a purchase price of $43,046 and 690 warrants by Autumn Plecher, LP of which Mr. Danner is a limited partner of the general partner. +(4) +Amounts reported include 1,388 shares purchased at a purchase price of $43,297 and 690 warrants by Harrell Ventures, LLC of which Mr. Harrell is the managing member . +In connection with the Beckman Subscription Agreement, Mr. Danner subscribed to purchase 1,850 shares of Beckman common stock (8,418 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Danner also received 925 warrants to purchase Beckman shares of common stock, which were converted into 4,205 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In connection with the Beckman Subscription Agreement, Mr. Harrell subscribed to purchase 672 shares of Beckman common stock (3,057 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Harrell also received 336 warrants to purchase Beckman shares of common stock, which were converted into 1,524 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +Pursuant to a Subscription Agreement dated March 31, 2017, Douglas S. Aron, who acted as the Executive Vice President and Chief Financial Officer of the Company from April 2017 until September 8, 2017, subscribed to purchase 32,102 shares of our common stock in exchange for a cash payment of $1 million. +80 +On July 25, 2017, we provided notice to all existing holders of the Company’s common stock that we are offering for sale up to approximately $20 million of the Company ’s common stock for $18.69 per share to those stockholders that were accredited investors. We closed the July 2017 Subscription Offer on August 23, 2017. Pursuant to this subscription offer, the following related persons purchased, directly or indirectly, more than $120,000 of our common stock: Mr. Crombie - $227,250, Mr. Danner - $163,650, Mr. Morgan - $121,650 and SCF-VII, L.P. - $14,039,100. We received consent from all the lenders under the Former Nine Credit Facility for the cash proceeds from the July 2017 Subscription Offer to be deposited in a segregated account that does not constitute collateral for the indebtedness thereunder. +Pursuant to the Employment Agreement dated November 20, 2017, as amended by the First Amendment thereto dated December 20, 2017, Clinton Roeder, the Senior Vice President and Chief Financial Officer of the Company, agreed to purchase $300,000 of our common stock during the 10-day period beginning on the earlier of (i) the closing of our IPO and (ii) February 22, 2018 (the date of such purchase, the “Funding Date”), at the Fair Market Value (as defined in the Stock Plan). Such purchase was completed on January 23, 2018. Pursuant to such Employment Agreement on January 23, 2018, the Company granted (i) options to purchase 32,102 shares of our common stock (as adjusted by the Stock Split and any other splits or adjustments determined by our board of directors) with an exercise price equal to the Fair Market Value (as defined in the Stock Plan) and (ii) $600,000 of shares of restricted stock at a price per share equal to the Fair Market Value (as defined in the Stock Plan), to Mr. Roeder under the Stock Plan. +Stockholders Agreement +In connection with the Combination, on February 28, 2017, we, SCF and substantially all of the holders of our common stock and warrants entered into the Second Amended and Restated Stockholders Agreement, which was further amended on July 24, 2017 (as amended, the “Existing Stockholders Agreement”). The Existing Stockholders Agreement contained provisions related to, among other things, stock transfer restrictions, tag-along and drag-along rights, preemptive rights, registration rights and board composition. +The Existing Stockholders Agreement, other than the provisions relating registration rights and certain miscellaneous provisions, terminated upon the consummation of our IPO on January 23, 2018. Following the consummation of our IPO, we will amend and restate the Existing Stockholders Agreement (the “Amended Stockholders Agreement”) to eliminate all terminated provisions. The registration rights provisions that will be contained in the Amended Stockholders Agreement are described below. +Demand Registration Rights +Under the Amended Stockholders Agreement, from and after 180 days following our IPO, SCF (and its permitted transferees) will have the right to demand (a “Demand Request”) on five occasions that we register all or any portion of the SCF Registrable Securities (as such term is defined in the Amended Stockholders Agreement) (a “Demand Registration”) so long as the SCF Registrable Securities proposed to be sold on an individual registration statement have an aggregate gross offering price of at least $10.0 million or at least $1.0 million if we are then eligible to register such sale on a Form S-3 registration statement (or any comparable or successor form) and provided that we are not required to effect more than one Demand Registration in any six-month period. After such time that we become eligible to use Form S-3 (or comparable form) for the registration under the Securities Act of any of our securities, any Demand Request with a reasonably anticipated aggregate offering price of $100.0 million may be for a “shelf” registration statement pursuant to Rule 415 under the Securities Act. +We may delay the filing of a registration statement pursuant to a Demand Request until a date not later than 60 days after the required filing date if (i) we are engaged in confidential negotiations or other confidential business activities that would require disclosure in the registration statement and our board of directors determines in good faith that such disclosure would be materially detrimental to us or (ii) we have experienced some other material non-public event or is in possession of material non-public information concerning the Company. We may also delay the filing if, prior to receiving a Demand Request, we are already proceeding with another offering for its own account or for the account of another requesting holder. +81 +Piggyback Registration Rights +If we propose to file a registration statement under the Securities Act relating to an offering of our common stock for our own account or for the account of any common stockholder (other than certain registration statements, including those relating to securities offered in connection with benefit plans or acquisitions), the holders of Registrable Securities (as defined in the Amended Stockholders Agreement) will have customary piggyback registration rights that allow them to include the Registrable Securities that they own in any such registration statement, and any related underwriting. We will provide written notice to holders of Registrable Securities of such filing as soon as practicable (but in no event less than 15 days prior to the anticipated filing). +If the managing underwriter of a proposed underwritten offering advises us that in its opinion the total amount of securities to be included in such offering is sufficiently large to materially and adversely affect the price or success of the offering, then the securities to be included in such offering will be allocated first to the requesting holders if the registration statement is pursuant to a Demand Request or, if not, then to us, and then pro rata among the holders of piggyback securities on the basis of the number of Registrable Securities then held by each such holder. +Holdback Agreements +Each holder of Registrable Securities will be subject to certain lock-up provisions that restrict transfer during the period beginning 14 days prior to, and continuing for a period not to exceed 180 days after, the date of our IPO final prospectus, or 90 days for any subsequent underwritten public offering of equity securities of the Company, except as part of such registration (subject to an extension of such lock-up period by up to 35 days in certain circumstances). +Registration Procedures and Expenses +The Amended Stockholders Agreement will contain customary procedures relating to underwritten offerings and the filing of registration statements. We will agree to pay all registration expenses incurred in connection with any registration, including all registration, qualification and filing fees, printing expenses, accounting fees, escrow fees, legal fees of the Company, reasonable fees of one counsel to the holders of Registrable Securities, blue sky fees and expenses and the expense of any special audits incident to or required by any such registration. All underwriting discounts and selling commissions and stock transfer taxes applicable to securities registered by holders and fees of counsel to any such holder (other than as described above) will be payable by holders of Registrable Securities. +Indemnification and Contribution +The Amended Stockholders Agreement will contain customary indemnification and contribution provisions by the Company for the benefit of holders participating in any registration. Each holder participating in any registration will also agree to indemnify the Company in respect of information provided by such holder to the Company for use in connection with such registration; provided that such indemnification will be limited to the net proceeds actually received by such indemnifying holder from the sale of Registrable Securities. +Procedures for Approval of Related Person Transactions +A “Related Party Transaction” is a transaction, arrangement or relationship in which we or any of our subsidiaries was, is or will be a participant, the amount of which involved exceeds $120,000, and in which any related person had, has or will have a direct or indirect material interest. A “Related Person” means: +• +any person who is, or at any time during the applicable period was, one of our executive officers or one of our directors; +• +any person who is known by us to be the beneficial owner of more than 5.0% of our common stock; +82 +• +any immediate family member of any of the foregoing persons, which means any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law of a director, executive o fficer or a beneficial owner of more than 5.0% of our common stock, and any person (other than a tenant or employee) sharing the household of such director, executive officer or beneficial owner of more than 5.0% of our common stock; and +• +any firm, corporation or other entity in which any of the foregoing persons is a partner or principal or in a similar position or in which such person has a 10.0% or greater beneficial ownership interest. +Our board of directors adopted a written related party transactions policy prior to the completion of our IPO. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Party Transactions and either approve or disapprove entry into the Related Party Transaction, subject to certain limited exceptions. In determining whether to approve or disapprove entry into a Related Party Transaction, the Audit Committee expects to take into account, among other factors, the following: (1) whether the Related Party Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and (2) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Party Transactions required to be disclosed in our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/item9a.txt b/raw/filings/0001532286/2017/0001564590-18-007130/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..382c988c2c4e340c0b94abfb58af60e8e4a43bc0 --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures . The Company’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is accumulated and communicated to its management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. As required by Rule 13a-15(b) under the Exchange Act, the Company’s management, with the participation of its principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2017. Based upon that evaluation, the Company’s principal executive officer and principal financial officer concluded that its disclosure controls and procedures were not effective as of December 31, 2017. +Material Weaknesses in Internal Control over Financial Reporting. In connection with a review of our financial statements for the three months ended March 31, 2017, we identified a material weakness in our internal control over the reporting of income tax expense (benefit), the related balance sheet accounts and other comprehensive income. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. +During the first quarter of 2017, we hired a tax professional as our tax director, who performed a detailed review of our deferred taxes and our tax provision and identified certain immaterial errors in our income tax expense (benefit) and deferred tax balance for the years ended December 31, 2016 and 2015. Upon review of our internal controls in connection with the identification of these errors, we determined that we did not design and maintain an effective control environment with formal accounting policies and controls, and with trained professionals with an appropriate level of income tax knowledge and experience, to properly analyze, record and disclose the accounting matters commensurate with our financial reporting requirements related to income taxes. Specifically, we did not have controls designed to address the accuracy of income tax expense (benefit) and related consolidated balance sheet accounts, including deferred income taxes, as well as adequate procedures and controls to review the work of external experts engaged to assist in income tax matters or to monitor the presentation and disclosure of income taxes. +This material weakness resulted in the need to correct misstatements in our combined financial statements as of and for the years ended December 31, 2016 and 2015 prior to their issuance. The misstatements were not material to either 2016 or 2015. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +In addition, in connection with the preparation of our financial statements for the nine months ended September 30, 2017, we identified a material weakness in our internal control over financial reporting, specifically as it related to segregation of certain accounting duties stemming from our decentralized accounting structure and limited number of accounting personnel. We did not design and maintain adequate controls to address segregation of certain accounting duties related to journal entries, account reconciliations and other accounting functions. Certain accounting personnel have the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy and completeness. Immaterial misstatements have been identified related to the inadequate segregation of accounting duties. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. +62 +Management’s Report Regarding Internal Control; Attestation report of the registered public accounting firm . This Annual Report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the SEC for newly public companies. +Changes in Internal Control over Financial Reporting . As described above, during the first quarter of 2017, we hired a tax professional as our tax director, who identified the misstatements related to deferred taxes and our tax provision as described above and will be responsible for performing a detailed review of our deferred taxes and our annual and quarterly tax provision for all future periods. Further, in the fourth quarter of 2017, we implemented additional review procedures within the accounting and finance department. These actions are subject to ongoing management review and the oversight of our board of directors. +During the fourth quarter of 2017, we began to remediate and plan to further remediate the material weakness relating to segregation of certain accounting duties. We have replaced the less sophisticated accounting systems used by our newly-acquired subsidiaries with the enterprise resource planning system used by the majority of our subsidiaries. Also, we are working with third party consultants to identify internal control risks and implement remedies. These actions are subject to ongoing management review and the oversight of our board of directors. \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/rp_note.txt b/raw/filings/0001532286/2017/0001564590-18-007130/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..036776040fccf88e1addf36e940472af2430fdb4 --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/rp_note.txt @@ -0,0 +1,14 @@ +13. Related party transactions +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, promissory notes totaling $2.5 million were issued to both a former executive officer of the Company in 2015, and to a current manager of the Company. The principal is due on June 30, 2019 (the “Maturity Date”). Interest of 4% per annum is due and payable on the Maturity Date. At December 31, 2017 and 2016, the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and $2.8 million, respectively. Unpaid interest at December 31, 2017 and 2016 totaled $0.4 million and $0.3 million, respectively. +As part of the acquisition of Crest in 2014, promissory notes totaling $9.4 million were issued to former owners of Crest, including Mr. Crombie, who is an executive of the Company. The principal is due on June 30, 2019. The interest rate is based on the prime rate, the federal funds rate or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement, and is due quarterly. Mr. Crombie paid $1.8 million during 2016 +F-27 +to pay his promissory note in full. At December 31, 2017 and 2016, the outstanding principal balance of the notes totaled $7.6 million. Unpaid interest, included in “Prepaid expenses and other” in the Consolidated Balance Sheets, totaled $8,000 and $19,000 at December 31, 2017 and 2016, respectively. +The Company leases office space, yard facilities and equipment, and purchases building maintenance services from Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million, $0.7 million and $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. There were payables of $13,000 and $0 at December 31, 2017 and 2016, respectively. +As part of the Tripoint acquisition on October 3, 2011, promissory notes totaling $1.1 million were issued to former owners of Tripoint who were members of management. The principal was due on September 15, 2015. Interest of 4% was due quarterly, but could be deferred and added to the outstanding principal balance at the election of the Company. In 2015, the outstanding balance of the notes, $0.9 million, including accrued interest, was repaid in full using a combination of $0.2 million of cash and common stock redemption valued at $0.7 million. The value attributed to common stock, as agreed between the Company and the former owners of Tripoint, was $33.11 per share, resulting in the cancellation of 20,417 shares. +The Company entered into a shared services agreement with a related party, whose manager, Benjamin Winston, is a stockholder of the Company, and was a member of Beckman’s board of directors from 2014 through the consummation of the Combination. The related party provides office space, personnel and certain general and administrative services to the Company. The Company paid the related party $0.7 million, $0.2 million and $0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $13,000 and $8,000 as of December 31, 2017 and 2016, respectively. +The Company leases facilities and buildings in Monahans, Texas and Enid, Oklahoma, from an entity owned by Mr. Winston. The Company incurred rent expense of $0.5 million, $0.6 million and $0.5 million to this entity for the years ended December 31, 2017, 2016 and 2015, respectively. There were no payables to or receivables from this related party at December 31, 2017 and December 31, 2016. +The Company utilizes a related party, whose manager is Mr. Winston, to transport equipment, chemicals, and supplies. The Company incurred expense of $1.2 million, $0.7 million and $0.7 million, for these services during the years ended December, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $0.1 million at December 31, 2017. There was no payable related to this party at December 31, 2016. +The Company facilitates pass-through billings on behalf of an entity owned by Mr. Winston. The Company recognizes no revenue or expense related to this activity. During the year ended December 31, 2017, the related entity billed the Company $40,000, and the Company billed respective customers the same amount. The Company collected cash for and reimbursed to the related entity $0.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $11,000 of pass-through billings to customers remained uncollected as of December 31, 2017. During the year ended December 31, 2016, the related entity billed the Company $0.8 million, and the Company rebilled respective customers the same amount. The Company collected cash for and reimbursed to the related entity $1.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $0.1 million of pass-through billings to customers remained uncollected as of December 31, 2016. During 2015, the related entity billed Beckman $2.2 million. Beckman rebilled respective customers of this related entity $2.2 million, and Beckman collected cash for and reimbursed to the related entity approximately $2.1 million. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million, $0.4 million and $0.5 million for services provided to this entity during the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding receivable due of $0.2 million and $0.1 million as of December 31, 2017 and 2016, respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas acts as the President of EOG Resources, Inc. The Company generated revenue from EOG Resources, Inc. of $34.4 million, $13.7 million and $24.9 million in 2017, 2016 and 2015, respectively. +F-28 \ No newline at end of file diff --git a/raw/filings/0001532286/2017/0001564590-18-007130/rpt_disclosure.txt b/raw/filings/0001532286/2017/0001564590-18-007130/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a7f3cb7a657409d327815d9283200eb6cc40deb --- /dev/null +++ b/raw/filings/0001532286/2017/0001564590-18-007130/rpt_disclosure.txt @@ -0,0 +1,105 @@ +Item 13. +Certain Relationships and Related Transactions, and Director Independence +On February 28, 2017, we closed the Combination with Beckman, a growth-oriented oilfield services company that provides a wide range of well and coiled tubing services. Pursuant to the Combination, all of the issued and outstanding shares of Beckman common stock were converted into shares of our common stock, except 1.6% of Beckman shares paid in cash. In addition to the conversion of all of the shares of outstanding common stock of Beckman to shares of our common stock, all of the restricted stock and outstanding stock options of Beckman were also converted to restricted stock and stock options of Nine. Options exercisable for approximately 17,313 shares of Beckman common stock with a weighted average exercise price of $123.02 per share and 20,225 shares of restricted stock of Beckman outstanding as of December 31, 2016 converted to options exercisable for approximately 78,715 shares of our common stock with a weighted average exercise price of $27.03 per share and 91,961 shares of restricted stock of Nine. +Prior to the Combination, Beckman was also an SCF Partners portfolio company. A key strategic rationale for the Combination was to enhance our ability to serve customers and our growth potential through broader product lines and basin diversification, enabling us to cross-sell our products and compete with larger companies. The Combination was a means of achieving these objectives and created various synergistic opportunities, including greater ability to raise capital for expansion, opportunity to develop broader and more diversified product lines, ability to compete with larger companies and opportunity to leverage internal initiatives. +Immediately prior to the Combination and the Subscription Offers (described below), SCF owned 615,525 shares of Beckman common stock or 56.4%. +77 +Immed iately following the completion of the transactions contemplated by the Combination and the Subscription Offers, SCF beneficially owned a total of 8,753,271 shares of our common stock (calculated pursuant to Rule 13d-3 under the Exchange Act). This benefic ial ownership consisted of (1) 7,528,526 shares of common stock issued to SCF in connection with the Combination, (2) 804,502 shares of common stock issued to SCF in connection with the Subscription Offers, and (3) warrants to purchase 402,243 shares of ou r common stock issued to SCF in connection with the Subscription Offers. For a discussion of the Combination, please see Note 1 to our consolidated financial statements, and for a discussion of the Subscription Offers, and related issuance of warrants to S CF, please see “—Subscription and warrant agreements.” +Transactions with our Significant Stockholders and our Directors and Executive Officers +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, promissory notes totaling $2.5 million were issued to both a former executive officer of the Company in 2015, and to a current manager of the Company. The principal is due on June 30, 2019 (the “Maturity Date”). Interest of 4% per annum is due and payable on the Maturity Date. At December 31, 2017 and 2016, the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and $2.8 million, respectively. Unpaid interest at December 31, 2017 and 2016 totaled $0.4 million and $0.3 million, respectively. +As part of the acquisition of Crest in 2014, promissory notes totaling $9.4 million were issued to former owners of Crest, including Mr. Crombie, who is an executive of the Company. The principal is due on June 30, 2019. The interest rate is based on the prime rate, the federal funds rate or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement, and is due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At December 31, 2017 and 2016, the outstanding principal balance of the notes totaled $7.6 million. Unpaid interest, included in “Prepaid expenses and other” in the Consolidated Balance Sheets, totaled $8,000 and $19,000 at December 31, 2017 and 2016, respectively. +The Company leases office space, yard facilities and equipment, and purchases building maintenance services from Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million, $0.7 million and $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively. There were payables of $13,000 and $0 at December 31, 2017 and 2016, respectively. +As part of the Tripoint acquisition on October 3, 2011, promissory notes totaling $1.1 million were issued to former owners of Tripoint who were members of management. The principal was due on September 15, 2015. Interest of 4% was due quarterly, but could be deferred and added to the outstanding principal balance at the election of the Company. In 2015, the outstanding balance of the notes, $0.9 million, including accrued interest, was repaid in full using a combination of $0.2 million of cash and common stock redemption valued at $0.7 million. The value attributed to common stock, as agreed between the Company and the former owners of Tripoint, was $33.11 per share, resulting in the cancellation of 20,417 shares. +The Company entered into a shared services agreement with a related party, whose manager, Benjamin Winston, is a stockholder of the Company, and was a member of Beckman’s board of directors from 2014 through the consummation of the Combination. The related party provides office space, personnel and certain general and administrative services to the Company. The Company paid the related party $0.7 million, $0.2 million and $0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $13,000 and $8,000 as of December 31, 2017 and 2016, respectively. +The Company leases facilities and buildings in Monahans, Texas and Enid, Oklahoma, from an entity owned by Mr. Winston. The Company incurred rent expense of $0.5 million, $0.6 million and $0.5 million to this entity for the years ended December 31, 2017, 2016 and 2015, respectively. There were no payables to or receivables from this related party at December 31, 2017 and December 31, 2016. +The Company utilizes a related party, whose manager is Mr. Winston, to transport equipment, chemicals, and supplies. The Company incurred expense of $1.2 million, $0.7 million and $0.7 million, for these services during the years ended December, 2017, 2016 and 2015, respectively. There was an outstanding payable to this related party of $0.1 million at December 31, 2017. There was no payable related to this party at December 31, 2016. +78 +The Company facilitates pass-through billings on behalf of an entity owned by Mr. Winston. The Company recognizes no revenue or expense related to this activity. During the year ended December 31, 2017, the related entity billed the Company $40,000 , and the Company billed respective customers the same amount. The Company collected cash for and reimbursed to the related entity $0.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $11,000 of pass-through billings to customers remained uncollected as of December 31, 2017. During the year ended December 31, 2016, the related entity billed the Company $0.8 million, and the Company rebilled respective customers the same amount. The Company collected cash for and reimburse d to the related entity $1.1 million. Within the Company’s trade accounts receivable and trade accounts payable, $0.1 million of pass-through billings to customers remained uncollected as of December 31, 2016. During 2015, the related entity billed Beckman $2.2 million. Beckman rebilled respective customers of this related entity $2.2 million, and Beckman collected cash for and reimbursed to the related entity approximately $2.1 million. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million, $0.4 million and $0.5 million for services provided to this entity during the years ended December 31, 2017, 2016 and 2015, respectively. There was an outstanding receivable due of $0.2 million and $0.1 million as of December 31, 2017 and 2016, respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas acts as the President of EOG Resources, Inc. The Company generated revenue from EOG Resources, Inc. of $34.4 million, $13.7 million and $24.9 million in 2017, 2016 and 2015, respectively. +Subscription and Warrant Agreements +In connection with the Combination and pursuant to subscription agreements dated March 10, 2017, we offered each of our stockholders (our existing stockholders and the Beckman stockholders) who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under Securities Act) the opportunity to purchase shares of our common stock worth $20 million in the aggregate, up to their pro-rata ownership of the Company (the “Combined Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $20 million of shares of our common stock, the eligible purchasers that elected to participate in the Combined Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $20 million in the aggregate. The proceeds from the Combined Nine Subscription Offer were used to (i) to finance the purchase of non-accredited investors’ shares in the Combination and pay fees and expenses related to the Combination and (ii) for general corporate purposes, including ensuring compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Combined Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Combined Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated March 10, 2017, we offered each of our existing stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of our common stock worth $5 million in the aggregate, up to their pro-rata ownership of the Company (the “Nine Subscription Offer”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $5 million of shares of our common stock, the eligible purchasers that elected to participate in the Nine Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of our common stock worth $5 million in the aggregate. The proceeds from the Nine Subscription Offer were retained by us to ensure compliance with our financial covenants under the Former Nine Credit Facility. In connection with the Nine Subscription Offer, we issued to those stockholders who purchased shares of our common stock a warrant to purchase additional shares of our common stock on the basis of one warrant share for every two shares purchased in the Nine Subscription Offer. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In addition to the Combined Nine Subscription Offer and the Nine Subscription Offer, though not in connection with the Combination, pursuant to subscription agreements dated February 10, 2017, Beckman offered each of its stockholders pre-Combination who were accredited investors or non-U.S. persons (as such term is defined in Regulation S under the Securities Act) the opportunity to purchase shares of its common stock worth $15 million in +79 +the aggregate, up to their pro-rata ownership of Beckman (the “Beckman Subscription Offer” and with the Combined Nine Subscription Offer and the Nine Subscription Offer, the “Subscription Offers”). If each eligible purchaser did not purchase its respective pro rata portion of such approximately $15 million of shares of its common stock, the eligible purchasers that elected to participate in the Beckman Subscription Offer were entitled, but not obligated, to purchase the remaining number of shares of its common stock worth $15 million in the aggregate. The proceeds from the Beckman Subscription Offer were used to pay outstanding indebtedness under the Fo rmer Beckman Credit Facility. In connection with the Beckman Subscription Offer, Beckman issued to those stockholders who purchased shares of its common stock a warrant to purchase additional shares of its common stock on the basis of one warrant share for every two shares purchased in the Beckman Subscription Offer. Beckman shares of common stock issued in the Beckman Subscription Offer and warrants purchased in the Beckman Subscription Offer converted into shares and warrants of our common stock based on the exchange ratio used with respect to the Combination. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +The following table identifies each related person who participated in the Combined Nine and Nine Subscription Offers. +Related person +No. of shares +purchased +$ amount +purchased +No. of warrant +shares(1) +Mark Baldwin +698 +$ +21,774 +345 +David Crombie(2) +10,344 +$ +322,598 +5,168 +Ernie L. Danner(3) +4,004 +$ +124,884 +1,998 +Ann G. Fox +239 +$ +59,815 +955 +Curtis F. Harrell(4) +1,388 +$ +43,297 +690 +Gary L. Thomas +698 +$ +21,774 +345 +(1) +The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +(2) +Amounts reported include 10,344 shares purchased at a purchase price of $322,598 and 5,168 warrants by DKM Investments, LP of which Mr. Crombie is a member. +(3) +Amounts reported include 1,380 shares purchased at a purchase price of $43,046 and 690 warrants by Autumn Plecher, LP of which Mr. Danner is a limited partner of the general partner. +(4) +Amounts reported include 1,388 shares purchased at a purchase price of $43,297 and 690 warrants by Harrell Ventures, LLC of which Mr. Harrell is the managing member . +In connection with the Beckman Subscription Agreement, Mr. Danner subscribed to purchase 1,850 shares of Beckman common stock (8,418 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Danner also received 925 warrants to purchase Beckman shares of common stock, which were converted into 4,205 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +In connection with the Beckman Subscription Agreement, Mr. Harrell subscribed to purchase 672 shares of Beckman common stock (3,057 shares of our common stock after giving effect to the application of the exchange ratio used with respect to the Combination to convert the shares of Beckman common stock into shares of our common stock) in exchange for a purchase price of $141.94. Mr. Harrell also received 336 warrants to purchase Beckman shares of common stock, which were converted into 1,524 warrants to purchase Nine shares of common stock after giving effect to the application of the exchange ratio use with respect to the Combination to convert the Beckman warrants into Nine warrants. The warrants were called by the Company on July 25, 2017, and all warrants that were not exercised by August 23, 2017 expired and are deemed cancelled. +Pursuant to a Subscription Agreement dated March 31, 2017, Douglas S. Aron, who acted as the Executive Vice President and Chief Financial Officer of the Company from April 2017 until September 8, 2017, subscribed to purchase 32,102 shares of our common stock in exchange for a cash payment of $1 million. +80 +On July 25, 2017, we provided notice to all existing holders of the Company’s common stock that we are offering for sale up to approximately $20 million of the Company ’s common stock for $18.69 per share to those stockholders that were accredited investors. We closed the July 2017 Subscription Offer on August 23, 2017. Pursuant to this subscription offer, the following related persons purchased, directly or indirectly, more than $120,000 of our common stock: Mr. Crombie - $227,250, Mr. Danner - $163,650, Mr. Morgan - $121,650 and SCF-VII, L.P. - $14,039,100. We received consent from all the lenders under the Former Nine Credit Facility for the cash proceeds from the July 2017 Subscription Offer to be deposited in a segregated account that does not constitute collateral for the indebtedness thereunder. +Pursuant to the Employment Agreement dated November 20, 2017, as amended by the First Amendment thereto dated December 20, 2017, Clinton Roeder, the Senior Vice President and Chief Financial Officer of the Company, agreed to purchase $300,000 of our common stock during the 10-day period beginning on the earlier of (i) the closing of our IPO and (ii) February 22, 2018 (the date of such purchase, the “Funding Date”), at the Fair Market Value (as defined in the Stock Plan). Such purchase was completed on January 23, 2018. Pursuant to such Employment Agreement on January 23, 2018, the Company granted (i) options to purchase 32,102 shares of our common stock (as adjusted by the Stock Split and any other splits or adjustments determined by our board of directors) with an exercise price equal to the Fair Market Value (as defined in the Stock Plan) and (ii) $600,000 of shares of restricted stock at a price per share equal to the Fair Market Value (as defined in the Stock Plan), to Mr. Roeder under the Stock Plan. +Stockholders Agreement +In connection with the Combination, on February 28, 2017, we, SCF and substantially all of the holders of our common stock and warrants entered into the Second Amended and Restated Stockholders Agreement, which was further amended on July 24, 2017 (as amended, the “Existing Stockholders Agreement”). The Existing Stockholders Agreement contained provisions related to, among other things, stock transfer restrictions, tag-along and drag-along rights, preemptive rights, registration rights and board composition. +The Existing Stockholders Agreement, other than the provisions relating registration rights and certain miscellaneous provisions, terminated upon the consummation of our IPO on January 23, 2018. Following the consummation of our IPO, we will amend and restate the Existing Stockholders Agreement (the “Amended Stockholders Agreement”) to eliminate all terminated provisions. The registration rights provisions that will be contained in the Amended Stockholders Agreement are described below. +Demand Registration Rights +Under the Amended Stockholders Agreement, from and after 180 days following our IPO, SCF (and its permitted transferees) will have the right to demand (a “Demand Request”) on five occasions that we register all or any portion of the SCF Registrable Securities (as such term is defined in the Amended Stockholders Agreement) (a “Demand Registration”) so long as the SCF Registrable Securities proposed to be sold on an individual registration statement have an aggregate gross offering price of at least $10.0 million or at least $1.0 million if we are then eligible to register such sale on a Form S-3 registration statement (or any comparable or successor form) and provided that we are not required to effect more than one Demand Registration in any six-month period. After such time that we become eligible to use Form S-3 (or comparable form) for the registration under the Securities Act of any of our securities, any Demand Request with a reasonably anticipated aggregate offering price of $100.0 million may be for a “shelf” registration statement pursuant to Rule 415 under the Securities Act. +We may delay the filing of a registration statement pursuant to a Demand Request until a date not later than 60 days after the required filing date if (i) we are engaged in confidential negotiations or other confidential business activities that would require disclosure in the registration statement and our board of directors determines in good faith that such disclosure would be materially detrimental to us or (ii) we have experienced some other material non-public event or is in possession of material non-public information concerning the Company. We may also delay the filing if, prior to receiving a Demand Request, we are already proceeding with another offering for its own account or for the account of another requesting holder. +81 +Piggyback Registration Rights +If we propose to file a registration statement under the Securities Act relating to an offering of our common stock for our own account or for the account of any common stockholder (other than certain registration statements, including those relating to securities offered in connection with benefit plans or acquisitions), the holders of Registrable Securities (as defined in the Amended Stockholders Agreement) will have customary piggyback registration rights that allow them to include the Registrable Securities that they own in any such registration statement, and any related underwriting. We will provide written notice to holders of Registrable Securities of such filing as soon as practicable (but in no event less than 15 days prior to the anticipated filing). +If the managing underwriter of a proposed underwritten offering advises us that in its opinion the total amount of securities to be included in such offering is sufficiently large to materially and adversely affect the price or success of the offering, then the securities to be included in such offering will be allocated first to the requesting holders if the registration statement is pursuant to a Demand Request or, if not, then to us, and then pro rata among the holders of piggyback securities on the basis of the number of Registrable Securities then held by each such holder. +Holdback Agreements +Each holder of Registrable Securities will be subject to certain lock-up provisions that restrict transfer during the period beginning 14 days prior to, and continuing for a period not to exceed 180 days after, the date of our IPO final prospectus, or 90 days for any subsequent underwritten public offering of equity securities of the Company, except as part of such registration (subject to an extension of such lock-up period by up to 35 days in certain circumstances). +Registration Procedures and Expenses +The Amended Stockholders Agreement will contain customary procedures relating to underwritten offerings and the filing of registration statements. We will agree to pay all registration expenses incurred in connection with any registration, including all registration, qualification and filing fees, printing expenses, accounting fees, escrow fees, legal fees of the Company, reasonable fees of one counsel to the holders of Registrable Securities, blue sky fees and expenses and the expense of any special audits incident to or required by any such registration. All underwriting discounts and selling commissions and stock transfer taxes applicable to securities registered by holders and fees of counsel to any such holder (other than as described above) will be payable by holders of Registrable Securities. +Indemnification and Contribution +The Amended Stockholders Agreement will contain customary indemnification and contribution provisions by the Company for the benefit of holders participating in any registration. Each holder participating in any registration will also agree to indemnify the Company in respect of information provided by such holder to the Company for use in connection with such registration; provided that such indemnification will be limited to the net proceeds actually received by such indemnifying holder from the sale of Registrable Securities. +Procedures for Approval of Related Person Transactions +A “Related Party Transaction” is a transaction, arrangement or relationship in which we or any of our subsidiaries was, is or will be a participant, the amount of which involved exceeds $120,000, and in which any related person had, has or will have a direct or indirect material interest. A “Related Person” means: +• +any person who is, or at any time during the applicable period was, one of our executive officers or one of our directors; +• +any person who is known by us to be the beneficial owner of more than 5.0% of our common stock; +82 +• +any immediate family member of any of the foregoing persons, which means any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law of a director, executive o fficer or a beneficial owner of more than 5.0% of our common stock, and any person (other than a tenant or employee) sharing the household of such director, executive officer or beneficial owner of more than 5.0% of our common stock; and +• +any firm, corporation or other entity in which any of the foregoing persons is a partner or principal or in a similar position or in which such person has a 10.0% or greater beneficial ownership interest. +Our board of directors adopted a written related party transactions policy prior to the completion of our IPO. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Party Transactions and either approve or disapprove entry into the Related Party Transaction, subject to certain limited exceptions. In determining whether to approve or disapprove entry into a Related Party Transaction, the Audit Committee expects to take into account, among other factors, the following: (1) whether the Related Party Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and (2) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Party Transactions required to be disclosed in our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/filing.txt b/raw/filings/0001532286/2018/0001532286-19-000004/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..1caf96dddeded82eab305d7712191354fcee2e0d --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/filing.txt @@ -0,0 +1,4823 @@ +10-K +1 +nine-20181231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +______________________________________________________________________________________ +FORM 10-K +_____________________________________________________________________________________ +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE TRANSITION PERIOD FROM TO +Commission File Number: 001-38347 +_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware +80-0759121 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston, TX 77019 +(Address of principal executive offices) +(281) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common Stock, par value $0.01 per share +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +o +Accelerated filer +o +Non-accelerated filer +x +Smaller reporting company +o +Emerging growth company +x +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 29, 2018) was $497,531,771 . +The number of shares of the registrant’s common stock outstanding at March 5, 2019 was 30,144,634 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant's Definitive Proxy Statement for its Annual Meeting of Stockholders to be held in May 2019. +TABLE OF CONTENTS +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +10 +Item 1B. +Unresolved Staff Comments +31 +Item 2. +Properties +31 +Item 3. +Legal Proceedings +32 +Item 4. +Mine Safety Disclosures +32 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities +33 +Item 6. +Selected Financial Data +33 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +35 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +53 +Item 8. +Financial Statements and Supplementary Data +54 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +F-36 +Item 9A. +Controls and Procedures +F-36 +Item 9B. +Other Information +F-37 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +F-38 +Item 11. +Executive Compensation +F-38 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +F-38 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +F-38 +Item 14. +Principal Accounting Fees and Services +F-38 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +F-39 +Item 16. +Form 10-K Summary +F-42 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +PART I +Item 1. +Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion and production services provider that targets unconventional oil and gas resource development across all North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators despite their associated increased well cost. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and drilling out plugs and performing associated remedial work as production comes online. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. We provide customers with plug-and-perf or pinpoint frac sleeve system technology to complete the remaining stages of the well. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our pinpoint frac sleeve system involves packers, either hydraulic or swellable, to isolate sections of the wellbore and frac sleeves to provide access to each stage for stimulation and production. Our equipment also includes large-diameter coiled tubing units and workover rigs that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. Once a well is producing, we are able to offer a range of production enhancement and well workover services through our fleet of well service rigs and ancillary equipment. +In October 2018, we acquired Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (collectively, “Magnum” and such acquisition, the “Magnum Acquisition”). Magnum, which is included in our Completion Solutions segment, is a leading oilfield completion tools company that is focused on the development of innovative tools for unconventional oil and gas resource development. Magnum has a broad offering of proprietary downhole completions consumables products, including a comprehensive line of dissolvable and composite frac plugs; disk subs, including intervention-less designs, for wellbore isolation and casing flotation device applications; and dissolvable frac balls. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to +1 +investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Business Segments +We operate in two segments: Completion Solutions and Production Solutions . Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. +Completion Solutions +The following is a description of the primary service offerings and deployment methods within the Completion Solutions business segment: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently have three high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment, and since 2012, we have deployed only new equipment for use in the fields. As of December 31, 2018 , we operated a total of 31 twin-pumping units. +From January 2014 through December 2018, we completed approximately 15,200 cementing jobs, with an on-time rate of approximately 89% . Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, fully-composite and dissolvable frac plugs, casing flotation tools, specialty open hole float equipment, disk subs, and centralizers. Our completion tools provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug and perf operations. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. From March 2011 through December 2018 , we deployed approximately 112,200 isolation, stage one, and casing flotation tools and approximately 22,400 frac sleeves. +Wireline Services: Our wireline services involve the use of a wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations, with 41 wireline units in the U.S. and 14 wireline units in Canada. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We currently have wireline units equipped with customized drums to hold up to 40,000 feet of Enviroline, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Enviroline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary +2 +specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2014 through December 2018 , we completed approximately 109,200 wireline stages with a success rate of approximately 99% . +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift installation, cementing, stimulation, and restimulation services. +We currently operate 16 coiled tubing units serving the Permian Basin, SCOOP/STACK region, and Haynesville markets. Each of our coiled tubing units carries data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Of the 16 coiled tubing units, we consider 12 to be “extended reach” units capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8’’ and 2 5/8’’) applications, we also offer 2’’ and 1 1/4’’ diameter solutions to our customers. From April 2014 through December 2018, we have performed approximately 7,500 jobs and deployed more than 157 million running feet of coiled tubing, with a success rate of over 99% . +Production Solutions +Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to plugging and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. Activities performed with our well servicing rigs can range from the milling of plugs following a plug-and-perf completion, to the installation and repair of artificial lift, to the ultimate plug and abandonment of a depleted well. Key components of our well services success include our geographic footprint, employee culture, fleet of rigs, and inventory of equipment. Our operations extend across the U.S. basins, and our employee culture fosters local relationships within this expansive geographic footprint through excellent customer service and basin-level expertise. +We utilize a fleet of 107 rigs, approximately 40% of which are capable of performing completion-oriented work. This fleet of rigs and the inventory of equipment maintained at each of our regional locations are tailored to the needs of our customers in each particular basin. The high-specification rigs we utilize are engineered to perform in the most demanding laterals being drilled in the U.S. today. In addition, we also own and operate auxiliary equipment necessary to support the activities of our rigs, swabbing units, hot oilers, high pressure pump trucks, cementers, vacuum trucks, and transport tankers in the basins in which we operate. These complementary services facilitate the production enhancement of existing wells or are called upon to plug and abandon a well at the end of its life. From January 2014 through December 2018, we operated more than 1,000,000 rig hours. According to the Association of Energy Service Companies, only 46% of industry reported well service rigs were active or available from January 2014 through December 2018. In contrast, 66% of our rigs have remained utilized in the same period. +Geographic Areas of Operation +We operate in all major onshore basins in both the U.S. and Canada, including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, Haynesville Formation, and Western Canada Sedimentary Basin. We provide our services through strategically placed operating facilities located in-basin throughout North America. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion and production trends and technology across all divisions and geography. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +3 +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. Additionally, our operations are directly affected by weather conditions. During the winter months (first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Lastly, throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +Weather conditions also affect the demand for, and prices of, oil and natural gas and, as a result, demand for our services. Demand for oil and natural gas is typically higher in the fourth and first quarters, resulting in higher prices in these quarters. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2018 , our top five customers collectively accounted for approximately 24% of our revenues. For the year ended December 31, 2018 , no single customer accounted for 10% or more of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the United States, Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors for our completion solutions include Halliburton Company, Schlumberger Limited, Baker Hughes, a GE company, Oil States International, C&J Energy Services, Inc., and a significant number of locally-oriented businesses. Our major competitors for our production solutions include Pioneer Energy Services Corp., Key Energy Services, Inc., Basic Energy Services, Inc., Superior Energy Services, Inc., and a significant number of locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines acquired in the Magnum Acquisition depend on a limited number of third-party suppliers and vendors. +4 +During the year ended December 31, 2018 , one supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality, execution at the wellsite, and scale. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. With the acquisition of Magnum, our internal research and development capabilities have increased substantially. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +5 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2018 , we had 2,261 employees (all of which were full time). We are not a party to any collective bargaining agreements. +Government Regulations and Environmental, Health, and Safety Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address the EPA’s +6 +alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain E&P related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If the EPA proposes rulemaking for revised oil and gas regulations, the consent decree requires that the EPA take final action following notice and comment rulemaking no later than July 15, 2021. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of its customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several, strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”), establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. In June 2016, OSHA finalized a new regulation regarding crystalline silica exposures, which included requirements that hydraulic fracturing operations implement dust controls to limit exposures to the substance by June 23, 2021. Additionally, the Federal Motor Carrier Safety Administration regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives, and the federal Nuclear Regulatory Commission establishes requirements for the protection against ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +Due to operating a fleet in excess of 1,100 commercial motor vehicles, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, a new EPA and U.S. Army Corps of Engineers (the “Corps”) rule defining the scope of federal jurisdiction over wetlands and other waters became effective (the “Clean Water Rule”). The Clean Water Rule was previously stayed nationwide to determine whether federal district or appellate courts had jurisdiction to hear cases challenging the rule. The EPA and the Corps issued a proposed rulemaking in June 2017 to repeal the Clean Water Rule and announced their intent to issue a new rule defining the Clean Water Act’s jurisdiction. Recently, in January 2018, the U.S. Supreme Court issued a decision finding that jurisdiction resides with the federal district courts to hear challenges to the Clean Water Rule; following which, the previously-filed district court +7 +cases have been allowed to proceed. Following the Supreme Court’s decision, the EPA and the Corps issued a final rule in January 2018 staying implementation of the 2015 rule for two years while the agencies reconsider the rule. Multiple states and environmental groups have challenged the stay, and in August 2018, a federal court in South Carolina issued an injunction against the EPA ’ s stay of the rule. In December 2018, the EPA and the Corps proposed a new rule defining the scope of federal jurisdiction over wetlands and other waters that would replace the Clean Water Rule. Future implementation of the proposed rule or the Clean Water Rule is uncertain at this time. To the extent either expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. These regulations change frequently. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air permit requirements, or utilize specific equipment or technologies to control emissions of certain pollutants. For example, in May 2016, the EPA finalized rules regarding criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, thereby triggering more stringent air permitting requirements. In addition, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”) for ozone from 75 to 70 parts per billion. In November 2017, the EPA published a list of areas that are in compliance with the new ozone standard and, separately in December 2017, issued responses to state recommendations for designating non-attainment areas. The EPA completed all initial area designations in July 2018. State implementation of the revised NAAQS could result in stricter permitting requirements, which in turn could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +The EPA has determined that emissions of greenhouse gases, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established greenhouse gas emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of greenhouse gases to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to greenhouse gas emissions permitting and best available control technology requirements because none of our facilities are presently major sources of greenhouse gas emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition, and results of operations. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and many states have already established regional greenhouse gas “cap-and-trade” programs. The adoption of any legislation or regulation that restricts emissions of greenhouse gases from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +8 +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, the EPA has taken several steps to delay implementation of its methane standards, including most recently in September 2018, when the EPA announced a proposed rule that rolls back parts of the 2016 performance standards. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. In addition, in April 2018, a coalition of states filed a lawsuit in the U.S. District Court for the District of Columbia aiming to force the EPA to establish guidelines for limiting methane emissions from existing sources in the oil and natural gas sector; that lawsuit is pending. The U.S. Bureau of Land Management (the “BLM”) previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. This repeal is the subject of legal challenges. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remain a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. These rules were finalized in June 2016 and, for certain facilities, compliance is required by August 29, 2019. The EPA is currently conducting a study on effluent guidelines for the oil and gas industry and held a public hearing on this study in October 2018. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high-volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity +9 +that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Where the business and operations of our customers are carried out on federal lands, those business and operations may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an Environmental Assessment that assesses the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act +The Endangered Species Act was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act. The U.S. Fish and Wildlife Service must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. If our customers were to have areas within their business and operations designated as critical or suitable habitat or a protected species, it could decrease demand for our services and have a material adverse effect on our business. +Item 1A. +Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Business and Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• +the level of prices, and expectations about future prices, for oil and natural gas; +• +the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• +the level of global and domestic oil and natural gas production; +• +the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• +governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• +the cost of exploring for, developing, producing, and delivering oil and natural gas; +• +available pipeline, storage, and other transportation capacity; +10 +• +worldwide political, military, and economic conditions; +• +lead times associated with acquiring equipment and products and availability of qualified personnel; +• +the discovery rates of new oil and natural gas reserves; +• +federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• +economic and political conditions in oil and natural gas producing countries; +• +actions of the Organization of the Petroleum Exporting Countries (“OPEC”), its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• +advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• +activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a greenhouse gas; +• +the price and availability of alternative fuels and energy sources; +• +global weather conditions and natural disasters; and +• +uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +The demand for our products and services and the rates we are able to charge are primarily influenced by current and anticipated oil and natural gas commodity prices and the related level of capital spending and drilling and completion activity in the areas in which we have operations. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the past five years, the posted price for West Texas Intermediate oil has ranged from a low of $26.19 per barrel in February 2016 to a high of $107.95 per barrel in June 2014, and the Henry Hub spot market price of gas has ranged from a low of $1.49 per MMBtu in March 2016 to a high of $7.98 per MMBtu in March 2014. Oil and natural gas commodity prices are expected to continue to be volatile. For example, oil and natural gas commodity prices declined significantly in the fourth quarter of 2018, with the posted price for West Texas Intermediate oil falling to a low of $44.48 per barrel in December 2018 as compared to the quarter-high of $76.40 in October 2018. If the prices of oil and natural gas continue to decline or remain depressed for a lengthy period, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. For example, between the third quarter of 2014 and the first quarter of 2016, oil and natural gas commodity prices declined significantly, which resulted in most of our customers reducing their exploration, development, and production activities, which in turn resulted in a reduction in the demand for our services, as well as the rates we were able to charge and the utilization of our assets, during this period as compared to levels in mid-2014. As another example, we believe that the drop in the price of oil at the end of 2018 had a negative impact on certain of our customers’ expectations about prices during 2019 and, as a result, the amount of their capital spending budgets for 2019. Any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +11 +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work. Our ability to be profitable and productive will depend upon our ability to employ and retain skilled workers. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. In addition, the shortage of fixed housing and the lack of employee housing in certain areas where we operate could make it difficult for us to attract and retain quality, long-term personnel. The right-sizing of our and our competitors’ labor force over the sustained period of commodity price declines that began in late 2014, as well as a significant decrease in the wages paid by us or our competitors as a result of reduced industry demand, has resulted in a reduction of the available skilled labor force to service the energy industry, and there is no assurance that the availability of skilled labor will improve following a subsequent increase in demand for our products or services or an increase in wage rates. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +We may be unable to implement price increases or maintain existing prices on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The oil and natural gas industry is intensely competitive and has been characterized by price erosion for new technologies as additional competing products enter the market. We may be unable to maintain the current pricing and profitability of our dissolvable plug products, including the products acquired in the Magnum Acquisition, in the future, which could harm our business. +We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. +We have been able to moderate average selling price declines in many of our proprietary product lines by continuing to introduce new and differentiated products with more valuable features and higher prices. However, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products +12 +decline significantly or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially in loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase inventory obsolescence and restrict our ability to fund our operations. +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• +equipment defects; +• +liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• +explosions and uncontrollable flows of gas or well fluids; +• +unusual or unexpected geological formations or pressures and industrial accidents; +• +blowouts; +• +fires; +• +cratering; +• +loss of well control; +• +collapse of the borehole; and +• +damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our completion and production services could become a source of spills or releases of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose customers and substantial revenue, and any litigation or claims, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +13 +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +Historically, we have experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur further operating losses and experience negative operating cash flow. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +Our revolving credit facility and the indenture governing our 8.750% Senior Notes due 2023 (the “Senior Notes”) have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• +incur additional indebtedness and guarantee indebtedness; +• +pay dividends or make other distributions or repurchase or redeem our capital stock; +• +transfer or sell assets; +• +make loans and investments; +• +incur liens; +• +enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• +consolidate, merge, or sell all or substantially all of our assets; +• +prepay, redeem, or repurchase certain debt; +• +issue certain preferred stock or similar equity securities; +• +make certain acquisitions and investments; +• +engage in transactions with affiliates; and +• +create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +As of December 31, 2018 , we had $400.0 million of Senior Notes outstanding, and we had $83.5 million of availability under our revolving credit facility, net of outstanding revolver borrowings of $35.0 million and an outstanding letter of credit of $0.5 million . Subject to the restrictions in our revolving credit facility and the indenture governing the Senior Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• +requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +14 +• +limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• +increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• +limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• +making us vulnerable to increases in interest rates as our indebtedness under our revolving credit facility may vary with prevailing interest rates; +• +placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or less restrictive terms governing their indebtedness; and +• +making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other +15 +characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion and production services may adversely affect our business, financial condition, and results of operations. +Fuel conservation measures may reduce oil and natural gas demand. +Fuel conservation measures, alternative fuel requirements, and increasing consumer demand for alternatives to oil and natural gas could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas may have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the increased competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels) could reduce demand for hydrocarbons and therefore for our products and services, which would lead to a reduction in our revenues. +Our success may be affected by our ability to implement new technologies and services. Additionally, we rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide services to our customers. Although other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense and delay. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result or termination of our manufacturing relationships, could have a material adverse effect on our financial condition, business, and results of operations. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +Certain of our product lines are subject to the risk of supplier concentration. +Certain of the product lines acquired in the Magnum Acquisition depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +16 +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of such proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot assure you that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution proceedings, a defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. We may not prevail in any such dispute resolution proceedings, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or otherwise violate the intellectual property rights of others. The results or costs of any such dispute resolution proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our business, regardless of its outcome. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our products and services. +17 +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2018 and 2017 , we spent approximately $11.6 million and $9.7 million , respectively, on capital expenditures related to maintenance. Our equipment typically does not generate revenue while it is undergoing maintenance, refurbishment, or upgrades. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. +Our future financial condition and results of operations could be adversely impacted by long-lived assets, goodwill, or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, goodwill, other intangible assets, or other assets in a short amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, goodwill, other intangible assets, or other assets that reduce our net income. +In 2018, we recorded a goodwill impairment charge of $13.0 million , which represents a full write-off of goodwill attributed to our Production Solutions segment, an intangible asset impairment charge of $9.3 million associated with indefinite-lived trade names, an intangible asset impairment charge of $9.8 million associated with definite-lived customer relationship intangible assets, and a property and equipment impairment charge of $45.7 million , in each case associated with our Production Solutions segment and due to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. In 2017, we recorded a goodwill impairment charge of $31.5 million and an intangible asset impairment charge of $3.8 million associated with definite-lived customer relationship intangible assets, in each case associated with a unit in our Completion Solutions segment and due to declining profitability and deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners. While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +Seasonal and adverse weather conditions adversely affect demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. During the winter months (first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For the years ended December 31, 2018 and 2017 , we generated approximately 3.7% and 4.0% , respectively, of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +18 +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects, and results of operations. +The growth of our business through acquisitions may expose us to various risks, including those relating to difficulties in identifying suitable, accretive acquisition opportunities and integrating businesses, assets, systems, and personnel, as well as difficulties in obtaining financing for targeted acquisitions and the potential for increased leverage or debt service requirements. +As a component of our business strategy, we have pursued and intend to continue to pursue selected, accretive acquisitions of complementary assets, businesses, and technologies, such as the Magnum Acquisition. Acquisitions involve numerous risks, including: +• +unanticipated costs and assumption of liabilities and exposure to unforeseen liabilities of acquired businesses, including, but not limited to, environmental liabilities; +• +difficulties in integrating the businesses, assets and financial accounting, operating, information and other systems of the acquired business and the acquired personnel; +• +limitations on our ability to properly assess and maintain an effective internal control environment over an acquired business in order to comply with public reporting requirements; +• +potential losses of key employees and customers of the acquired businesses; +• +inability to commercially develop acquired technologies; +• +risks of entering markets in which we have limited prior experience; and +• +increases in our expenses and working capital requirements. +The process of integrating an acquired business may involve unforeseen costs and delays or other operational, technical, and financial difficulties and may require a disproportionate amount of management attention and financial and other resources. In addition, even following successful integration, the anticipated benefits of an acquisition may not be realized fully or at all or may take longer to realize than expected. Our failure to achieve consolidation savings, to incorporate the acquired businesses and assets into our existing operations successfully, or to minimize any unforeseen operational difficulties could have a material adverse effect on our financial condition and results of operations. +With respect to the Magnum Acquisition in particular, we are devoting significant management attention and resources to integrating Magnum’s business practices, cultures, and operations. Also, we have assumed certain potential liabilities and could be exposed to additional unknown and contingent liabilities associated with Magnum, including post-closing tax obligations and other liabilities for activities of Magnum before the consummation of the Magnum Acquisition, including violations of laws, rules and regulations, commercial disputes, tax liabilities, and other known and unknown liabilities. We have performed a certain level of due diligence in connection with the Magnum Acquisition and have attempted to verify the representations made by Magnum, but there may be liabilities related to Magnum of which we are unaware. There is a risk that we could ultimately be liable for obligations such as post-closing tax obligations relating to Magnum for which indemnification is either not available or not sufficient, which could materially adversely affect our business, results of operations, and cash flow. +There is intense competition for acquisition opportunities in our industry. Competition for acquisitions may increase the cost of, or cause us to refrain from, completing acquisitions. Furthermore, we may not have sufficient capital resources to complete additional acquisitions. Historically, we have financed acquisitions primarily with funding from our equity investors, cash generated by operations, and borrowings. We may incur substantial indebtedness to finance future acquisitions and also may issue equity, debt, or convertible securities in connection with such acquisitions. Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible +19 +securities could be dilutive to our existing stockholders. Furthermore, we may not be able to obtain additional financing on satisfactory terms. Even if we have access to the necessary capital, we may be unable to continue to identify additional suitable acquisition opportunities, negotiate acceptable terms, or successfully acquire identified targets. +Our ability to grow through acquisitions and manage growth will require us to continue to invest in operational, financial, and management information systems and to attract, retain, motivate, and effectively manage our employees. The inability to effectively manage the integration of acquisitions could reduce our focus on current operations and subsequent acquisitions, which, in turn, could negatively impact our earnings and growth. Our financial position and results of operations may fluctuate significantly from period to period, based on whether or not significant acquisitions are completed in particular periods. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, greenhouse gasses, nonattainment areas, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the EPA, the U.S. Department of Transportation (the “DOT”), U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards. The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +20 +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. +There is considerable uncertainty surrounding regulation of methane emissions. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, the EPA has taken several steps to delay implementation of its methane standards, including most recently in September 2018, when the EPA announced a proposed rule that rolls back parts of the 2016 performance standards. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. In addition, in April 2018, a coalition of states filed a lawsuit in the U.S. District Court for the District of Columbia aiming to force the EPA to establish guidelines for limiting methane emissions from existing sources in the oil and natural gas sector; that lawsuit is pending. The BLM previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. This repeal is the subject of legal challenges. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. These rules were finalized in June 2016 and, for certain facilities, compliance is required by August 29, 2019. The EPA is currently conducting a study on effluent guidelines for the oil and gas extraction industry and held a public hearing on this study in October 2018. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our products and services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals, or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high-volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +21 +Existing or future laws and regulations related to greenhouse gases and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of greenhouse gasses that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to greenhouse gas emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns. Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of greenhouse gases in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to greenhouse gases and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of greenhouse gasses that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Finally, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +A portion of our revenue is derived from sales to customers outside of the United States, which exposes us to risks inherent in doing business internationally. +As a result of the Magnum Acquisition, a greater percentage of our revenue is derived from sales to customers outside of the United States. In 2018, Magnum derived 38.7% of its revenue from sales to customers outside of the United States. Sales to customers in countries other than the United States are subject to various risks, including: +• +volatility in political, social, and economic conditions; +• +social unrest, acts of terrorism, war, or other armed conflicts; +• +confiscatory taxation or other adverse tax policies; +• +deprivation of contract rights; +• +trade and economic sanctions or other restrictions imposed by the European Union, the United States, or other countries; +• +exposure under the U.S. Foreign Corrupt Practices Act (the “FCPA”) or similar legislation, as discussed in the below risk factor; and +• +currency exchange controls. +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The FCPA, the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anticorruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. Following the Magnum Acquisition, we now operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. +22 +Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act, in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Our operations are subject to cyber security risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cyber security risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cyber security attacks. These risks could have a material adverse effect on our business, financial condition, and result of operations and could lead to litigation or regulatory action against us. +23 +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license, and effective December 2017, the Federal Motor Carrier Safety Administration has mandated electronic logging devices in all interstate commercial trucks. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and greenhouse gas emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2018 , our five largest customers collectively accounted for approximately 24% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Our executive officers and certain key personnel are critical to our business and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer of our Completion Solutions segment, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +24 +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the United States or other countries, anti-terrorist efforts, and other armed conflicts involving the United States or other countries, including continued hostilities in the Middle East, may adversely affect the United States and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. In Texas, rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +Our Canadian operations subject us to currency translation risk, which could cause our results to fluctuate significantly from period to period. +A portion of our revenues is derived from our Canadian activities and operations. As a result, we translate the results of our operations and financial condition of our Canadian operations into U.S. dollars. Therefore, our reported results of operations and financial condition are subject to changes in the exchange rate between the two currencies. Fluctuations in foreign currency exchange rates could affect our revenue, expenses, and operating margins. Currently, we do not hedge our exposure to changes in foreign exchange rates. +Risks Related to Our Common Stock +Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +SCF VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) owned approximately 30% of our outstanding common stock as of December 31, 2018. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents, and approval of acquisition offers and other significant corporate transactions. In addition, one of the Magnum sellers owned approximately 17% of our outstanding common stock as of December 31, 2018. This concentration of ownership by a small group of stockholders will limit other stockholders’ ability to influence corporate matters, and as a result, actions may be taken that other stockholders may not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their shares of our common stock. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with significant stockholders. +25 +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. SCF is not subject to any obligation to maintain its ownership interest in us and may elect at any time to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies, which could adversely affect our cash flows or results of operations. +Certain of our directors may have conflicts of interest because they are also directors or officers of SCF. The resolution of these conflicts of interest may not be in our or other stockholders’ best interests. +Certain of our directors, namely David C. Baldwin and Andrew L. Waite, are currently officers of SCF’s ultimate general partner. In addition, Mr. Baldwin and Mr. Waite are both directors of Forum Energy Technology, a corporation in which SCF and its affiliates own an approximate 19% equity interest as of December 31, 2018 . These positions may conflict with such individuals’ duties as one of our directors regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in the best interest of the Company or its stockholders. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates, and its other portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our charter further provides that no such person or party shall be liable to us by reason of the fact that such person pursues any such business opportunity or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or otherwise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approved by the holders of at least 80% of the voting power of the outstanding stock of the corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. +The requirements of being a public company, including compliance with the reporting requirements of the Exchange Act, and the requirements of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the New York Stock Exchange (the “NYSE”), may strain our resources, increase our costs, and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner. +As a public company, we are subject to laws, regulations, and requirements with which we were not required to comply as a private company, including compliance with reporting requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act and the NYSE. As a newly public company, complying with these statutes, regulations, and requirements occupies a significant amount of time of our board of directors and management and has significantly increased our costs and expenses as compared to when we were a private company. For example, as a newly public company, we have had to institute a more comprehensive compliance function, establish new internal policies, such as those relating to insider trading, hire additional accounting and other staff, implement an internal audit function, and involve and retain to a greater degree outside counsel and accountants. Compliance with these requirements may strain our resources, increase our costs, and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner. In +26 +addition, being a public company subject to these rules and regulations has made it more expensive for us to obtain director and officer liability insurance as compared to when we were a private company. +Taking advantage of the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors. +We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which at least $700 million of equity securities are held by non-affiliates as of the last day of our then most recently completed second fiscal quarter); (iii) the date on which we have issued, in any three-year period, more than $1.0 billion in non-convertible debt securities; and (iv) December 31, 2023, which is the last day of the fiscal year ending after the fifth anniversary of the completion of our IPO. An emerging growth company may take advantage of certain reduced reporting and other requirements that are otherwise applicable generally to public companies. Pursuant to these reduced disclosure requirements, emerging growth companies are not required to, among other things, comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, provide certain disclosures regarding executive compensation, hold stockholder advisory votes on executive compensation, or obtain stockholder approval of any golden parachute payments not previously approved. In addition, emerging growth companies have longer phase-in periods for the adoption of new or revised financial accounting standards. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. +We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards under Section 107 of the JOBS Act, until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our common stock price may be more volatile. +At the end of the 2019 fiscal year we may no longer qualify as an “emerging growth company,” and we may no longer be able to take advantage of certain exemptions from various reporting requirements. +We are an emerging growth company, and we will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which at least $700 million of equity securities are held by non-affiliates as of the last day of our then most recently completed second fiscal quarter); (iii) the date on which we have issued, in any three-year period, more than $1.0 billion in non-convertible debt securities; and (iv) December 31, 2023, which is the last day of the fiscal year ending after the fifth anniversary of the completion of our IPO. Accordingly, if we meet clause (i), (ii), or (iii) of the preceding sentence, we would no longer qualify as an emerging growth company, and we would no longer be able to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are emerging growth companies. Following the time that we are no longer an emerging growth company, we will be required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. Further, we will not be able to take advantage of the same reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements that smaller reporting companies are permitted to provide or exemptions from the requirements of holding a nonbinding advisory stockholder vote on executive compensation, frequency of approval of executive compensation, and of any golden parachute payments not previously approved. In addition, we will no longer be able to take advantage of Section 107 of the JOBS Act that provides that an emerging growth company may take advantage of the extended transition period provided in the Securities Act of 1933, as amended (the “Securities Act”), and the Exchange Act for complying with new or revised accounting standards. Compliance with these additional rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly, and increase demand on our systems and resources. +27 +We have identified material weaknesses in our internal control over financial reporting, with regard to segregation of certain accounting duties and with regard to the reporting of income tax expense (benefit), related balance sheet accounts, and other comprehensive income. We may identify additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to meet our reporting obligations. +A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In connection with the preparation of our financial statements for the nine months ended September 30, 2017, we identified a material weakness in our internal control over financial reporting, specifically as it related to segregation of certain accounting duties stemming from our decentralized accounting structure and limited number of accounting personnel. We did not design and maintain adequate controls to address segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. Certain accounting personnel had the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy, and completeness. Immaterial misstatements have been identified related to the inadequate segregation of accounting duties. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. In response to this material weakness, our management is in the process of replacing the less sophisticated accounting systems used by the majority of our newly acquired subsidiaries with the enterprise resource planning system used by the majority of our existing subsidiaries and developing and implementing controls and procedures to ensure the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. These actions are subject to ongoing management review and the oversight of our board of directors. +In addition, in connection with a review of our financial statements for the three months ended March 31, 2017, we identified a material weakness in our internal control over the reporting of income tax expense (benefit), the related balance sheet accounts, and other comprehensive income. During the first quarter of 2017, we hired a tax professional as our tax director, who performed a detailed review of our deferred taxes and our tax provision and identified certain immaterial errors in our income tax expense (benefit) and deferred tax balance for the years ended December 31, 2016 and 2015. Upon review of our internal controls in connection with the identification of these errors, we determined that we did not design and maintain an effective control environment with formal accounting policies and controls, and with trained professionals with an appropriate level of income tax knowledge and experience, to properly analyze, record, and disclose the accounting matters commensurate with our financial reporting requirements related to income taxes. Specifically, we did not have controls designed to address the accuracy of income tax expense (benefit) and related combined balance sheet accounts, including deferred income taxes, as well as adequate procedures and controls to review the work of external experts engaged to assist in income tax matters or to monitor the presentation and disclosure of income taxes. This material weakness resulted in the need to correct misstatements in our combined financial statements as of and for the years ended December 31, 2016 and 2015 prior to their issuance. The misstatements were not material to either 2016 or 2015. This material weakness could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. As of December 31, 2018 , we have remediated this material weakness in our internal control over financial reporting. In particular, we re-evaluated the roles and responsibilities within our tax function to ensure our tax department has an appropriate level of tax and accounting knowledge, experience, and training to meet our tax and financial reporting requirements, implemented additional controls and enhanced existing controls to ensure the completeness and accuracy of the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income, and completed the documentation, implementation, and testing of these corrective actions. +The material weaknesses described above or any newly identified material weakness could limit our ability to prevent or detect a misstatement of our accounts or disclosures that could result in a material misstatement of our annual or interim financial statements. We cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to remediate the control deficiencies that led to the material weaknesses in our internal control over financial reporting described above or to avoid potential future material weaknesses. In addition, an independent registered public accounting firm has never performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act because no such evaluation has been required. Had our independent registered public accounting firm performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act, additional material weaknesses may have been identified. +28 +Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. If we are unable to successfully remediate our existing or any future material weakness in our internal control over financial reporting, or identify any additional material weaknesses that may exist, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, we may be unable to prevent fraud, investors may lose confidence in our financial reporting, and our stock price may decline as a result. Additionally, our reporting obligations as a public company could place a significant strain on our management, operational and financial resources, and systems for the foreseeable future and may cause us to fail to timely achieve and maintain the adequacy of our internal control over financial reporting. +If securities or industry analysts do not publish research reports or publish unfavorable research about our business, the price and trading volume of our common stock could decline. +The trading market for our common stock depends in part on the research reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our securities, the price of our securities would likely decline. If one or more of these analysts ceases to cover us or fails to publish regular reports on us, interest in the purchase of our securities could decrease, which could cause the price of our common stock and other securities and their trading volume to decline. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our charter described in the preceding sentence. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +29 +We do not intend to pay dividends on our common stock, and our debt agreements place certain restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on its investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt agreements place certain restrictions on our ability to pay cash dividends. Consequently, unless we revise our dividend policy, a stockholder’s only opportunity to achieve a return on its investment in us will be by selling its common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased its shares of our common stock. +Future sales of our common stock in the public market could reduce our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute a stockholder’s ownership in us. +Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock. We are unable to predict the effect that such sales may have on the prevailing market price of our common stock. SCF and certain of our other stockholders are parties to the Second Amended and Restated Stockholders Agreement, as amended, and the sellers of Magnum are parties to a Registration Rights Agreement, both of which require us to effect the registration of their shares in certain circumstances. In addition, in connection with our initial public offering (the “IPO”), we filed a registration statement on Form S-8 with the SEC providing for the registration of shares of our common stock issued or reserved for issuance under our equity incentive plan. Subject to the satisfaction of vesting conditions and the requirements of Rule 144, shares registered under the registration statement on Form S-8 will be available for resale immediately in the public market without restriction. +We may issue additional capital stock in the future that will result in dilution to all other stockholders. We may also raise capital through equity financings in the future. As part of our business strategy, we may acquire or make investments in complementary companies, products, or technologies and issue equity securities to pay for any such acquisition or investment. Any such issuances of additional capital stock may cause stockholders to experience significant dilution of their ownership interests and the per share value of our common stock to decline. +We may not be able to utilize a portion of our net operating loss carryforwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2018 , the Company had federal and state income tax NOLs of approximately $163.6 million , which will begin to expire between 2023 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). +Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate (as defined in Section 382). However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in the IPO, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +30 +Item 1B. +Unresolved Staff Comments +None. +Item 2. +Properties +The following table describes the material facilities owned or leased by us as of December 31, 2018 . +Segment +Location +Basin/ Region +Leased or Owned +Principal/Most +Significant Use +Headquarters +Houston, TX +— +Leased +Corporate Headquarters/Administrative +Completion +Athens, TX +— +Leased +Operations +Completion +Baker, MT +Bakken +Owned +Operations/Administrative +Completion +Canadian County, OK +SCOOP/STACK +Leased +Operations +Completion +Canonsburg, PA +Marcellus +Leased +Administrative +Completion +Calgary, AB, Canada +— +Leased +Administrative +Completion +Calgary, AB, Canada +WCSB +Leased +Operations/Administrative +Completion +Charleroi, PA +Marcellus/Utica +Leased +Operations +Completion +Cheyenne, WY +Rockies +Leased +Operations +Completion +Corpus Christi, TX +— +Leased +Operations/Administrative +Completion +Dickinson, ND +Bakken +Leased +Operations/Administrative +Completion +Dickinson, ND +Bakken +Leased +Operations +Completion +Enid, OK +SCOOP/STACK +Leased +Operations/Administrative +Completion +Fort St. John, BC, Canada +WCSB +Leased +Operations +Completion +Fort Worth, TX +— +Leased +Administrative +Completion +Frederick/Longmont, CO +Rockies +Leased +Operations +Completion +Grand Prairie, AB, Canada +WCSB +Leased +Operations +Completion +Hobbs, NM +Permian +Leased +Operations +Completion +Jacksboro, TX +Barnett +Leased +Operations +Completion +Kilgore, TX +Haynesville +Leased +Operations/Administrative +Completion +Marietta, OH +Marcellus/Utica +Leased +Operations +Completion +Midland, TX +Permian +Leased +Operations +Completion +Midland, TX +Permian +Leased +Operations +Completion +Midland, TX +Permian +Leased +Operations +Completion +Midland, TX +Permian +Owned +Operations/Administrative +Completion +Midland, TX +Permian +Leased +Administrative +Completion +Monahans, TX +Permian +Leased +Operations/Administrative +Completion +Oklahoma City, OK +SCOOP/STACK +Leased +Operations +Completion +Pittsburgh, PA +Marcellus +Leased +Operations +Completion +Pleasanton, TX +Eagle Ford +Leased +Operations +Completion +Poolville, TX +— +Owned +Operations +Completion +Red Deer, AB, Canada +WCSB +Leased +Operations +Completion +San Antonio, TX +Eagle Ford +Leased +Operations/Administrative +Completion +Shawnee, OK +SCOOP/STACK +Leased +Operations +Completion +Sweetwater, TX +Permian +Leased +Operations +Completion +Ulster, PA +Marcellus/Utica +Leased +Operations +Completion +Tyler, TX +Haynesville +Leased +Operations +Completion +Washington, PA +Marcellus/Utica +Leased +Operations +Completion +Whitecourt, AB, Canada +WCSB +Leased +Operations +Completion +Williston, ND +Bakken +Owned +Operations +31 +Completion +Williston, ND +Bakken +Owned +Operations/Administrative +Production +Big Lake, TX +Permian +Owned +Operations/Administrative +Production +Casper, WY +Rockies +Owned +Operations/Administrative +Production +Douglas, WY +Rockies +Owned +Operations/Administrative +Production +Edgerton, WY +Rockies +Owned +Operations +Production +Gaylord, MI +Antrim +Owned +Operations +Production +Gillette, WY +Rockies +Leased +Operations/Administrative +Production +Harrison, MI +Antrim +Owned +Operations +Production +Hennessey, OK +SCOOP/STACK +Owned +Operations +Production +Kalkaska, MI +Antrim +Owned +Operations/Administrative +Production +Mesick, MI +Antrim +Owned +Operations +Production +Midland, TX +Permian +Owned +Operations/Administrative +Production +Powell, WY +Rockies +Owned +Operations +Production +Thermopolis, WY +Rockies +Leased +Operations/Administrative +Production +Tioga, ND +Bakken +Leased +Operations +Production +Worland, WY +Rockies +Leased +Operations +Item 3. +Legal Proceeding +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. +On August 31, 2017, an accident occurred while a five-employee crew of Big Lake Services, LLC, a subsidiary of Nine (“Big Lake Services”), was performing workover services at an oil and gas wellsite near Midland, Texas, operated by Pioneer Natural Resources USA, Inc. (“Pioneer Natural Resources”), resulting in the death of a Big Lake Services employee, Juan De La Rosa. On December 7, 2017, a lawsuit was filed on behalf of Mr. De La Rosa’s minor children in the Midland County District Court against Pioneer Natural Resources, Big Lake Services, and Phillip Hamilton related to this accident. The petition alleges, among other things, that the defendants acted negligently, resulting in the death of Mr. De La Rosa. On March 14, 2018, a plea in intervention was filed on behalf of Mr. De La Rosa’s parents, alleging similar claims. The plaintiffs and intervenors sought money damages, including punitive damages. On December 17, 2018, a mediation was held, and the parties reached an agreement in principle to settle this matter. We have tendered this matter to our insurance company for defense and indemnification of Big Lake Services and the other defendants and expect this settlement will be fully funded by our insurance company. Finalization of the settlement is subject to the execution of definitive documentation and approval by the court. +Item 4. +Mine Safety Disclosures +Not applicable. +32 +PART II +Item 5. +Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities +Market Information +In connection with the IPO, our common stock began trading on the NYSE under the symbol “NINE” on January 19, 2018. +Holders +As of March 5, 2019, we had 69 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +On October 1, 2018, in connection with, and as partial consideration for, an acquisition of another company, in a transaction that did not involve any underwriters, underwriting discounts, or commissions or any public offering, we issued 15,745 shares of our common stock to the sellers in such acquisition that were not registered under the Securities Act, in reliance on the private offering exemption of Section 4(a)(2) of the Securities Act, based on the following factors: (i) the number of offerees, (ii) the absence of general solicitation, (iii) investment representations obtained from those receiving shares of our common stock, including with respect to their sophistication, (iv) the provision of appropriate disclosure, and (v) the placement of restrictive legends on the certificates reflecting the securities. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +Item 6. +Selected Financial Data +This section presents our selected consolidated financial data for the periods and as of the dates indicated. The financial data set forth below, as well as our audited financial statements and related notes, give effect to the Company’s merger with Beckman Production Services, Inc. (“Beckman”) which was completed on February 28, 2017 (the “Combination”) and represent the consolidated results of Nine, Beckman, and their respective subsidiaries. The selected historical consolidated financial data presented below is not intended to replace our historical Consolidated Financial Statements . The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II and “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report in order to fully understand those factors which may affect the comparability of the information presented below. +33 +Year Ended December 31, +2018 +2017 +2016 +2015 +(in thousands, except share and per share amounts) +Statement of operations data: +Revenues +$ +827,174 +$ +543,660 +$ +282,354 +$ +478,522 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +639,298 +448,467 +246,109 +373,191 +General and administrative expenses +75,993 +49,552 +39,387 +42,862 +Depreciation +54,257 +53,422 +55,260 +58,894 +Amortization of intangibles +9,558 +8,799 +9,083 +8,650 +Impairment of property and equipment +45,694 +— +— +— +Impairment of goodwill +12,986 +31,530 +12,207 +35,540 +Impairment of intangibles +19,065 +3,800 +— +— +Loss on equity method investment +347 +368 +— +— +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +3,320 +2,004 +Loss from operations +(28,293 +) +(56,966 +) +(83,012 +) +(42,619 +) +Other expense +Interest expense +22,315 +15,703 +14,185 +9,886 +Total other expense +22,315 +15,703 +14,185 +9,886 +Loss from continuing operations before income taxes +(50,608 +) +(72,669 +) +(97,197 +) +(52,505 +) +Provision (benefit) for income taxes +2,375 +(4,987 +) +(26,286 +) +(14,323 +) +Loss from continuing operations, net of tax +(52,983 +) +(67,682 +) +(70,911 +) +(38,182 +) +Loss from discontinued operations, net of tax of $0, $0, $0 and $513 +— +— +— +(935 +) +Net loss +(52,983 +) +(67,682 +) +(70,911 +) +(39,117 +) +Other comprehensive income (loss), net of tax +Foreign currency translation adjustments, net of $0 tax in each period +(1,159 +) +(198 +) +210 +(4,067 +) +Total other comprehensive income (loss), net of tax +(1,159 +) +(198 +) +210 +(4,067 +) +Total comprehensive loss +$ +(54,142 +) +$ +(67,880 +) +$ +(70,701 +) +$ +(43,184 +) +Historical earnings per share data: +Weighted average shares outstanding – basic +24,411,213 +14,887,006 +13,268,540 +13,193,380 +Loss from continuing operations per share – basic +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +$ +(2.89 +) +Loss from discontinued operations per share – basic +— +— +— +(0.07 +) +Loss per share – basic +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +Weighted average shares outstanding – fully diluted +24,411,213 +14,887,006 +13,268,540 +13,193,380 +Loss from continuing operations – fully diluted +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +$ +(2.89 +) +Loss from discontinued operations per share – fully diluted +— +— +— +(0.07 +) +Loss per share – fully diluted +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +$ +(2.96 +) +Balance sheet data at period end: +Cash and cash equivalents +$ +63,615 +$ +17,513 +$ +4,074 +$ +18,877 +Property and equipment, net +211,644 +259,039 +273,210 +325,894 +Total assets +1,141,172 +578,859 +576,094 +658,434 +Long-term debt +424,978 +— +244,262 +249,641 +Total stockholders’ equity +$ +594,823 +$ +287,358 +$ +288,186 +$ +352,676 +Statement of cash flows data: +Net cash provided by (used in) operating activities +$ +89,577 +$ +5,671 +$ +(3,290 +) +$ +140,367 +Net cash used in investing activities +(389,765 +) +(44,464 +) +(4,176 +) +(19,251 +) +Net cash provided by (used in) financing activities +$ +346,691 +52,342 +$ +(7,315 +) +$ +(126,878 +) +All shares and per share data reflect the 8.0256 for 1 stock split that took place in January 2018. +34 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” in Item 6 of Part II and “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion and production services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +Recent Events +Magnum Acquisition +On October 25, 2018 (the “Closing Date”), pursuant to the terms of a Securities Purchase Agreement dated October 15, 2018 (the “Magnum Purchase Agreement”), we acquired all of the equity interests of Magnum for approximately $334.5 million in upfront cash consideration, subject to customary adjustments, and 5.0 million shares of our common stock, which were issued to the sellers of Magnum in a private placement. The Magnum Purchase Agreement also includes the potential for additional future payments in cash of (i) up to 60% of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2025 and (ii) up to $25.0 million based on sales of certain dissolvable plug products in 2019. For additional information on the Magnum Acquisition, see Note 3 – Acquisitions and Combinations included in Item 8 of Part II of this Annual Report . +Senior Notes +On October 25, 2018, we issued $400.0 million principal amount of Senior Notes. The proceeds from the Senior Notes, together with cash on hand and borrowings under the 2018 ABL Credit Facility (as defined below), were used to (i) fund a portion of the upfront cash purchase price of the Magnum Acquisition, (ii) repay all indebtedness under the credit facility entered into in conjunction with our IPO, and (iii) pay fees and expenses associated with the issuance of the Senior Notes, the Magnum Acquisition, and the 2018 ABL Credit Facility. For additional information on the Senior Notes, see Note 8 – Debt Obligations included in Item 8 of Part II of this Annual Report . +2018 ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”) that permits aggregate borrowings of up to $200.0 million , subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “2018 ABL Credit Facility”). Concurrent with the effectiveness of the 2018 ABL Credit Facility, we borrowed approximately $35.0 million to fund a portion of the upfront cash purchase price of the Magnum Acquisition. For additional information on the 2018 ABL Credit Facility, see Note 8 – Debt Obligations included in Item 8 of Part II of this Annual Report . +Initial Public Offering +In January 2018, the Company completed its IPO of 8,050,000 shares of common stock (including 1,050,000 shares pursuant to an over-allotment option) at a price to the public of $23.00 per share. +35 +Beckman Combination +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017, we merged with Beckman, and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc. Prior to the Combination, SCF-VII, L.P. had controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the combined Company was accounted for using reorganization accounting (i.e., “as if” pooling of interest) for entities under common control. For additional information on the Combination, see Note 3 – Acquisitions and Combinations included in Item 8 of Part II of this Annual Report . +In this Annual Report, unless the context otherwise requires, the terms “Nine,” “we,” “us,” “our,” and the “Company” refer to (i) Nine Energy Service, Inc. and its subsidiaries together with Beckman prior to the Combination and (ii) Nine Energy Service, Inc. and its subsidiaries after the Combination. +Business Segments +We operate in two segments: +• +Completion Solutions : Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Through our Completion Solutions segment, we provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug and perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +• +Production Solutions : Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to ultimate plug and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion and production services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting both our Completion Solutions and Production Solutions segments are labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +36 +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• +Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of each of our segments compared to historical revenue drivers or market metrics applicable to that service. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• +Adjusted Gross Profit (Excluding Depreciation and Amortization) : Adjusted gross profit (excluding depreciation and amortization) is a key metric that we use to evaluate segment operating performance and to determine resource allocation between segments. We define segment adjusted gross profit (excluding depreciation and amortization) as segment revenues less segment direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “ Non-GAAP Financial Measures ” below. +• +Adjusted EBITDA : We define Adjusted EBITDA as net income (loss) before interest expense, taxes, and depreciation and amortization, further adjusted for (i) property and equipment, goodwill, and/or intangible asset impairment charges, (ii) transaction and integration costs related to acquisitions and our IPO, (iii) loss or gain from discontinued operations, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on equity method investment, (vi) stock-based compensation expense, (vii) loss or gain on sale of property and equipment, and (viii) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business and restructuring costs. For additional information, see “ Non-GAAP Financial Measures ” below. +• +Return on Invested Capital (“ROIC”): We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) transaction and integration costs related to acquisitions and our IPO, (ii) property and equipment, goodwill, and/or intangible asset impairment charges, (iii) interest expense, and (iv) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior year-end total capital for use in this analysis. For additional information, see “ Non-GAAP Financial Measures ” below. +• +Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Factors Affecting the Comparability of Our Results of Operations +Our future results of operations may not be comparable to our historical results of operations for the periods presented, and our historical results of operations among the periods presented may not be comparable to each other, primarily for the reasons described below: +Public Company Expenses : We have only been a publicly traded company since the first quarter of 2018. We incur direct, incremental general and administrative expenses as a result of being a publicly traded company, including costs associated with hiring additional financial and other personnel, instituting a more comprehensive compliance function, implementing an internal audit function, annual and quarterly reports to stockholders, quarterly tax provision preparation, independent auditor fees, other expenses relating to compliance with the rules and regulations of the SEC, listing standards of the NYSE and the Sarbanes-Oxley Act, investor relations activities, registrar and transfer agent fees, incremental director and officer liability insurance costs, and independent director compensation. These direct, incremental general and administrative expenses are not included in our historical results of operations, except for the year ended December 31, 2018. +37 +The Magnum Acquisition: Our historical results of operations included in this Annual Report include the impact of the Magnum Acquisition from the Closing Date through the end of the year. As a result, the historical results of operations prior to the Closing Date may not give you an accurate indication of what our actual results would have been if the Magnum Acquisition had been completed at the beginning of the period presented, or of what our future results of operations are likely to be for the following reasons: +• +As a result of the Magnum Acquisition and the application of purchase accounting, our identifiable net assets have been adjusted to their estimated fair value as of the Closing Date. These adjusted valuations will increase our operating expenses primarily due to an increase in the carrying value and related amortization of our intangible assets with definite lives. Additionally, the excess of the total purchase price over the estimated fair value of the identifiable net assets acquired as of the Closing Date has been allocated to goodwill. We have recorded a significant increase in goodwill as a result of the preliminary determination of the estimated fair value of the identifiable net assets acquired. +• +As a result of the Magnum Acquisition, our completion tools line constitutes a larger portion of our business. We expect that the Magnum Acquisition will generate additional free cash flow, reduce overall capital intensity, and improve our margins. We also expect that the Magnum Acquisition will further diversify our basin exposure and add significant size and scale. For additional information on the Magnum Acquisition, see Note 3 – Acquisitions and Combinations included in Item 8 of Part II of this Annual Report . +• +We incurred significant indebtedness in connection with the consummation of the Magnum Acquisition, and our total indebtedness and related interest expense is significantly higher than prior to the Magnum Acquisition. As of December 31, 2018, we had approximately $435.0 million of total debt before deferred financing costs. For additional information on our debt obligations, see Note 8 – Debt Obligations included in Item 8 of Part II of this Annual Report . +Industry Trends and Outlook +Our business depends to a significant extent on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. During 2018, oil prices rose to their highest levels since the downturn that began in late 2014. However, during the fourth quarter of 2018, oil prices declined approximately 40%, which is generally believed to be due to concerns over a worldwide oversupply of oil as well as concerns over the possible slowing of global demand growth. In response, OPEC members and some nonmembers, including Russia, have renewed pledges to reduce planned production in an effort to draw down a global oversupply and to rebalance supply and demand. While these and other events are expected to provide support for a more balanced supply and demand environment later in 2019, the U.S. Energy Information Administration currently forecasts that the average price per barrel of oil in 2019 will be below the 2018 average, and we expect ongoing oil price volatility as compliance with the output reduction agreements, changes in oil inventories, and actual demand growth is reported. Similarly, natural gas prices are expected to continue to be volatile. +The sharp decline in oil price that occurred at the end of 2018 appears to have created some uncertainty about our customers’ expectations about future prices, which in turn led to customer budgets for 2019 that are more limited than previously anticipated and will likely impact E&P investments in 2019, which could adversely affect our business. If there is price improvement in oil and natural gas throughout 2019, operator activity could increase, which could positively affect our business. Significant factors that are likely to affect 2019 commodity prices include the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally; the extent to which members of OPEC and other oil exporting nations adhere to and agree to extend the agreed oil production cuts; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. +Operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. +38 +Results of Operations +Year Ended December 31, 2018 Compared to Year Ended December 31, 2017 +Year Ended December 31, +2018 +2017 +Change +(in thousands) +Revenues +Completion Solutions +$ +745,316 +$ +465,773 +$ +279,543 +Production Solutions +81,858 +77,887 +3,971 +827,174 +$ +543,660 +$ +283,514 +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Completion Solutions +568,497 +384,641 +183,856 +Production Solutions +70,801 +63,826 +6,975 +639,298 +448,467 +190,831 +Adjusted gross profit +Completion Solutions +176,819 +81,132 +95,687 +Production Solutions +11,057 +14,061 +(3,004 +) +187,876 +95,193 +92,683 +General and administrative expenses +75,993 +49,552 +26,441 +Depreciation +54,257 +53,422 +835 +Amortization of intangibles +9,558 +8,799 +759 +Impairment of property and equipment +45,694 +— +45,694 +Impairment of goodwill +12,986 +31,530 +(18,544 +) +Impairment of intangibles +19,065 +3,800 +15,265 +Loss on equity method investment +347 +368 +(21 +) +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +(6,419 +) +Loss from operations +(28,293 +) +(56,966 +) +28,673 +Interest expense +22,315 +15,703 +6,612 +Loss before income taxes +(50,608 +) +(72,669 +) +22,061 +Provision (benefit) for income taxes +2,375 +(4,987 +) +7,362 +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +14,699 +Revenues +Revenue increased $283.5 million , or 52% , to $827.2 million in 2018, primarily due to an increase in activity in our Completion Solutions segment. Both of our segments depend, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America. In turn, such activity and capital spending are strongly influenced by current and expected oil and natural gas prices, which gradually improved during 2017 and the first three quarters of 2018. During 2017, the closing price of oil reached a high of $60.46 per barrel, and the closing price of natural gas reached a high of $3.71 per MMBtu. During 2018, the closing price per barrel of oil reached $77.41 , and the closing price of natural gas reached a high of $6.24 per MMBtu. +The increase in revenue by reportable segment is discussed below. +Completion Solutions : Revenue increased $279.5 million , or 60% , to $745.3 million in 2018, primarily due to a significant increase in completions activity and increased pricing in response to the improvement of industry conditions in comparison to 2017. The increase in demand and price for our services resulted from our customers increasing their North American capital expenditures, as well as drilling and completing more new wells in 2018 compared to 2017. Wireline revenue increased 86% for 2018, reflecting improved pricing and increased activity; total wireline stages completed increased 51% due to the increase in overall market activity. Completion tools revenue increased 100% , reflecting a 115% increase in stages; tools revenue per stage fell 7% due to the transition to a higher volume of plugs sold versus sleeves, reflective of the market change. +39 +Cementing revenue increased by 44% , primarily due to a 21% increase in job count and improved pricing. Coiled tubing services revenue increased 34% , mainly due to improved pricing, as total job count increased by 12% . +Production Solutions: Revenue increased $4.0 million , or 5% , to $81.9 million in 2018. Rig activity, measured in hours worked, decreased 3% , but was more than offset by an increase in non-rig work and a reduction in third-party costs charged to customers. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues increased $190.8 million , or 43% , to $639.3 million in 2018. The increase was a result of an increase in revenue-generating activity related to improvement in the oil and gas market in comparison to 2017. Materials installed in wells and consumed while performing services increased $91.0 million . Employee costs increased $69.7 million , and other costs such as repairs and maintenance, vehicle, travel and meals and entertainment expense, increased $30.1 million , mostly related to increased levels of activity. +The increase in cost of revenues by reportable segment is discussed below. +Completion Solutions: Cost of revenues increased $183.9 million , or 48% , to $568.5 million in 2018. Costs related to materials installed in wells and consumed while performing services increased $90.4 million , primarily as a result of the increased level of activity. Employee costs increased $66.1 million , as headcount was increased in response to the increase in activity and revenue. Other costs such as repair and maintenance, vehicle, travel and meals, and entertainment expense, increased $27.3 million , mostly related to increased levels of activity. +Production Solutions : Costs of revenues increased $7.0 million , or 11% , to $70.8 million in 2018. Costs related to materials consumed while performing services increased $0.6 million , primarily as a result of the increased level of activity. Employee costs increased by $3.6 million , due in part to reinstatement of salaries that were previously reduced. Other costs, such as vehicle, repair and maintenance, and facilities expense, increased by $2.8 million , mostly related to increased level of activity. +Adjusted Gross Profit +Completion Solutions : Adjusted gross profit (excluding depreciation and amortization) increased $95.7 million to $176.8 million in 2018 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +Production Solutions : Adjusted gross profit (excluding depreciation and amortization) decreased $3.0 million to $11.1 million in 2018 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses increased by $26.4 million , to $76.0 million in 2018. The increase was primarily attributed to higher compensation, benefits and other employee related costs due to increased business activity in comparison to 2017. In addition, the overall increase was partly attributed to 2018 transaction and integration costs primarily related to the Magnum Acquisition and our IPO, as well an increase in professional fees and other costs inherent to being a public company. +Depreciation +Depreciation expense increased $0.8 million to $54.3 million in 2018, primarily due to an increase in capital expenditures, partly attributed to increased business activity in comparison to 2017. +Amortization of Intangibles +Amortization expense increased $0.8 million to $9.6 million in 2018, primarily due to a $2.0 million increase in amortization attributed to the intangible assets acquired as part of the Magnum Acquisition. The overall increase in intangible amortization was partially offset by the write-off of intangible assets associated with one of the reporting units in our Completions Solutions segment in 2017. We expect amortization expense to increase in future periods as a result of the intangible assets acquired as part of the Magnum Acquisition. +40 +Impairment of Property and Equipment +In 2018, we recorded a property and equipment impairment charge of $45.7 million in our Production Solutions segment due to deteriorating market conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. We did not record any property and equipment impairment charges in 2017. +Impairment of Goodwill +In 2018, we recorded a goodwill impairment charge of $13.0 million , which represents a full write-off of goodwill in our Production Solutions segment due to deteriorating market conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. In 2017, we recorded a goodwill impairment charge of $31.5 million associated with a reporting unit in our Completion Solutions segment due to declining profitability and deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners. +Impairment of Intangibles +In 2018, we recorded an intangible asset impairment charge of $9.3 million associated with indefinite-lived trade names in our Production Solutions segment. In addition, we recorded an intangible asset impairment charge of $9.8 million associated with definite-lived customer relationship intangible assets in our Production Solutions segment. Both intangible asset impairment charges were primarily due to deteriorating market conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. In 2017, we recorded an intangible asset impairment charge of $3.8 million associated with definite-lived customer relationship intangible assets in a reporting unit in our Completion Solutions segment due to declining profitability and deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners. +Interest Expense +Interest expense increased $6.6 million to $22.3 million in 2018. The increase was primarily attributed to $6.9 million in commitment fees associated with a potential bridge financing in connection with the Magnum Acquisition. The overall increase in interest expense was partially offset by a reduction in interest expense due to a lower debt balance for the most part of 2018 (i.e. prior to the Magnum Acquisition and related financing transactions). We expect interest expense to increase in future periods in conjunction with our increased debt balance in the fourth quarter of 2018 related to the Senior Notes. +Provision (Benefit) for Income Taxes +Our effective tax rate was (4.7)% for 2018 and 6.9% for 2017. The valuation allowance against our deferred tax assets results in tax expense that does not directly correlate with changes in our income levels. Our tax expense for 2018 is comprised of state jurisdictions where income is expected to exceed available NOLs and tax amortization of indefinite-lived intangible assets, which are excluded when calculating the amount of valuation allowance needed. Therefore, the change in pre-tax book income is the primary driver behind the negative effective tax rate for 2018. +Adjusted EBITDA +Adjusted EBITDA increased $82.8 million to $141.1 million in 2018. The Adjusted EBITDA increase is primarily due to the changes in revenues and expenses discussed above. For additional information, see “ Non-GAAP Financial Measures ” below. +41 +Year Ended December 31, 2017 Compared to Year Ended December 31, 2016 +Year Ended December 31, +2017 +2016 +Change +(in thousands) +Revenues +Completion Solutions +$ +465,773 +$ +221,468 +$ +244,305 +Production Solutions +77,887 +60,886 +17,001 +543,660 +282,354 +261,306 +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Completion Solutions +384,641 +194,436 +190,205 +Production Solutions +63,826 +51,673 +12,153 +448,467 +246,109 +202,358 +Adjusted gross profit +Completion Solutions +81,132 +27,032 +54,100 +Production Solutions +14,061 +9,213 +4,848 +95,193 +36,245 +58,948 +General and administrative expenses +49,552 +39,387 +10,165 +Depreciation +53,422 +55,260 +(1,838 +) +Amortization of intangibles +8,799 +9,083 +(284 +) +Impairment of goodwill +31,530 +12,207 +19,323 +Impairment of intangibles +3,800 +— +3,800 +Loss on equity method investment +368 +— +368 +Loss on sale of property and equipment +4,688 +3,320 +1,368 +Loss from operations +(56,966 +) +(83,012 +) +26,046 +Interest expense +15,703 +14,185 +1,518 +Loss before income taxes +(72,669 +) +(97,197 +) +24,528 +Benefit for income taxes +(4,987 +) +(26,286 +) +21,299 +Net loss +$ +(67,682 +) +$ +(70,911 +) +$ +3,229 +Revenues +Revenue increased $261.3 million , or 93% , to $543.7 million in 2017. Both segments’ businesses depend to a significant extent on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America, which in turn are strongly influenced by current and expected oil and natural gas prices, which were low during most of 2016, but showed improvement during 2017. During 2016, the closing price of oil reached a 12-year low of $26.19 per barrel, and the closing price of natural gas reached an 18-year low of $1.49 per MMBtu. During 2017, the closing price of oil reached a high of $60.46 per barrel, and the closing price of natural gas reached a high of $3.71 per MMBtu. +The increase in revenue by reportable segment is discussed below. +Completion Solutions : Revenue increased $244.3 million , or 110% , to $465.8 million in 2017, primarily due to a significant increase in completions activity and increased pricing in 2017 in response to the improvement of industry conditions. The increase in demand and price for our services resulted from our customers increasing their North American capital expenditures and drilling and completing more new wells in 2017 as compared to 2016. Wireline revenue increased 67% , and total wireline stages completed increased 65% due to the increase in overall market activity. Completion tools revenue increased 173% , reflecting a 243% increase in stages. Revenue per stage fell 20% due to transition from a higher volume of plugs sold from sleeves reflective of the market change. Cementing revenue increased by 154% on a 75% increase in job count and improved pricing from 2016 to 2017. Coiled tubing services revenue increased 107% with total jobs increasing 48% . +42 +Production Solutions : Revenue increased $17.0 million , or 28% , to $77.9 million in 2017. Hours worked for the Production Solutions segment increased by 26% for 2017. The increases were primarily attributable to our customers’ increase in well maintenance and increased well completions activity, which was in response to the improvement of industry conditions described above. Production Solutions average pricing increased by 1% for 2017. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues in 2017 increased $202.4 million , or 82% , compared to 2016. The increase was a result of an increase in revenue-generating activity related to improvement in the oil and gas market. Activity-driven costs were primarily responsible for the increase; materials installed in wells and consumed while performing services increased $94.5 million , and other activity-driven costs were $43.5 million higher. Compensation and benefits increased $60.5 million . +Completion Solutions : Cost of revenues increased $190.2 million , or 98% , to $384.6 million in 2017. The increase was driven primarily by the increased level of activity. Costs related to materials installed in wells and consumed while performing services increased $93.4 million , and other activity-driven costs increased $39.7 million . Additionally, compensation and benefits were $54.4 million higher, as headcount was increased in response to the increase in revenue and forecasted activity increases. +Production Solutions : Cost of revenues increased $12.2 million , or 24% , to $63.8 million in 2017. The increase was due to the increase in revenue-generating activity. Compensation and benefits increased $6.1 million , and other activity-driven costs increased $5.9 million . +Adjusted Gross Profit +Completion Solutions : Adjusted gross profit (excluding depreciation and amortization) increased $54.1 million to $81.1 million in 2017 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +Production Solutions : Adjusted gross profit (excluding depreciation and amortization) increased $4.8 million to $14.1 million in 2017 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses increased $10.2 million , or 26% , to $49.6 million in 2017. The increase was partly due to a $3.2 million increase in legal, audit, and other professional fees incurred in connection with the combination of Nine with Beckman and related to preparations for the IPO. Compensation and benefits, including stock-based compensation, increased $6.8 million , and other general and administrative expenses increased in order to support the Company’s increased level of activity. These increases were partly offset by a $1.3 million decline in the revaluation of the contingent liability related to the purchase of Pat Greenlee Builders, LLC (“Scorpion”). +Depreciation +Depreciation expense decreased $1.8 million , or 3% , to $53.4 million in 2017. The decrease resulted primarily from sales of fixed assets during 2016 and 2017. +Amortization of Intangibles +Amortization of intangibles decreased $0.3 million in 2017. +Impairment of Goodwill +In 2017, we recorded a goodwill impairment charge of $31.5 million associated with one reporting unit in our Completion Solutions segment due to declining profitability and deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners. In 2016, we recorded a goodwill impairment charge of $12.2 million in another reporting unit in the Completion Solutions segment due to persistently low completions activity in the market where the unit operates. +Impairment of Intangibles +In 2017, we recorded an intangible asset impairment charge of $3.8 million associated with definite-lived customer relationship intangible assets in a reporting unit in our Completion Solutions segment due to declining profitability and +43 +deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners. In 2016, we did not record any intangible asset impairment charges. +Interest Expense +Interest expense was $15.7 million in 2017, an increase of $1.5 million from 2016 due to a higher debt balance between periods. +Benefit for Income Taxes +The effective tax rate for 2017 was 6.9% , compared with 27.0% for 2016. Our tax position changed during the fourth quarter of 2016 when a valuation allowance was recorded against the net deferred tax asset. We have excluded deferred tax liabilities related to certain indefinite-lived intangible assets when calculating the amount of valuation allowance needed as these liabilities cannot be considered a source of income when determining the realizability of the net deferred tax assets. A full valuation allowance typically results in an effective rate of 0% , but the underlying tax amortization of the indefinite-lived intangible assets, along with the rate change impact of tax reform, resulted in the effective tax rate of 6.9% for 2017. +Adjusted EBITDA +Adjusted EBITDA was $58.2 million in 2017 as compared with $9.5 million in 2016, an increase of 510% . The Adjusted EBITDA increase is primarily due to the changes in revenues and expenses discussed above. For additional information, see “ Non-GAAP Financial Measures ” below. +Non-GAAP Financial Measures +EBITDA and Adjusted EBITDA +EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define EBITDA as net income (loss) before interest expense, depreciation, amortization of intangibles, and provision (benefit) for income taxes. +We define Adjusted EBITDA as EBITDA further adjusted for (i) property and equipment, goodwill, and/or intangible asset impairment charges, (ii) transaction and integration costs related to acquisitions and our IPO, (iii) loss or gain from discontinued operations, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on equity method investment, (vi) stock-based compensation expense, (vii) loss or gain on sale of property and equipment, and (viii) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business and restructuring costs. +Management believes EBITDA and Adjusted EBITDA are useful because they allow us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income in arriving at these measures because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. These measures should not be considered as an alternative to, or more meaningful than, net income as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from these measures are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of these measures. Our computations of these measures may not be comparable to other similarly titled measures of other companies. We believe that these are widely followed measures of operating performance. +44 +The following table presents a reconciliation of the non-GAAP financial measures of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +EBITDA reconciliation: +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +(70,911 +) +Interest expense +22,315 +15,703 +14,185 +Depreciation +54,257 +53,422 +55,260 +Amortization of intangibles +9,558 +8,799 +9,083 +Provision (benefit) for income taxes +2,375 +(4,987 +) +(26,286 +) +EBITDA +$ +35,522 +$ +5,255 +$ +(18,669 +) +Adjusted EBITDA reconciliation: +EBITDA +$ +35,522 +$ +5,255 +$ +(18,669 +) +Impairment of property and equipment +45,694 +— +— +Impairment of goodwill +12,986 +31,530 +12,207 +Impairment of intangibles +19,065 +3,800 +— +Transaction and integration costs +10,327 +3,622 +— +Loss on revaluation of contingent liabilities (1) +3,262 +415 +1,735 +Loss on equity method investment +347 +368 +— +Stock-based compensation expense +13,221 +7,568 +5,711 +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +3,320 +Legal fees and settlements (2) +2,358 +974 +4,145 +Restructuring costs +— +— +1,088 +Adjusted EBITDA +$ +141,051 +$ +58,220 +$ +9,537 +(1) Amounts relate to the revaluation of contingent liabilities associated with our recent acquisitions. The impact is included in “General and administrative expenses” our Consolidated Statements of Income and Comprehensive Income (Loss) . For additional information on contingent liabilities, see Note 11 – Commitments and Contingencies included Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the Fair Labor Standards Act and/or similar state laws. +Return on Invested Capital +ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) transaction and integration costs related to acquisitions and our IPO, (ii) property and equipment, goodwill, and/or intangible asset impairment charges, (iii) interest expense, and (iv) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We then take the average of the current and prior year-end total capital for use in this analysis. +Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation of ROIC may not be comparable to other similarly titled measures of other companies. +45 +The following table provides an explanation of our calculation of ROIC at December 31, 2018: +Year Ended December 31, +2018 +(in thousands) +Net loss +$ +(52,983 +) +Add back: +Transaction and integration costs +10,327 +Impairment of property and equipment +45,694 +Impairment of goodwill +12,986 +Impairment of intangibles +19,065 +Interest expense +22,315 +Provision for deferred income taxes +898 +After-tax net operating profit +$ +58,302 +Total capital as of prior year-end: +Total stockholders’ equity +$ +287,358 +Total debt +242,235 +Less cash and cash equivalents +(17,513 +) +Total capital +$ +512,080 +Total capital as of year-end: +Total stockholders’ equity +$ +594,823 +Total debt +435,000 +Less cash and cash equivalents +(63,615 +) +Total capital +$ +966,208 +Average total capital +$ +739,144 +ROIC +7.9 +% +Adjusted Gross Profit (Excluding Depreciation and Amortization) +GAAP defines gross profit as revenues less cost of revenues and includes in costs of revenues depreciation and amortization. We define adjusted gross profit (excluding depreciation and amortization) as revenues less cost of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (excluding depreciation and amortization) to evaluate operating performance and to determine resource allocation between segments. We prepare adjusted gross profit (excluding depreciation and amortization) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (excluding depreciation and amortization) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (excluding depreciation and amortization) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (excluding depreciation and amortization) or similarly titled measures in the same manner as we do. +46 +The following table presents a reconciliation of adjusted gross profit (excluding depreciation and amortization) to GAAP gross profit (loss). +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Calculation of gross profit (loss) +Revenues +$ +827,174 +$ +543,660 +$ +282,354 +Cost of revenues (exclusive of depreciation and amortization shown separately below) +639,298 +448,467 +246,109 +Depreciation (related to cost of revenues) +53,358 +52,536 +54,344 +Amortization of intangibles +9,558 +8,799 +9,083 +Gross profit (loss) +$ +124,960 +$ +33,858 +$ +(27,182 +) +Adjusted gross profit (excluding depreciation and amortization) reconciliation: +Gross profit (loss) +$ +124,960 +$ +33,858 +$ +(27,182 +) +Depreciation (related to cost of revenues) +53,358 +52,536 +54,344 +Amortization of intangibles +9,558 +8,799 +9,083 +Adjusted gross profit (excluding depreciation and amortization) +$ +187,876 +$ +95,193 +$ +36,245 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash flows from operating activities, external borrowings, proceeds from the IPO, and capital contributions (prior to the IPO). Our principal uses of cash are to fund capital expenditures and acquisitions, to service our outstanding debt, and to fund our working capital requirements. In 2018, we issued $400.0 million of Senior Notes to, together with cash on hand and borrowings under the 2018 ABL Credit Facility, fund the Magnum Acquisition as well as fully repay and terminate the term loan borrowings and the outstanding revolving credit commitments under our prior credit facility. For additional information regarding the Senior Notes and our prior credit facility, see Note 8 – Debt Obligations included in Item 8 of Part II of this Annual Report . +We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. In addition, our ability to satisfy our liquidity requirements depends on our future operating performance, which is affected by prevailing economic conditions, the level of drilling, completion and production activity for North American onshore oil and natural gas resources, and financial and business and other factors, many of which are beyond our control. +Our total 2018 capital expenditure budget, excluding possible acquisitions, was between $53.0 million and $57.0 million , and the actual amount of capital expenditures incurred in 2018 was $52.6 million . Our capital expenditure budget for 2019, excluding possible acquisitions, is expected to be between $60.0 million and $70.0 million . The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures and the amount we ultimately spend will depend on a number of factors including expected industry activity levels and company initiatives. We believe borrowings under the 2018 ABL Credit Facility, together with cash flows from operations, should be sufficient to fund our capital requirements for the next twelve months. At December 31, 2018 , we had $63.6 million of cash and cash equivalents and $83.5 million of availability under the 2018 ABL Credit Facility, which resulted in a total liquidity position of $147.1 million . +Although we do not budget for acquisitions, pursuing growth through acquisitions is a significant part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +2018 ABL Credit Facility +On October 25, 2018, we entered into the 2018 ABL Credit Agreement. The 2018 ABL Credit Agreement permits aggregate borrowings of up to $200.0 million , subject to a borrowing base, including a Canadian tranche with a sub-limit of up +47 +to $25.0 million and a sub-limit of $50.0 million for letters of credit. The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to us and our domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be CDOR loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75% to 1.25% and the applicable margin for LIBOR loans or CDOR loans vary from 1.75% to 2.25% in each depending on our leverage ratio. We are permitted to repay any amounts borrowed prior to the maturity date without any premium or penalty subject to minimum amounts of prepayments and customary LIBOR breakage costs. In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. Such commitment fee is payable quarterly in arrears. At December 31, 2018, the interest rate on the 2018 ABL Credit Facility was 4.69% . +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below a certain threshold or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. We were in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2018. +Our obligations under the 2018 ABL Credit Facility may be accelerated, subject to customary grace and cure periods, upon the occurrence of certain events of default. Such events of default include customary events for a financing agreement of this type, including payment defaults, the inaccuracy of representation and warranties, defaults in the performance of affirmative or negative covenants, defaults on other material indebtedness of us or certain of our subsidiaries, defaults related to judgments and the occurrence of a change in control. +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +Concurrent with the effectiveness of the 2018 ABL Credit Facility, we borrowed approximately $35.0 million to fund a portion of the upfront cash purchase price of the Magnum Acquisition. +At December 31, 2018, our availability under the 2018 ABL Credit Facility was approximately $83.5 million , net of outstanding revolver borrowings of $35.0 million and an outstanding letter of credit of $0.5 million . +Cash Flows +Our cash flows for the years ended December 31, 2018 , 2017 , and 2016 are presented below: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Operating activities +$ +89,577 +$ +5,671 +$ +(3,290 +) +Investing activities +(389,765 +) +(44,464 +) +(4,176 +) +Financing activities +346,691 +52,342 +(7,315 +) +Impact of foreign exchange rate on cash +(401 +) +(110 +) +(22 +) +Net change in cash and cash equivalents +$ +46,102 +$ +13,439 +$ +(14,803 +) +Operating Activities +Net cash provided by operating activities was $89.6 million in 2018 compared to $5.7 million in net cash provided by operating activities in 2017 . The $83.9 million increase in net cash provided by operating activities was primarily due to a $67.9 million increase in net cash flow provided by operations, adjusted for any non-cash items compared to 2017 and mainly +48 +attributed to revenue growth year-over-year. In addition, net cash provided by working capital increased $16.0 million in comparison to 2017 due primarily to increased levels of business activity. +Net cash provided by operating activities was $5.7 million in 2017 compared to $3.3 million in net cash used in operating activities for 2016 . The $9.0 million increase in net cash provided by operating activities was due to the general improvement in profitability and the receipt of a $14.6 million tax refund in 2017, partially offset by increases in accounts receivable and inventories less increases in accounts payable and accrued liabilities, all related to business growth. +Investing Activities +Net cash used in investing activities was $389.8 million in 2018 compared to $44.5 million in net cash used in investing activities in 2017. The $345.3 million increase in net cash used in investing activities was primarily attributed to $350.0 million in cash flow used in acquisitions in 2018 coupled with a $1.4 million increase in cash purchases of property and equipment in comparison to 2017. The overall increase in net cash used in investing activities was partially offset by an increase in proceeds from notes receivable payments of $2.9 million , an increase in proceeds from the sale of property and equipment (including casualty losses) of $2.2 million as well as a $1.0 million equity investment in 2017 that did not recur in 2018. +Net cash used in investing activities was $44.5 million in 2017 compared to $4.2 million in net cash used in investing activities in 2016. The $40.3 million increase in net cash used in investing activities was primarily attributed to a $36.1 million increase in cash purchases of property and equipment in comparison to 2016, coupled with a reduction in proceeds from the repayment of notes receivable of $1.8 million and proceeds received from the sale of property and equipment (including casualty losses) of $ 1.4 million . In addition, we paid $1.0 million in an equity investment in 2017. +Financing Activities +Net cash provided by financing activities was $346.7 million in 2018 compared to $52.3 million in net cash provided by financing activities in 2017 . The $294.3 million increase in net cash provided by financing activities was primarily attributed to $525.0 million in proceeds received in 2018 from the Senior Notes and the 2018 IPO Term Credit Loan Facility (as defined and described in Note 8 – Debt Obligations included in Item 8 of Part II of this Annual Report) coupled with an increase of $110.4 million in proceeds received from the IPO and issuances of common stock. In addition, we made a $2.4 million cash distribution to non-accredited investors in 2017 that did not recur in 2018. The overall increase in net cash provided by financing activities was partially offset by an increase of $248.5 million in payments on term loans, an increase of $57.9 million in payments on revolving credit facilities, a $15.6 million increase in deferred financing costs and a reduction of $21.5 million in proceeds from revolving credit facilities in comparison to 2017. +Net cash provided by financing activities totaled $52.3 million in 2017 compared to $7.3 million in net cash used in financing activities in 2016 . The $59.7 million increase in net cash provided by financing activities was primarily attributed to an increase of $60.9 million in proceeds received from issuances of common stock coupled with a reduction of $23.7 million in payments on revolving credit facilities in comparison to 2016. The overall increase in net cash provided by financing activities was partially offset by an $18.7 million reduction in proceeds from revolving credit facilities, an increase of $2.7 million in payments on term loans and a reduction of $1.1 million in proceeds from notes payable in comparison to 2017. In addition, we made a $2.4 million cash distribution to non-accredited investors in 2017. +Contractual Obligations +In the normal course of business, we enter into various contractual obligations that impact or could impact our liquidity. The table below contains our known contractual commitments at December 31, 2018 . +Payments Due by Period for the Year Ended December 31, +2019 +2020 +2021 +2022 +2023 +Thereafter +Total +(in thousands) +Senior Notes (1) +$ +— +$ +— +$ +— +$ +— +$ +400,000 +$ +— +$ +400,000 +2018 ABL Credit Facility (2) +— +— +— +— +35,000 +— +35,000 +Interest expense (3) +36,641 +36,641 +36,641 +36,641 +29,915 +— +176,479 +Capital leases +902 +935 +935 +754 +33 +— +3,559 +Operating leases +10,204 +6,568 +5,566 +4,893 +4,760 +15,005 +46,996 +Total +$ +47,747 +$ +44,144 +$ +43,142 +$ +42,288 +$ +469,708 +$ +15,005 +$ +662,034 +49 +(1) Includes principal only. +(2) The amount presented in the table above represents the outstanding principal borrowings under the 2018 ABL Credit Facility as of December 31, 2018 and does not include future commitment fees, amortization of deferred financing costs, interest expense, or other fees. These outstanding principal borrowings must be repaid prior to the maturity date, which is October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. Any future borrowings or repayments could change the total amount outstanding under the 2018 ABL Credit Facility. +(3) Consists of fixed rate interest on the Senior Notes and interest on the 2018 ABL Credit Facility based on borrowings and interest rates as of December 31, 2018 . +Off-Balance Sheet Arrangements +At December 31, 2018 , we had a letter of credit of $0.5 million , which represented an off-balance sheet arrangement as defined in Item 303(a)(4)(ii) of Regulation S-K. As of December 31, 2018 , no liability has been recognized in our Consolidated Balance Sheets for the letter of credit. +Critical Accounting Policies +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Certain accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. We provide expanded discussion of our more significant accounting policies, estimates, and judgments below. We believe that most of these accounting policies reflect our more significant estimates and assumptions used in preparation of our financial statements. +Emerging Growth Company Status +We are an “emerging growth company” as defined in the JOBS Act. Under Section 107 of the JOBS Act, as an emerging growth company, we are taking advantage of an extended transition period for the adoption of new or revised financial accounting standards, including the reduced reporting requirements and exemptions, and the longer phase-in periods for the adoption of new or revised financial accounting standards, until we are no longer an emerging growth company. Our election to use the longer phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Revenue Recognition +We recognize revenue for products and services based upon purchase orders, contracts, or other persuasive evidence of an arrangement with the customer that include fixed or determinable prices and that do not include right of return or other similar provisions or other post-delivery obligations. Revenue is recognized for services when they are rendered and collectability is reasonably assured. Revenue for products is recognized upon delivery, customer acceptance, and when collectability is reasonably assured. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the asset. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +50 +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying +amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the estimated fair value of the asset. The fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Impairment losses are reflected in operating income (loss) in our Consolidated Statements of Income and Comprehensive Income (Loss). +In the fourth quarter of 2018, we recorded a property and equipment impairment charge of $45.7 million and a definite-lived customer relationship intangible asset impairment charge of $9.8 million . These impairment charges represent the difference between the carrying value and the estimated fair value of the long-lived assets associated with our Production Solutions segment and are due to deteriorating conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. For additional information on these impairment charges, see Note 5 – Property and Equipment included in Item 8 of Part II of this Annual Report. +Valuation of Goodwill and Intangible Assets +Goodwill has an indefinite useful life and is not subject to amortization. Intangible assets with indefinite useful lives (specifically trademarks and trade names) are also not subject to amortization. For goodwill and intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Goodwill is reviewed for impairment by comparing the carrying value of each of our reporting unit’s net assets (including allocated goodwill) to the fair value of our reporting unit. The fair value of our reporting unit is determined by using a combination of both the income approach (discounted cash flows of forecasted income) and the market approach (public comparable company multiple of earnings before interest, taxes, depreciation and amortization or “EBITDA”). Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the fair value of the intangible asset. The fair value of intangible assets with indefinite useful lives (specifically trademarks and trade names) is estimated upon acquisition using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, a terminal growth rate, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. We recognize a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds our reporting unit’s fair value. We recognize an indefinite-lived intangible asset impairment charge for the amount by which the carrying value of the intangible asset exceeds the fair value of the intangible asset. Any impairment losses are reflected in “Operating income (loss)” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The fair value of technology and the fair value of customer relationships are estimated upon acquisition using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the fair value of the intangible asset. The fair value of non-compete agreements is estimated upon acquisition using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicated that their carrying amount may not be recoverable. +In the fourth quarter of 2018, in connection with our annual goodwill impairment test, we recorded a goodwill impairment charge of $13.0 million , which represents a full write-off of goodwill in our Production Solutions segment. +In addition, in the fourth quarter of 2018, in connection with our annual indefinite-lived intangible asset impairment test, we recorded an intangible asset impairment charge of $9.3 million associated with indefinite-lived trade names in our Production Solutions segment. +51 +As described above in “Critical Accounting Policies – Valuation of Long-Lived Assets” and also in the fourth quarter of 2018, we recorded an intangible asset impairment charge of $9.8 million related to definite-lived customer relationship intangible assets associated with our Production Solutions segment. +In the fourth quarter of 2017, in connection with our annual goodwill impairment test, we recorded a goodwill impairment charge of $31.5 million associated with one reporting unit in our Completion Solutions segment. +In the fourth quarter of 2017, we also recorded an intangible asset impairment charge of $3.8 million related to definite-lived customer relationship intangible assets associated with one reporting unit in our Completion Solutions segment. +For additional information on goodwill and both indefinite-lived and definite-lived intangible asset impairment charges, see Note 6 – Goodwill and Intangible Assets included in Item 8 of Part II of this Annual Report . +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. Legal costs are expensed as incurred. +Stock-based Compensation +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Fair value of the stock-based compensation was measured using the Black-Scholes model for all of the options outstanding. These models require assumptions and estimates for inputs, especially the estimate of the volatility in the value of the underlying share price, that affect the resultant values and hence the amount of compensation expense recognized. We determine the estimate of volatility periodically based on the weighted averages for the stocks of comparable publicly traded companies. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in general and administrative expenses in our Consolidated Statements of Income and Comprehensive Income (Loss) . +Determining Fair Market Value +Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. We estimate the fair value of each option grant using the Black-Scholes option-pricing model. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – Prior to our IPO, when our stock was not publicly traded, we determined volatility based on an analysis of the PHLX Oil Service Index that tracks publicly traded oilfield service stocks. Subsequent to our IPO and as a publicly traded company, we develop our expected volatility based upon a weighted average volatility of its peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +52 +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates, commodity prices, and non-U.S. currency exchange rates. +Interest Rate Risk +We have interest rate exposure arising from our variable interest rate borrowings. These variable interest rate borrowings are impacted by changes in short-term interest rates. A hypothetical one-percentage point increase in interest rates on our variable interest rate debt outstanding as of December 31, 2018 would increase our annual interest expense by $0.4 million . We do not hedge our exposure to changes in interest rates, and we manage our exposure by using a combination of fixed and variable-rate debt. +Commodity Price Risk +Our fuel purchases expose us to commodity price risk. Our fuel costs consist primarily of diesel fuel used by our various trucks and other motorized equipment. The prices for fuel are volatile and are impacted by changes in supply and demand, as well as market uncertainty and regional shortages. Recently we have been able to pass along price increases to our customers; however, we may be unable to do so in the future. As of December 31, 2018, we were not engaged in commodity price hedging activities, and we are not currently engaged in such activities. +Non-U.S. Currency Exchange Rates +Our operating facilities are in the U.S. and Canadian markets, and as a result our primary exposure to fluctuations in currency exchange rates relates to fluctuations between the U.S. dollar and the Canadian dollar. In Canada, the effects of currency fluctuations are largely mitigated because local expenses of such operations are also generally denominated in the local currency. However, there may be instances in which costs and revenue will not be matched with respect to currency denomination, and we may experience economic loss and a negative impact on earnings or net assets solely as a result of foreign currency exchange rate fluctuations. We do not hedge our exposure to changes in foreign exchange rates. For additional information on risk associated with Non-U.S. currency exchange rates, see “Risk Factors” in Item 1A of Part I of this Annual Report. +Assets and liabilities for which the functional currency is the local currency are translated using the exchange rates in effect at the balance sheet date, resulting in translation adjustments that are reflected as accumulated other comprehensive income in the stockholders’ equity section on our balance sheet. We recorded adjustments to our equity account of approximately $1.2 million for the year ended December 31, 2018 and $0.2 million for each of the years ended December 31, 2017 and 2016 to reflect the net impact of the changes in the strength of the Canadian dollar against the U.S. dollar. +53 +Item 8. +Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017, and 2016 +F-3 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2018, 2017, and 2016 +F-4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016 +F-5 +Notes to Consolidated Financial Statements +F-6 +54 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2018 and 2017 , and the related consolidated statements of income and comprehensive income (loss), of stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2018 , including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +March 7, 2019 +We have served as the Company’s auditor since 2011. +F-1 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2018 +2017 +Assets +Current assets +Cash and cash equivalents +$ +63,615 +$ +17,513 +Accounts receivable, net +154,783 +99,565 +Inventories, net +91,435 +22,230 +Prepaid expenses and other current assets +15,717 +7,929 +Notes receivable from shareholders (Note 14) +7,626 +— +Total current assets +333,176 +147,237 +Property and equipment, net +211,644 +259,039 +Definite-lived intangible assets, net +173,451 +41,514 +Goodwill +307,804 +93,756 +Indefinite-lived intangible assets +108,711 +22,031 +Other long-term assets +6,386 +4,806 +Notes receivable from shareholders (Note 14) +— +10,476 +Total assets +$ +1,141,172 +$ +578,859 +Liabilities and Stockholders’ Equity +Current liabilities +Current portion of long-term debt +$ +— +$ +241,509 +Accounts payable +46,132 +29,643 +Accrued expenses +61,434 +14,687 +Current portion of capital lease obligations +665 +— +Income taxes payable +57 +581 +Total current liabilities +108,288 +286,420 +Long-term liabilities +Long-term debt +424,978 +— +Deferred income taxes +5,915 +5,017 +Long-term capital lease obligations +2,330 +— +Other long-term liabilities +4,838 +64 +Total liabilities +546,349 +291,501 +Commitments and contingencies (Note 11) +Stockholders’ equity +Common stock (120,000,000 shares authorized at $.01 par value; 30,163,408 and 15,810,540 shares issued and outstanding at December 31, 2018 and 2017 respectively) +302 +158 +Additional paid-in capital +746,428 +384,965 +Accumulated other comprehensive loss +(4,843 +) +(3,684 +) +Accumulated deficit +(147,064 +) +(94,081 +) +Total stockholders’ equity +594,823 +287,358 +Total liabilities and stockholders’ equity +$ +1,141,172 +$ +578,859 +All share data reflects the 8.0256 for 1 stock split that took place in January 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2018 +2017 +2016 +Revenues +$ +827,174 +$ +543,660 +$ +282,354 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +639,298 +448,467 +246,109 +General and administrative expenses +75,993 +49,552 +39,387 +Depreciation +54,257 +53,422 +55,260 +Amortization of intangibles +9,558 +8,799 +9,083 +Impairment of property and equipment +45,694 +— +— +Impairment of goodwill +12,986 +31,530 +12,207 +Impairment of intangibles +19,065 +3,800 +— +Loss on equity method investment +347 +368 +— +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +3,320 +Loss from operations +(28,293 +) +(56,966 +) +(83,012 +) +Other expense +Interest expense +22,315 +15,703 +14,185 +Total other expense +22,315 +15,703 +14,185 +Loss before income taxes +(50,608 +) +(72,669 +) +(97,197 +) +Provision (benefit) for income taxes +2,375 +(4,987 +) +(26,286 +) +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +(70,911 +) +Loss per share +Basic +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +Diluted +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +Weighted average shares outstanding +Basic +24,411,213 +14,887,006 +13,268,540 +Diluted +24,411,213 +14,887,006 +13,268,540 +Other comprehensive income (loss), net of tax +Foreign currency translation adjustments, net of $0 tax in each period +$ +(1,159 +) +$ +(198 +) +$ +210 +Total other comprehensive income (loss), net of tax +(1,159 +) +(198 +) +210 +Total comprehensive loss +$ +(54,142 +) +$ +(67,880 +) +$ +(70,701 +) +All share data reflects the 8.0256 for 1 stock split that took place in January 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(In thousands, except share and per share amounts) +Common Stock +Additional +Paid-in +Accumulated +Other +Comprehensive +Retained +Earnings +(Accumulated +Total +Stockholders’ +Shares +Amounts +Capital +Income (Loss) +Deficit) +Equity +Stockholders’ equity as of December 31, 2015 +13,300,214 +$ +133 +$ +311,727 +$ +(3,696 +) +$ +44,512 +$ +352,676 +Issuance of common stock +86,772 +1 +499 +— +— +500 +Stock-based compensation expense +— +— +5,711 +— +— +5,711 +Other comprehensive income +— +— +— +210 +— +210 +Net loss +— +— +— +— +(70,911 +) +(70,911 +) +Stockholders’ equity as of December 31, 2016 +13,386,986 +$ +134 +$ +317,937 +$ +(3,486 +) +$ +(26,399 +) +$ +288,186 +Issuance of common stock +2,501,643 +25 +61,897 +— +— +61,922 +Distribution to non-accredited investors +(78,089 +) +(1 +) +(2,437 +) +— +— +(2,438 +) +Stock-based compensation expense +— +— +7,568 +— +— +7,568 +Other comprehensive loss +— +— +— +(198 +) +— +(198 +) +Net loss +— +— +— +— +(67,682 +) +(67,682 +) +Stockholders’ equity as of December 31, 2017 +15,810,540 +$ +158 +$ +384,965 +$ +(3,684 +) +$ +(94,081 +) +$ +287,358 +Issuance of common stock in IPO, net of offering costs +8,050,000 +81 +168,180 +— +— +168,261 +Stock issued under stock compensation plan +1,166,587 +12 +(12 +) +— +— +— +Issuance of common stock for acquisitions +5,015,745 +50 +177,797 +— +— +177,847 +Stock-based compensation expense +— +— +13,221 +— +— +13,221 +Exercise of stock options +135,817 +1 +2,904 +— +— +2,905 +Vesting of restricted stock +(28,324 +) +— +(927 +) +— +— +(927 +) +Other issuances of common stock +13,043 +— +300 +— +— +300 +Other comprehensive loss +— +— +— +(1,159 +) +— +(1,159 +) +Net loss +— +— +— +— +(52,983 +) +(52,983 +) +Stockholders’ equity as of December 31, 2018 +30,163,408 +$ +302 +$ +746,428 +$ +(4,843 +) +$ +(147,064 +) +$ +594,823 +All share data reflect the 8.0256 for 1 stock split that took place in January 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2018 +2017 +2016 +Cash flows from operating activities +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +(70,911 +) +Adjustments to reconcile net loss to net cash provided by (used in) operating activities +Depreciation +54,257 +53,422 +55,260 +Amortization of intangibles +9,558 +8,799 +9,083 +Amortization of deferred financing costs +2,966 +1,615 +2,355 +Provision for (recovery of) doubtful accounts +(268 +) +176 +— +Provision (benefit) for deferred income taxes +898 +(5,815 +) +(12,159 +) +Provision for inventory obsolescence +844 +1,359 +287 +Impairment of property and equipment +45,694 +— +— +Impairment of goodwill +12,986 +31,530 +12,207 +Impairment of intangibles +19,065 +3,800 +— +Stock-based compensation expense +13,221 +7,568 +5,711 +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +3,320 +Loss on revaluation of contingent liabilities (Note 11) +3,262 +415 +1,735 +Loss on equity method investment +347 +368 +— +Changes in operating assets and liabilities, net of effects from acquisitions +Accounts receivable, net +(24,972 +) +(52,180 +) +2,073 +Inventories, net +(15,041 +) +(8,212 +) +(558 +) +Prepaid expenses and other current assets +(5,722 +) +1,472 +(3,172 +) +Accounts payable and accrued expenses +27,156 +12,530 +(2,396 +) +Income taxes receivable/payable +(255 +) +15,158 +(5,848 +) +Other assets and liabilities +295 +(3,340 +) +(277 +) +Net cash provided by (used in) operating activities +89,577 +5,671 +(3,290 +) +Cash flows from investing activities +Acquisitions, net of cash acquired +(349,986 +) +— +— +Proceeds from sales of property and equipment +2,183 +1,452 +2,918 +Proceeds from property and equipment casualty losses +1,743 +300 +262 +Proceeds from notes receivable payments +2,941 +— +1,774 +Purchases of property and equipment +(46,646 +) +(45,216 +) +(9,130 +) +Equity method investment +— +(1,000 +) +— +Net cash used in investing activities +(389,765 +) +(44,464 +) +(4,176 +) +Cash flows from financing activities +Proceeds from revolving credit facilities +35,000 +56,481 +75,136 +Payments on revolving credit facilities +(96,182 +) +(38,287 +) +(61,956 +) +Proceeds from Senior Notes +400,000 +— +— +Proceeds from term loan +125,000 +— +— +Payments on term loans +(270,975 +) +(22,475 +) +(19,725 +) +Proceeds from notes payable—insurance premium financing +— +— +1,127 +Payments on notes payable—insurance premium financing +— +(272 +) +(855 +) +Payments on capital leases +(128 +) +— +— +Payments of contingent liability on Scorpion purchase +(3,445 +) +(1,325 +) +(297 +) +Proceeds from issuance of common stock in IPO, net of offering costs +171,450 +— +— +Proceeds from other issuances of common stock +300 +61,374 +500 +Proceeds from exercise of stock options +2,905 +— +— +Vesting of restricted stock +(927 +) +— +— +Distribution to non-accredited investors +— +(2,438 +) +— +Cost of debt issuance +(16,307 +) +(716 +) +(1,245 +) +Net cash provided by (used in) financing activities +346,691 +52,342 +(7,315 +) +Impact of foreign currency exchange on cash +(401 +) +(110 +) +(22 +) +Net increase (decrease) in cash and cash equivalents +46,102 +13,439 +(14,803 +) +Cash and cash equivalents +Cash and cash equivalents at beginning of period +17,513 +4,074 +18,877 +Cash and cash equivalents at end of period +$ +63,615 +$ +17,513 +$ +4,074 +Supplemental disclosures of cash flow information: +Cash paid for interest +$ +5,981 +$ +14,987 +$ +12,442 +Cash paid (refunded) for income taxes +$ +1,697 +$ +(14,344 +) +$ +(8,716 +) +Non-cash investing and financing activities: +Issuance of common stock related to business acquisitions +$ +177,847 +$ +547 +$ +— +Contingent liability related to business acquisitions +$ +23,982 +$ +— +$ +— +Capital expenditures in accounts payable and accrued expenses +$ +4,476 +$ +1,675 +$ +1,540 +Property and equipment obtained by capital leases +$ +3,123 +$ +— +$ +— +Receivable from property and equipment insurance +$ +1,199 +$ +— +$ +— +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies and provides a range of production enhancement and well workover services. The Company is headquartered in Houston, Texas. +Initial Public Offering +In January 2018, the Company completed its initial public offering (“IPO”) of 8,050,000 shares of common stock (including 1,050,000 shares pursuant to an over-allotment option) at a price to the public of $23.00 per share pursuant to a registration statement on Form S-1 (File 333-217601), as amended and declared effective by the Securities and Exchange Commission (the “SEC”) on January 18, 2018. +Magnum Acquisition +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018 (the “Magnum Purchase Agreement”), the Company acquired all of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum” and such acquisition, the “Magnum Acquisition”) for approximately $334.5 million in upfront cash consideration, subject to customary adjustments, and 5.0 million shares of the Company’s common stock, which were issued to the sellers of Magnum in a private placement. The Magnum Purchase Agreement also includes the potential for additional future payments in cash of (i) up to 60% of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2025 and (ii) up to $25.0 million based on sales of certain dissolvable plug products in 2019. For additional information on the Magnum Acquisition, see Note 3 – Acquisitions and Combinations . +Beckman Combination +On February 28, 2017, pursuant to the terms and conditions of a combination agreement dated February 3, 2017, the Company merged with Beckman Production Services, Inc. (“Beckman”), and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc. (the “Combination”). Prior to the Combination, SCF-VII, L.P. had controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012, respectively. The merger of the entities into the combined company was accounted for using reorganization accounting (i.e., “as if” pooling of interest) for entities under common control. For additional information on the Combination, see Note 3 – Acquisitions and Combinations . +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). +Principles of Consolidation +The Consolidated Financial Statements as of December 31, 2018 and 2017 , and for the years ended December 31, 2018 , 2017 , and 2016 , include the accounts of Nine and Beckman and their wholly owned subsidiaries. For additional information on the history of Nine, see Note 1 – Company and Organization . All inter-company balances and transactions have been eliminated in the consolidation. +F-6 +Use of Estimates +The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include but are not limited to fair value assumptions used in purchase accounting and in analyzing goodwill, other intangible assets, and long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, stock-based compensation fair value, estimated realizable value on excess and obsolete inventories, deferred taxes and income tax contingencies, and losses on accounts receivable. It is at least reasonably possible that the estimates used will change within the next year. +Reclassifications +Certain reclassifications have been made to prior period amounts to conform to the current period financial statement presentation. These reclassifications relate to the breakout of “Definite-lived intangible assets, net” and “Indefinite-lived intangible assets” in the Company’s Consolidated Balance Sheets . +Revenue Recognition +The Company recognizes revenue for products and services based upon purchase orders, contracts, or other persuasive evidence of an arrangement with the customer that include fixed or determinable prices and that do not include right of return or other similar provisions or other post-delivery obligations. Revenue is recognized for products upon delivery, customer acceptance, and when collectability is reasonably assured. Revenue is recognized for services when they are rendered and collectability is reasonably assured. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the U.S. Dollar (“USD”). The financial position and results of operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets . The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) and its Consolidated Statements of Changes in Stockholders’ Equity. +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices, industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +Bad debt expense recoveries was $0.3 million for the year ended December 31, 2018 , while bad debt expense was $0.2 million for the year ended December 31, 2017 . There was no bad debt expense for the year ended December 31, 2016 . The allowance for doubtful accounts was $0.5 million and $0.6 million at December 31, 2018 and 2017 , respectively. +F-7 +Concentration of Credit Risk +The majority of the Company’s customers operate in the oil and gas industry. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and can therefore negatively impact spending by the Company’s customers. +No customer accounted for at least 10% of revenues for the years ended December 31, 2018 and 2017 . Revenues for the year ended December 31, 2016 included sales to one customer that individually represented 10% or more of total revenue. +Concentration of Supplier Risk +Purchases during the years ended December 31, 2018 , 2017 , and 2016 included purchases from one supplier that individually represented more than 10% of total operating purchases. The accounts payable to this vendor totaled 15% and 17% of total accounts payable at December 31, 2018 and 2017 , respectively. +Equity Method Investment +The Company accounts for investments, which it does not control but has the ability to significantly influence, using the equity method of accounting. Under this method, the investment is carried originally at cost, increased by any allocated share of the investee’s net income and contributions made, and decreased by any allocated share of the investee’s net losses and distributions received. The investee’s allocated share of income and losses is based on the rights and priorities outlined in the equity investment agreement. +On March 13, 2017, the Company entered into an agreement to acquire shares of the Series B Preferred Stock of Deep Imaging Technologies (“DIT”) for $1.0 million . DIT provides an advanced electromagnetic fracture monitoring service which allows its customers to make on-site decisions regarding efficiencies. The Company’s investment in DIT is accounted for as an equity method investment, as the Company has a non-controlling interest in DIT but has the ability to exercise significant influence. +From the date of the investment through December 31, 2018 , the Company’s share of DIT’s net loss was $0.7 million , and is reported as “Loss on equity method investment” in its Consolidated Statements of Income and Comprehensive Income (Loss) and as a reduction of the investment in DIT, which is reported within “Other long-term assets” in its Consolidated Balance Sheets . +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the asset. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying +amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the estimated fair value of the asset. The fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Impairment losses are reflected in operating income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +In the fourth quarter of 2018, the Company recorded a property and equipment impairment charge of $45.7 million and a definite-lived customer relationship intangible asset impairment charge of $9.8 million . These impairment charges represent the difference between the carrying value and the estimated fair value of the long-lived assets associated with the Company’s Production Solutions segment and are due to deteriorating conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there +F-8 +is more technological differentiation and value. For additional information on these impairment charges, see Note 5 – Property and Equipment . +Goodwill and Intangible Assets +Goodwill has an indefinite useful life and is not subject to amortization. Intangible assets with indefinite useful lives (specifically trademarks and trade names) are also not subject to amortization. For goodwill and intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Goodwill is reviewed for impairment by comparing the carrying value of each of the Company’s reporting unit’s net assets (including allocated goodwill) to the fair value of the reporting unit. The fair value of the reporting unit is determined by using a combination of both the income approach (discounted cash flows of forecasted income) and the market approach (public comparable company multiple of earnings before interest, taxes, depreciation and amortization or “EBITDA”). Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the fair value of the intangible asset. The fair value of intangible assets with indefinite useful lives (specifically trademarks and trade names) is estimated upon acquisition using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, a terminal growth rate, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds the reporting unit’s fair value. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the fair value of the intangible asset. Any impairment losses are reflected in in operating income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The fair value of technology and the fair value of customer relationships is estimated upon acquisition using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the fair value of the intangible asset. The fair value of non-compete agreements is estimated upon acquisition using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicated that their carrying amount may not be recoverable. +In the fourth quarter of 2018, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $13.0 million , which represents a full write-off of goodwill attributed to its Production Solutions segment. +In addition, in the fourth quarter of 2018, in connection with its annual indefinite-lived intangible asset impairment test, the Company recorded an intangible asset impairment charge of $9.3 million associated with indefinite-lived trade names in its Production Solutions segment. +As described above in “Property and Equipment” and also in the fourth quarter of 2018, the Company recorded an intangible asset impairment charge of $9.8 million related to definite-lived customer relationship intangible assets associated with its Production Solutions segment. +In the fourth quarter of 2017, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $31.5 million associated with one reporting unit in its Completion Solutions segment. +In the fourth quarter of 2017, the Company recorded an intangible asset impairment charge of $3.8 million related to definite-lived customer relationship intangible assets associated with one reporting unit in its Completion Solutions segment. +For additional information on goodwill and both indefinite-lived and definite-lived intangible asset impairment charges, see Note 6 – Goodwill and Intangible Assets . +F-9 +Equity +In January 2018, there was an 8.0256 for 1 stock split immediately preceding the IPO. All shares and per share data reflect the effect of the stock split. +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. +Compensation expense is recorded for restricted stock over the applicable vesting period based on the Company’s closing stock price as of the grant date. Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +Expected Life +The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility +Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. Prior to the Company’s IPO, when its stock was not publicly traded, the Company determined volatility based on an analysis of the PHLX Oil Service Index that tracks publicly traded oilfield service stocks. Subsequent to the IPO and as a publicly traded company, the Company developed its expected volatility based upon a weighted average volatility of its peer group. +Dividend Yield +At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +Risk-free Interest Rate +The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Forfeitures +As a result of the adoption of Accounting Standards Update (‘‘ASU”) No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Fair Value of Common Stock +Prior to the Company’s IPO, the value of the Company’s stock at the time of each option grant used to establish the strike price was estimated by management in accordance with an internal valuation model and approved by the Company’s Board of Directors. The valuation model was based upon an average of cash flow and book value multiples of comparable companies. The comparable companies selected reflect the market’s view on key sector, geographic, and product type exposure that are similar to those that impact the Company’s business. The value was further subject to judgmental factors such as prevailing market conditions, changes in the stock prices of other oilfield service companies, and the overall outlook for the Company and its products in general. +After the Company’s IPO, the stock value is the publicly traded share price. +Income Taxes +The Company accounts for income taxes under ASC 740. Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences +F-10 +are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 8 – Debt Obligations . +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 3 – Acquisitions and Combinations and Note 11 – Commitments and Contingencies . +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. The diluted earnings (loss) per share computation is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the period, taking into effect, if any, shares that would be issuable upon the exercise of outstanding stock options, reduced by the number of shares purchased by the Company at cost, when such amounts are dilutive to the earnings per share calculation. There was no dilutive effect for the year ended December 31, 2018 , 2017 , or 2016 as the Company was in a net loss position for those years. For additional information on earnings (loss) per share, see Note 13 – Earnings (Loss) Per Share . +Accounting Pronouncements Recently Adopted +In January 2017, the Financial Accounting Standards Board (the ‘‘FASB’’) issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the new standard, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative +F-11 +impairment test is necessary. The new standard should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company early adopted ASU No. 2017-04 during the fourth quarter of 2018. For additional information on the impact of the Company’s goodwill impairment test in accordance with ASU No. 2017-04, see Note 6 – Goodwill and Intangible Assets . +Accounting Pronouncements Not Yet Adopted – Revenue Recognition +Background +In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) , which supersedes the current revenue recognition guidance. The standard is based on the principle that revenue is recognized to depict the transfer of goods and services to customers in the amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and asset recognized from costs incurred to obtain or fulfill a contract. The FASB subsequently issued ASU No. 2016-08, ASU No. 2016-10, and ASU No. 2016-12 which provide additional guidance around Topic 606. These amendments are encompassed in the Company’s reference to ASU No. 2014-09 below. +Quantitative Disclosures of Directional Effects of Adoption +The Company, as an emerging growth company, will adopt ASU No. 2014-09 on January 1, 2019 utilizing the modified retrospective approach. Under this approach, the Company will recognize the cumulative effect of initially applying ASU 2014-09 as an increase to the opening balance of retained earnings. Although still in process of determining the impact, the Company expects this adjustment to be immaterial to its opening balance of retained earnings. +Qualitative Status of Management’s Implementation Efforts +During 2018, in preparation for the adoption of ASU No. 2014-09, the Company began a review of the various types of customer contract arrangements for each of its businesses. These reviews include the following: +• +accumulating all customer contractual arrangements; +• +identifying the individual performance obligations pursuant to each arrangement; +• +quantifying the considerations under each arrangement; +• +allocating the consideration under each arrangement to the identified performance obligation; and +• +determining the timing of revenue recognition pursuant to each arrangement. +The Company has completed the majority of these contract reviews and is currently updating and implementing revised accounting system processes in order to capture information required to be disclosed under ASU No. 2014-09. +The Company has begun updating its current accounting policies to align with revenue recognition practices under ASU No. 2014-09. As part of its evaluation of contracts with customers, the Company holds regular meetings with key stakeholders across the organization to determine the impact of ASU No. 2014-09 on its business processes. Additionally, the Company continues to evaluate its internal processes to address risks associated with incorporating ASU No. 2014-09. Upon adoption, the Company will also implement new internal controls associated with incorporating ASU No. 2014-09, which is not expected to result in a material change in its existing control environment. +Disclosure Requirements +The Company’s disclosures related to revenue recognition will be significantly expanded under ASU No. 2014-09, specifically around the quantitative and qualitative information associated with performance obligations, changes in contract assets and liabilities, and the disaggregation of revenue. As an emerging growth company, the Company will not include these expanded disclosures until its Annual Report on Form 10-K for the year ending December 31, 2019. Currently, the Company is in the process of evaluating these disclosure requirements for future reporting. +F-12 +Accounting Pronouncements Not Yet Adopted – Other +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The standard, which requires the use of a modified retrospective transition approach, includes a number of optional practical expedients that entities may elect to apply. In July 2018, the FASB issued a new, optional transition method that will give companies the option to use the effective date as the date of initial application on transition. Based on initial evaluation, the Company expects to include operating leases with durations greater than twelve months on its Consolidated Balance Sheets. The Company is currently in the process of accumulating and evaluating all the necessary information required to properly account for its lease portfolio under the new standard. The Company will provide additional information about the expected financial impact as it progresses through the evaluation and implementation of the standard. Although the standard will be generally effective for fiscal years beginning after December 15, 2018, the Company plans to adopt for the fiscal year beginning after December 15, 2019, as an emerging growth company. +In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments . This new guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice, including: debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. As an emerging growth company, the Company plans to adopt the new standard for the fiscal year beginning after December 15, 2018. The Company is currently evaluating the impact of the standard on its Consolidated Financial Statements. +In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business , in an effort to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this standard provide a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the integrated set of assets and activities is not a business. The Company is currently evaluating the impact of the new standard on its Consolidated Financial Statements. Although the standard is generally effective for fiscal years beginning after December 15, 2017, the Company plans to adopt for the fiscal year beginning after December 15, 2018, as an emerging growth company. Entities will be required to apply the guidance prospectively when adopted. +3. Acquisitions and Combinations +Magnum Acquisition +Purchase Consideration +On October 25, 2018 (the “Closing Date”), pursuant to the terms of the Magnum Purchase Agreement, the Company acquired all of the equity interests of Magnum for approximately $334.5 million in upfront cash consideration, subject to customary adjustments, and 5.0 million shares of the Company’s common stock, which were issued to the sellers of Magnum in a private placement. The Magnum Purchase Agreement also includes the potential for additional future payments in cash of (i) up to 60% of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2025 and (ii) up to $25.0 million based on sales of certain dissolvable plug products in 2019 (the “Magnum Earnout”). +The Magnum Acquisition has been accounted for as a business combination using the acquisition method. Under the acquisition method of accounting, the fair value of the consideration transferred is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values as of the acquisition date, with the remaining unallocated amount recorded as goodwill. Transaction costs incurred by the Company related to the Magnum Acquisition amounted to $5.2 million . +F-13 +The following table summarizes the fair value of purchase consideration transferred on the Closing Date: +Fair Value +(in thousands) +Proceeds from newly issued Senior Notes and 2018 ABL Credit Facility (1) +$ +296,622 +Cash provided from operations +58,760 +Total upfront cash consideration +$ +355,382 +Issuance of the Company’s common shares +177,350 +Contingent consideration (2) +23,029 +Total purchase consideration +$ +555,761 +(1) Senior Notes and 2018 ABL Credit Facility are defined in Note 8 – Debt Obligations . +(2) The estimated fair value of the Magnum Earnout was based on a Monte Carlo simulation model with estimated outcomes ranging from $0 to $25.0 million . The estimated fair value of the Magnum Earnout is based upon available information and certain assumptions, known at the time of this Annual Report, which management believes are reasonable. Any difference in the actual Magnum Earnout from the estimated fair value of the Magnum Earnout will be recorded in operating income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on the Magnum Earnout, see Note 11 – Commitments and Contingencies . +The final determination of the fair value of assets acquired and liabilities assumed at the Closing Date will be completed as soon as possible, but no later than one year from the Closing Date (the “Measurement Period”). The Company’s preliminary purchase price allocation is subject to revision as additional information about the fair value of assets and liabilities becomes available. Additional information that existed as of the Closing Date, but at the time was unknown to the Company, may become known to the Company during the remainder of the Measurement Period. The final determination of fair value may differ materially from these preliminary estimates. +The following table summarizes the preliminary allocation of the purchase price of the Magnum Acquisition to the assets acquired and liabilities assumed based on the fair value as of the Closing Date, with the excess of the purchase price over the estimated fair value of the identifiable net assets acquired recorded as goodwill: +Purchase Price Allocation +(in thousands) +Cash and cash equivalents +$ +8,509 +Accounts receivable, net +30,441 +Income taxes receivable +272 +Inventories, net +55,169 +Prepaid expenses and other current assets +1,147 +Property and equipment, net +3,729 +Goodwill +225,839 +Definite-lived intangible, assets +148,000 +Indefinite-lived intangible assets, net +96,000 +Other long-term assets +1,055 +Accounts payable +(3,626 +) +Accrued expenses +(10,759 +) +Other long-term liabilities +(15 +) +Total net assets acquired +$ +555,761 +All goodwill acquired is attributable to expected synergies gained through the Magnum Acquisition as well as the assembled workforce. In addition, all goodwill acquired is included in the Completion Solutions segment and is deductible for tax purposes. For additional information on goodwill, see Note 6 – Goodwill and Intangible Assets . +F-14 +A portion of the fair value consideration transferred has been preliminarily assigned to identifiable intangible assets as follows: +Customer Relationships +Non-Compete Agreements +Technology +Definite-Lived Intangible Assets Total +Trade Names +Other Intangible Assets +Indefinite-Lived Intangible Assets Total +(in thousands, except weighted average useful life information) +Fair value +$25,000 +$3,000 +$120,000 +$148,000 +$95,000 +$1,000 +$96,000 +Weighted average useful life +9.0 +2.1 +15.0 +Indefinite +Indefinite +The fair value of technology and the fair value of customer relationships was estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the fair value of the intangible asset. The fair value of trade names was estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. The fair value of the non-compete agreements was estimated using a with and without scenario where cash flows were projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement was not in place. +Pro Forma +Magnum’s results of operations since the Closing Date are included in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss), as part of its Completion Solutions segment, for the year ended December 31, 2018. It is impractical to quantify the contribution of Magnum since the Closing Date, as the business was fully integrated into the Company’s existing operations in 2018. +The following unaudited pro forma condensed combined financial information was derived from the Company’s historical Consolidated Financial Statements and Magnum’s historical combined financial statements, gives effect to the Magnum Acquisition as if it had occurred on January 1, 2017, and reflects pro forma adjustments based on available information and certain assumptions the Company believes are reasonable. These pro forma adjustments include the following: +• +The pro forma impact of the amortization of intangible assets and depreciation of property, plant, and equipment based on the estimated fair values of the identifiable assets; +• +The pro forma impact of the elimination of sales commissions due from or paid by Magnum to an intercompany entity that was not included in the Magnum Acquisition; +• +The pro forma impact of the elimination of insurance premiums paid by Magnum to a captive insurance entity under common ownership that was not included in the Magnum Acquisition, for additional insurance coverage that was not replaced subsequent to the close of the transaction; +• +The pro forma impact of interest expense related to the Magnum Acquisition; +• +The tax benefit of the aforementioned pro forma adjustments; and +• +The pro forma impact to weighted average shares outstanding to reflect the issuance of 5.0 million shares to the sellers of Magnum as of the beginning of the period presented. +The unaudited pro forma condensed combined financial information is presented for illustrative purposes only and is not necessarily indicative of the financial position that would have existed or the financial results that would have occurred if the Magnum Acquisition had been consummated on January 1, 2017, nor is it necessarily indicative of the Company’s future financial position, or operating results. Further, the unaudited pro forma condensed combined financial information does not reflect the realization of any expected cost savings or other synergies from the Magnum Acquisition as a result of restructuring activities and other planned costs savings initiatives following the completion of the Magnum Acquisition. +F-15 +The following table summarizes selected unaudited financial information of the Company on a pro forma basis: +2018 +2017 +(in thousands, except per share amounts) +Revenues +$ +948,282 +$ +633,248 +Net loss +$ +(55,447 +) +$ +(78,993 +) +Loss per share +Basic +$ +(1.89 +) +$ +(3.97 +) +Diluted +$ +(1.89 +) +$ +(3.97 +) +Frac Tech Acquisition +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (the “Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. This acquisition was not material to the Company’s Consolidated Financial Statements . +Beckman Combination +On February 28, 2017 , pursuant to the terms and conditions of a combination agreement dated February 3, 2017 , the Company merged with Beckman and all of the issued and outstanding shares of Beckman common stock were converted into shares of common stock of Nine Energy Service, Inc. at a ratio of 0.567154 Nine shares per Beckman share, other than 1.6% of Beckman shares paid in cash. Prior to the Combination, SCF-VII, L.P. had controlled a majority of the voting interests of Nine and Beckman since February 28, 2011 and July 31, 2012 , respectively. The merger of the entities into the combined company was accounted for using reorganization accounting (i.e., “as if” pooling of interest) for entities under common control. +In conjunction with the Combination, in addition to the conversion of Beckman shares into Nine shares, other events occurred, including: +• +The conversion of Beckman shares owned by non-accredited shareholders of Beckman at the time of the Combination into cash at a price of $17.69 per Beckman share; +• +Payment of cash for Beckman shares that converted into fractional Nine shares at the price of $31.18 per Nine share; +• +The conversion of options to purchase Beckman common stock into options to purchase Nine common stock; +• +The conversion of Beckman restricted shares into Nine restricted shares; +• +The conversion of warrants to purchase Beckman common stock into warrants to purchase Nine common stock; +• +The issuance of options to purchase Nine common stock; +• +The issuance, on a pro-rata basis, to the Company’s shareholders of Nine common stock based on a subscription amount equal to the number of common shares issued at a price of $31.18 . The subscription was offered to all shareholders of record at the time of the Combination. Any unsubscribed shares were reallocated among the shareholders; and +• +The issuance to the Company’s shareholders of Nine warrants equal to one half of the amount of shares issued related to the subscription described above. +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $1.9 million and $2.9 million at December 31, 2018 and 2017 , respectively. +F-16 +Inventories, net as of December 31, 2018 and 2017 were comprised of the following: +December 31, +2018 +2017 +(in thousands) +Raw materials +$ +38,890 +$ +939 +Work in progress +130 +— +Finished goods +54,301 +24,197 +Inventories +93,321 +25,136 +Reserve for obsolescence +(1,886 +) +(2,906 +) +Inventories, net +$ +91,435 +$ +22,230 +5. Property and Equipment +Property and equipment amounts as of December 31, 2018 and 2017 were as follows: +December 31, +Estimated +Useful Lives +2018 +2017 +(in thousands) +Operating equipment +1 to 12 years +$ +394,881 +$ +397,802 +Autos and trucks +1 to 7 years +30,770 +32,973 +Furniture, fixtures, and equipment +2 to 12 years +4,330 +3,179 +Shop equipment +3 to 15 years +17,300 +13,463 +Buildings +7 to 39 years +9,784 +14,260 +Leasehold improvements +3 to 11 years +1,488 +963 +Land +indefinite +1,618 +2,087 +460,171 +464,727 +Less: Accumulated depreciation +(248,527 +) +(205,688 +) +Property and equipment, net +$ +211,644 +$ +259,039 +Depreciation expense was $54.3 million , $53.4 million , and $55.3 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +F-17 +2018 Property and Equipment Impairment +In the fourth quarter of 2018, market conditions in the Company’s Production Solutions segment began to deteriorate due to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. This weakened market outlook indicated that the carrying amount of long-lived assets associated with the Company’s Production Solutions segment may not be recoverable. As such, the Company performed an impairment assessment of all long-lived assets associated with its Production Solutions segment under ASC 360, Property, Plant and Equipment at December 31, 2018. Based on this assessment, which is in consideration of its best internal projections, the Company determined that the carrying amount of long-lived assets associated with its Production Solutions segment exceeded the estimated future undiscounted cash flows derived from the long-lived assets associated with the segment. As such, the Company determined the Level 3 fair value of the long-lived assets associated with its Production Solutions segment using a combination of the income approach (discounted cash flows of forecasted income) and the market approach (consideration of market sales values for similar assets). Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital and future market conditions, among others. The Company believes that the estimates and assumptions used in determining fair value are reasonable and appropriate. Based on its fair value determination, the Company recorded an impairment charge of $45.7 million related to property and equipment associated with its Production Solutions segment and an impairment charge of $9.8 million related to definite-lived customer relationship intangible assets associated with its Production Solutions segment. The property and equipment impairment charge is included in the line item “Impairment of property and equipment” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 , and the definite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 . The total impairment charge represents the difference between the carrying value and the estimated fair value of the long-lived assets associated with its Production Solutions segment and was allocated across the long-lived asset classifications in the Production Solutions segment. The occurrence of future events or deteriorating conditions could result in additional impairment assessments and related charges subsequent to December 31, 2018. +6. Goodwill and Intangible Assets +Goodwill +The changes in the net carrying amount of the components of goodwill for the years ended December 31, 2018 and 2017 were as follows: +Goodwill +Gross Value +Accumulated Impairment Loss +Net +(in thousands) +Balance as of December 31, 2016 +$ +173,033 +$ +(47,747 +) +$ +125,286 +Impairment +— +(31,530 +) +(31,530 +) +Balance as of December 31, 2017 +$ +173,033 +$ +(79,277 +) +$ +93,756 +Additions +227,034 +— +227,034 +Impairment +— +(12,986 +) +(12,986 +) +Balance as of December 31, 2018 +$ +400,067 +$ +(92,263 +) +$ +307,804 +Goodwill by segment for the years ended December 31, 2018 and 2017 was as follows: +Completion Solutions +Production Solutions +Total +(in thousands) +2018 +2017 +2018 +2017 +2018 +2017 +Balance as of January 1 +$ +80,770 +$ +112,300 +$ +12,986 +$ +12,986 +$ +93,756 +$ +125,286 +Additions +227,034 +— +— +— +227,034 +— +Impairment +— +(31,530 +) +(12,986 +) +— +(12,986 +) +(31,530 +) +Balance as of December 31 +$ +307,804 +$ +80,770 +$ +— +$ +12,986 +$ +307,804 +$ +93,756 +The Company performs its annual goodwill impairment test on December 31 or when there is an indication an impairment may have occurred. Prior to 2017 , Beckman performed its annual goodwill impairment test as of October 31. In the +F-18 +fourth quarter of 2017, the goodwill impairment test date for Beckman was changed to December 31 in order to align more closely with the Company’s planning and forecasting process. +2018 Goodwill Impairment +In the fourth quarter of 2018, due to deteriorating market conditions in the Company’s Production Solutions segment attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value, there was a reduction in the outlook for expected future cash flows in the segment and as a result, the segment’s carrying value exceeded its estimated fair value. As such, in the fourth quarter of 2018, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $13.0 million , which represented a full write-off of goodwill attributed to its Production Solutions segment. This goodwill impairment charge is included in the line item “Impairment of goodwill” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 . +2017 Goodwill Impairment +In the fourth quarter of 2017, due to declining profitability and deteriorating market conditions, which included a shift from open hole completions to significantly less profitable cemented liners, there was a reduction in the outlook for expected future cash flows in one reporting unit in the Company’s Completion Solutions segment and as a result, the reporting unit’s carrying value exceeded its estimated fair value. As such, in the fourth quarter of 2017, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $31.5 million associated with the reporting unit. This goodwill impairment charge is included in the line item “Impairment of goodwill” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2017 . +Intangible Assets +The changes in the net carrying amount of the components of intangible assets for the years ended December 31, 2018 and 2017 were as follows: +2018 +Customer Relationships +Non-Compete Agreements +Technology +Definite-Lived Intangible Asset Total +Trade Names +Other Intangible Assets +Indefinite-Lived Intangible Asset Total +(in thousands, except weighted average amortization period information) +Balance as of December 31, 2017 +$ +39,645 +$ +725 +$ +1,144 +$ +41,514 +$ +22,020 +$ +11 +$ +22,031 +Additions +25,000 +3,000 +123,240 +151,240 +95,000 +1,000 +96,000 +Amortization expense +(6,962 +) +(849 +) +(1,747 +) +(9,558 +) +— +— +— +Impairment +(9,719 +) +(26 +) +— +(9,745 +) +(9,320 +) +— +(9,320 +) +Balance as of December 31, 2018 +$ +47,964 +$ +2,850 +$ +122,637 +$ +173,451 +$ +107,700 +$ +1,011 +$ +108,711 +Weighted average amortization period +7.3 +3.5 +14.6 +Indefinite +Indefinite +F-19 +2017 +Customer Relationships +Non-Compete Agreements +Technology +Definite-Lived Intangible Asset Total +Trade Names +Other Intangible Assets +Indefinite-Lived Intangible Asset Total +(in thousands, except weighted average amortization period information) +Balance as of December 31, 2016 +$ +51,144 +$ +1,514 +$ +1,455 +$ +54,113 +$ +22,020 +$ +11 +$ +22,031 +Additions +— +— +— +— +— +— +— +Amortization expense +(7,699 +) +(789 +) +(311 +) +(8,799 +) +— +— +— +Impairment +(3,800 +) +— +— +(3,800 +) +— +— +— +Balance as of December 31, 2017 +$ +39,645 +$ +725 +$ +1,144 +$ +41,514 +$ +22,020 +$ +11 +$ +22,031 +Weighted average amortization period +7.7 +1.1 +3.7 +Indefinite +Indefinite +2018 Indefinite-Lived Intangible Asset Impairment +In the fourth quarter of 2018, due to deteriorating market conditions in the Company’s Production Solutions segment attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value, there was a reduction in the outlook for expected future cash flows attributed to indefinite-lived trade names associated with the segment, and as a result, the trade names’ carrying value exceeded its estimated fair value. As such, in the fourth quarter of 2018, in connection with its annual indefinite-lived intangible asset impairment test, the Company recorded an intangible asset impairment charge of $9.3 million associated with the indefinite-lived trade names in its Production Solutions segment. This indefinite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 . +2018 Definite-Lived Intangible Asset Impairment +In the fourth quarter of 2018, the Company also recorded an impairment charge of $9.8 million related to definite-lived customer relationship intangible assets associated with its Production Solutions segment. This definite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 . For additional information on this definite-lived impairment charge, see Note 5 – Property and Equipment . +2017 Definite-Lived Intangible Asset Impairment +In the fourth quarter of 2017, completions methodology in the area of one of the Completion Solutions segment’s reporting units began to shift from open hole completions to significantly less profitable cemented liners, which resulted in declining revenue and profitability within the reporting unit. The Company determined that these factors indicate that the carrying amount of long-lived assets associated with the reporting unit may not be recoverable. As such, the Company performed an impairment assessment of all long-lived assets associated with the reporting unit under ASC 360, Property, Plant and Equipment at December 31, 2017. Fair value of the long-lived assets associated with the reporting unit was determined by estimating the net present value of the future cash flows over the life of the long-lived assets. Using Level 3 inputs of the fair value hierarchy, critical assumptions for those valuations include estimated activity levels, revenue, and operating expenses. Based on this valuation, the Company recorded an impairment charge of $3.8 million related to definite-lived customer relationship intangible assets associated with this reporting unit. This definite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2017. +Amortization of Intangibles +Amortization of intangibles was $9.6 million , $8.8 million , and $9.1 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +F-20 +Future estimated amortization of intangibles is as follows: +(in thousands) +Year Ending December 31, +2019 +$ +18,368 +2020 +17,227 +2021 +16,876 +2022 +14,222 +2023 +12,276 +Thereafter +94,482 +$ +173,451 +7. Accrued Expenses +Accrued expenses as of December 31, 2018 and 2017 consisted of the following: +2018 +2017 +(in thousands) +Accrued compensation and benefits +$ +11,930 +$ +6,923 +Accrued bonus +13,250 +1,351 +Sales tax payable +1,185 +767 +Magnum contingent liability +20,922 +— +Scorpion contingent liability +— +1,730 +Accrued interest +7,031 +148 +Other accrued expenses +7,116 +3,768 +Total accrued expenses +$ +61,434 +$ +14,687 +8. Debt Obligations +The Company’s debt obligations as of December 31, 2018 and 2017 were as follows: +2018 +2017 +(in thousands) +Senior Notes +$ +400,000 +$ +— +2018 ABL Credit Facility +35,000 +— +2018 IPO Term Loan Credit Facility +— +— +Legacy Term Loans +— +145,975 +Legacy Revolving Credit Facilities +— +96,260 +Total debt before deferred financing costs +$ +435,000 +$ +242,235 +Deferred financing costs +(10,022 +) +(726 +) +Total debt +$ +424,978 +$ +241,509 +Less: Current portion of long-term debt +— +(241,509 +) +Long-term debt +$ +424,978 +$ +— +Senior Notes +On October 25, 2018, the Company issued $400.0 million principal amount of 8.750% Senior Notes due 2023 (the “Senior Notes”). The Senior Notes were issued under an indenture, dated as of October 25, 2018 (the “Indenture”), by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as Trustee. The Senior Notes bear interest at an annual rate of 8.750% payable on May 1 and November 1 of each year with the first interest payment being due on May 1, 2019 . +The Senior Notes are senior unsecured obligations of the Company and are fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s current domestic subsidiaries and by certain future subsidiaries. +F-21 +At any time prior to November 1, 2020, the Company may, from time to time, redeem up to 35% of the aggregate principal amount of the Senior Notes with an amount of cash not greater than the net cash proceeds of certain equity offerings at a redemption price equal to 108.750% of the principal amount of the Senior Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding the date of redemption, provided that at least 65% of the aggregate principal amount of the Senior Notes issued under the Indenture remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of such equity offering. Also, at any time prior to November 1, 2020, the Company may, on any one or more occasions, redeem all or a part of the Senior Notes at a redemption price equal to 100% of the principal amount of the Senior Notes redeemed, plus a “make-whole” premium plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. On and after November 1, 2020, the Company may redeem the Senior Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount of the Senior Notes to be redeemed) set forth below, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption if redeemed during the 12-month period beginning on November 1 of the years indicated below: +Year +Redemption Price +2020 +104.375 +% +2021 +102.188 +% +2022 and thereafter +100.000 +% +If the Company experiences certain changes of control, each holder of Senior Notes may require the Company to repurchase all or a portion of its Senior Notes for cash at a price equal to 101% of the principal amount of such Senior Notes, plus any accrued but unpaid interest, if any, to, but excluding, the date of repurchase. +The Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit the Company’s ability and the ability of its restricted subsidiaries to: (i) incur or guarantee additional indebtedness or issue certain types of preferred stock; (ii) pay dividends or make other distributions or repurchase or redeem their capital stock; (iii) transfer or sell assets; (iv) make loans and investments; (v) incur liens; (vi) enter into agreements that restrict dividends or other payments from their non-guarantor restricted subsidiaries to them; (vii) consolidate, merge, or transfer all or substantially all of their assets; (viii) prepay, redeem, or repurchase certain debt; (ix) issue certain preferred stock or similar equity securities, (x) make certain acquisitions and investments; (xi) engage in transactions with affiliates; and (xii) create unrestricted subsidiaries. The Company was in compliance with the provisions of the Indenture at December 31, 2018 . +Upon an event of default, the trustee or the holders of at least 25% in aggregate principal amount of then outstanding Senior Notes may declare the Senior Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any restricted subsidiary of the Company that is a significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding Senior Notes to become due and payable. +The proceeds from the Senior Notes, together with cash on hand and borrowings under the 2018 ABL Credit Facility (as defined and described below), were used to (i) fund a portion of the upfront cash purchase price of the Magnum Acquisition, (ii) repay all indebtedness under the 2018 IPO Credit Agreement (as defined and described below) and (iii) pay fees and expenses associated with the issuance of the Senior Notes, the Magnum Acquisition, and the 2018 ABL Credit Facility. +During the year ended December 31, 2018 , the Company paid approximately $10.4 million of deferred financing costs in connection with the issuance of the Senior Notes. These costs are direct deductions from the carrying amount of the Senior Notes and are being amortized through interest expense through the maturity date of the Senior Notes using the effective interest method. The unamortized portion of these deferred financing costs was $10.0 million at December 31, 2018 . +2018 ABL Credit Facility +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A. as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permits aggregate borrowings of up to $200.0 million , subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “2018 ABL Credit Facility”). The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws +F-22 +of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be CDOR loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75% to 1.25% and the applicable margin for LIBOR loans or CDOR loans vary from 1.75% to 2.25% , in each depending on the Company’s leverage ratio. The Company is permitted to repay any amounts borrowed prior to the maturity date without any premium or penalty subject to minimum amounts of prepayments and customary LIBOR breakage costs. In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. Such commitment fee is payable quarterly in arrears. At December 31, 2018, the interest rate on the 2018 ABL Credit Facility was 4.69% . +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below a certain threshold or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. The Company was in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2018 . +The Company’s obligations under the 2018 ABL Credit Facility may be accelerated, subject to customary grace and cure periods, upon the occurrence of certain events of default. Such events of default include customary events for a financing agreement of this type, including payment defaults, the inaccuracy of representation and warranties, defaults in the performance of affirmative or negative covenants, defaults on other material indebtedness of the Company or certain of its subsidiaries, defaults related to judgments, and the occurrence of a change in control. +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +Concurrent with the effectiveness of the 2018 ABL Credit Facility, the Company borrowed approximately $35.0 million to fund a portion of the upfront cash purchase price of the Magnum Acquisition. +At December 31, 2018 , the Company’s availability under the 2018 ABL Credit Facility was approximately $83.5 million , net of outstanding revolver borrowings of $35.0 million and an outstanding letter of credit of $0.5 million . +2018 IPO Credit Agreement +On September 14, 2017, the Company entered into a credit agreement (as amended on November 20, 2017, the “2018 IPO Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JP Morgan”) as administrative agent and certain other financial institutions that became effective upon the consummation of the IPO in January 2018 (the “Effective Date”). Pursuant to the terms of the 2018 IPO Credit Agreement, the Company and its domestic restricted subsidiaries were entitled to borrow $125.0 million of term loans (the “2018 IPO Term Loan Credit Facility”), which the Company drew in full on the Effective Date. In January 2018, the Company also made a mandatory prepayment of $9.7 million against the 2018 IPO Term Loan Credit Facility, which approximated 50.0% of the estimated net proceeds from the IPO in excess of $150.0 million , as prescribed under the 2018 IPO Credit Agreement. +In addition, under the 2018 IPO Credit Agreement, the Company and its domestic restricted subsidiaries were entitled to borrow up to $50.0 million (including letters of credit) as revolving credit loans under the revolving commitments (the “2018 IPO Revolving Credit Facility”). On October 25, 2018, the Company fully repaid and terminated the 2018 IPO Credit Agreement as more fully described above. +In the first quarter of 2018, concurrent with the effectiveness of the 2018 IPO Credit Agreement, using proceeds received from the IPO and borrowings under the 2018 IPO Term Loan Credit Facility, the Company fully repaid and terminated the term loans (the “Legacy Term Loans”) and revolving credit facilities (the “Legacy Revolving Credit Facilities”) under the Legacy Nine Credit Agreement (as defined below) and the Legacy Beckman Credit Agreement (as defined below). +All of the obligations under the 2018 IPO Credit Agreement were secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of the Company and its domestic restricted subsidiaries, excluding certain assets. +F-23 +Loans to the Company and its domestic restricted subsidiaries under the 2018 IPO Credit Agreement were either base rate loans or LIBOR loans. The applicable margin for base rate loans varied from 1.50% to 2.75% , and the applicable margin for LIBOR loans varied from 2.50% to 3.75% , in each case depending on the Company’s leverage ratio. The Company was permitted to repay any amounts borrowed prior to the maturity date without any premium or penalty other than customary LIBOR breakage costs. In addition, a commitment fee of 0.50% per annum was charged on the average daily unused portion of the revolving commitments. Such commitment fee was payable quarterly in arrears. +Legacy Term Loans and Legacy Revolving Credit Facilities +In 2014, the Company entered into the Amended and Restated Credit Agreement (as amended, the “Legacy Nine Credit Agreement”) with HSBC Bank USA, N.A., as U.S. administrative agent, HSBC Bank Canada, as Canadian agent, and certain other financial institutions. As of December 31, 2017, the Company had a $35.2 million term loan and $84.8 million in outstanding revolving borrowings (including letters of credit) under the Legacy Nine Credit Agreement. All loans and other obligations under the Legacy Nine Credit Agreement were scheduled to mature on May 31, 2018. +In 2014, Beckman entered into a credit agreement (as amended, the “Legacy Beckman Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, and certain other financial institutions. As of December 31, 2017, Beckman had $110.8 million of term loans and $11.5 million in outstanding revolving borrowings under the Legacy Beckman Credit Agreement. All loans and other obligations under the Legacy Beckman Credit Agreement were scheduled to mature on June 30, 2018. +As described above, in the first quarter of 2018, concurrent with the effectiveness of the 2018 IPO Credit Agreement, using proceeds received from the IPO and borrowings under the 2018 IPO Term Loan Credit Facility, the Company fully repaid and terminated the Legacy Term Loans and the Legacy Revolving Credit Facilities under the Legacy Nine Credit Agreement and the Legacy Beckman Credit Agreement. +Debt Extinguishment Costs +During the year ended December 31, 2018 , the Company recorded debt extinguishment costs of approximately $8.8 million , which consisted of a $6.9 million commitment fee associated with a potential bridge financing in the fourth quarter of 2018, as well as $1.2 million in unamortized deferred financing costs associated with the termination of the 2018 IPO Credit Agreement in the fourth quarter of 2018 and $0.7 million in unamortized deferred financing costs associated with the termination of the Legacy Nine Credit Agreement and the Legacy Beckman Credit Agreement in the first quarter of 2018. The unamortized deferred financing costs were being amortized through the maturity dates of each agreement using the effective interest method. These debt extinguishment costs are included in the interest expense line item in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2018 . +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2018 and 2017 was as follows: +2018 +2017 +(in thousands) +Senior Notes +$ +376,000 +$ +— +2018 ABL Credit Facility +35,000 +— +2018 IPO Term Loan Credit Facility +— +— +Legacy Term Loans +— +145,975 +Legacy Revolving Credit Facilities +$ +— +$ +96,260 +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. The 2018 ABL Credit Facility is also classified within Level 2 of the fair value hierarchy. Due to the short-term maturity of the 2018 ABL Credit Facility, its fair value approximates its carrying value. +9. Defined Contribution Plans +Background +Nine, Beckman, and Magnum sponsored defined contribution plans under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +F-24 +Effective January 1, 2018, the existing Nine Energy Service 401(k) Plan (the “Existing Nine Plan”) was terminated and merged with the Beckman 401(k) Plan (the “Beckman Plan”) into the new Nine Energy Service 401(k) Plan (the “New Nine Plan”). Under the New Nine Plan, employee contributions were matched by the Company as they were matched under the Existing Nine Plan, at 100% of the first 3% and 50% of the remaining up to 5% of compensation that a participant contributed to the plan. +Under the Beckman Plan, the Company matched employee contributions at 50% of the first 5% of compensation that a participant contributed to the plan. +Under the Magnum 401(k) Plan (the “Magnum Plan”), the Company matched employee contributions at 100% of the first 3% of compensation and 50% of the remaining up to 5% of compensation that a participant contributed to the plan. +Contributions +For the year ended December 31, 2018 , the Company made employer contributions of $3.2 million under the New Nine Plan and $0.2 million of contributions under the Magnum Plan. +For the year ended December 31, 2017 , the Company made no contributions under the Existing Nine Plan. During 2017 , for the Beckman Plan, the Company incurred a liability of $0.6 million for contributions that were made in 2018. +For the year ended December 31, 2016 , the Company made no contributions under the Existing Nine Plan. Under the Beckman Plan, the Company made no contributions during 2016, but incurred a liability of $0.4 million for contributions that were made in 2017. +10. Stock-based Compensation +Nine +Stock Options +Information about stock option activity during the years ended December 31, 2018 and 2017 was as follows: +2018 Activity +Number of +Shares in +Underlying +Options +Weighted +Average +Exercise Price +Remaining +Weighted Average +Contractual Life +in Years +Intrinsic Value +(in thousands) +Beginning balance +1,068,791 +$ +30.79 +7.6 +$ +3,282 +Granted +32,102 +23.01 +6.0 +— +Exercised +(121,577 +) +20.71 +— +1,728 +Forfeited +(21,657 +) +29.17 +— +5 +Total outstanding +957,659 +$ +31.98 +6.9 +$ +6 +Options exercisable +667,922 +$ +33.20 +6.2 +$ +3 +F-25 +2017 Activity +Number of +Shares in +Underlying +Options +Weighted +Average +Exercise Price +Remaining +Weighted Average +Contractual Life +in Years +Intrinsic Value +(in thousands) +Beginning balance +656,646 +$ +31.26 +6.9 +$ +2,863 +Beckman options converted to Nine options +78,714 +27.03 +5.9 +360 +Granted +471,456 +30.94 +9.2 +113 +Exercised +— +— +— +— +Forfeited +(138,025 +) +31.38 +— +55 +Total outstanding +1,068,791 +$ +30.79 +7.6 +$ +3,282 +Options exercisable +347,225 +$ +23.77 +6.1 +$ +2,571 +The intrinsic value at December 31, 2018 and 2017 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2018 and 2017 , respectively. +The assumptions used in the Black-Scholes pricing model to estimate the fair value of the options granted in 2018 , 2017 , and 2016 are as follows: +2018 +2017 +2016 +Weighted average grant-date fair value +$ +13.11 +$ +14.70 +$ +10.44 +Assumptions +Expected life (in years) +6.0 +6.0 +6.0 +Volatility +47.0 +% +47.1 +% +47.0 +% +Dividend yield +0.0 +% +0.0 +% +0.0 +% +Risk free interest rate +2.47 +% +2.16 +% +1.46 +% +Compensation expense recorded was approximately $3.5 million , $3.3 million , and $2.7 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. As of December 31, 2018 , the Company expects to record compensation expense of approximately $2.6 million over the remaining options term of approximately 1.3 years . Future stock option grants will result in additional compensation expense. +Restricted Stock +Information about restricted stock activity during the years ended December 31, 2018 , 2017 , and 2016 was as follows: +2018 +2017 +2016 +Nonvested at the beginning of the year +373,861 +131,179 +146,074 +Beckman restricted stock converted to Nine restricted stock +— +91,961 +— +Granted +805,897 +302,797 +24,157 +Vested +(148,740 +) +(77,093 +) +(39,052 +) +Cancelled +(13,073 +) +(74,983 +) +— +Nonvested at the end of the year +1,017,945 +373,861 +131,179 +The weighted-average grant date fair value of the restricted stock was $26.01 , $31.18 , and $22.63 during the years ended December 31, 2018 , 2017 , and 2016 , respectively. The total amount of compensation expense related to the restricted stock awards recorded was approximately $9.7 million , $4.3 million , and $1.7 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. As of December 31, 2018 , the Company expects to record compensation expense related to restricted stock of approximately $17.9 million over the remaining restricted stock term of approximately 2.1 years . +F-26 +Beckman +Stock Options +During 2017 , concurrent with the combination of Nine and Beckman, all Beckman stock options were converted to Nine stock options. All information related to Company stock option activity for the year ended December 31, 2018 is shown in the “Nine – Stock Options” section above, and the Beckman stock option activity for the year ended December 31, 2017 was as follows: +2017 Activity +Number of +Shares in +Underlying +Options +Weighted +Average +Exercise Price +Remaining +Weighted Average +Contractual Life +in Years +Intrinsic Value +Beginning balance +17,313 +$ +123.02 +5.9 +$ +— +Beckman options converted to Nine options +(17,313 +) +123.02 +5.9 +— +Granted +— +— +— +— +Exercised +— +— +— +— +Forfeited +— +— +— +— +Total outstanding +— +$ +— +— +$ +— +Options exercisable +— +$ +— +— +$ +— +The intrinsic value at December 31, 2017 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as December 31, 2017 . +All options granted in 2018 and 2017 by the Company are shown in the “Nine – Stock Options” section above. The assumptions used in the Black-Scholes pricing model to estimate the fair value of the Beckman options granted in 2016 were as follows: +2016 +Weighted average grant-date fair value +$ +86.18 +Assumptions +Expected life (in years) +7.0 +Volatility +98.6 +% +Dividend yield +0.0 +% +Risk free interest rate +2.00 +% +Compensation expense for the Beckman stock options was approximately $0.2 million for the year ended December 31, 2016 . +Restricted Stock +During 2017 , concurrent with the combination of Nine and Beckman, all Beckman restricted stock was converted to Nine restricted stock. All restricted stock granted in 2018 by the Company is shown in the “Nine – Restricted Stock” section above. Information about Beckman restricted stock activity during the years ended December 31, 2017 and 2016 was as follows: +2017 +2016 +Nonvested at the beginning of the year +20,225 +17,576 +Beckman restricted stock converted to Nine restricted stock +(20,225 +) +— +Granted +— +9,092 +Vested +— +(5,631 +) +Cancelled +— +(812 +) +Nonvested at the end of the year +— +20,225 +F-27 +The weighted average grant date fair value of the Beckman restricted stock was $77.00 during the year ended December 31, 2016 . The total amount of compensation expense related to the Beckman restricted stock awards was approximately $0 million and $1.0 million for the years ended December 31, 2017 and 2016 , respectively. +11. Commitments and Contingencies +Litigation +From time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +On August 31, 2017, an accident occurred while a five-employee crew of Big Lake Services, LLC, a subsidiary of Nine (“Big Lake Services”), was performing workover services at an oil and gas wellsite near Midland, Texas, operated by Pioneer Natural Resources USA, Inc. (“Pioneer Natural Resources”), resulting in the death of a Big Lake Services employee, Juan De La Rosa. On December 7, 2017 , a lawsuit was filed on behalf of Mr. De La Rosa’s minor children in the Midland County District Court against Pioneer Natural Resources, Big Lake Services, and Phillip Hamilton related to this accident. The petition alleges, among other things, that the defendants acted negligently, resulting in the death of Mr. De La Rosa. On March 14, 2018, a plea in intervention was filed on behalf of Mr. De La Rosa’s parents, alleging similar claims. The plaintiffs and intervenors sought money damages, including punitive damages. On December 17, 2018, a mediation was held, and the parties reached an agreement in principle to settle this matter. The Company has tendered this matter to its insurance company for defense and indemnification of Big Lake Services and the other defendants and expects this settlement will be fully funded by the Company’s insurance company. Finalization of the settlement is subject to the execution of definitive documentation and approval by the court. +Leases +The Company leases equipment, vehicles, office space, yard facilities, and employee housing in the United States and in Canada where the Company operates, under leases classified as operating. The original lease terms require monthly rental payments and expire from 2018 through 2029. Other leases for various equipment and facilities are on a month-to-month basis or have expired during 2018 . Total rent expense for all operating leases was approximately $13.0 million , $7.2 million , and $6.3 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +The following schedule shows the future total minimum lease payments under these non-cancelable leases as of December 31, 2018 : +(in thousands) +Year ending December 31, +2019 +$ +10,204 +2020 +6,568 +2021 +5,566 +2022 +4,893 +2023 +4,760 +Thereafter +15,005 +$ +46,996 +Self-Insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance clams. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $1.6 million and $1.3 million at December 31, 2018 and 2017 , respectively, and is included under the caption “Accrued expenses” in the Company’s Consolidated Balance Sheets . +F-28 +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Contingent Liabilities +The Company has recorded the following contingent liabilities at December 31, 2018 : +Magnum Earnout +The Magnum Purchase Agreement includes the potential for additional future payments in cash of (i) up to 60% of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2025 and (ii) up to $25.0 million based on sales of certain dissolvable plug products in 2019. For additional information on the Magnum Acquisition, see Note 3 – Acquisitions and Combinations . +Frac Tech Earnout +On October 1, 2018, pursuant to the terms and conditions of the Frac Tech Purchase Agreement, the Company acquired Frac Tech. The Frac Tech Purchase Agreement includes, among other things, the potential for additional future payments, based on certain Frac Tech sales volume metrics through December 31, 2023. +Scorpion Earnout +In connection with the acquisition of Pat Greenlee Builders, LLC (“Scorpion”) in 2015 , the Company recorded a liability for contingent consideration to be paid in shares of Company common stock and in cash, contingent upon quantities of Scorpion Composite Plugs ™ sold during 2016 and gross margin related to the product sales for three years following the acquisition. A cash payment of $1.3 million was made during 2017 , and common stock was issued based on gross margin on sales of Scorpion plugs in the second year following acquisition. The forecasted quantities of plug sales and the related gross margin increased again during the year ended December 31, 2017 , resulting in a revaluation loss of $0.4 million . During the year ended December 31, 2018 , a revaluation loss of $1.7 million occurred. In the fourth quarter of 2018 , the Company paid out the contingent liability in the amount of $3.4 million . +The following is a reconciliation of the beginning and ending amounts of the contingent liabilities (level 3) for the year ended December 31, 2018 : +Magnum +Frac Tech +Scorpion +Total +(in thousands) +Balance at January 1, 2018 +$ +— +$ +— +$ +1,730 +$ +1,730 +Fair value of contingent earnout liability initially recorded in connection with the acquisitions +23,029 +953 +— +23,982 +Payment +— +— +(3,445 +) +(3,445 +) +Revaluation adjustments +1,492 +55 +1,715 +3,262 +Balance at December 31, 2018 +$ +24,521 +$ +1,008 +$ +— +$ +25,529 +The following is a reconciliation of the beginning and ending amounts of the contingent liabilities (level 3) for the year ended December 31, 2017 : +Magnum +Frac Tech +Scorpion +Total +(in thousands) +Balance at January 1 +$ +— +$ +— +$ +3,187 +$ +3,187 +Common stock issuance +— +— +(547 +) +(547 +) +Payment +— +— +(1,325 +) +(1,325 +) +Revaluation adjustments +— +— +415 +415 +Balance at December 31 +$ +— +$ +— +$ +1,730 +$ +1,730 +The contingent consideration related to the contingent liabilities is reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include estimated gross margin related to forecasted sales of the plugs, term of the agreement, and a risk adjusted discount factor. Contingent liabilities include $20.9 million and +F-29 +$1.7 million reported in “Accrued expenses” at December 2018 and 2017 , respectively, and $4.6 million and $0.0 million reported in “Other long-term liabilities” at December 2018 and 2017 , respectively, in the Company’s Consolidated Balance Sheets . The impact of the revaluation adjustments is included in “General and administrative expenses” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) . +12. Taxes +On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (the “Tax Act”) with some provisions effective as early as 2017 while others were delayed until 2018. This change in U.S. tax law included a reduction in the federal corporate tax rate from 35% to 21% for years beginning after 2017, which resulted in the remeasurement of the Company’s U.S. net deferred income tax liabilities. The Company’s 2017 income tax provision includes a provisional $3.0 million net income tax benefit related to the remeasurement of its U.S. net deferred income tax liabilities. During 2018, the Company completed its analysis of the provisional items, resulting in immaterial adjustments primarily related to cumulative temporary differences. In addition, the Company has elected to treat the global intangible low-taxed income provisions of the Tax Act as a period cost in the year incurred. +The components of the provision (benefit) for income taxes for the years ended December 31, 2018 , 2017 , and 2016 were as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Current +US Federal +$ +(93 +) +$ +(50 +) +$ +(14,295 +) +US State +1,558 +878 +168 +Foreign +12 +— +— +Total current provision (benefit) +1,477 +828 +(14,127 +) +Deferred +US Federal +767 +(5,455 +) +(14,206 +) +US State +131 +(360 +) +2,047 +Foreign +— +— +— +Total deferred provision (benefit) +898 +(5,815 +) +(12,159 +) +Total provision (benefit) for income taxes +$ +2,375 +$ +(4,987 +) +$ +(26,286 +) +The provision (benefit) for income taxes for the years ended December 31, 2018 , 2017 , and 2016 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Tax benefit at statutory rate +$ +(10,628 +) +$ +(25,434 +) +$ +(33,689 +) +Foreign rate differential +(56 +) +241 +367 +State income taxes, net of federal benefit +108 +70 +766 +Impact on deferred taxes from Combination +— +(2,025 +) +— +Effect of Tax Act +Effect of tax rate reduction on deferred tax +— +6,649 +— +Effect of tax rate reduction on deferred tax valuation +— +(9,668 +) +— +Nondeductible expenses +1,426 +1,559 +1,660 +Impact from goodwill impairment +1,030 +— +— +Loss of tax benefits due to carryback +— +— +998 +Valuation allowance (excluding impact of Tax Act) +10,137 +24,066 +2,804 +Adoption of ASU 2016-09 +— +— +141 +Other +358 +(445 +) +667 +$ +2,375 +$ +(4,987 +) +$ +(26,286 +) +F-30 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2018 and 2017 were as follows: +December 31, +2018 +2017 +(in thousands) +Deferred income tax assets: +Inventories +$ +626 +$ +500 +Goodwill and intangible assets +13,581 +8,837 +Deferred tax benefit from net losses +30,139 +31,112 +Stock-based compensation +4,635 +3,129 +Tax credit carryforwards +660 +677 +Accrued expenses +4,188 +1,390 +Other +168 +86 +Total deferred income tax assets +53,997 +45,731 +Less: Valuation allowance +(28,862 +) +(18,950 +) +Net deferred income tax assets +25,135 +26,781 +Deferred income tax liabilities: +Property and equipment +(31,050 +) +(31,798 +) +Prepaid expenses and other +— +— +Total deferred income tax liabilities +(31,050 +) +(31,798 +) +Net deferred income tax liability +$ +(5,915 +) +$ +(5,017 +) +As of December 31, 2018 , the Company had federal and state net operating losses of approximately $163.6 million . The federal net operating loss related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state net operating losses can be used from 10 to 20 years and vary by state. A small portion of state net operating losses will begin to expire in 2023. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its net operating loss carry forwards (“NOLs”) and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results and goodwill impairments recorded during 2018 , 2017 , and 2016, the Company continues to be in a three -year cumulative loss position for the year ending December 31, 2018 . According to FASB ASC 740, Income Taxes, cumulative losses in recent years represent significant negative evidence in considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its U.S. domestic and Canadian deferred tax assets. The Company has excluded the deferred tax liabilities related to certain indefinite-lived intangible assets when calculating the amount of valuation allowance needed as these liabilities cannot be considered as a source of income when determining the realizability of the net deferred tax assets. The 2018 results include an increase in the Company’s valuation allowance of approximately $10.0 million primarily due to the impairment recorded during 2018 in the Production Solutions segment. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a potential decrease to its effective tax rate. +The Company is subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2015. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +F-31 +The Company accounts for uncertain tax positions in accordance with guidance in FASB ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2018 +(in thousands) +Balance at January 1, 2018 +$ +568 +Additional based on tax positions related to prior years +— +Additional based on tax positions related to current year +— +Reduction based on tax positions related to prior years +— +Lapse of statute of limitations +— +Balance at December 31, 2018 +$ +568 +The total amount of unrecognized tax benefits at December 31, 2018 was $0.6 million . The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income and Comprehensive Income (Loss) . As of December 31, 2018 , no interest and penalties have been accrued. +13. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding during each period and the assumed exercise of potentially dilutive stock options and restricted stock. +Basic and diluted earnings (loss) per common share was computed as follows: +2018 +2017 +2016 +(in thousands, except for share and per share amounts) +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +(70,911 +) +Average shares outstanding +24,411,213 +14,887,006 +13,268,540 +Loss per share (basic and diluted) +$ +(2.17 +) +$ +(4.55 +) +$ +(5.34 +) +The diluted earnings per share calculation excludes all stock options and unvested restricted stock for 2018 , 2017 , and 2016 because there is a net loss for each period and their inclusion would be anti-dilutive. +14. Related Party Transactions +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, the Company issued promissory notes totaling $2.5 million to both a former executive officer of the Company and a current manager of the Company. The principal was due on June 30, 2019 (the “Maturity Date”), and interest of 4% per annum had been due and was payable on the Maturity Date. During the fourth quarter of 2018, the Company received full payment on the notes, resulting in no outstanding balance and no unpaid interest at December 31, 2018 . At December 31, 2017 , the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and unpaid interest totaled $0.4 million . +As part of the acquisition of Crest Pumping Technologies, LLC (“Crest”) in 2014, the Company issued promissory notes totaling $9.4 million to former owners of Crest, including David Crombie, who is an executive officer of the Company. The principal is due on June 30, 2019 . The interest rate is based on the prime rate, the federal funds rate, or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement and is due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At December 31, 2018 and 2017 , the outstanding principal balance of the notes of the remaining individuals totaled $7.6 million . Unpaid interest, included in “Prepaid expenses and other current assets” in the Company’s Consolidated Balance Sheets , totaled $10,000 and $8,000 at December 31, 2018 and 2017 , respectively. +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million , $0.8 million , and $0.7 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. There were no payables and payables of $13,000 +F-32 +at December 31, 2018 and 2017 , respectively. The Company also purchased $1.0 million of equipment during the year ended December 31, 2018 from an entity in which Mr. Crombie is a limited partner. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Lynn Frazier, a beneficial owner of more than 5% of the Company’s stock. Total rental expense associated with this office space was $0.2 million for the year ended December 31, 2018 . +At December 31, 2018 , the Company recorded a receivable of $1.8 million due from the sellers of Magnum primarily attributed to sales commissions paid to an intercompany entity that was not included in the Magnum Acquisition. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million , $0.7 million , and $0.4 million for services provided to this entity during the years ended December 31, 2018 , 2017 , and 2016 , respectively. There was an outstanding receivable due from such entity $0.1 million and $0.2 million as of December 31, 2018 and 2017 , respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas, a director of the Company, acted as the President of EOG Resources, Inc. in the years ended December 31, 2018 , 2017 , and 2016 . The Company generated revenue from EOG Resources, Inc. of $45.0 million , $34.4 million , and $13.7 million in the years ended December 31, 2018 , 2017 , and 2016 , respectively. +15. Segment Information +Beginning with the first quarter of 2017, the Company realigned its segments due to the acquisition of Beckman. This change is reflected on a retrospective basis in accordance with GAAP. The Company is reporting its results of operations in the following two segments: Completion Solutions and Production Solutions . +The Completion Solutions segment consists primarily of cementing, completion tools, wireline, and coiled tubing services, while the Production Solutions consists of rig-based well maintenance and workover services. +The Company’s reportable segments are strategic units that offer distinct products and services. They are managed separately since each business segment requires different marketing strategies. Operating segments have not been aggregated as part of a reportable segment. The Company evaluates the performance of its reportable segments based on adjusted gross profit. This segmentation is representative of the manner in which the Chief Operating Decision Maker (“CODM”) and its Board of Directors view the business. The Company considers the CODM to be its Chief Executive Officer. +F-33 +Summary financial data by segment is as follows. The amounts labeled “Corporate” relate to assets not allocated to the reportable segments. +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Revenues +Completion Solutions +$ +745,316 +$ +465,773 +$ +221,468 +Production Solutions +81,858 +77,887 +60,886 +$ +827,174 +$ +543,660 +282,354 +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Completion Solutions +$ +568,497 +$ +384,641 +$ +194,436 +Production Solutions +70,801 +63,826 +51,673 +$ +639,298 +$ +448,467 +246,109 +Adjusted gross profit +Completion Solutions +$ +176,819 +$ +81,132 +$ +27,032 +Production Solutions +11,057 +14,061 +9,213 +$ +187,876 +$ +95,193 +$ +36,245 +General and administrative expenses +75,993 +49,552 +39,387 +Depreciation +54,257 +53,422 +55,260 +Amortization of intangibles +9,558 +8,799 +9,083 +Impairment of property and equipment +45,694 +— +— +Impairment of goodwill +12,986 +31,530 +12,207 +Impairment of intangibles +19,065 +3,800 +— +Loss on equity method investment +347 +368 +— +(Gain) loss on sale of property and equipment +(1,731 +) +4,688 +3,320 +Loss from operations +$ +(28,293 +) +$ +(56,966 +) +$ +(83,012 +) +Other expense +Interest expense +22,315 +15,703 +14,185 +Total other expense +22,315 +15,703 +14,185 +Loss before income taxes +(50,608 +) +(72,669 +) +(97,197 +) +Provision (benefit) for income taxes +2,375 +(4,987 +) +(26,286 +) +Net loss +$ +(52,983 +) +$ +(67,682 +) +$ +(70,911 +) +Capital expenditures by segment for years ended December 31, 2018 , 2017 , and 2016 were as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Completion Solutions +$ +48,361 +$ +40,626 +$ +7,358 +Production Solutions +3,548 +4,590 +1,772 +Corporate +661 +— +— +$ +52,570 +$ +45,216 +$ +9,130 +F-34 +Total assets by segment as of December 31, 2018 and 2017 were as follows: +December 31, +2018 +2017 +(in thousands) +Completion Solutions +$ +1,045,643 +$ +428,702 +Production Solutions +35,086 +119,607 +Corporate +60,443 +30,550 +$ +1,141,172 +$ +578,859 +Revenue by country for the years ended December 31, 2018 , 2017 , and 2016 were as follows: +2018 +2017 +2016 +Amount +Percentage +Amount +Percentage +Amount +Percentage +(in thousands) +(in thousands) +(in thousands) +United States +$ +796,221 +96.3 +% +$ +521,914 +96.0 +% +$ +269,893 +95.6 +% +Canada and other +30,953 +3.7 +% +21,746 +4.0 +% +12,461 +4.4 +% +$ +827,174 +100.0 +% +$ +543,660 +100.0 +% +$ +282,354 +100.0 +% +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2018 and 2017 were as follows: +December 31, +2018 +2017 +(in thousands) +United States +$ +377,623 +$ +295,939 +Canada and other +7,472 +4,614 +$ +385,095 +$ +300,553 +16. Quarterly Financial Data (Unaudited) +Summarized quarterly financial data for the years ended December 31, 2018 and 2017 are presented below. +March 31, 2018 +June 30, +2018 +September 30, 2018 +December 31, 2018 +(in thousands, except per share amounts) +Revenue +$ +173,807 +$ +205,492 +$ +218,427 +$ +229,448 +Income (loss) from operations +4,698 +11,486 +16,356 +(60,833 +) +Income (loss) before income taxes +1,768 +9,671 +14,788 +(76,835 +) +Net income (loss) +1,675 +9,019 +13,658 +(77,335 +) +Earnings (loss) per common share +Basic (1) +$ +0.08 +$ +0.38 +$ +0.57 +$ +(2.78 +) +Diluted (1) +$ +0.08 +$ +0.37 +$ +0.56 +$ +(2.78 +) +March 31, 2017 +June 30, +2017 +September 30, 2017 +December 31, 2017 +(in thousands, except per share amounts) +Revenue +$ +105,353 +$ +135,860 +$ +148,167 +$ +154,280 +Loss from operations +(14,790 +) +(8,141 +) +(193 +) +(33,842 +) +Loss before income taxes +(18,548 +) +(12,070 +) +(4,286 +) +(37,765 +) +Net loss +(20,714 +) +(12,105 +) +(5,052 +) +(29,811 +) +Net loss per common share +Basic and diluted +$ +(1.50 +) +$ +(0.82 +) +$ +(0.34 +) +$ +(1.89 +) +F-35 +(1) As a result of the shares issued during the year, earnings per share for each of the year’s four quarters, which are based on weighted average shares outstanding during each quarter, may not equal the annual loss per share as reflected on the Company’s Consolidated Balance Sheets . +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2018 . Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of December 31, 2018 , due to the material weakness in internal control over financial reporting as described below. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +As of December 31, 2018 , our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was not effective as of December 31, 2018 , due to the material weakness in internal control over financial reporting as described below. +As previously reported in our Annual Report on Form 10-K for the year ended December 31, 2017 , we did not design and maintain adequate controls to address the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. Certain accounting personnel had the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy, and completeness. Immaterial misstatements were identified in 2017 related to the inadequate segregation of accounting duties. This material weakness could result in misstatement of the aforementioned accounts and disclosures that would result in a material misstatement in our annual or interim consolidated financial statements that would not be prevented or detected on a timely basis. +Remediation Efforts to Address the Material Weakness +In response to the material weakness identified above, our management, with oversight from our Audit Committee, continues to implement the remediation steps listed in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2017 . More specifically, our management has performed, or is in the process of performing, the following: +• +Replaced the less sophisticated accounting systems used by the majority of our newly acquired subsidiaries with the enterprise resource planning system used by the majority of our existing subsidiaries. +F-36 +• +Developing and implementing controls and procedures to ensure the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. +We are committed to continuous improvement of our internal control processes and to continuous review of our financial reporting controls and procedures; however, until the remediation steps set forth above are fully implemented and concluded to be operating effectively, the material weakness described above will continue to exist. In addition, as we continue to evaluate and work to improve our internal control over financial reporting, we may identify additional measures to address the material weakness identified above or determine to modify certain of the remediation steps described above. Our management, with oversight from our Audit Committee, will continue to take steps to remediate the material weakness identified above as expeditiously as possible and enhance the overall design and capability of our control environment. +Remediation of Previously Reported Material Weakness in Internal Control over Financial Reporting +We also previously reported in our Annual Report on Form 10-K for the year ended December 31, 2017, a material weakness in our internal control over financial reporting related to the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. As of December 31, 2018, we have remediated the previously reported material weakness by performing the following: +• +Reevaluated the roles and responsibilities within our tax function to ensure our tax department has an appropriate level of tax and accounting knowledge, experience, and training to meet our tax and financial reporting requirements. This process culminated in the hiring of an experienced tax professional as our tax director. +• +Implemented additional controls and enhanced existing controls to ensure the completeness and accuracy of the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. +We have completed the documentation, implementation, and testing of the corrective actions described above and, as of December 31, 2018, have concluded that the steps taken have remediated the material weakness related to the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There were no changes in internal control over financial reporting that occurred during the quarterly period ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. +Other Information +None. +F-37 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. +Item 11. +Executive Compensation +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. +Item 13. +Certain Relationships and Related Transactions, and Director Independence +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. +Item 14. +Principal Accounting Fees and Services +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. +F-38 +PART IV +Item 15. Exhibits, Financial Statement Schedules +(a) Documents Filed With This Report +1. Financial Statement +The following consolidated financial statements of the Company are filed as a part of this report: +Reports of Independent Registered Public Accounting Firms +F-1 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017, and 2016 +F-3 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2018, 2017, and 2016 +F-4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016 +F-5 +Notes to Consolidated Financial Statements +F-6 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number +Description +2.1† +Combination Agreement, dated as of February 3, 2017, by and among Nine Energy Service, Inc., Beckman Production Services, Inc. and Beckman Merger Sub, Inc. (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +2.2† +Securities Purchase Agreement, dated as of October 15, 2018, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, Frazier Family Foundation, Inc., as sellers, Warren Lynn Frazier, solely in his capacity as seller representative, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, Nine Energy Service, Inc. and certain other parties named therein (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 15, 2018). +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +4.4 +Indenture, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee (including Form of Note) (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +F-39 +4.5* +Supplemental Indenture and Guarantee, dated as of November 23, 2018, by and among MOTI Holdco, LLC, Magnum Oil Tools GP, LLC, and Magnum Oil Tools International, LTD, Nine Energy Service, Inc. and certain other subsidiaries and Wells Fargo Bank, National Association, as a trustee. +4.6 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +10.1 +Credit Agreement, dated as of September 14, 2017, among Nine Energy Service, Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Amendment No. 4 to Registration Statement on Form S-1 filed on November 14, 2017). +10.2 +First Amendment to Credit Agreement, dated as of November 20, 2017, among Nine Energy Service, Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.22 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +10.3 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +10.4+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.5+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.6+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.7+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.8+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.9+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.10+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.11+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 26, 2018). +10.12+ +Employment Agreement between Edward Bruce Morgan and Nine Energy Service, LLC, dated as of April 6, 2017 (Incorporated by reference to Exhibit 10.18 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.13+ +Amended and Restated Employment Agreement between Edward Bruce Morgan and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 26, 2018). +10.14+ +Employment Agreement between Theodore R. Moore, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of March 12, 2017 (Incorporated by reference to Exhibit 10.19 of Nine Energy Service, Inc.’s Amendment No. 1 to Registration Statement on Form S-1 filed on May 19, 2017). +10.15+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 26, 2018). +F-40 +10.16+ +Employment Agreement between Clinton Roeder, Nine Energy Service, Inc. and Nine Energy Service, LLC, dated as of November 20, 2017 (Incorporated by reference to Exhibit 10.21 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +10.17+ +First Amendment to Employment Agreement between Clinton Roeder and Nine Energy Service, LLC, dated as of December 21, 2017 (Incorporated by reference to Exhibit 10.23 of Nine Energy Service, Inc.’s Amendment No. 5 to Registration Statement on Form S-1 filed on December 21, 2017). +10.18+ +Amended and Restated Employment Agreement between Clinton Roeder and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 26, 2018). +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +101* +Interactive Data Files. +_______________________________________ +* +Filed herewith. +** +Furnished herewith. +† +The schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K and will be provided to the Securities and Exchange Commission upon request. ++ +Management contract or compensatory plan or arrangement. +F-41 +Item 16. +Form 10-K Summary. +None. +F-42 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: +/s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 7, 2019 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 7, 2019 . +Signature +Title +/s/ Ann G. Fox +President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Clinton Roeder +Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Clinton Roeder +/s/ S. Brett Luz +Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Ernie L. Danner +Chairman of the Board +Ernie L. Danner +/s/ David C. Baldwin +Director +David C. Baldwin +/s/ Mark E. Baldwin +Director +Mark E. Baldwin +/s/ Curtis F. Harrell +Director +Curtis F. Harrell +/s/ Gary L. Thomas +Director +Gary L. Thomas +/s/ Scott E. Schwinger +Director +Scott E. Schwinger +/s/ Andrew L. Waite +Director +Andrew L. Waite +/s/ Darryl K. Willis +Director +Darryl K. Willis +F-43 \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/filing_metadata.csv b/raw/filings/0001532286/2018/0001532286-19-000004/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..db30162b3f3b01fae00220f5422319976059cfbd --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2019-03-07,2018-12-31,2019-03-07T22:00:39.000Z,0001532286-19-000004,nine-20181231x10k.htm,10-K,11255109,1,0,https://www.sec.gov/Archives/edgar/data/1532286/000153228619000004/nine-20181231x10k.htm,https://www.sec.gov/Archives/edgar/data/1532286/000153228619000004/,2018,2018,1 diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/item1.txt b/raw/filings/0001532286/2018/0001532286-19-000004/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..260c3fa4930a5ce83d6c89ae7dfaa309cd100c2c --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/item1.txt @@ -0,0 +1,100 @@ +Item 1. +Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion and production services provider that targets unconventional oil and gas resource development across all North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators despite their associated increased well cost. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and drilling out plugs and performing associated remedial work as production comes online. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. We provide customers with plug-and-perf or pinpoint frac sleeve system technology to complete the remaining stages of the well. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our pinpoint frac sleeve system involves packers, either hydraulic or swellable, to isolate sections of the wellbore and frac sleeves to provide access to each stage for stimulation and production. Our equipment also includes large-diameter coiled tubing units and workover rigs that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. Once a well is producing, we are able to offer a range of production enhancement and well workover services through our fleet of well service rigs and ancillary equipment. +In October 2018, we acquired Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (collectively, “Magnum” and such acquisition, the “Magnum Acquisition”). Magnum, which is included in our Completion Solutions segment, is a leading oilfield completion tools company that is focused on the development of innovative tools for unconventional oil and gas resource development. Magnum has a broad offering of proprietary downhole completions consumables products, including a comprehensive line of dissolvable and composite frac plugs; disk subs, including intervention-less designs, for wellbore isolation and casing flotation device applications; and dissolvable frac balls. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to +1 +investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Business Segments +We operate in two segments: Completion Solutions and Production Solutions . Our Completion Solutions segment provides services integral to the completion of unconventional wells through a full range of tools and methodologies. Our Production Solutions segment provides a range of production enhancement and well workover services that are performed with a well servicing rig and ancillary equipment. +Completion Solutions +The following is a description of the primary service offerings and deployment methods within the Completion Solutions business segment: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently have three high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment, and since 2012, we have deployed only new equipment for use in the fields. As of December 31, 2018 , we operated a total of 31 twin-pumping units. +From January 2014 through December 2018, we completed approximately 15,200 cementing jobs, with an on-time rate of approximately 89% . Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, fully-composite and dissolvable frac plugs, casing flotation tools, specialty open hole float equipment, disk subs, and centralizers. Our completion tools provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug and perf operations. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. From March 2011 through December 2018 , we deployed approximately 112,200 isolation, stage one, and casing flotation tools and approximately 22,400 frac sleeves. +Wireline Services: Our wireline services involve the use of a wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations, with 41 wireline units in the U.S. and 14 wireline units in Canada. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We currently have wireline units equipped with customized drums to hold up to 40,000 feet of Enviroline, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Enviroline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary +2 +specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2014 through December 2018 , we completed approximately 109,200 wireline stages with a success rate of approximately 99% . +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift installation, cementing, stimulation, and restimulation services. +We currently operate 16 coiled tubing units serving the Permian Basin, SCOOP/STACK region, and Haynesville markets. Each of our coiled tubing units carries data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Of the 16 coiled tubing units, we consider 12 to be “extended reach” units capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8’’ and 2 5/8’’) applications, we also offer 2’’ and 1 1/4’’ diameter solutions to our customers. From April 2014 through December 2018, we have performed approximately 7,500 jobs and deployed more than 157 million running feet of coiled tubing, with a success rate of over 99% . +Production Solutions +Our well servicing business encompasses a full range of services performed with a mobile well servicing rig (or workover rig) and ancillary equipment throughout a well’s life cycle from completion to plugging and abandonment. Our rigs and personnel install and remove downhole equipment and eliminate obstructions in the well to facilitate the flow of oil and natural gas, often immediately increasing a well’s production. We believe the production increases generated by our well services substantially enhance our customers’ returns and significantly reduce their payback periods. Activities performed with our well servicing rigs can range from the milling of plugs following a plug-and-perf completion, to the installation and repair of artificial lift, to the ultimate plug and abandonment of a depleted well. Key components of our well services success include our geographic footprint, employee culture, fleet of rigs, and inventory of equipment. Our operations extend across the U.S. basins, and our employee culture fosters local relationships within this expansive geographic footprint through excellent customer service and basin-level expertise. +We utilize a fleet of 107 rigs, approximately 40% of which are capable of performing completion-oriented work. This fleet of rigs and the inventory of equipment maintained at each of our regional locations are tailored to the needs of our customers in each particular basin. The high-specification rigs we utilize are engineered to perform in the most demanding laterals being drilled in the U.S. today. In addition, we also own and operate auxiliary equipment necessary to support the activities of our rigs, swabbing units, hot oilers, high pressure pump trucks, cementers, vacuum trucks, and transport tankers in the basins in which we operate. These complementary services facilitate the production enhancement of existing wells or are called upon to plug and abandon a well at the end of its life. From January 2014 through December 2018, we operated more than 1,000,000 rig hours. According to the Association of Energy Service Companies, only 46% of industry reported well service rigs were active or available from January 2014 through December 2018. In contrast, 66% of our rigs have remained utilized in the same period. +Geographic Areas of Operation +We operate in all major onshore basins in both the U.S. and Canada, including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, Haynesville Formation, and Western Canada Sedimentary Basin. We provide our services through strategically placed operating facilities located in-basin throughout North America. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion and production trends and technology across all divisions and geography. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +3 +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. Additionally, our operations are directly affected by weather conditions. During the winter months (first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Lastly, throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +Weather conditions also affect the demand for, and prices of, oil and natural gas and, as a result, demand for our services. Demand for oil and natural gas is typically higher in the fourth and first quarters, resulting in higher prices in these quarters. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2018 , our top five customers collectively accounted for approximately 24% of our revenues. For the year ended December 31, 2018 , no single customer accounted for 10% or more of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the United States, Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors for our completion solutions include Halliburton Company, Schlumberger Limited, Baker Hughes, a GE company, Oil States International, C&J Energy Services, Inc., and a significant number of locally-oriented businesses. Our major competitors for our production solutions include Pioneer Energy Services Corp., Key Energy Services, Inc., Basic Energy Services, Inc., Superior Energy Services, Inc., and a significant number of locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines acquired in the Magnum Acquisition depend on a limited number of third-party suppliers and vendors. +4 +During the year ended December 31, 2018 , one supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality, execution at the wellsite, and scale. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. With the acquisition of Magnum, our internal research and development capabilities have increased substantially. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +5 +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2018 , we had 2,261 employees (all of which were full time). We are not a party to any collective bargaining agreements. +Government Regulations and Environmental, Health, and Safety Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address the EPA’s +6 +alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain E&P related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations is not necessary. If the EPA proposes rulemaking for revised oil and gas regulations, the consent decree requires that the EPA take final action following notice and comment rulemaking no later than July 15, 2021. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of its customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several, strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”), establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. In June 2016, OSHA finalized a new regulation regarding crystalline silica exposures, which included requirements that hydraulic fracturing operations implement dust controls to limit exposures to the substance by June 23, 2021. Additionally, the Federal Motor Carrier Safety Administration regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives, and the federal Nuclear Regulatory Commission establishes requirements for the protection against ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +Due to operating a fleet in excess of 1,100 commercial motor vehicles, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, a new EPA and U.S. Army Corps of Engineers (the “Corps”) rule defining the scope of federal jurisdiction over wetlands and other waters became effective (the “Clean Water Rule”). The Clean Water Rule was previously stayed nationwide to determine whether federal district or appellate courts had jurisdiction to hear cases challenging the rule. The EPA and the Corps issued a proposed rulemaking in June 2017 to repeal the Clean Water Rule and announced their intent to issue a new rule defining the Clean Water Act’s jurisdiction. Recently, in January 2018, the U.S. Supreme Court issued a decision finding that jurisdiction resides with the federal district courts to hear challenges to the Clean Water Rule; following which, the previously-filed district court +7 +cases have been allowed to proceed. Following the Supreme Court’s decision, the EPA and the Corps issued a final rule in January 2018 staying implementation of the 2015 rule for two years while the agencies reconsider the rule. Multiple states and environmental groups have challenged the stay, and in August 2018, a federal court in South Carolina issued an injunction against the EPA ’ s stay of the rule. In December 2018, the EPA and the Corps proposed a new rule defining the scope of federal jurisdiction over wetlands and other waters that would replace the Clean Water Rule. Future implementation of the proposed rule or the Clean Water Rule is uncertain at this time. To the extent either expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. These regulations change frequently. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air permit requirements, or utilize specific equipment or technologies to control emissions of certain pollutants. For example, in May 2016, the EPA finalized rules regarding criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, thereby triggering more stringent air permitting requirements. In addition, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”) for ozone from 75 to 70 parts per billion. In November 2017, the EPA published a list of areas that are in compliance with the new ozone standard and, separately in December 2017, issued responses to state recommendations for designating non-attainment areas. The EPA completed all initial area designations in July 2018. State implementation of the revised NAAQS could result in stricter permitting requirements, which in turn could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +The EPA has determined that emissions of greenhouse gases, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established greenhouse gas emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of greenhouse gases to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to greenhouse gas emissions permitting and best available control technology requirements because none of our facilities are presently major sources of greenhouse gas emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition, and results of operations. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and many states have already established regional greenhouse gas “cap-and-trade” programs. The adoption of any legislation or regulation that restricts emissions of greenhouse gases from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +8 +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, the EPA has taken several steps to delay implementation of its methane standards, including most recently in September 2018, when the EPA announced a proposed rule that rolls back parts of the 2016 performance standards. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. In addition, in April 2018, a coalition of states filed a lawsuit in the U.S. District Court for the District of Columbia aiming to force the EPA to establish guidelines for limiting methane emissions from existing sources in the oil and natural gas sector; that lawsuit is pending. The U.S. Bureau of Land Management (the “BLM”) previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. This repeal is the subject of legal challenges. As a result, future implementation of both the EPA and BLM methane rules is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remain a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. These rules were finalized in June 2016 and, for certain facilities, compliance is required by August 29, 2019. The EPA is currently conducting a study on effluent guidelines for the oil and gas industry and held a public hearing on this study in October 2018. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York and Vermont have banned or are in the process of banning the use of high-volume hydraulic fracturing. Alternatively, some municipalities are or have considered zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity +9 +that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Where the business and operations of our customers are carried out on federal lands, those business and operations may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an Environmental Assessment that assesses the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act +The Endangered Species Act was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act. The U.S. Fish and Wildlife Service must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. If our customers were to have areas within their business and operations designated as critical or suitable habitat or a protected species, it could decrease demand for our services and have a material adverse effect on our business. \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/item13.txt b/raw/filings/0001532286/2018/0001532286-19-000004/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..b30c95be18927e1f4e04e25086aba0e0a37550ac --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/item13.txt @@ -0,0 +1,3 @@ +Item 13. +Certain Relationships and Related Transactions, and Director Independence +The information required in response to this item will be set forth in our definitive proxy statement for the 2019 annual meeting of stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/item9a.txt b/raw/filings/0001532286/2018/0001532286-19-000004/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..d41849f4b1f41363524320b38b4ef938c31e330d --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/item9a.txt @@ -0,0 +1,28 @@ +Item 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2018 . Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of December 31, 2018 , due to the material weakness in internal control over financial reporting as described below. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +As of December 31, 2018 , our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was not effective as of December 31, 2018 , due to the material weakness in internal control over financial reporting as described below. +As previously reported in our Annual Report on Form 10-K for the year ended December 31, 2017 , we did not design and maintain adequate controls to address the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. Certain accounting personnel had the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy, and completeness. Immaterial misstatements were identified in 2017 related to the inadequate segregation of accounting duties. This material weakness could result in misstatement of the aforementioned accounts and disclosures that would result in a material misstatement in our annual or interim consolidated financial statements that would not be prevented or detected on a timely basis. +Remediation Efforts to Address the Material Weakness +In response to the material weakness identified above, our management, with oversight from our Audit Committee, continues to implement the remediation steps listed in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2017 . More specifically, our management has performed, or is in the process of performing, the following: +• +Replaced the less sophisticated accounting systems used by the majority of our newly acquired subsidiaries with the enterprise resource planning system used by the majority of our existing subsidiaries. +F-36 +• +Developing and implementing controls and procedures to ensure the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. +We are committed to continuous improvement of our internal control processes and to continuous review of our financial reporting controls and procedures; however, until the remediation steps set forth above are fully implemented and concluded to be operating effectively, the material weakness described above will continue to exist. In addition, as we continue to evaluate and work to improve our internal control over financial reporting, we may identify additional measures to address the material weakness identified above or determine to modify certain of the remediation steps described above. Our management, with oversight from our Audit Committee, will continue to take steps to remediate the material weakness identified above as expeditiously as possible and enhance the overall design and capability of our control environment. +Remediation of Previously Reported Material Weakness in Internal Control over Financial Reporting +We also previously reported in our Annual Report on Form 10-K for the year ended December 31, 2017, a material weakness in our internal control over financial reporting related to the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. As of December 31, 2018, we have remediated the previously reported material weakness by performing the following: +• +Reevaluated the roles and responsibilities within our tax function to ensure our tax department has an appropriate level of tax and accounting knowledge, experience, and training to meet our tax and financial reporting requirements. This process culminated in the hiring of an experienced tax professional as our tax director. +• +Implemented additional controls and enhanced existing controls to ensure the completeness and accuracy of the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. +We have completed the documentation, implementation, and testing of the corrective actions described above and, as of December 31, 2018, have concluded that the steps taken have remediated the material weakness related to the reporting of our income tax provision (benefit) and the related balance sheet accounts and other comprehensive income. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There were no changes in internal control over financial reporting that occurred during the quarterly period ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/rp_note.txt b/raw/filings/0001532286/2018/0001532286-19-000004/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..cb13c44f170119f9e767969f5bcc94178eb6ab87 --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/rp_note.txt @@ -0,0 +1,10 @@ +14. Related Party Transactions +During 2014, in conjunction with an exercise of warrants to provide a capital infusion, the Company issued promissory notes totaling $2.5 million to both a former executive officer of the Company and a current manager of the Company. The principal was due on June 30, 2019 (the “Maturity Date”), and interest of 4% per annum had been due and was payable on the Maturity Date. During the fourth quarter of 2018, the Company received full payment on the notes, resulting in no outstanding balance and no unpaid interest at December 31, 2018 . At December 31, 2017 , the outstanding balance of the notes, including principal and unpaid interest, totaled $2.9 million and unpaid interest totaled $0.4 million . +As part of the acquisition of Crest Pumping Technologies, LLC (“Crest”) in 2014, the Company issued promissory notes totaling $9.4 million to former owners of Crest, including David Crombie, who is an executive officer of the Company. The principal is due on June 30, 2019 . The interest rate is based on the prime rate, the federal funds rate, or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement and is due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At December 31, 2018 and 2017 , the outstanding principal balance of the notes of the remaining individuals totaled $7.6 million . Unpaid interest, included in “Prepaid expenses and other current assets” in the Company’s Consolidated Balance Sheets , totaled $10,000 and $8,000 at December 31, 2018 and 2017 , respectively. +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by Mr. Crombie. Total lease expense and building maintenance expense was $0.8 million , $0.8 million , and $0.7 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. There were no payables and payables of $13,000 +F-32 +at December 31, 2018 and 2017 , respectively. The Company also purchased $1.0 million of equipment during the year ended December 31, 2018 from an entity in which Mr. Crombie is a limited partner. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Lynn Frazier, a beneficial owner of more than 5% of the Company’s stock. Total rental expense associated with this office space was $0.2 million for the year ended December 31, 2018 . +At December 31, 2018 , the Company recorded a receivable of $1.8 million due from the sellers of Magnum primarily attributed to sales commissions paid to an intercompany entity that was not included in the Magnum Acquisition. +The Company provides services to Citation Oil & Gas Corp., an entity owned by Curtis F. Harrell, a director of the Company. The Company billed $0.7 million , $0.7 million , and $0.4 million for services provided to this entity during the years ended December 31, 2018 , 2017 , and 2016 , respectively. There was an outstanding receivable due from such entity $0.1 million and $0.2 million as of December 31, 2018 and 2017 , respectively. +The Company provides services in the ordinary course of business to EOG Resources, Inc. Gary L. Thomas, a director of the Company, acted as the President of EOG Resources, Inc. in the years ended December 31, 2018 , 2017 , and 2016 . The Company generated revenue from EOG Resources, Inc. of $45.0 million , $34.4 million , and $13.7 million in the years ended December 31, 2018 , 2017 , and 2016 , respectively. \ No newline at end of file diff --git a/raw/filings/0001532286/2018/0001532286-19-000004/rpt_disclosure.txt b/raw/filings/0001532286/2018/0001532286-19-000004/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..cdc4668ebbe6fbee4ac451a06d95ae36d1d81c67 --- /dev/null +++ b/raw/filings/0001532286/2018/0001532286-19-000004/rpt_disclosure.txt @@ -0,0 +1,48 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Our Board adopted a written related person transactions policy prior to the completion of our IPO, under which a “Related Person +Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or +disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or +disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to +an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Person Transactions required to be disclosed in +our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +During 2014, in conjunction with an +exercise of warrants to provide a capital infusion, the Company issued promissory notes totaling $2.5 million to both a former executive officer of the Company and a current manager of the Company. The principal was due on June 30, 2019 +(the “Maturity Date”), and interest of 4% per annum had been due and was payable on the Maturity Date. During the fourth quarter of 2018, the Company received full payment on the notes, resulting in no outstanding balance and no unpaid +interest at December 31, 2018. +As part of the acquisition of Crest Pumping Technologies, LLC (“Crest”) in 2014, the +Company issued promissory notes totaling $9.4 million to former owners of Crest, including David Crombie, who is an executive officer of the Company. The principal was due on June 30, 2019. The interest rate was based on the prime rate, +the federal funds rate, or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement and was due quarterly. Mr. Crombie paid $1.8 million during 2016 to pay his promissory note in full. At +December 31, 2018, the outstanding principal balance of the notes of the remaining individuals totaled $7.6 million and unpaid interest, included in “Prepaid expenses and other current assets” in the Company’s Consolidated +Balance Sheets, totaled $10,000. During the second quarter of 2019, the Company received the full principal balance of the notes outstanding as well as any unpaid interest. +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by +Mr. Crombie. Total lease expense and building maintenance expense associated with these entities was $0.8 million, $0.8 million, and $0.8 million for the years ended December 31, 2019, 2018, and 2017, respectively. The +Company also purchased of equipment of $1.4 million and $1.0 million for the years ended December 31, 2019 and 2018, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to +this entity relating to equipment purchases of $0.1 million at the year ended December 31, 2019. +In addition, the Company +leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Lynn Frazier, a beneficial owner of more than 5% of the Company’s stock. Total rental expense associated with this office space was $1.5 million and +$0.2 million for the years ended December 31, 2019 and 2018, respectively. +At December 31, 2018, the Company had an open +receivable due from the sellers of Magnum primarily attributed to sales commissions paid to an intercompany entity that was not included in the Magnum Acquisition. The Company received payment in full in the first quarter of 2019. +The Company provides services to Citation Oil & Gas Corp. (“Citation”), an entity owned by a director of the Company. The +Company billed $0.4 million, $0.7 million, and $0.7 million for services provided to Citation during the years ended December 31, 2019, 2018, and 2017, respectively. There was an outstanding receivable due from Citation of +$0.1 million as of December 31, 2018. +37 +Table of Contents +The Company provides services to EOG Resources, Inc. (“EOG”). Gary L. Thomas, a +director of the Company, acted as the President of EOG until his retirement on December 31, 2018. The Company generated revenue from EOG of $45.0 million and $34.4 million during the years ended December 31, 2018 and 2017, +respectively. There was an outstanding receivable due from EOG of $7.0 million at December 31, 2018. +The Company purchases +cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Two of the Company’s directors also serve as directors of Forum. The Company was billed $1.9 million, $1.7 million, and +$1.2 million for cable during the years ended December 31, 2019, 2018, and 2017, respectively. There was an outstanding payable due to the entity of $0.3 million and $0.1 million at December 31, 2019 and 2018, respectively. +The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed $8.0 million, $8.1 million, and $5.0 million for coiled tubing string during the years ended December 31, 2019, 2018, and 2017, +respectively. There was an outstanding payable due to the entity of $0.9 million on December 31, 2019. +The Company purchases +chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also serves as a director of Select. The Company was billed $2.1 million, $2.0 million, and $1.8 million +for chemicals during the years ended December 31, 2019, 2018, and 2017, respectively. There was an outstanding payable due to Select of $0.1 million at December 31, 2019. +During the fourth quarter of 2019, the Company sold coiled tubing equipment for $5.9 million to National Energy Services Reunited +(“NESR”). One of the Company’s directors also serves as a director of NESR. In 2019, the Company provided $0.9 million of products and rentals to NESR. At December 31, 2019, there was a receivable of $6.8 million for +the coiled tubing equipment and the products and services. +On June 5, 2019, Ann G. Fox, President and Chief Executive Officer and a +director of the Company, was elected as a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $18.4 million for the year ended December 31, 2019. 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PERIOD FROM TO +Commission File Number: 001-38347 +_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware 80-0759121 +(State or other jurisdiction of +incorporation or organization) (I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston , TX 77019 +(Address of principal executive offices) +( 281 ) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, par value $0.01 per share NINE New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer o +Non-accelerated filer ☒ Smaller reporting company ☒ +Emerging growth company ☒ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 30, 2020) was $ 31,916,670 . +The number of shares of the registrant’s common stock outstanding at March 4, 2021 was 31,555,321 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant’s Definitive Proxy Statement for its 2021 Annual Meeting of Stockholders. +TABLE OF CONTENTS +PART I +Item 1. +Business +3 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +34 +Item 2. +Properties +34 +Item 3. +Legal Proceedings +34 +Item 4. +Mine Safety Disclosures +35 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities +36 +Item 6. +Selected Financial Data +36 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +37 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +55 +Item 8. +Financial Statements and Supplementary Data +56 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +57 +Item 9A. +Controls and Procedures +57 +Item 9B. +Other Information +57 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +58 +Item 11. +Executive Compensation +58 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +58 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +58 +Item 14. +Principal Accounting Fees and Services +58 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +59 +Item 16. +Form 10-K Summary +62 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +SUMMARY OF PRINCIPAL RISK FACTORS +Our business is subject to a number of risks and uncertainties. The following is a summary of the principal risk factors that could materially adversely affect our business, financial condition and results of operations. A more complete statement of those risks and uncertainties is set forth in “Risk Factors” in Item 1A of Part I of this Annual Report. +• Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile and strongly influenced by current and expected oil and natural gas prices. If the prices of oil and natural gas continue to decline or remain depressed for a lengthy period, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +• The recent coronavirus pandemic and related economic repercussions have had, and are expected to continue to have, a significant adverse impact on our business, and depending on the duration of the pandemic and its effect on the oil and gas industry, could have a material adverse effect on our business, liquidity, results of operations, and financial condition. +• Our substantial debt obligations could have significant adverse consequences on our business and future prospects, and restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +• We may be unable to maintain existing prices or implement price increases on our products and services, and intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +• Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +• Our operations are subject to conditions inherent in the oilfield services industry, such as equipment defects, liabilities arising from accidents or damage involving our fleet of trucks or other equipment, explosions and uncontrollable flows of gas or well fluids, and loss of well control. +• If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially in loss of market share and damaged customer relationships. +• We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +• We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +• We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +• Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +• Our success may be affected by our ability to implement new technologies and services. +• Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +• Our future financial condition and results of operations could be adversely impacted by asset impairment charges. +• Increased attention to climate change and conservation measures may reduce oil and natural gas demand, and we face various risks associated with increased activism against oil and natural gas exploration and development activities. +• Seasonal and adverse weather conditions adversely affect demand for our products and services. +2 +PART I +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across all North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators despite their associated increased well cost. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline truck and reel, as well as our composite or dissolvable frac plugs. We also offer a pinpoint frac sleeve system technology to complete the remaining stages of the well. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and +3 +liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment, and since 2012, we have deployed only new equipment for use in the fields. As of December 31, 2020, we had a total of 40 pumping units. +From January 2014 through December 2020, we completed approximately 22,000 cementing jobs, with an on-time rate of approximately 91%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 91% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2014 through December 2020, we deployed approximately 241,200 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. We currently operate 47 wireline pumpdown units in the United States (the “U.S.”). Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line Wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2014 through December 2020, we completed approximately 171,000 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +We currently operate 14 coiled tubing units serving the Permian Basin and Haynesville markets. Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Of the 14 coiled tubing units, we consider 12 to be “extended reach” units capable of reaching the toe of wells with total measured +4 +depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” diameter solutions to our customers. From April 2014 through December 2020, we have performed approximately 9,800 jobs and deployed more than 218 million running feet of coiled tubing, with a success rate of over 99%. +Well Services: On August 30, 2019, we sold our Production Solutions segment. For additional information on this divestiture, see Note 16 – Segment Information included in Item 8 of Part II of this Annual Report. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rockies, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2020, our top five customers collectively accounted for approximately 37% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, +5 +including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, NexTier Oilfield Solutions, KLX Energy Services Holdings, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2020, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our +6 +customers’ operations. +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2020, we had 735 employees, of which 733 were full-time. We are not a party to any collective bargaining agreements. +Coronavirus Pandemic +The worldwide coronavirus outbreak in early 2020, which was declared a pandemic by the World Health Organization in March 2020, the uncertainty regarding its impact, and various governmental actions taken to mitigate its impact have resulted in an unprecedented decline in demand for oil. In the midst of the ongoing pandemic, the Organization of the Petroleum Exporting Countries (“OPEC”) and other oil producing nations, including Russia (collectively, “OPEC+”), were initially unable to reach an agreement on production levels for crude oil, at which point Saudi Arabia and Russia initiated efforts to aggressively increase production. The convergence of these events created the unprecedented dual impact of a massive decline in the demand for oil coupled with the risk of a substantial increase in supply. While OPEC+ agreed in April 2020 to cut production, downward pressure on commodity prices has remained and could continue for the foreseeable future. +In response to lower oil prices, our customers have generally revised their capital budgets downward and adjusted their operations accordingly, which has caused a significant decline in demand for our products and services. +While we cannot predict the length of time that market disruptions resulting from the coronavirus pandemic and efforts to mitigate its effects will continue, the ultimate impact on our business, or the pace or extent of any subsequent recovery, we +7 +expect the coronavirus pandemic and related effects to continue to have a material adverse impact on commodity prices and our business generally. We have experienced inefficiencies and logistical challenges surrounding stay-at-home orders and remote work arrangements, travel restrictions, and an inability to commute to certain facilities and job sites, as we provide services and products to our customers. For more information, see “Risk Factors – Risks Related to the Coronavirus Pandemic” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Impact of the Coronavirus Pandemic; Industry Trends and Outlook” in Item 7 of Part II of this Annual Report. +During the pandemic, we have maintained our commitment to the safety of our employees, customers, vendors, and community at large, and we have taken, and are continuing to take, a proactive approach to navigating the pandemic. To mitigate exposure and risk, we have implemented processes and procedures across our entire organization based on federal, regional, and local guidelines and mandates, and our Health, Safety & Environment and management teams are in frequent communication with our entire employee base to ensure they are receiving updated guidelines, processes, and procedures. In response to the pandemic, we have implemented the following changes, for example: at the field level, we are working closely with our customers and vendors to update standard operating procedures, based on social distancing, hand washing, and other recommended best practices set forth by the Centers for Disease Control and Prevention; electronic assessments have been employed to check the health of employees prior to reporting to work, to ensure facilities are being properly cleaned and sanitized, and to check visitor health before arrival to a Nine location; internal case managers have been identified to handle all coronavirus-related cases, and all confirmed and potential cases are tracked through closure; many of our corporate and office employees are working virtually to avoid unnecessary risk and exposure; and we have significantly limited any work-related travel. We are actively monitoring updates from regulatory and government bodies and evolving our strategy accordingly in an effort to keep our workforce and communities healthy. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. For example, in December 2016, the EPA and environmental groups entered into a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting certain E&P related oil and gas wastes from regulation as hazardous wastes under RCRA. The consent decree required the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations pertaining to oil and gas wastes or to sign a determination that revision of the regulations was not necessary. On April 23, 2019, the EPA determined that a revision of the regulations was not necessary. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our +8 +operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”), establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. In June 2016, OSHA finalized a regulation regarding crystalline silica exposures, which included requirements that hydraulic fracturing operations implement dust controls to limit exposures to the substance by June 23, 2021. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives, and the federal Nuclear Regulatory Commission establishes requirements for the protection against ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2020, we operated a fleet in excess of 550 commercial motor vehicles. As such, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the U.S. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, the EPA and U.S. Army Corps of Engineers (the “Corps”) issued a rule defining the scope of federal jurisdiction over wetlands and other waters; however, this rule was repealed on October 22, 2019. On January 23, 2020, the EPA and the Corps issued the Navigable Waters Protection Rule re-defining the term “waters of the United States” as applied under the Clean Water Act and narrowing the scope of waters subject to federal regulation, and the final rule became effective on June 22, 2020. This Navigable Waters Protection Rule is subject to various pending legal challenges, and a federal district court in Colorado stayed implementation of the rule. The stay is limited to application of the rule in Colorado; the rule has taken effect in all other states. At President Biden’s direction, the EPA and the Corps requested the litigation be stayed while the agencies review the rule. To the extent a future rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar +9 +structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +The federal Clean Air Act (the “CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. These regulations change frequently. These laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air permit requirements, or utilize specific equipment or technologies to control emissions of certain pollutants. In addition, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”) for ozone from 75 to 70 parts per billion. In November 2017, the EPA published a list of areas that are in compliance with the new ozone standard and, separately in December 2017, issued responses to state recommendations for designating non-attainment areas. The EPA completed all initial area designations in July 2018. State implementation of the revised NAAQS could result in stricter permitting requirements, which in turn could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +The EPA has determined that emissions of greenhouse gases, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established greenhouse gas emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of greenhouse gases to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to greenhouse gas emissions permitting and best available control technology requirements because none of our facilities are presently major sources of greenhouse gas emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. Although the agreement does not create any binding obligations for nations to limit their greenhouse gas emissions, it does include pledges to voluntarily limit or reduce future emissions. On June 1, 2017, President Trump announced that the U.S. would withdraw from the Paris Agreement and that it would potentially seek to renegotiate the Paris Agreement on more favorable terms. The U.S. completed the process of withdrawing from the Paris Agreement on November 4, 2020. In response to the United States’ withdrawal announcement, various corporations, investors, and U.S. state and local governments publicly pledged to further the goals of the Paris Agreement. On January 20, 2021, President Biden issued written notification to the United Nations of the United States’ intention to rejoin the Paris Agreement, which became effective on February 19, 2021. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and many states have already established regional greenhouse gas “cap-and-trade” programs. The adoption of any legislation or regulation that restricts emissions of greenhouse gases from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an +10 +important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, the EPA has taken several steps to delay implementation of its methane standards, including most recently in September 2020, when the EPA finalized the Reconsideration Rule that rolls back parts of the 2016 performance standards. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. Separately, in September 2020, the EPA finalized the Review Rule rescinding requirements related to the regulations of methane emissions from the oil and natural gas industry. Both rules are subject to ongoing litigation and, on January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the Reconsideration Rule by September 2021 and consider revising the Review Rule. Therefore, the scope of future obligations continues to remain uncertain. In addition, in April 2018, a coalition of states filed a lawsuit in the U.S. District Court for the District of Columbia aiming to force the EPA to establish guidelines for limiting methane emissions from existing sources in the oil and natural gas sector; that lawsuit is pending. On March 20, 2015, the U.S. Bureau of Land Management (the “BLM”) finalized a rule regulating hydraulic fracturing activities on federal lands, including requirements for the disclosure, wellbore integrity, and handling of flowback water; however, on December 29, 2017, the BLM issued a rescission of the hydraulic fracturing rule. This rescission and the rule as promulgated are subject to ongoing litigation. The BLM also previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. The 2016 rule and the rescission were invalidated by separate federal district courts. As a result, future implementation of methane rules by either the EPA or the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. These rules were finalized in June 2016, and after a legal challenge by environmental groups, in July 2019, the EPA declined to revise the rules. The EPA conducted a study on effluent guidelines for the oil and gas industry, and a draft of this study was published in May 2019. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York, Vermont, Maryland, and Washington have banned, or are in the process of banning, the use of high-volume hydraulic fracturing. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs +11 +and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior, to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. On July 16, 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. Among other revisions, the rules redefined environmental “effects” or “impacts” as the effects “that are reasonably foreseeable and have a reasonably close causal relationship to the proposed action or alternatives.” The rule also eliminated the current “direct,” “indirect,” or “cumulative” categories of effects. The new regulations are subject to ongoing litigation in several federal district courts, and future implementation of the regulations is unclear. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (the “ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In August 2019, the FWS and National Marine Fisheries Service issued three rules amending implementation of the ESA regulations revising, among other things, the process for listing species and designating critical habitat. A coalition of states and environmental groups have challenged the three rules and the litigation remains pending. In addition, on December 18, 2020, the FWS amended its regulations governing critical habitat designations. We anticipate the rule will be subject to litigation. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. On January 7, 2021, the Department of the Interior finalized a rule limiting application of the MBTA; however the Department of the Interior under President Biden delayed the effective date of the rule and opened a public comment period for further review. Future implementation of the rules implementing the Endangered Species Act and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. +12 +Item 1A. Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• the level of prices, and expectations about future prices, for oil and natural gas; +• the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• the level of global and domestic oil and natural gas production; +• the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• the cost of exploring for, developing, producing, and delivering oil and natural gas; +• available pipeline, storage, and other transportation capacity; +• worldwide political, military, and economic conditions; +• global or national health epidemics or concerns, such as the recent coronavirus outbreaks, which may reduce demand for oil, natural gas, and related products because of reduced global or national economic activity; +• lead times associated with acquiring equipment and products and availability of qualified personnel; +• the discovery rates of new oil and natural gas reserves; +• federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• economic and political conditions in oil and natural gas producing countries; +• actions of OPEC, its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a greenhouse gas; +• the price and availability of alternative fuels and energy sources; +• global weather conditions and natural disasters; and +13 +• uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies, which are strongly influenced by current and expected oil and natural gas prices. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the past five years ending December 31, 2020, the posted price for West Texas Intermediate (“WTI”) oil has ranged from a low of $(36.98) per barrel in April 2020 to a high of $77.41 per barrel in June 2018, and the Henry Hub spot market price of gas has ranged from a low of $1.33 per MMBtu in September 2020 to a high of $6.24 per MMBtu in January 2018. Oil and natural gas commodity prices were particularly volatile in 2020 as a result of multiple significant factors impacting supply and demand in the global oil and natural gas markets, including those relating to the coronavirus pandemic. In 2020, the daily spot prices for WTI crude oil ranged from a high of $63.27 per barrel to a low of $(36.98) per barrel, and the Henry Hub spot market price of gas ranged from a low of $1.33 per MMBtu to a high of $3.14 per MMBtu. Oil and natural gas commodity prices are expected to continue to be volatile. If the prices of oil and natural gas continue to decline or remain depressed for a lengthy period, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +Significant factors that are likely to affect near-term commodity prices include the extent to which members of OPEC and other oil exporting nations continue to reduce oil export prices and increase production; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally; changes to energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Impact of the Coronavirus Pandemic; Industry Trends and Outlook” in Item 7 of Part II of this Annual Report. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. Even if oil and natural gas prices improve, E&P operator activity may not materially increase, as they remain focused on operating within their capital plans. Moreover, any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, or expectations of such a drop or of prolonged weak oil and natural gas commodity price environments, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +Increased attention to climate change and conservation measures may reduce oil and natural gas demand. +Increased attention to climate change, consumer demand for alternatives to oil and natural gas, and competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels) could reduce demand for oil and natural gas and therefore our products and services, which would lead to a reduction in our revenues and have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +14 +A negative shift in investor sentiment of the oil and gas industry could adversely affect our ability to raise debt and equity capital. +Certain segments of the investor community have developed negative sentiment towards investing in our industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment advisors and certain sovereign wealth funds, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Certain other stakeholders have also pressured commercial and investment banks to stop financing oil and gas production and related infrastructure projects. Such developments, including environmental activism and initiatives aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. These developments may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +We face various risks associated with increased activism against oil and natural gas exploration and development activities. +Opposition toward oil and natural gas drilling and development activity has been growing globally and is particularly pronounced in the U.S. Companies in the oil and natural gas industry are often the target of activist efforts from both individuals and non-governmental organizations regarding safety, human rights, environmental matters, sustainability, and business practices. Anti-development activists are working to, among other things, reduce access to federal and state government lands and delay or cancel certain operations such as drilling and development. If activism against oil and natural gas exploration and development persists or increases, there could be a material adverse effect on our business, financial condition, and results of operations. +Risks Related to the Coronavirus Pandemic +The recent coronavirus pandemic and related economic repercussions have had, and are expected to continue to have, a significant adverse impact on our business, and depending on the duration of the pandemic and its effect on the oil and gas industry, could have a material adverse effect on our business, liquidity, results of operations, and financial condition. +The coronavirus pandemic and related economic repercussions have created significant volatility, uncertainty, and turmoil in the oil and gas industry. These events have directly affected our business and have exacerbated the potential negative impact from many of the risks described in this Annual Report, including those relating to our customers’ capital spending and trends in oil and natural gas prices. For example, demand for our products and services has and continues to decline as our customers continue to revise their capital budgets downwards and swiftly adjust their operations in response to lower commodity prices. In addition, the decline in market conditions resulted in goodwill impairment charges of $296.2 million recorded in the first quarter of 2020. We are also experiencing inefficiencies and logistical challenges surrounding stay-at-home orders and remote work arrangements, travel restrictions, and an inability to commute to certain facilities and job sites, as we provide services and products to our customers. +In the midst of the ongoing coronavirus pandemic, OPEC+ was initially unable to reach an agreement to continue to impose limits on the production of crude oil. The convergence of these events created the unprecedented dual impact of a global oil demand decline coupled with the risk of a substantial increase in supply. Oil demand significantly deteriorated as a result of the virus outbreak in March 2020 and corresponding preventative measures taken around the world to mitigate the spread of the virus, and at the same time, aggressive increases in production of oil by Saudi Arabia and Russia created a significant surplus in the supply of oil. While OPEC+ agreed in April 2020 to cut production, downward pressure on commodity prices has continued, as the coronavirus pandemic has continued with resurgences in the U.S. and worldwide. +Given the nature and significance of the events described above, we are not able to enumerate all potential risks to our business; however, we believe that in addition to the impacts described above, other current and potential impacts of these recent events include, but are not limited to: +• disruption to our supply chain for raw materials essential to our business, including restrictions on importing and exporting products; +• notices from customers, suppliers, and other third parties arguing that their non-performance under our contracts with them is permitted as a result of force majeure or other reasons; +• liquidity challenges, including impacts related to delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies; +• a credit rating downgrade of our corporate debt and potentially higher borrowing costs in the future; +15 +• a need to preserve liquidity, which could result in a delay or change in our capital investment plan; +• cyber security issues, as digital technologies may become more vulnerable and experience a higher rate of cyber attacks in the current environment of remote connectivity; +• litigation risk and possible loss contingencies related to coronavirus and its impact, including with respect to commercial contracts, employee matters, and insurance arrangements; +• reduction of our workforce to adjust to market conditions, including severance payments, retention issues, and an inability to hire employees when market conditions improve; +• additional impairments along with other accounting charges as demand for our services and products decreases; +• infections and quarantining of our employees and the personnel of our customers, suppliers, and other third parties in areas in which we operate; +• changes in the regulation of the production of hydrocarbons, such as the imposition of limitations on the production of oil and gas by states or other jurisdictions, that may result in additional limits on demand for our products and services; +• actions undertaken by national, regional, and local governments and health officials to contain the virus or treat its effects; and +• a structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel, and interact, or in connection with a global recession or depression. +Given the dynamic nature of these events, we cannot reasonably estimate the period of time that the coronavirus pandemic and related market conditions will persist, the full extent of the impact they will have on our business, financial condition, results of operations, or cash flows or the pace or extent of any subsequent recovery. +The confluence of events described above have had, and are expected to continue to have, a significant impact on our business, and depending on the duration of the pandemic and its effect on the oil and gas industry, could have, a material adverse effect on our business, liquidity, results of operations, and financial condition. +Risks Related to Our Indebtedness +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +As of December 31, 2020, we had $346.7 million of 8.750% Senior Notes due 2023 (the “Senior Notes”) outstanding, and we had $37.9 million of availability under the 2018 ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report), net of outstanding letters of credit of $0.5 million. Subject to the restrictions in the 2018 ABL Credit Facility and the indenture governing the Senior Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our current or future level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +• limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• making us vulnerable to increases in interest rates as our indebtedness under the 2018 ABL Credit Facility may vary with prevailing interest rates; +16 +• placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or less restrictive terms governing their indebtedness; and +• making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. In addition, any debt restructuring transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +The 2018 ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) and the indenture governing our Senior Notes have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• incur additional indebtedness and guarantee indebtedness; +• pay dividends or make other distributions or repurchase or redeem our capital stock; +• transfer or sell assets; +• make loans and investments; +• incur liens; +• enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• consolidate, merge, or sell all or substantially all of our assets; +• prepay, redeem, or repurchase certain debt; +• issue certain preferred stock or similar equity securities; +• make certain acquisitions and investments; +• engage in transactions with affiliates; and +17 +• create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Uncertainty relating to the London Interbank Offered Rate (“LIBOR”) calculation process and potential phasing out of LIBOR after 2021 may adversely affect the market value of our current or future debt obligations. +Loans to us and our domestic related subsidiaries under the 2018 ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) may be base rate loans or LIBOR loans. LIBOR is calculated by reference to a market for interbank lending, and it is based on increasingly fewer actual transactions. This reduction increases the subjectivity of the LIBOR calculation process and increases the risk of manipulation. Actions by the regulators or law enforcement agencies, as well as ICE Benchmark Administration (the current administrator of LIBOR), may result in changes to the manner that LIBOR is determined or the establishment of alternative reference rates. For example, on July 27, 2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. U.S. Dollar LIBOR will likely be replaced by the Secured Overnight Financing Rate (“SOFR”) published by the Federal Reserve Bank of New York; however, the timing of this shift is currently unknown. SOFR is an overnight rate instead of a term rate, making SOFR an inexact replacement for LIBOR, and there is not an established process to create robust, forward-looking, SOFR term rates. Changing the benchmark rate for LIBOR loans from LIBOR to SOFR requires calculations of a spread. Industry organizations are attempting to structure the spread calculation in a manner that minimizes the possibility of value transfer between counterparties, borrowers, and lenders by the transition, but there is no assurance that the calculated spread will be fair and accurate. At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be implemented. If LIBOR ceases to exist, we may need to renegotiate the 2018 ABL Credit Facility to determine the interest rate to replace LIBOR with the new standard that is established. As such, the potential effect of any such event on our interest expense cannot yet be determined. +Competition and Market Risks +We may be unable to maintain existing prices or implement price increases on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +18 +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The oil and natural gas industry is intensely competitive and has been characterized by price erosion for new technologies as additional competing products enter the market. Throughout 2020 we experienced, and we continue to experience, a decline in the pricing and profitability of our dissolvable plug products and, to a lesser extent, our composite plug products. Any further declines in the future may harm our business. +We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. +We are continuing to work on reducing manufacturing costs of our products, as well as introducing new and differentiated technology to improve profitability, however, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products decline further or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion services may adversely affect our business, financial condition, and results of operations. +Operational Risks +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• equipment defects; +19 +• liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• explosions and uncontrollable flows of gas or well fluids; +• unusual or unexpected geological formations or pressures and industrial accidents; +• blowouts; +• fires; +• cratering; +• loss of well control; +• collapse of the borehole; and +• damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our services could become a source of spills or release of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose customers and substantial revenue, and any litigation or claims, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public and make it more difficult for us to compete effectively or obtain adequate insurance in the future. +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2020 and 2019, we spent approximately $2.9 million and $13.6 million, respectively, on capital expenditures related to maintenance, and we expect to spend approximately $13 million to $14 million on capital expenditures related to maintenance in 2021. Our equipment typically does not generate revenue while it is undergoing maintenance, refurbishment, or upgrades. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. In addition, although such projects may require material capital expenditures, there is no assurance that they will generate a positive return. +Risks Related to Our Customers and Suppliers +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially in loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we +20 +underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase inventory obsolescence, and restrict our ability to fund our operations. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our products and services. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2020, our five largest customers collectively accounted for approximately 37% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Certain of our product lines are subject to the risk of supplier concentration, and certain of our product lines are subject to exclusive distribution arrangements, which we may not be able to maintain. +Certain of the product lines depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +In addition, we have arrangements with certain technology companies and manufacturers that give us exclusive distribution rights to certain product offerings. In some cases, we are, or may in the future will be, required to meet certain minimum volume or other requirements in order to retain our arrangement. If any of these companies or manufacturers terminate our right to sell some or all of their products, modify or terminate our exclusive distribution arrangement, or change the applicable terms and conditions of sale, our business and results of operations could be adversely affected. +Regulatory, Compliance, and Legal Risks +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which +21 +could have a material adverse effect on our business, financial condition, prospects, and results of operations. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act (“FLSA”), in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation, and the results or costs of any such cases may have an adverse effect on our business, operating results, and financial condition. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. In Texas, rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, greenhouse gases, air pollution, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and +22 +transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills of hazardous materials onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the oversight of the EPA, the U.S. Department of Transportation (the “DOT”), U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards (the “Tier 4” standards). The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels and published permitting guidance in February 2014 addressing the performance of such activities using diesel fuels. +There is considerable uncertainty surrounding regulation of methane emissions. In 2016, the EPA issued final regulations under the CAA establishing performance standards, including standards for the capture of methane emissions released during hydraulic fracturing. However, the EPA has taken several steps to delay implementation of its methane standards, including most recently in September 2020, when the EPA finalized the Reconsideration Rule that rolls back parts of +23 +the 2016 performance standards. Various industry and environmental groups have separately challenged both the original standards and the EPA’s attempts to delay implementation of the rule. Separately, in September 2020, the EPA finalized the Review Rule, rescinding requirements related to the regulation of methane emissions from the oil and natural gas industry. Both rules are subject to ongoing litigation, and on January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the Reconsideration Rule by September 2021 and consider revising the Review Rule. Therefore, future obligations continue to remain uncertain. In addition, in April 2018, a coalition of states filed a lawsuit in the U.S. District Court for the District of Columbia aiming to force the EPA to establish guidelines for limiting methane emissions from existing sources in the oil and natural gas sector; that lawsuit is pending. On March 20, 2015, the BLM finalized a rule regulating hydraulic fracturing activities on federal lands, including requirements for disclosure, wellbore integrity, and handling of flowback water; however, on December 29, 2017, the BLM issued a rescission of the hydraulic fracturing rule. This rescission and the rule as promulgated are subject to ongoing litigation. The BLM also previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. The 2016 rule and the rescission were invalidated by separate federal district courts. As a result, future implementation of methane rules by either the EPA or the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other greenhouse gas emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. These rules were finalized in June 2016, and after a legal challenge by environmental groups, in July 2019, the EPA declined to revise the rules. The EPA is currently conducting a study on effluent guidelines for the oil and gas extraction industry, and a draft of this study was published in May 2019. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our products and services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources. The final report concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals, or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York, Vermont, Maryland, and Washington have banned, or are in the process of banning, the use of high-volume hydraulic fracturing. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +Existing or future laws and regulations related to greenhouse gases and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of greenhouse gases that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to greenhouse gas emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns (e.g., numerous cities, including San Francisco, CA, have banned the use of natural gas in new construction starting in 2020, and other cities, including Seattle, WA, are considering similar initiatives). Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of greenhouse gases in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to +24 +greenhouse gases and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of greenhouse gases that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Finally, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The U.S. Foreign Corrupt Practices Act (the “FCPA”), the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anticorruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. We operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as +25 +changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license, and effective December 2017, the FMCSA has mandated electronic logging devices in all interstate commercial trucks. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and greenhouse gas emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +Risks Related to Technology +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot assure you that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. Additionally, we cannot assure you that our intellectual property rights will deter or prevent competitors from creating similar purpose products for our customers. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently-developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution proceedings, a defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. We may not prevail in any such dispute resolution proceedings, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or otherwise violate the intellectual property rights of others. Also, as a part of resolving such disputes, we may enter into cross-licenses, which could reduce the value of our existing intellectual property rights. The results or costs of any such dispute resolution proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our +26 +business, regardless of its outcome. +Our success may be affected by our ability to implement new technologies and services. Additionally, we rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our products and services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide such products and services to our customers. Although we believe other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense, delay, and potential changes to certain product components. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result of termination of our manufacturing relationships or patent infringement claims, could have a material adverse effect on our financial condition, business, and results of operations. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +Our operations are subject to cyber security risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cyber security risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cyber security attacks. These risks could have a material adverse effect on our business, financial condition, and results of operations and could lead to litigation or regulatory action against us. +Risks Related to Certain Significant Stockholders +Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +SCF VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) owned approximately 29% of our outstanding common stock as of December 31, 2020. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents, and approval of acquisition offers and other significant corporate transactions. In addition, another one of our stockholders beneficially owned approximately 16% of our outstanding common stock as of December 31, 2020. This concentration of ownership by a small group of stockholders will limit other stockholders’ ability to influence corporate matters, and as a result, actions may be taken that other stockholders may not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their shares of our common stock. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with significant stockholders. +27 +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. SCF is not subject to any obligation to maintain its ownership interest in us and may elect at any time to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies, which could adversely affect our cash flows or results of operations. +Certain of our directors may have conflicts of interest because they are also directors or officers of SCF. The resolution of these conflicts of interest may not be in our or other stockholders’ best interests. +Certain of our directors, namely David C. Baldwin and Andrew L. Waite, are currently officers of SCF’s ultimate general partner. Mr. Baldwin and Mr. Waite are also both directors of Forum Energy Technologies, a corporation in which SCF and its affiliates own an approximate 15% equity interest as of December 31, 2020. In addition, Mr. Waite is a director of National Energy Reunited Corp., a corporation in which SCF owns an approximate 9% equity interest as of December 31, 2020. These positions may conflict with such individuals’ duties as one of our directors regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in our or our other stockholders’ best interest. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates, and its other portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our charter further provides that no such person or party shall be liable to us by reason of the fact that such person pursues any such business opportunity or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or otherwise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approved by the holders of at least 80% of the voting power of the outstanding stock of the corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. +Risks Related to Human Capital +Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +28 +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work, and our success depends, in large part, upon our ability to employ and retain key employees, technical personnel, and other skilled and qualified workers. To attract and retain qualified employees, we must compensate them at market levels. Recent cost-cutting measures across the organization include decreases in cash and equity compensation for our employees, which may adversely affect our ability to attract and retain qualified employees. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our liquidity and competitive position, our business, financial condition or results of operations could suffer. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. The right-sizing of our and our competitors’ labor force, as well as a significant decrease in the wages paid by us or our competitors as a result of reduced industry demand, has resulted in a reduction of the available skilled labor force to service the energy industry. To the extent that there is an increase in demand for our products or services, there is no assurance that the availability of skilled labor will improve. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +Other Material Risks +We do not intend to pay dividends on our common stock, and our debt agreements place certain restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on his investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt agreements place certain restrictions on our ability to pay cash dividends. Consequently, unless we revise our dividend policy, a stockholder’s only opportunity to achieve a return on his investment in us will be by selling his common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased his shares of our common stock. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +Historically, we have experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur further operating losses and experience negative operating cash flow. +Our future financial condition and results of operations could be adversely impacted by long-lived assets or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, other intangible assets, or other assets in a short amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, other intangible assets, or other assets that reduce our net income. +In 2020, we recorded goodwill impairment charges of $296.2 million in our tools, cementing, and wireline reporting units within our Completions Solutions segment due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in our stock price and the Level 2 fair value of our Senior Notes. +In 2019, we recorded a goodwill impairment charge of $20.3 million and an intangible asset impairment charge of $12.7 million associated with indefinite-lived trade names in our coiled tubing reporting unit within our Completion Solutions segment as well as an intangible asset impairment charge of $7.1 million associated with definite-lived customer relationship intangible assets and a property and equipment impairment charge of $66.2 million in our coiled tubing asset group within our Completion Solutions segment. These impairment charges were due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. +29 +Additionally, in 2019, we recorded an intangible asset impairment charge of $95.0 million associated with indefinite-lived trade names in our completion tools reporting unit within our Completion Solutions segment and due to the transitioning of certain trade names from our 2018 acquisitions to our trade names in order to better funnel and allocate resources, create a stronger identity, facilitate cross-selling, and streamline and simplify communication with existing customers. +While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +Seasonal and adverse weather conditions adversely affect demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. In addition, most scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For the years ended December 31, 2020 and 2019, we generated approximately 0.5% and 2.2%, respectively, of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the U.S. or other countries, anti-terrorist efforts, and other armed conflicts involving the U.S. or other countries, including continued hostilities in the Middle East, may adversely affect the U.S. and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +A portion of our revenue is derived from sales to customers outside of the U.S., which exposes us to risks inherent in doing business internationally. +In 2020, we derived 5.0% of our revenue from sales to customers outside of the U.S. Sales to customers in countries other than the U.S. are subject to various risks, including: +• volatility in political, social, and economic conditions; +• social unrest, acts of terrorism, war, or other armed conflicts; +• confiscatory taxation or other adverse tax policies; +• deprivation of contract rights; +• trade and economic sanctions or other restrictions imposed by the European Union, the U.S., or other countries; +30 +• exposure under the FCPA or similar legislation, as discussed in the below risk factor; and +• currency exchange controls. +If we do not meet the continued listing requirements of the New York Stock Exchange (“NYSE”), the NYSE may delist our common stock. +To remain listed on the NYSE, the average closing price of our common stock must not fall below $1.00 per share over a period of 30 consecutive trading days. In April 2020, we received written notification from the NYSE that we did not satisfy this minimum average closing share price condition. In June 2020, we regained compliance with this condition; however, there is no assurance that we will be able to continue to do so. Further, our common stock could be delisted if (i) our average market capitalization over a consecutive 30 trading-day period is less than $15 million, or (ii) our common stock trades at an “abnormally low” price. If our common stock were to be delisted for any reason, it could negatively impact us by, among other things, reducing the liquidity and market price of our common stock, reducing the number of investors willing to hold or acquire our common stock, and negatively impacting our ability to access equity markets and obtain financing. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter and bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. These exclusive forum provisions are not intended to apply to actions arising under the Exchange Act or the Securities Act of 1933, as amended. The Court of Chancery of the State of Delaware has recently held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL. +Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provisions of our charter and bylaws. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter or bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +31 +Taking advantage of the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors. +We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which at least $700 million of equity securities are held by non-affiliates as of the last day of our then most recently completed second fiscal quarter); (iii) the date on which we have issued, in any three-year period, more than $1.0 billion in non-convertible debt securities; and (iv) December 31, 2023, which is the last day of the fiscal year ending after the fifth anniversary of the completion of our initial public offering (the “IPO”). An emerging growth company may take advantage of certain reduced reporting and other requirements that are otherwise applicable generally to public companies. Pursuant to these reduced disclosure requirements, emerging growth companies are not required to, among other things, comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, provide certain disclosures regarding executive compensation, hold stockholder advisory votes on executive compensation, or obtain stockholder approval of any golden parachute payments not previously approved. In addition, emerging growth companies have longer phase-in periods for the adoption of new or revised financial accounting standards. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. +We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards under Section 107 of the JOBS Act, until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our common stock price may be more volatile. +On the other hand, once we are no longer an emerging growth company, compliance with rules and regulations that do not currently apply to us as an emerging growth company will increase our legal and financial compliance costs, may make some activities more difficult, time-consuming, or costly, and will increase demand on our systems and resources. +We previously identified material weaknesses in our internal control over financial reporting. We may identify additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to meet our reporting obligations. +Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In 2017, we identified material weaknesses in our internal control over financial reporting, and immaterial misstatements were identified as result. We believe that these material weaknesses have been successfully remediated as of December 31, 2020. +Any newly identified material weakness could limit our ability to prevent or detect a misstatement of our accounts or disclosures that could result in a material misstatement of our annual or interim financial statements. In such case, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, we may be unable to prevent fraud, investors may lose confidence in our financial reporting, and our stock price may decline as a result. We cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to avoid potential future material weaknesses. +We may not be able to utilize a portion of our net operating loss carry forwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2020, we had federal and state income tax NOLs of approximately $345.0 million, which will begin to expire between 2023 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). +32 +Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate (as defined in Section 382). However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in the IPO, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +33 +Item 1B. Unresolved Staff Comments +None. +Item 2. Properties +The following table describes the material facilities owned or leased by us as of December 31, 2020. +Location Basin/Region Leased or Owned Principal/Most +Significant Use +Houston, TX — Leased Corporate Headquarters/Administrative +Athens, TX — Leased Operations +Baker, MT Bakken Owned Operations/Administrative +Bergen, Norway — Leased Operations +El Reno, OK SCOOP/STACK Leased Operations +Charleroi, PA Marcellus/Utica Leased Operations +Corpus Christi, TX — Leased Operations/Administrative +Dickinson, ND Bakken Leased Operations/Administrative +Enid, OK SCOOP/STACK Leased Operations/Administrative +Fort Worth, TX — Leased Administrative +Hobbs, NM Permian Leased Operations +Jacksboro, TX Barnett Leased Operations +Kilgore, TX Haynesville Leased Operations +Longview, TX Haynesville Owned Operations +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Mead, CO Rockies Leased Operations +Midland, TX Permian Leased Operations +Midland, TX Permian Owned Operations/Administrative +Midland, TX Permian Leased Operations/Administrative +Midland, TX Permian Leased Operations +Monahans, TX Permian Leased Operations/Administrative +Oklahoma City, OK SCOOP/STACK Leased Operations +Pleasanton, TX Eagle Ford Leased Operations +Poolville, TX — Owned Operations +Red Deer, AB, Canada WCSB Leased Operations +San Antonio, TX Eagle Ford Leased Operations/Administrative +Sweetwater, TX Permian Leased Operations +Ulster, PA Marcellus/Utica Leased Operations +Tyler, TX Haynesville Leased Operations +Williston, ND Bakken Owned Operations +Williston, ND Bakken Owned Operations/Administrative +Item 3. Legal Proceeding +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. For additional information related to legal proceedings, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +34 +Item 4. Mine Safety Disclosures +Not applicable. +35 +PART II +Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities +Market Information +Nine Energy Service, Inc.’s common stock is traded on the NYSE under the symbol “NINE.” +Holders +As of March 4, 2021, we had 48 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +None. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +Item 6. Selected Financial Data +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +36 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. +This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• Adjusted Gross Profit (Loss) : Adjusted gross profit (loss) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues +37 +(excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted EBITDA : We define Adjusted EBITDA as net income (loss) before interest, taxes, and depreciation and amortization, further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of contingent liabilities, (iv) gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. For additional information, see “Non-GAAP Financial Measures” below. +• Return on Invested Capital (“ROIC”): We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss or gain on the sale of subsidiaries, (vi) gain on the extinguishment of debt, and (vii) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. For additional information, see “Non-GAAP Financial Measures” below. +• Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Factors Affecting the Comparability of Our Results of Operations +Our future results of operations may not be comparable to our historical results of operations for the periods presented, and our historical results of operations among the periods presented may not be comparable to each other. +Our historical results of operations included in this Annual Report include the impact of the divestiture of the Production Solutions segment on August 30, 2019. Future results of operations will not include activity related to the Production Solutions segment. For additional information on the divestiture of the Production Solutions segment, see Note 16 – Segment Information included in Item 8 of Part II of this Annual Report. +Impact of the Coronavirus Pandemic; Industry Trends and Outlook +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. The worldwide coronavirus outbreak in early 2020, which was declared a pandemic by the World Health Organization in March 2020, the uncertainty regarding its impact, and various governmental actions taken to mitigate its impact resulted in an unprecedented decline in demand for oil. In the midst of the ongoing pandemic, OPEC+ was initially unable to reach an agreement on production levels for crude oil, at which point Saudi Arabia and Russia initiated efforts to aggressively increase production. The convergence of these events created the unprecedented dual impact of a massive decline in the demand for oil coupled with the risk of a substantial increase in supply. While OPEC+ agreed in April 2020 to cut production, downward pressure on commodity prices persisted throughout 2020, and the imbalance between the supply of and demand for oil, as well as the uncertainty around the extent and timing of an economic recovery, caused extreme market volatility and a substantial adverse effect on oil prices. In 2020, the WTI price averaged approximately $39 per barrel as compared to $57 per barrel in 2019. +In response to lower oil prices, our customers have generally revised their capital budgets downward and adjusted their operations accordingly, which has caused a significant decline in demand for our products and services. These reductions were most evident in the Permian Basin where total completions declined approximately 53% in 2020 versus 2019 per the Energy Information Administration (the “EIA”). Additionally, the EIA reported total U.S. completions declined approximately 49% +38 +year over year, and new wells drilled declined approximately 56%. This overall decline in activity, coupled with downward pricing pressure, has led to a significant reduction in our revenue and profitability for 2020. +Thus far in 2021, despite oil prices having improved, demand for our products and services and our near-term prospects remain depressed, and we expect our customer’s capital spend and drilling and completion activity will be down in 2021 versus 2020. Because of sustained lower activity into 2021, we expect pricing will remain depressed for the near-term, offsetting much or possibly all of the anticipated revenue increases. In particular, our cementing and coiled tubing services have experienced improved profitability and pricing; however, we expect such improvements to be outweighed by the challenges faced by our completion tools and wireline services with respect to both utilization and pricing. Even with further improvements in oil prices, our business in 2021 may not improve materially or at all if downward pricing pressures remain. +While we cannot predict the length of time that market disruptions resulting from the coronavirus pandemic and efforts to mitigate its effects will continue, the ultimate impact on our business, or the pace or extent of any subsequent recovery, we expect the coronavirus pandemic and related effects will continue to have a material adverse impact on demand for oil, commodity prices, and our business generally. We have experienced inefficiencies and logistical challenges surrounding stay-at-home orders and remote work arrangements, travel restrictions, and an inability to commute to certain facilities and job sites, as we provide services and products to our customers. +During the pandemic, we have maintained our commitment to the safety of our employees, customers, vendors, and community at large, and we have taken, and are continuing to take, a proactive approach to navigating the pandemic. To mitigate exposure and risk, we have implemented processes and procedures across our entire organization based on federal, regional, and local guidelines and mandates, and our Health, Safety & Environment and management teams are in frequent communication with our entire employee base to ensure they are receiving updated guidelines, processes, and procedures. In response to the pandemic, we have implemented the following changes, for example: at the field level, we are working closely with our customers and vendors to update standard operating procedures, based on social distancing, hand washing, and other recommended best practices set forth by the Centers for Disease Control and Prevention; electronic assessments have been employed to check the health of employees prior to reporting to work, to ensure facilities are being properly cleaned and sanitized, and to check visitor health before arrival to our locations; internal case managers have been identified to handle all coronavirus-related cases, and all confirmed and potential cases are tracked through closure; many of our corporate and office employees are working virtually to avoid unnecessary risk and exposure; and we have significantly limited any work-related travel. We are actively monitoring updates from regulatory and government bodies and evolving our strategy accordingly in an effort to keep our workforce and communities healthy. +Other significant factors that are likely to affect commodity prices moving forward include the extent to which members of OPEC+ and other oil exporting nations continue to reduce oil export prices and increase production; the effect of energy, monetary, and trade policies of the U.S.; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally; new energy policies put in place by the new administration and EPA; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. Even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. +In this challenging environment, we will nevertheless continue to focus on generating returns and cash flow. Due to our high level of variable costs and the asset-light make-up of our business, we were able to quickly implement cost-cutting measures and will continue our efforts to adapt as the market dictates. +Generally, operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. Nonetheless, we have experienced increased pricing pressures, and an increase in customer focus on price over performance, with respect to certain of our products and services, including our dissolvable frac plugs. As a result, although we expect our sales of dissolvable frac plugs to increase, due to significant pricing pressures from customers, increased competition, and our inability to proportionately reduce our materials costs, our ability to profit from such sales may be limited. +39 +Other Significant Events +Production Solutions Divestiture +On August 30, 2019, we sold our Production Solutions segment for approximately $17.1 million in cash. In connection with this divestiture, we recorded a loss of $15.9 million during the year ended December 31, 2019. For additional information on this divestiture, see Note 16 – Segment Information included in Item 8 of Part II of this Annual Report. +Magnum Acquisition +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018, we acquired all of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum” and such acquisition, the “Magnum Acquisition”) for approximately $334.5 million in upfront cash consideration, subject to customary adjustments, and 5.0 million shares of our common stock, which were issued to the sellers of Magnum in a private placement. +40 +Results of Operations +Year Ended December 31, +2020 2019 Change +(in thousands) +Revenues +Completion Solutions $ 310,851 $ 774,665 $ (463,814) +Production Solutions (1) +— 58,272 (58,272) +$ 310,851 $ 832,937 $ (522,086) +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Completion Solutions $ 302,157 $ 620,125 $ (317,968) +Production Solutions (1) +— 49,854 (49,854) +$ 302,157 $ 669,979 $ (367,822) +Adjusted gross profit (loss) +Completion Solutions $ 8,694 $ 154,540 $ (145,846) +Production Solutions (1) +— 8,418 (8,418) +$ 8,694 $ 162,958 $ (154,264) +General and administrative expenses $ 49,346 $ 81,327 $ (31,981) +Depreciation 32,431 50,544 (18,113) +Amortization of intangibles 16,467 18,367 (1,900) +Impairment of goodwill 296,196 20,273 275,923 +Impairment of intangibles — 114,804 (114,804) +Impairment of property and equipment — 66,200 (66,200) +(Gain) loss on revaluation of contingent liabilities 276 (21,187) 21,463 +Loss on sale of subsidiaries — 15,896 (15,896) +Gain on sale of property and equipment (2,857) (538) (2,319) +Loss from operations $ (383,165) $ (182,728) $ (200,437) +Non-operating (income) expenses (1,759) 38,910 (40,669) +Loss before income taxes (381,406) (221,638) (159,768) +Benefit for income taxes (2,458) (3,887) 1,429 +Net loss $ (378,948) $ (217,751) $ (161,197) +(1) We sold the Production Solutions segment to Brigade Energy Service LLC on August 30, 2019. For additional information on the divestiture of the Production Solutions segment, see Note 16 – Segment Information. +Revenues +Revenues decreased $522.1 million, or 63%, to $310.9 million in 2020 which was primarily related to reduced activity and pricing pressure caused by poor market conditions, including an economic recession associated with the coronavirus pandemic, as well as international pricing and production disputes, in comparison to 2019. We depend, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore in North America. In turn, activity and capital spending are strongly influenced by current and expected oil and natural gas prices. During 2020, the average closing price was $39.16 per barrel of WTI, and the average closing price of natural gas was $2.03 per MMBtu. During 2019, the average closing price was $56.98 per barrel of WTI, and the average closing price of natural gas was $2.56 per MMBtu. +Additional information with respect to revenues by historical reportable segment is discussed below . +Completion Solutions : Revenues decreased $463.8 million, or 60%, to $310.9 million in 2020. The decrease was +41 +prevalent across all lines of service and was a direct reflection of pricing pressures caused by reasons described above. More specifically, wireline revenues decreased $154.1 million, or 65%, as total completed wireline stages decreased by 59% in comparison to 2019. In addition, cementing revenues (including pump downs) decreased by $115.3 million, or 53%, as total cement job count decreased 46% in comparison to 2019, tools revenues decreased $107.3 million, or 58%, as completion tools stages decreased by 44% in comparison to 2019, and coiled tubing revenues decreased by $87.1 million, or 65%, as total days worked decreased by 53% in comparison to 2019. +Production Solutions: Revenues decreased $58.3 million, or 100%, for 2020 as the Production Solutions segment was sold on August 30, 2019. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues decreased $367.8 million, or 55%, to $302.2 million in 2020, which is primarily related to reduced activity and pricing pressure caused by poor market conditions, including an economic recession associated with the coronavirus pandemic, in comparison to 2019. +Additional information with respect to cost of revenues by historical reportable segment is discussed below. +Completion Solutions: Cost of revenue decreased $317.9 million, or 51%, to $302.2 million in 2020. The decrease in comparison to 2019 was prevalent across all lines of service and was a direct reflection of reasons described above. More specifically, the decrease was primarily related to a $180.8 million decrease in materials installed and consumed while performing services, a $103.3 million decrease in employee costs, a $30.9 million decrease in other costs such as repair and maintenance, vehicle, travel, and meals and entertainment, and a $6.1 million decrease in transaction and integration costs association with the Magnum Acquisition. The overall decrease in cost of revenues was partially offset by a $2.1 million increase in bad debt expense and a $1.1 million increase in non-cash facility lease costs between periods. +Production Solutions : Cost of revenue decreased $49.9 million, or 100%, for 2020 as the Production Solutions segment was sold on August 30, 2019. +Adjusted Gross Profit (Loss) +Completion Solutions : Adjusted gross profit decreased $145.9 million to $8.7 million in 2020 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +Production Solutions : Adjusted gross profit decreased $8.4 million to $0.0 million in 2020 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses decreased $32.0 million to $49.3 million in 2020. The decrease in comparison to 2019 was primarily related to a $22.1 million decrease in employee costs due mainly to headcount and salary reductions, including the suspension of matching contributions under the Nine Energy Service 401(k) Plan, across the organization. The overall decrease was also partly attributed to a $6.8 million reduction in transaction and integration costs associated with the Magnum Acquisition and a $4.0 million decrease in other general and administrative expenses such as professional fees, marketing, travel expense, as well as expenses associated with the recently sold Production Solutions segment. The overall decrease in general and administrative expenses was partially offset by a $1.0 million increase in severance and other general administrative type restructuring costs between periods. +Depreciation +Depreciation expense decreased $18.1 million to $32.4 million in 2020. The decrease in comparison to 2019 was related to a $9.9 million reduction in depreciation expense associated with our coiled tubing business mainly due to the property and equipment charge recorded in the fourth quarter of 2019, coupled with a $5.0 million reduction in depreciation expense in the Production Solutions segment, which was sold on August 30, 2019, and a $3.2 million reduction in depreciation expense in other lines of service within our Completion Solutions segment due to a decrease in capital expenditures between periods. +Amortization of Intangibles +Amortization of intangibles decreased $1.9 million to $16.5 million in 2020, primarily due to a $0.9 million decrease in amortization associated with certain non-compete agreements that were fully amortized in 2019, coupled with a $0.8 million decrease in amortization associated with our coiled tubing business due to the intangible asset impairment charge recorded in +42 +the fourth quarter of 2019 as well as a $0.2 million decrease in amortization associated with a customer relationship intangible that was fully amortized in 2020. +Impairment of Goodwill +In 2020, we recorded goodwill impairment charges of $296.2 million in our tools, cementing, and wireline reporting units within our Completion Solutions segment due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in our stock price and the Level 2 fair value of our Senior Notes. +In comparison, in 2019, we recorded a goodwill impairment charge of $20.3 million in our Completion Solutions segment due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. +Impairment of Intangibles +In 2019, we recorded intangible asset impairment charges of $107.7 million associated with indefinite-lived trade names and an intangible asset impairment charge of $7.1 million associated with definite-lived customer relationship intangible assets, all within our Completion Solutions segment. These intangible asset impairment charges were primarily due to the transitioning of certain Magnum trade names to our trade names. These intangible asset impairment charges were also partly attributed to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. These intangible asset impairment charges did not recur in 2020. +Impairment of Property and Equipment +In 2019, we recorded a property and equipment impairment charge of $66.2 million in our Completion Solutions segment due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. These property and equipment impairment charges did not recur in 2020. +(Gain) Loss on Revaluation of Contingent Liabilities +We recorded a $0.3 million loss on the revaluation of contingent liabilities in 2020 compared to a $21.2 million gain on the revaluation of contingent liabilities recorded in 2019. The $21.5 million change was primarily related to a $0.8 million loss on the revaluation of the Magnum Earnout (as defined in Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report) in 2020 compared to a $21.9 million gain on the revaluation of the Magnum Earnout in 2019. The Magnum Earnout was terminated in the second quarter of 2020. The change was partially offset by a $0.5 million gain on the revaluation of the earnout associated with our acquisition of Frac Technology AS (the “Frac Tech Earnout”) in 2020 compared to a $0.7 million loss on the revaluation of the Frac Tech Earnout. +(Gain) Loss on Sale of Subsidiaries +We recorded a $15.9 million loss on the sale of subsidiaries in 2019 associated with the sale of the historical Production Solutions segment. This loss on the sale of subsidiaries did not recur in 2020. +Non-Operating (Income) Expenses +We recorded $1.8 million in non-operating income for 2020 compared to $38.9 million in non-operating expenses for 2019. The $40.7 million change was primarily related to a $37.8 million gain on the extinguishment of debt related to the repurchase of Senior Notes in 2020 that did not occur in 2019. The change is also partly attributable to a $3.0 million reduction in interest expense and a $0.1 million decrease in interest income between periods. +Provision (Benefit) for Income Taxes +Our effective tax rate was 0.6% for 2020 and 1.8% for 2019. Our tax benefit for 2020 primarily comprised of changes to our valuation allowance position due to impairment recorded during the year, as well as the benefit from the five-year net operating loss carryback provided by the Coronavirus Aid, Relief, and Economic Security Act signed into law during 2020. +43 +Adjusted EBITDA +Adjusted EBITDA decreased $138.8 million to a $25.8 million loss for 2020. The Adjusted EBITDA decrease is primarily due to the changes in revenue and expenses discussed above. See “Non-GAAP Financial Measures” below for further explanation. +Non-GAAP Financial Measures +EBITDA and Adjusted EBITDA +EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define EBITDA as net income (loss) before interest, taxes, depreciation, and amortization. +We define Adjusted EBITDA as EBITDA further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of contingent liabilities, (iv) gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. +Management believes EBITDA and Adjusted EBITDA are useful because they allow us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at these measures because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. These measures should not be considered as an alternative to, or more meaningful than, net income (loss) as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from these measures are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of these measures. Our computations of these measures may not be comparable to other similarly titled measures of other companies. We believe that these are widely followed measures of operating performance. +44 +The following table presents a reconciliation of the non-GAAP financial measures of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year Ended December 31, +2020 2019 +(in thousands) +EBITDA reconciliation: +Net loss $ (378,948) $ (217,751) +Interest expense 36,759 39,770 +Interest income (615) (860) +Benefit for income taxes (2,458) (3,887) +Depreciation 32,431 50,544 +Amortization of intangibles 16,467 18,367 +EBITDA $ (296,364) $ (113,817) +Adjusted EBITDA reconciliation: +EBITDA $ (296,364) $ (113,817) +Impairment of goodwill 296,196 20,273 +Impairment of intangibles — 114,804 +Impairment of property and equipment — 66,200 +Transaction and integration costs 146 13,047 +(Gain) loss on revaluation of contingent liabilities (1) +276 (21,187) +Gain on extinguishment of debt (37,841) — +Loss on sale of subsidiaries — 15,896 +Restructuring charges 4,907 3,976 +Stock-based compensation expense 9,744 14,057 +Gain on sale of property and equipment (2,857) (538) +Legal fees and settlements (2) +39 307 +Adjusted EBITDA $ (25,754) $ 113,018 +(1) Amounts relate to the revaluation of contingent liabilities associated with our 2018 acquisitions. The impact is included in our Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 – Commitments and Contingencies included Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. +45 +Return on Invested Capital +ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss or gain on the sale of subsidiaries, (vi) gain on the extinguishment of debt, and (vii) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. +Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation of ROIC may not be comparable to other similarly titled measures of other companies. +The following table provides an explanation of our calculation of ROIC for the years ended December 31, 2020 and 2019: +Year Ended December 31, +2020 2019 +(in thousands) +Net loss $ (378,948) $ (217,751) +Add back: +Impairment of goodwill 296,196 20,273 +Impairment of intangibles — 114,804 +Impairment of property and equipment — 66,200 +Transaction and integration costs 146 13,047 +Interest expense 36,759 39,770 +Interest income (615) (860) +Restructuring charges 4,907 3,976 +Loss on sale of subsidiaries — 15,896 +Gain on extinguishment of debt (37,841) — +Benefit for deferred income taxes (1,588) (4,327) +After-tax net operating profit (loss) $ (80,984) $ 51,028 +Total capital as of prior period-end: +Total stockholders’ equity $ 389,877 $ 594,823 +Total debt 400,000 435,000 +Less cash and cash equivalents (92,989) (63,615) +Total capital as of prior period-end $ 696,888 $ 966,208 +Total capital as of period-end: +Total stockholders’ equity $ 20,409 $ 389,877 +Total debt 348,637 400,000 +Less cash and cash equivalents (68,864) (92,989) +Total capital as of period-end $ 300,182 $ 696,888 +Average total capital $ 498,535 $ 831,548 +ROIC -16.2 % 6.1 % +46 +Adjusted Gross Profit (Loss) +GAAP defines gross profit (loss) as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit (loss) because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (loss) to evaluate operating performance. We prepare adjusted gross profit (loss) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (loss) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (loss) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (loss) or similarly titled measures in the same manner as we do. +The following table presents a reconciliation of adjusted gross profit (loss) to GAAP gross profit (loss). +Year Ended December 31, +2020 2019 +(in thousands) +Calculation of gross profit (loss) +Revenues $ 310,851 $ 832,937 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 302,157 669,979 +Depreciation (related to cost of revenues) 30,161 47,006 +Amortization of intangibles 16,467 18,367 +Gross profit (loss) $ (37,934) $ 97,585 +Adjusted gross profit reconciliation: +Gross profit (loss) $ (37,934) $ 97,585 +Depreciation (related to cost of revenues) 30,161 47,006 +Amortization of intangibles 16,467 18,367 +Adjusted gross profit $ 8,694 $ 162,958 +47 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash on hand, cash flows from operating activities and, if needed, external borrowings. Our principal uses of cash are to fund capital expenditures and acquisitions, to service our outstanding debt, and to fund our working capital requirements. We may also, from time to time, make open market debt repurchases (including our Senior Notes) when it is opportunistic to do to manage our debt maturity profile. In 2018, we issued $400.0 million of Senior Notes, together with cash on hand and borrowings under the 2018 ABL Credit Facility (as defined below), to fund the Magnum Acquisition as well as fully repay and terminate the term loan borrowings and the outstanding revolving credit commitments under our prior credit facility. For additional information regarding the Senior Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. In the third quarter of 2019, we divested the Production Solutions segment for approximately $17.1 million in cash. We used such proceeds to support working capital requirements and fund a portion of our 2020 capital expenditures. +We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. In addition, our ability to satisfy our liquidity requirements depends on our future operating performance, which is affected by prevailing economic conditions, the level of drilling, completion and production activity for North American onshore oil and natural gas resources, and financial and business and other factors, many of which are beyond our control. In 2020, in response to rapidly deteriorating market conditions driven in large part by the coronavirus pandemic, we implemented certain cost-cutting measures across the organization. We expect to continue to maintain many of these measures, including those relating to employee compensation, and may implement additional cost-cutting measures, as necessary. We can make no assurance regarding our ability to successfully implement such measures, or whether such measures would be sufficient to mitigate a decline in our financial performance. +Our total 2020 capital expenditure budget, excluding possible acquisitions, was between $10.0 million and $15.0 million, and the actual amount of capital expenditures incurred in 2020 was $10.2 million. Our capital expenditure budget for 2021, excluding possible acquisitions, is expected to be between $15.0 million and $20.0 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures and the amount we ultimately spend will depend on a number of factors including expected industry activity levels and company initiatives. +Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a significant part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +At December 31, 2020, we had $68.9 million of cash and cash equivalents and $37.9 million of availability under the 2018 ABL Credit Facility (as defined below), which resulted in a total liquidity position of $106.8 million. As of February 28, 2021, we had approximately $62 million of cash and cash equivalents, which has decreased our total liquidity position. Although we believe our total liquidity position will continue to materially erode, due in large part to interest payments due on the Senior Notes, we believe that, based on our current forecasts, our cash on hand, together with cash flow from operations, and borrowings under the 2018 ABL Credit Facility, should be sufficient to fund our capital requirements for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts, which are materially dependent on our financial performance and the ever-changing market. +Senior Notes +On October 25, 2018, we issued the Senior Notes due 2023 under an indenture, dated as of October 25, 2018 (the “Indenture”), by and among us, including certain of our subsidiaries, and Wells Fargo, National Association, as Trustee. The Senior Notes bear interest at an annual rate of 8.750% payable on May 1 and November 1 of each year, and the first interest payment was due on May 1, 2019. Based on current amounts outstanding as of February 28, 2021, the semi-annual interest payments are $15.2 million each. The Senior Notes are senior unsecured obligations and are fully and unconditionally guaranteed on a senior unsecured basis by each of our current domestic subsidiaries and by certain future subsidiaries. +The Indenture contains covenants that limit our ability and the ability of our restricted subsidiaries to engage in certain activities. We were in compliance with the provisions of the Indenture at December 31, 2020. +48 +Upon an event of default, the trustee or the holders of at least 25% in aggregate principal amount of then outstanding Senior Notes may declare the Senior Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to us, any of our restricted subsidiaries that are a significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding Senior Notes to become due and payable. +We repurchased approximately $53.3 million of Senior Notes at a repurchase price of approximately $14.6 million in cash for the year ended December 31, 2020. Deferred financing costs associated with these transactions were $0.9 million for the year ended December 31, 2020. As a result, for the year ended December 31, 2020, we recorded a $37.8 million gain on the extinguishment of debt, which was calculated as the difference between the repurchase price and the carrying amount of the Senior Notes partially offset by the deferred financing costs. The gain on extinguishment of debt is included as a separate line item in our Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2020. In +addition to repurchases, from time to time, we have explored, and may continue to further consider, transactions to restructure +or refinance a portion of the Senior Notes. Any such transactions may involve the issuance of additional equity or convertible +debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to +holders of our common stock and could contain covenants that will restrict our operations. +For additional information on the Senior Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +2018 ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), that permits aggregate borrowings of up to $200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “2018 ABL Credit Facility”). The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to us and our domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75% to 1.25% and the applicable margin for LIBOR loans or CDOR loans vary from 1.75% to 2.25% in each depending on our leverage ratio. In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below $18.75 million or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. We were in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2020. +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +At December 31, 2020, our availability under the 2018 ABL Credit Facility was approximately $37.9 million, net of outstanding letters of credit of $0.5 million. +49 +Cash Flows +Our cash flows for the years ended December 31, 2020, and 2019 are presented below: +Year Ended December 31, +2020 2019 +(in thousands) +Operating activities $ (4,901) $ 101,305 +Investing activities (1,778) (34,121) +Financing activities (17,385) (37,905) +Impact of foreign exchange rate on cash (61) 95 +Net change in cash and cash equivalents $ (24,125) $ 29,374 +Operating Activities +Net cash used in operating activities was $4.9 million in 2020 compared to $101.3 million in net cash provided by operating activities in 2019. The $106.2 million decrease in net cash provided by operating activities was primarily a result of a $107.5 million decrease in cash flow provided by operations, adjusted for any non-cash items, primarily due to an increase in net loss in 2020 compared to 2019. The overall decrease in net cash provided by operating activities was partially offset by an increase of $1.3 million in cash collections and other changes in working capital which provided an increased source of cash in 2020 in comparison to 2019. +Investing Activities +Net cash used in investing activities was $1.8 million in 2020 compared to $34.1 million in net cash used in investing activities in 2019. The $32.3 million decrease in net cash used in investing activities was primarily related to a decrease of $55.5 million in cash purchases of property and equipment in 2020 in comparison to 2019. The overall decrease was also partly due to an increase in proceeds from sales of property and equipment (including insurance) of $2.3 million in 2020 compared to 2019. The overall decrease in net cash used in investing activities was partially offset by $16.9 million in proceeds from the sale of subsidiaries, $7.6 million in proceeds from notes receivable payments, and $1.0 million proceeds of acquisitions, which we received in 2019 that did not recur in 2020. +Financing Activities +Net cash used in financing activities was $17.4 million in 2020 compared to $37.9 million in net cash used in financing activities in 2019. The $20.5 million decrease in net cash used in financing activities was primarily related to $45.0 million in payments on the 2018 ABL Credit Facility in 2019 that did not recur in 2020. The overall decrease was also partly due to a decrease of $1.5 million in cash used for the vesting of restricted stock in 2020 in comparison to 2019. The overall decrease in net cash used in financing activities was partially offset by $14.6 million of purchases of the Senior Notes and $0.3 million of payments on the Magnum Promissory Notes (as defined in Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report) in 2020 that did not occur in 2019, coupled with $10.0 million in proceeds from the 2018 ABL Credit Facility in 2019 that did not recur in 2020 as well as an additional $1.0 million in payments of contingent liabilities and $0.1 million in payments on finance leases in comparison to 2019. +Contractual Obligations +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide this information. +Off-Balance Sheet Arrangements +At December 31, 2020, we had letters of credit of $0.5 million, which represented off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K. As of December 31, 2020, no liability has been recognized in our Consolidated Balance Sheet for the letters of credit. +Operating leases were excluded from our Consolidated Balance Sheet as of December 31, 2019 but are included in our Consolidated Balance Sheet as of December 31, 2020 following the January 1, 2020 effective date of Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”). For additional information, see “Critical Accounting Policies” below as well as Note 2 – Significant Accounting Policies and Note 6 – Leases in Item 8 of Part II of this Annual Report. +50 +Critical Accounting Policies +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Certain accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. We provide expanded discussion of our more significant accounting policies, estimates, and judgments below. We believe that most of these accounting policies reflect our more significant estimates and assumptions used in preparation of our financial statements. +Emerging Growth Company Status +We are an “emerging growth company” as defined in the JOBS Act. Under Section 107 of the JOBS Act, as an emerging growth company, we are taking advantage of an extended transition period for the adoption of new or revised financial accounting standards, including the reduced reporting requirements and exemptions, and the longer phase-in periods for the adoption of new or revised financial accounting standards, until we are no longer an emerging growth company. Our election to use the longer phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Smaller Reporting Company Status +We are a “smaller reporting company” as defined by the SEC. As such, we are eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. Our disclosures in this Annual Report reflect these scaled requirements. +Revenue Recognition +We recognize revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products are received by a customer’s domestic common carrier at our facility or when the product is received by the customer’s international carrier. We believe this recognition policy reflects the point at which the customer has control of the product as required by ASC 606. +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. We exclude sales taxes, value added taxes, and other taxes we collect concurrent with revenue-producing activities from revenue. +Our revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For domestic product sales, we typically recognize revenue when we meet our performance obligation upon the shipment of the products from our facilities to our customer. For international product sales, we typically recognize revenue when we meet our performance obligation upon receipt of the products by the customer’s international carrier. We recognize service revenue over the time the service is performed as the customer consumes and benefits from the use of our products and services for well service. Service revenues represent revenue recognized over time, as our customer arrangements typically provide agreed upon hourly or daily fixed-rates, and we recognize service revenue based upon the number of hours or days services have been performed. +Contracts for our products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period we stand ready to provide our services to our client as needed. Our payment terms vary by the type and location of our customers and type of product and service offered. We receive cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date we invoice a customer. Since +51 +the period between the delivery of our products and services and our receipt of customer payment for these products and services is not expected to exceed one year, we have elected not to calculate or disclose a financing component for our customer contracts. +Contract Estimates +We receive reimbursements from our customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of our influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. We are considered a principal in these transactions and record the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of our contracts due to the dynamic nature of well operations and the services we provide for our customers. We consider contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of our contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. We classify contract liabilities as unearned income. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For additional information, see Note 2 – Significant Accounting Policies and Note 3 – Revenues in Item 8 of Part II of this Annual Report. +Leases +On December 31, 2020, we adopted ASC 842 effective January 1, 2020. Under ASC 842, we determine if an arrangement is a lease at inception. To the extent that we determine an arrangement represents a lease, we classify that lease as an operating lease or a finance lease. +We capitalize operating leases on our Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that would have been incurred to borrow over a similar term the funds necessary to purchase the leased asset. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2020 and 2019. +Accounting for finance leases under ASC 842 remained unchanged from previous accounting guidance. +For additional information, see Note 2 – Significant Accounting Policies and Note 6 – Leases in Item 8 of Part II of this Annual Report. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful life of the asset. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through +52 +the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income and Comprehensive Income (Loss). +With a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as sharp declines in oil and natural gas prices, the carrying amount of long-lived assets (inclusive of definite-lived intangible assets and property and equipment) associated with our asset groups may not be recoverable. As such, we performed an impairment assessment of long-lived assets in our asset groups under Accounting Standards Codification 360, Property, Plant and Equipment (“ASC 360”) at March 31, 2020, based on our best internal projections and the likelihood of various outcomes. Based on our assessment, we determined that the estimated future undiscounted cash flows derived from long-lived assets associated with our asset groups exceeded the carrying amount of long-lived assets associated with our asset groups, and no impairment to long-lived assets was required. No events triggered additional impairment tests under ASC 360 through December 31, 2020. However, the occurrence of future events or deteriorating market conditions could result in additional impairment assessments under ASC 360 subsequent to December 31, 2020. +In the fourth quarter of 2019, we recorded a property and equipment impairment charge of $66.2 million and a definite-lived customer relationship intangible asset impairment charge of $7.1 million. These impairment charges represent the difference between the carrying value and the estimated fair value of the long-lived assets in our coiled tubing asset group within our Completion Solutions segment and were due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. +For additional information on these impairment charges, see Note 5 – Property and Equipment included in Item 8 of Part II of this Annual Report. +Valuation of Goodwill and Intangible Assets +Goodwill has an indefinite useful life and is not subject to amortization. Intangible assets with indefinite useful lives (specifically trademarks and trade names) are also not subject to amortization. For goodwill and intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Goodwill is reviewed for impairment by comparing the carrying value of each of our reporting unit’s net assets (including allocated goodwill) to the Level 3 fair value of our reporting unit. The Level 3 fair value of our reporting unit is determined by using the income approach (discounted cash flows of forecasted income). Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives (specifically trademarks and trade names) is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. We recognize a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds our reporting unit’s Level 3 fair value. We recognize an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Any impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +53 +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. +In the first quarter of 2020, in connection with an interim goodwill impairment test, we recorded goodwill impairment charges of $296.2 million in our tools, cementing, and wireline reporting units within our Completions Solutions segment due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in our stock price and the Level 2 fair value of our Senior Notes. +In the fourth quarter of 2019, in connection with our annual goodwill impairment test, we recorded a goodwill impairment charge of $20.3 million, in our coiled tubing reporting unit within our Completion Solutions segment. In addition, in the fourth quarter of 2019, in connection with our annual indefinite-lived intangible asset impairment test, we recorded an intangible asset impairment charge of $12.7 million associated with the indefinite-lived trade names in our coiled tubing reporting unit and an intangible asset impairment charge of $95.0 million associated with the indefinite-lived trade names in our completion tools reporting unit, both within our Completion Solutions segment. As described above in “Critical Accounting Policies – Valuation of Long-Lived Assets” and also in the fourth quarter of 2019, we recorded an intangible asset impairment charge of $7.1 million associated with the definite-lived customer relationship intangible assets in our coiled tubing asset group within our Completion Solutions segment. +For additional information on goodwill and both indefinite-lived and definite-lived intangible asset impairment charges, see Note 7 – Goodwill and Intangible Assets included in Item 8 of Part II of this Annual Report. +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. Legal costs are expensed as incurred. +Stock-based Compensation +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in “General and administrative expenses” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Determining Fair Market Value +Fair value of all the options outstanding was measured using the Black-Scholes model. Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – We develop our expected volatility based upon a weighted average volatility of our peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +54 +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Fair value of the stock-based compensation for all of the performance share units outstanding was measured using a Monte Carlo simulation model. +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +55 +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2020 and 2019 +F- 3 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2020 and 2019 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +56 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of income and comprehensive income (loss), of stockholders’ equity and of cash flows for the years then ended, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. +Changes in Accounting Principle +As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2020. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +March 8, 2021 +We have served as the Company’s auditor since 2011. +F-1 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2020 2019 +Assets +Current assets +Cash and cash equivalents $ 68,864 $ 92,989 +Accounts receivable, net 41,235 96,889 +Income taxes receivable 1,392 660 +Inventories, net 38,402 60,945 +Prepaid expenses and other current assets 16,270 17,434 +Total current assets 166,163 268,917 +Property and equipment, net 102,429 128,604 +Operating lease right of use assets, net 36,360 — +Finance lease right of use assets, net 1,816 — +Intangible assets, net 132,524 148,991 +Goodwill — 296,196 +Other long-term assets 3,308 8,187 +Total assets $ 442,600 $ 850,895 +Liabilities and Stockholders’ Equity +Current liabilities +Accounts payable $ 18,140 $ 35,490 +Accrued expenses 17,139 24,730 +Current portion of long-term debt 844 — +Current portion of operating lease obligations 6,200 — +Current portion of finance lease obligations 1,092 995 +Total current liabilities 43,415 61,215 +Long-term liabilities +Long-term debt 342,714 392,059 +Long-term operating lease obligations 32,295 — +Long-term finance lease obligations 1,109 2,201 +Deferred income taxes — 1,588 +Other long-term liabilities 2,658 3,955 +Total liabilities 422,191 461,018 +Commitments and contingencies (Note 12) +Stockholders’ equity +Common stock ( 120,000,000 shares authorized at $ 0.01 par value; 31,557,809 and 30,555,677 shares issued and outstanding at December 31, 2020 and 2019 respectively) +316 306 +Additional paid-in capital 768,429 758,853 +Accumulated other comprehensive loss ( 4,501 ) ( 4,467 ) +Accumulated deficit ( 743,835 ) ( 364,815 ) +Total stockholders’ equity 20,409 389,877 +Total liabilities and stockholders’ equity $ 442,600 $ 850,895 +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2020 2019 +Revenues +Service $ 231,719 $ 646,508 +Product 79,132 186,429 +310,851 832,937 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Service 220,960 528,643 +Product 81,197 141,336 +General and administrative expenses 49,346 81,327 +Depreciation 32,431 50,544 +Amortization of intangibles 16,467 18,367 +Impairment of goodwill 296,196 20,273 +Impairment of intangibles — 114,804 +Impairment of property and equipment — 66,200 +(Gain) loss on revaluation of contingent liabilities 276 ( 21,187 ) +Loss on sale of subsidiaries — 15,896 +Gain on sale of property and equipment ( 2,857 ) ( 538 ) +Loss from operations ( 383,165 ) ( 182,728 ) +Interest expense 36,759 39,770 +Interest income ( 615 ) ( 860 ) +Gain on extinguishment of debt ( 37,841 ) — +Other income ( 62 ) — +Loss before income taxes ( 381,406 ) ( 221,638 ) +Benefit for income taxes ( 2,458 ) ( 3,887 ) +Net loss $ ( 378,948 ) $ ( 217,751 ) +Loss per share +Basic $ ( 12.74 ) $ ( 7.43 ) +Diluted $ ( 12.74 ) $ ( 7.43 ) +Weighted average shares outstanding +Basic 29,744,830 29,308,107 +Diluted 29,744,830 29,308,107 +Other comprehensive income (loss), net of tax +Foreign currency translation adjustments, net of $ 0 tax in each period +$ ( 34 ) $ 376 +Total other comprehensive income (loss), net of tax ( 34 ) 376 +Total comprehensive loss $ ( 378,982 ) $ ( 217,375 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(In thousands, except share amounts) +Common Stock Additional +Paid-in Accumulated +Other +Comprehensive Retained +Earnings +(Accumulated Total +Stockholders’ +Shares Amounts Capital Income (Loss) Deficit) Equity +Stockholders’ equity as of December 31, 2018 30,163,408 $ 302 $ 746,428 $ ( 4,843 ) $ ( 147,064 ) $ 594,823 +Issuance of common stock under stock compensation plan, net of forfeitures 462,622 5 ( 5 ) — — — +Stock-based compensation expense — — 14,057 — — 14,057 +Exercise of stock options 674 — 15 — — 15 +Vesting of restricted stock ( 71,027 ) ( 1 ) ( 1,642 ) — — ( 1,643 ) +Other comprehensive income — — — 376 — 376 +Net loss — — — — ( 217,751 ) ( 217,751 ) +Stockholders’ equity as of December 31, 2019 30,555,677 $ 306 $ 758,853 $ ( 4,467 ) $ ( 364,815 ) $ 389,877 +Cumulative effect adjustment of lease implementation (Note 6) — — — — ( 72 ) ( 72 ) +Issuance of common stock under stock compensation plan, net of forfeitures 1,151,915 11 ( 11 ) — — — +Stock-based compensation expense — — 9,744 — — 9,744 +Vesting of restricted stock ( 149,783 ) ( 1 ) ( 157 ) — — ( 158 ) +Other comprehensive loss — — — ( 34 ) — ( 34 ) +Net loss — — — — ( 378,948 ) ( 378,948 ) +Stockholders’ equity as of December 31, 2020 31,557,809 $ 316 $ 768,429 $ ( 4,501 ) $ ( 743,835 ) $ 20,409 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2020 2019 +Cash flows from operating activities +Net loss $ ( 378,948 ) $ ( 217,751 ) +Adjustments to reconcile net loss to net cash provided by operating activities +Depreciation 32,431 50,544 +Amortization of intangibles 16,467 18,367 +Amortization of operating leases 8,897 — +Amortization of deferred financing costs 2,836 2,984 +Provision for doubtful accounts 2,820 849 +Benefit for deferred income taxes ( 1,588 ) ( 4,327 ) +Provision for inventory obsolescence 8,957 5,148 +Impairment of goodwill 296,196 20,273 +Impairment of intangibles — 114,804 +Impairment of property and equipment — 66,200 +Impairment of operating lease 466 — +Stock-based compensation expense 9,744 14,057 +Gain on extinguishment of debt ( 37,841 ) — +Gain on sale of property and equipment ( 2,857 ) ( 538 ) +(Gain) loss on revaluation of contingent liabilities 276 ( 21,187 ) +Loss on sale of subsidiaries — 15,896 +Changes in operating assets and liabilities, net of effects from acquisitions +Accounts receivable, net 52,914 41,852 +Inventories, net 13,600 22,545 +Prepaid expenses and other current assets 1,368 2,395 +Accounts payable and accrued expenses ( 25,456 ) ( 27,901 ) +Income taxes receivable/payable ( 732 ) ( 294 ) +Other assets and liabilities ( 4,451 ) ( 2,611 ) +Net cash provided by (used in) operating activities ( 4,901 ) 101,305 +Cash flows from investing activities +Acquisitions, net of cash acquired — 1,020 +Proceeds from sale of subsidiaries — 16,914 +Proceeds from sales of property and equipment 6,402 3,702 +Proceeds from property and equipment casualty losses 1,237 1,576 +Proceeds from notes receivable payments — 7,626 +Purchases of property and equipment ( 9,417 ) ( 64,959 ) +Net cash used in investing activities ( 1,778 ) ( 34,121 ) +Cash flows from financing activities +Proceeds from 2018 ABL Credit Facility — 10,000 +Payments on 2018 ABL Credit Facility — ( 45,000 ) +Purchases of Senior Notes ( 14,561 ) — +Payments on Magnum Promissory Notes ( 281 ) — +Payments on finance leases ( 995 ) ( 903 ) +Payments of contingent liabilities ( 1,390 ) ( 374 ) +F-5 +Year Ended December 31, +2020 2019 +Proceeds from exercise of stock options — 15 +Vesting of restricted stock ( 158 ) ( 1,643 ) +Net cash used in financing activities ( 17,385 ) ( 37,905 ) +Impact of foreign currency exchange on cash ( 61 ) 95 +Net increase (decrease) in cash and cash equivalents ( 24,125 ) 29,374 +Cash and cash equivalents +Cash and cash equivalents at beginning of period 92,989 63,615 +Cash and cash equivalents at end of period $ 68,864 $ 92,989 +Supplemental disclosures of cash flow information: +Cash paid for interest $ 34,421 $ 37,376 +Cash paid (refunded) for income taxes $ ( 540 ) $ 517 +Non-cash investing and financing activities: +Termination of contingent liability related to business acquisition $ 3,375 $ — +Capital expenditures in accounts payable and accrued expenses $ 747 $ 10 +Property and equipment obtained by finance leases $ — $ 1,621 +Receivable from property and equipment sale (including insurance) $ 3,223 $ 5,949 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies. The Company is headquartered in Houston, Texas. +Risks and Uncertainties +The Company’s business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. The worldwide coronavirus outbreak in early 2020, which was declared a pandemic by the World Health Organization in March 2020, the uncertainty regarding its impact, and various governmental actions taken to mitigate its impact have resulted in an unprecedented decline in demand for oil. In the midst of the ongoing pandemic, the Organization of the Petroleum Exporting Countries and other oil producing nations, including Russia, were initially unable to reach an agreement on production levels for crude oil, at which point Saudi Arabia and Russia initiated efforts to aggressively increase production. The convergence of these events created the unprecedented dual impact of a massive decline in the demand for oil, coupled with the risk of a substantial increase in supply, which has directly affected the Company. While the Company cannot predict the length of time that market disruptions resulting from the coronavirus pandemic and efforts to mitigate its effects will continue, the ultimate impact on its business, or the pace or extent of any subsequent recovery, the Company expects the coronavirus pandemic and related effects to continue to have a material adverse impact on commodity prices and its business generally. +Historically, the Company has met its liquidity needs principally from cash on hand, cash flow from operations and, if needed, external borrowings. In response to the above events, the Company has implemented certain cost-cutting measures across the organization to continue to maintain its current liquidity position. Based on its current forecasts, the Company believes that cash on hand, together with cash flow from operations, and borrowings under the 2018 ABL Credit Facility (as defined in Note 9 – Debt Obligations), should be sufficient to fund its capital requirements for at least the next twelve months from the issuance date of its consolidated financial statements. +F-7 +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial statements as of December 31, 2020 and 2019, and for the years ended December 31, 2020 and 2019, include the accounts of Nine and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. +Use of Estimates +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include fair value assumptions used in purchase accounting and in analyzing goodwill, definite and indefinite-lived intangible assets, and property and equipment for possible impairment, useful lives used in depreciation and amortization expense, stock-based compensation fair value, estimated realizable value on excess and obsolete inventories, deferred taxes and income tax contingencies, and losses on accounts receivable. It is at least reasonably possible that the estimates used will change within the next year. +Revenue Recognition +The Company recognizes revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products are received by a customer’s domestic common carrier at the Company’s facility or when the product is received by the customer’s international carrier. The Company believes this recognition policy reflects the point at which the customer has control of the product as required by ASC 606. +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company excludes sales taxes, value added taxes, and other taxes it collects concurrent with revenue-producing activities from revenue. +The Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For domestic product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. For international product sales, the Company typically recognizes revenue when it meets its performance obligation upon receipt of the products by the customer’s international carrier. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. Service revenues represent revenue recognized over time, as the Company’s customer arrangements typically provide agreed upon hourly or daily fixed-rates, and the Company recognizes service revenue based upon the number of hours or days services have been performed. +Contracts for the Company’s products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period the Company stands ready to provide its services to its client as needed. +The Company’s payment terms vary by the type and location of its customers and type of product and service offered. The Company receives cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date the Company invoices a customer. Since the period between the delivery of the Company’s products and services and the Company’s receipt of customer payment for these products and services is not expected to exceed one year, the Company has elected not to calculate or disclose a financing component for its customer contracts. +F-8 +Contract Estimates +The Company receives reimbursements from its customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of the Company’s influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. The Company is considered a principal in these transactions and records the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of the Company’s contracts due to the dynamic nature of well operations and the services the Company provides for its customers. The Company considers contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of the Company’s contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Any contract assets are included in “Accounts receivable, net” in the Company’s Consolidated Balance Sheets. Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. The Company classifies contract liabilities as unearned income which is included in “Accrued expenses” in the Company’s Consolidated Balance Sheets. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For information regarding the Company’s revenue, see Note 3 – Revenues . +Leases +On December 31, 2020, the Company adopted Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”) effective January 1, 2020. Prior to January 1, 2020, the Company accounted for leases under Accounting Standards Codification 840 (“ASC 840”). All periods, including quarterly periods, previously reported under ASC 840 will continue to be reported under ASC 840, and periods beginning December 31, 2020 and after are reported under ASC 842. +The Company determines if an arrangement is a lease at inception. To the extent an arrangement represents a lease, the Company classifies that lease as an operating lease or a finance lease. +The Company capitalizes operating leases on its Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that the Company would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2020. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2020 and 2019. +Accounting for finance leases under ASC 842 remained unchanged from previous accounting guidance and are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2020 and in the line items “Property and equipment, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2019. +For additional information regarding the Company’s leases, see Note 6 – Leases. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not +F-9 +necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the United States Dollar (“USD”). The financial position and results of operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) and its Consolidated Statements of Changes in Stockholders’ Equity. +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus, receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices, industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +The Company had $ 41.2 million and $ 96.9 million of “Accounts receivable, net” at December 31, 2020 and 2019, respectively. The Company maintains an allowance for doubtful accounts based on the expected collectability of accounts receivable, which is included in “Accounts receivable, net” on the Company’s Consolidated Balance Sheets. The Company had an allowance for doubtful accounts of $ 3.4 million and $ 0.8 million at December 31, 2020 and 2019, respectively. Bad debt expense was $ 2.8 million and $ 0.8 million for the years ended December 31, 2020 and 2019, respectively. +Concentration of Credit Risk +The Company derives a significant portion of its revenues from companies in the exploration and production (“E&P”) industry, and its customer base includes a broad range of integrated and independent domestic E&P companies and international E&P companies operating in the markets that the Company serves. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and can therefore negatively impact spending by the Company’s customers. One customer accounted for more than 10% of the revenues for the year ended December 31, 2020. No customer accounted for more than 10% of revenues for the year ended December 31, 2019. +Concentration of Supplier Risk +Purchases during the years ended December 31, 2020 and 2019 did not include purchases from any supplier that individually represented more than 10% of total operating purchases. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the assets. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying +F-10 +amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +With a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as sharp declines in oil and natural gas prices, the carrying amount of long-lived assets (inclusive of definite-lived intangible assets and property and equipment) associated with the Company’s asset groups may not be recoverable. As such, the Company performed an impairment assessment of long-lived assets in its asset groups under Accounting Standards Codification 360, Property, Plant and Equipment (“ASC 360”) at March 31, 2020, based on its best internal projections and the likelihood of various outcomes. Based on its assessment, the Company determined that the estimated future undiscounted cash flows derived from long-lived assets associated with its asset groups exceeded the carrying amount of long-lived assets associated with its asset groups, and no impairment to long-lived assets was required. No events triggered additional impairment tests under ASC 360 through December 31, 2020. However, the occurrence of future events or deteriorating market conditions could result in additional impairment assessments under ASC 360 subsequent to December 31, 2020. +In the fourth quarter of 2019, the Company recorded a property and equipment impairment charge of $ 66.2 million and a definite-lived customer relationship intangible asset impairment charge of $ 7.1 million. These impairment charges represent the difference between the carrying value and the estimated fair value of the long-lived assets in the Company’s coiled tubing asset group within its Completion Solutions segment and were due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. For additional information on these impairment charges, see Note 5 – Property and Equipment. +Valuation of Goodwill and Intangible Assets +Goodwill has an indefinite useful life and is not subject to amortization. Intangible assets with indefinite useful lives (specifically trademarks and trade names) are also not subject to amortization. For goodwill and intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Goodwill is reviewed for impairment by comparing the carrying value of each of the Company’s reporting unit’s net assets (including allocated goodwill) to the Level 3 fair value of the reporting unit. The Level 3 fair value of the reporting unit is determined by using the income approach (discounted cash flows of forecasted income). Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives (specifically trademarks and trade names) is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds the reporting unit’s Level 3 fair value. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Any impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in +F-11 +circumstances indicate that their carrying amount may not be recoverable. +In the first quarter of 2020, in connection with an interim goodwill impairment test, the Company recorded goodwill impairment charges of $ 296.2 million in its tools, cementing, and wireline reporting units within its Completion Solutions segment due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in the Company’s stock price and the Level 2 fair value of its Senior Notes (as defined in Note 9 – Debt Obligations). +In the fourth quarter of 2019, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $ 20.3 million in its coiled tubing reporting unit within its Completion Solutions segment. In addition, in the fourth quarter of 2019, in connection with its annual indefinite-lived intangible asset impairment test, the Company recorded an intangible asset impairment charge of $ 12.7 million associated with the indefinite-lived trade names in its coiled tubing reporting unit and an intangible asset impairment charge of $ 95.0 million associated with the indefinite-lived trade names in its completion tools reporting unit, both within its Completion Solutions segment. As described above in “Valuation of Long-Lived Assets” and also in the fourth quarter of 2019, the Company recorded an intangible asset impairment charge of $ 7.1 million associated with the definite-lived customer relationship intangible assets in its coiled tubing asset group within its Completion Solutions segment. +For additional information on goodwill and both indefinite-lived and definite-lived intangible asset impairment charges, see Note 7 – Goodwill and Intangible Assets. +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. As a result of the adoption of ASU No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Restricted Stock and Restricted Stock Units +Compensation expense is recorded for restricted stock and restricted stock units over the applicable vesting period based on the Company’s closing stock price as of the grant date. +Performance Units +Performance stock units are recorded at their fair value and expensed over their performance period. Fair value for performance stock units is measured using a Monte Carlo simulation model. +Options +Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +• The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +• Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company developed its expected volatility based upon a weighted average volatility of its peer group. +• At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +• The risk-free interest rate is based on United States’ Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +F-12 +Income Taxes +The Company accounts for income taxes under Accounting Standards Codification 740, Income Taxes (“ASC 740”) . Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 9 – Debt Obligations. +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 12 – Commitments and Contingencies. +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, taking into effect, if any, the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as potentially dilutive restricted stock, restricted stock units, and performance stock units. There was no dilutive effect for the year ended December 31, 2020 and 2019 as the Company was in a net loss position for those years. For additional information on earnings (loss) per share, see Note 14 – Earnings (Loss) Per Share. +Accounting Pronouncements Recently Adopted +In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. ASU 2016-02 was subsequently amended by multiple ASUs. Together, these ASUs establish a ROU model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. Effective January 1, 2020, the Company adopted ASC 842. Prior to January 1, 2020, the Company accounted +F-13 +for leases under ASC 840. All periods, including quarterly periods, previously reported under ASC 840 will continue to be reported under ASC 840, and periods beginning December 31, 2020 and after are reported under ASC 842. For additional information about the Company’s adoption of ASC 842, see Note 6 – Leases. +In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement , which eliminates, adds, and modifies certain disclosure requirements for fair value measurements as part of its disclosure framework project. The standard is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The standard is required to be applied retrospectively, except the new Level 3 disclosure requirements are applied prospectively. The Company adopted ASU 2018-13 in the first quarter of 2020, and it did not have a material impact on the Company’s consolidated financial statements. +Accounting Pronouncements Not Yet Adopted +In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , which provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. The amendments in ASU 2020-04 are effective for all entities as of March 12, 2020 through December 31, 2022. An entity may elect to apply the amendments for contract modifications as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. The Company is currently evaluating the impact of the standard on its consolidated financial statements. +In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 provides additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. The amendments in ASU 2018-15 align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Costs for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post implementation stages are expensed as the activities are performed. ASU 2018-15 is effective for public businesses for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and plans, to adopt the new standard for fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021. The Company is currently evaluating the impact of the standard on its consolidated financial statements. +In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in ASU 2016-13 replace the current incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information. ASU 2016-13 is effective for Securities and Exchange Commission filers, excluding smaller reporting companies, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and plans, to adopt the new standard for the fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company is currently evaluating the impact of the standard on its consolidated financial statements. +3. Revenues +Disaggregation of Revenues +The Company adopted ASC 606 on December 31, 2019, effective January 1, 2019, using the modified retrospective method. Accordingly, results for the year ended December 31, 2019 and periods thereafter are presented in accordance with ASC 606 while prior period results, including those presented below for the year ended December 31, 2019, have not been adjusted and are reported under the previous revenue recognition guidance. +F-14 +Disaggregated revenue for the years ended December 31, 2020 and 2019 was as follows: +Year Ended December 31, 2020 +Completion Solutions +Production Solutions (2) +Total +(in thousands) +Cement $ 102,631 $ — $ 102,631 +Tools 79,132 — 79,132 +Wireline 81,684 — 81,684 +Coiled tubing 47,404 — 47,404 +Well service — — — +Total revenues $ 310,851 $ — $ 310,851 +Year Ended December 31, 2019 +Completion Solutions +Production Solutions (2) +Total +(in thousands) +Cement $ 217,893 $ — $ 217,893 +Tools 186,429 — 186,429 +Wireline 235,800 — 235,800 +Coiled tubing 134,543 — 134,543 +Well service — 58,272 58,272 +Total revenues $ 774,665 $ 58,272 $ 832,937 +Year Ended December 31, 2020 +Completion Solutions +Production Solutions (2) +Total +(in thousands) +Service (1) +$ 231,719 $ — $ 231,719 +Product (1) +79,132 — 79,132 +Total $ 310,851 $ — $ 310,851 +Year Ended December 31, 2019 +Completion Solutions +Production Solutions (2) +Total +(in thousands) +Service (1) +$ 588,236 $ 58,272 $ 646,508 +Product (1) +186,429 — 186,429 +Total $ 774,665 $ 58,272 $ 832,937 +(1) The Company recognizes revenues from the sales of products at a point in time and revenues from the sales of services over time. +(2) The Production Solutions segment was sold to Brigade Energy Service LLC (“Brigade”) on August 30, 2019. For additional information on the Production Solutions divestiture, see Note 16 – Segment Information. +Performance Obligations +At December 31, 2020 and December 31, 2019, the amount of remaining performance obligations were not material. +Contract Balances +At December 31, 2020 and December 31, 2019, contract assets and contract liabilities were not material. +F-15 +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $ 13.3 million and $ 5.4 million at December 31, 2020 and 2019, respectively. +Inventories, net as of December 31, 2020 and 2019 were comprised of the following: +December 31, +2020 2019 +(in thousands) +Raw materials $ 33,361 $ 38,823 +Work in progress 367 — +Finished goods 17,952 27,555 +Inventories 51,680 66,378 +Reserve for obsolescence ( 13,278 ) ( 5,433 ) +Inventories, net $ 38,402 $ 60,945 +5. Property and Equipment +Property and equipment amounts as of December 31, 2020 and 2019 were as follows: +December 31, +Estimated +Useful Lives 2020 2019 +(in thousands) +Operating equipment +1 to 12 years +$ 296,491 $ 293,237 +Autos and trucks +1 to 7 years +4,102 15,053 +Furniture, fixtures, and equipment +2 to 12 years +4,100 4,054 +Shop equipment +3 to 15 years +13,558 16,144 +Buildings +7 to 39 years +8,489 7,991 +Leasehold improvements +3 to 11 years +1,320 1,653 +Land indefinite 791 791 +328,851 338,923 +Less: Accumulated depreciation ( 226,422 ) ( 210,319 ) +Property and equipment, net $ 102,429 $ 128,604 +Depreciation expense was $ 32.4 million and $ 50.5 million for the years ended December 31, 2020 and 2019, respectively. +With a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as sharp declines in oil and natural gas prices, the carrying amount of long-lived assets (inclusive of definite-lived intangible assets and property and equipment) associated with the Company’s asset groups may not be recoverable. As such, the Company performed an impairment assessment of long-lived assets in its asset groups under ASC 360 at March 31, 2020, based on its best internal projections and the likelihood of various outcomes. Based on its assessment, the Company determined that the estimated future undiscounted cash flows derived from long-lived assets associated with its asset groups exceeded the carrying amount of long-lived assets associated with its asset groups, and no impairment to long-lived assets was required. No events triggered additional impairment tests under ASC 360 through December 31, 2020. However, the occurrence of future events or deteriorating market conditions could result in additional impairment assessments under ASC 360 subsequent to December 31, 2020. +F-16 +2019 Property and Equipment Impairment +With a recent decline in exploration and production capital budgets and activity, coupled with an over-supply of new coiled tubing units, the demand for coiled tubing during the drill-out phase of the overall completions process diminished in the fourth quarter of 2019, shrinking the overall coiled tubing market. Additionally, in the fourth quarter of 2019, dissolvable plug technology became more widely adopted by operators, which significantly reduced and will potentially eliminate the need for coiled tubing drill-outs. This weakened market outlook indicated that the carrying amount of long-lived assets in the Company’s coiled tubing asset group within its Completion Solutions segment might not have been recoverable. As such, the Company performed an impairment assessment of all long-lived assets in its coiled tubing asset group within its Completion Solutions segment under ASC 360 at December 31, 2019. Based on this assessment, which was in consideration of its best internal projections, the Company determined that the carrying amount of long-lived assets in its coiled tubing reporting asset group within its Completion Solutions segment exceeded the estimated future undiscounted cash flows derived from its coiled tubing asset group’s long-lived assets. As such, the Company determined the fair value of the long-lived assets in its coiled tubing asset group within its Completion Solutions segment using the market approach (consideration of market sales values for similar assets). Based on its fair value determination, the Company recorded an impairment charge of $ 66.2 million related to property and equipment in its coiled tubing asset group within its Completion Solutions segment and an impairment charge of $ 7.1 million related to definite-lived customer relationship intangible assets in its coiled tubing asset group within its Completion Solutions segment. The property and equipment impairment charge is included in the line item “Impairment of property and equipment” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2019, and the definite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2019. The total impairment charge represents the difference between the carrying value and the estimated fair value of the long-lived assets in the Company’s coiled tubing asset group within its Completion Solutions segment and was allocated across the long-lived asset classifications in its coiled tubing asset group within its Completion Solutions segment. +6. Leases +Implementation of ASC 842 +On December 31, 2020, the Company adopted ASC 842 with an effective date of January 1, 2020. The Company took advantage of various practical expedients provided by ASC 842, including: +• use of the transition package of practical expedients which, among other things, allows the Company to carry forward the historical lease classification for existing leases; +• making an accounting policy election for leases with an initial term of 12 months or less to be excluded from the Consolidated Balance Sheets; and +• electing to not separate non-lease components from lease components for all classes of underlying lease assets. +Prior to January 1, 2020, the Company accounted for leases under ASC 840. All periods previously reported under ASC 840 will continue to be reported under ASC 840, and periods beginning December 31, 2020 and after are reported under ASC 842. +The adoption of ASC 842 resulted in the recording of net operating lease right of use assets of approximately $ 42.8 million and operating lease obligations of approximately $ 44.1 million as of January 1, 2020. The cumulative effect on retained earnings was not material. The adoption of ASC 842 did not materially affect the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2020. +Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Company’s Consolidated Balance Sheets. Lease with an initial term greater than 12 months are recognized in the Company’s Consolidated Balance Sheets based on lease classification as either operating or financing. Some of the Company’s lease agreements include lease and non-lease components for which the Company has elected to not separate for all classes of underlying assets. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may sublease its real estate to third parties, subject to certain provision of the lease, when it has no future use for the property. +F-17 +Operating Leases +As a lessee, the Company’s operating lease portfolio primarily consists of operating leases for equipment, vehicles, office space, yard facilities, and employee housing. Operating lease ROU assets and operating lease obligations are recognized based on the present value of the future minimum lease payments at commencement date. As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate based on the lease information available at the commencement date in determining the present value of future payments. The incremental borrowing rate utilized is based upon the interest rate associated with the Company’s 2018 ABL Credit Facility (as defined in Note 9 – Debt Obligations) which is utilized to fund its working capital needs and planned capital expenditures. The Company’s leases have remaining terms of one to ten years and may include options to extend or terminate the lease. The operating lease ROU assets also include any upfront lease payments made and exclude lease incentives and initial direct costs incurred. +The Company leases most of these properties under long-term (greater than one year) non-cancelable term leases many of which contain renewal options that can extend the lease term from one to five years and some of which contain escalation clauses. The Company may also enter into short-term or month-to-month operating leases. Options to renew these leases are generally not considered reasonably certain to be exercised due to the nature of the Company’s operations and the markets it serves. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease. +The Company also leases supplemental equipment, typically under cancellable short-term contracts which are less than 30 days. This equipment is typically required for a specific project and for a short duration. Due to the nature of the Company’s operations, any option to renew these short-term leases is generally not considered reasonably certain to be exercised. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease, and the lease payments during these periods are similarly excluded from the calculation of operating lease asset and lease obligation balances. +Operating lease expense consists of rent expense related to leases that were included in ROU assets under ASC 842. The Company recognizes operating lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable operating lease payments typically include charges for property taxes and insurance, and some leases contain variable payments related to non-lease components, including common area maintenance and usage of facilities or office equipment (for example, copiers). The Company does not have variable expenses. +Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2020. +Finance Leases +Finance leases are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2020 and in the line items “Property and equipment, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheet as of December 31, 2019. +Additional Information +The following table summarizes the components of the Company’s lease expense recognized for the year ended December 31, 2020, excluding variable lease and prepaid rent costs: +Year Ended December 31, 2020 +(in thousands) +Operating lease expense +Operating lease right of use assets $ 8,897 +Operating lease non right of use assets 5,795 +Total operating lease expense $ 14,692 +Finance lease expense +Depreciation of right of use assets $ 321 +Interest on lease obligations 257 +Total finance lease expense $ 578 +Total rent expense for all operating leases was approximately $ 11.5 million for the year ended December 31, 2019. +F-18 +Operating lease expense is included in the line items “Cost of revenues” and “General and administrative expenses” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2020 and 2019. +Supplemental information related to leases was as follows as of December 31, 2020: +December 31, 2020 +Operating leases +Weighted average remaining lease term 7.0 +Weighted average discount rate 5.0 % +Finance leases +Weighted average remaining lease term 2.0 +Weighted average discount rate 9.3 % +Supplemental balance sheet information related to leases was as follows as of December 31, 2020: +December 31, 2020 +(in thousands) +Operating lease right of use assets +Operating lease right of use assets, gross $ 43,061 +Less: Accumulated amortization ( 6,701 ) +Operating lease right of use assets, net $ 36,360 +Operating lease obligations +Current portion of operating lease obligations $ 6,200 +Long-term operating lease obligations 32,295 +Total operating lease obligations $ 38,495 +Finance lease right of use assets +Finance lease right of use assets, gross $ 2,952 +Less: Accumulated depreciation ( 1,136 ) +Finance lease right of use assets, net $ 1,816 +Finance lease obligations +Current portion of finance lease obligations $ 1,092 +Long-term finance lease obligations 1,109 +Total finance lease obligations $ 2,201 +F-19 +Future annual minimum lease payments as of December 31, 2020 were as follows: +Operating Lease Right of Use Obligations Finance Leases Total +(in thousands) +2021 $ 7,947 $ 1,253 $ 9,200 +2022 6,757 1,098 7,855 +2023 6,500 66 6,566 +2024 5,066 — 5,066 +2025 4,481 — 4,481 +Thereafter 15,050 — 15,050 +Total lease payments $ 45,801 $ 2,417 $ 48,218 +Less: present value discount ( 7,306 ) ( 216 ) ( 7,522 ) +Present value of lease obligations $ 38,495 $ 2,201 $ 40,696 +Future annual minimum lease payments as of December 31, 2019 were as follows (in thousands): +2020 $ 10,597 +2021 8,504 +2022 7,485 +2023 6,649 +2024 4,470 +Thereafter 17,105 +Total lease payments $ 54,810 +Supplemental cash flow information related to leases was as follows for the year ended December 31, 2020: +Year Ended December 31, 2020 +(in thousands) +Cash paid for amounts included in the measurement of lease obligations: +Operating cash flows from operating leases $ 8,592 +Operating cash flows from finance leases $ 321 +Financing cash flows from finance leases $ ( 995 ) +Right of use assets obtained in exchange for lease obligations: +Operating leases $ 1,099 +F-20 +7. Goodwill and Intangible Assets +Goodwill +The changes in the net carrying amount of the components of goodwill for the years ended December 31, 2020 and 2019 were as follows: +Goodwill +Gross Value Accumulated Impairment Loss Net +(in thousands) +Balance as of December 31, 2018 $ 400,067 $ ( 92,263 ) $ 307,804 +Purchase price adjustments (1) +8,665 — 8,665 +Impairment — ( 20,273 ) ( 20,273 ) +Balance as of December 31, 2019 $ 408,732 $ ( 112,536 ) $ 296,196 +Impairment — ( 296,196 ) ( 296,196 ) +Balance as of December 31, 2020 $ 408,732 $ ( 408,732 ) $ — +(1) The Company recorded adjustments to the fair value of goodwill in relation to its 2018 purchase of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum” and such acquisition, the “Magnum Acquisition”). +Goodwill by segment for the years ended December 31, 2020 and 2019 was as follows: +Completion Solutions +2020 2019 +(in thousands) +Balance as of January 1, $ 296,196 $ 307,804 +Additions — — +Purchase price adjustments (1) +— 8,665 +Impairment ( 296,196 ) ( 20,273 ) +Balance as of December 31, $ — $ 296,196 +(1) The Company recorded adjustments to the fair value of goodwill in relation to the Magnum Acquisition. +Historically, the Company performed its annual goodwill impairment test on December 31 or when there was an indication an impairment may have occurred. +2020 Goodwill Impairment +With a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as, sharp declines in oil and natural gas prices, the outlook for expected future cash flows associated with the Company’s reporting units decreased dramatically in the first quarter of 2020. Based on these events, an indication of impairment associated with the Company’s reporting units occurred, triggering an interim goodwill impairment test of the Level 3 fair value of each reporting unit under Accounting Standards Codification 350, Intangibles - Goodwill and Other (“ASC 350”) at March 31, 2020. +As such, based on its Level 3 fair value determination in connection with the interim goodwill impairment test under ASC 350, the Company recorded goodwill impairment charges of $ 296.2 million in the first quarter of 2020 associated with its tools, cementing, and wireline reporting units. These charges represented a full write-off of goodwill and were due to the events described above, coupled with an increased weighted average cost of capital driven by a reduction in the Company’s stock price and the Level 2 fair value of its Senior Notes (as defined in Note 9 – Debt Obligations). These goodwill impairment charges are included in the line item “Impairment of goodwill” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2020. +F-21 +2019 Goodwill Impairment +With a recent decline in exploration and production capital budgets and activity, coupled with an over-supply of new coiled tubing units, the demand for coiled tubing during the drill-out phase of the overall completions process diminished in the fourth quarter of 2019, shrinking the overall coiled tubing market. Additionally, in the fourth quarter of 2019, dissolvable plug technology became more widely adopted by operators, which significantly reduced and will potentially eliminate the need for coiled tubing drill-outs. As a consequence, the outlook for expected future cash flows in the Company’s coiled tubing reporting unit within its Completion Solutions segment reduced as the coiled tubing reporting unit’s carrying value exceeded its estimated Level 3 fair value. As such, in the fourth quarter of 2019, in connection with its annual goodwill impairment test, the Company recorded a goodwill impairment charge of $ 20.3 million in its coiled tubing reporting unit within its Completion Solutions segment. This goodwill impairment charge is included in the line item “Impairment of goodwill” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2019. +Intangible Assets +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2020 and 2019 were as follows: +2020 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 38,084 ) $ 25,186 5.5 +Non-compete agreements 6,500 ( 5,366 ) 1,134 2.8 +Technology 125,110 ( 19,906 ) 105,204 12.7 +In-process research and development 1,000 — 1,000 Indefinite +Total $ 195,880 $ ( 63,356 ) $ 132,524 +2019 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 30,734 ) $ 32,536 6.0 +Non-compete agreements 6,500 ( 4,966 ) 1,534 3.8 +Technology 125,110 ( 11,189 ) 113,921 13.6 +In-process research and development 1,000 — 1,000 Indefinite +Total $ 195,880 $ ( 46,889 ) $ 148,991 +2019 Indefinite-Lived Intangible Asset Impairment +With a recent decline in exploration and production capital budgets and activity, coupled with an over-supply of new coiled tubing units, the demand for coiled tubing during the drill-out phase of the overall completions process diminished in the fourth quarter of 2019, shrinking the overall coiled tubing market. Additionally, in the fourth quarter of 2019, dissolvable plug technology became more widely adopted by operators, which significantly reduced and will potentially eliminate the need for coiled tubing drill-outs. As a consequence, the outlook for expected future cash flows attributed to indefinite-lived trade names associated with the Company’s coiled tubing reporting unit within its Completion Solutions segment reduced as the trade names’ carrying value exceeded its estimated fair value. In addition, in the fourth quarter of 2019, the Company changed its marketing strategy and began the process of transitioning certain Magnum trade names to the Company’s trade names in order to better funnel and allocate resources, create a stronger identity, facilitate cross-selling, and streamline and simplify communication with existing customers. As a consequence, the outlook for expected future cash flows attributed to indefinite-lived trade names in the Company’s completion tools reporting unit within its Completion Solutions segment also reduced as the trade names’ carrying value exceeded its estimated fair value. As such, in the fourth quarter of 2019, in connection with its annual indefinite-lived intangible asset impairment test, the Company recorded an intangible asset impairment charge of $ 12.7 million associated with the indefinite-lived trade names in its coiled tubing reporting unit and an intangible asset impairment charge of $ 95.0 million associated with the indefinite-lived trade names in its completion tools reporting unit, both within its Completion Solutions segment. These indefinite-lived intangible asset impairment charges are included in the line item +F-22 +“Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2019. +2019 Definite-Lived Intangible Asset Impairment +In the fourth quarter of 2019, the Company also recorded an impairment charge of $ 7.1 million related to definite-lived customer relationship intangible assets in its coiled tubing asset group within its Completion Solutions segment. This definite-lived intangible asset impairment charge is included in the line item “Impairment of intangibles” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2019. For additional information on this definite-lived impairment charge, see Note 5 – Property and Equipment. +Amortization of Intangibles +Amortization of intangibles was $ 16.5 million and $ 18.4 million for the years ended December 31, 2020 and 2019, respectively. +Future estimated amortization of intangibles is as follows: +Year Ending December 31, (in thousands) +2021 $ 16,116 +2022 13,463 +2023 11,516 +2024 11,183 +2025 11,183 +Thereafter 68,063 +$ 131,524 +8. Accrued Expenses +Accrued expenses as of December 31, 2020 and 2019 consisted of the following: +December 31, +2020 2019 +(in thousands) +Accrued compensation and benefits $ 5,430 $ 7,009 +Accrued interest 5,313 6,091 +Accrued bonus — 5,043 +Other accrued expenses 6,396 6,587 +Accrued expenses $ 17,139 $ 24,730 +9. Debt Obligations +The Company’s debt obligations as of December 31, 2020 and 2019 were as follows: +December 31, +2020 2019 +(in thousands) +Senior Notes $ 346,668 $ 400,000 +2018 ABL Credit Facility — — +Magnum Promissory Notes 1,969 — +Total debt before deferred financing costs $ 348,637 $ 400,000 +Deferred financing costs ( 5,079 ) ( 7,941 ) +Total debt $ 343,558 $ 392,059 +Less: Current portion of long-term debt ( 844 ) — +Long-term debt $ 342,714 $ 392,059 +F-23 +Senior Notes +Background +On October 25, 2018, the Company issued $ 400.0 million principal amount of 8.750 % Senior Notes due 2023 (the “Senior Notes”). The Senior Notes were issued under an indenture, dated as of October 25, 2018 (the “Indenture”), by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as Trustee. The Senior Notes bear interest at an annual rate of 8.750 % payable on May 1 and November 1 of each year, and the first interest payment was due on May 1, 2019. The Senior Notes are senior unsecured obligations of the Company and are fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s current domestic subsidiaries and by certain future subsidiaries. +The Indenture contains covenants that limit the Company’s ability and the ability of its restricted subsidiaries to engage in certain activities. The Company was in compliance with the provisions of the Indenture at December 31, 2020. +Upon an event of default, the trustee or the holders of at least 25 % in aggregate principal amount of then outstanding Senior Notes may declare the Senior Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any restricted subsidiary of the Company that is a significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding Senior Notes to become due and payable. +Unamortized deferred financing costs associated with the Senior Notes were $ 5.1 million and $ 7.9 million at December 31, 2020 and 2019, respectively. These costs are direct deductions from the carrying amount of the Senior Notes and are being amortized through interest expense through the maturity date of the Senior Notes using the effective interest method. +Extinguishment of Debt +The Company repurchased approximately $ 53.3 million of Senior Notes at a repurchase price of approximately $ 14.6 million in cash for the year ended December 31, 2020. Deferred financing costs associated with these transactions were $ 0.9 million for the year ended December 31, 2020. As a result, for the year ended December 31, 2020, the Company recorded a $ 37.8 million gain on the extinguishment of debt, which was calculated as the difference between the repurchase price and the carrying amount of the Senior Notes partially offset by the deferred financing costs. The gain on extinguishment of debt is included as a separate line item in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2020 . +2018 ABL Credit Facility +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A. as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permits aggregate borrowings of up to $ 200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $ 25.0 million and a sub-limit of $ 50.0 million for letters of credit (the “2018 ABL Credit Facility”). The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75 % to 1.25 % and the applicable margin for LIBOR loans or CDOR loans vary from 1.75 % to 2.25 %, in each depending on the Company’s leverage ratio. In addition, a commitment fee of 0.50 % per annum will be charged on the average daily unused portion of the revolving commitments. +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below $ 18.75 million or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. The Company was in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2020. +F-24 +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +At December 31, 2020, the Company’s availability under the 2018 ABL Credit Facility was approximately $ 37.9 million, net of outstanding letters of credit of $ 0.5 million. +Magnum Promissory Notes +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018 (as amended on June 7, 2019, the “Magnum Purchase Agreement”), the Company acquired all of the equity interests of Magnum. The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019 (the “Magnum Earnout”). +On June 30, 2020, pursuant to an amendment to the Magnum Purchase Agreement to terminate the remaining Magnum Earnout and all obligations related thereto (the “Magnum Purchase Agreement Amendment”), the Company issued promissory notes with an aggregated principal amount of $ 2.3 million (the “Magnum Promissory Notes”) to the sellers of Magnum. The Magnum Promissory Notes bear interest at a rate of 6.0 % per annum. The principal amount of the Magnum Promissory Notes will be paid in equal quarterly installments beginning January 1, 2021. The entire unpaid principal amount will be due and payable on the maturity date, which is the earlier of October 1, 2022 and the business day after the date on which the Company sells, transfers or otherwise disposes of the “E-Set” tools business to an unaffiliated third party, unless such sale, transfer or disposition is made, directly or indirectly, as part of the sale, transfer or disposition of the Dissolvable Plugs Business or due to the occurrence of a Change of Control Event (each as defined in the Magnum Purchase Agreement). +For additional information regarding the termination of the Magnum Earnout, see Note 12 – Commitments and Contingencies. +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2020 and 2019 was as follows: +December 31, +2020 2019 +(in thousands) +Senior Notes $ 156,001 $ 324,000 +2018 ABL Credit Facility $ — $ — +Magnum Promissory Notes $ 1,969 $ — +The fair value of the Senior Notes, 2018 ABL Credit Facility, and the Magnum Promissory Notes is classified as Level 2 in the fair value hierarchy. The fair value of the Senior Notes is established based on observable inputs in less active markets. The fair value of the 2018 ABL Credit Facility and the Magnum Promissory Notes approximates their carrying value. +10. Defined Contribution Plans +Background +Nine and Magnum sponsored defined contribution plans under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +Effective January 1, 2019, under the Nine Energy Service 401(k) Plan (the “Nine Plan”), employee contributions were matched by the Company at 100 % of the first 5 % of the participant’s eligible compensation . Effective April 1, 2019, the Magnum Oil Tools International Ltd. Profit Sharing & 401(k) Plan (the “Magnum Plan”) merged with the Nine Plan. Prior to the merger, under the Magnum Plan, the Company had matched employee contributions at 100 % of the first 3 % and 50 % of the remaining up to 5 % of the participant’s eligible compensation. +Effective April 25, 2020, Nine suspended its matching contributions for employees. +F-25 +Contributions +For the year ended December 31, 2020, the Company made employer contributions of $ 1.4 million under the Nine Plan. +For the year ended December 31, 2019, the Company made employer contributions of $ 4.8 million under the Nine Plan and no contributions under the Magnum Plan +11. Stock-based Compensation +Stock Options +Information about stock option activity during the years ended December 31, 2020 and 2019 was as follows: +2020 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 816,427 $ 32.51 5.8 $ — +Granted — — — — +Exercised — — — — +Forfeited ( 466 ) 31.18 — — +Expired ( 113,419 ) 31.78 — — +Total outstanding 702,542 $ 32.63 4.5 $ — +Options exercisable 702,542 $ 32.63 4.5 $ — +2019 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 957,659 $ 31.98 6.9 $ 6 +Granted — — — — +Exercised ( 674 ) 22.63 — 2 +Forfeited ( 28,050 ) 30.18 — — +Expired ( 112,508 ) 28.66 — — +Total outstanding 816,427 $ 32.51 5.8 $ — +Options exercisable 704,944 $ 32.99 5.5 $ — +The intrinsic value at December 31, 2020 and 2019 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2020 and 2019, respectively. +The Company granted no options in 2020 and 2019. +Compensation expense recorded was approximately $ 0.3 million and $ 1.8 million for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, there is no remaining compensation expense related to options for the Company to expense. Future stock option grants will result in additional compensation expense. +F-26 +Restricted Stock and Restricted Stock Units +Information about restricted stock and restricted stock unit activity during the years ended December 31, 2020 and 2019 was as follows: +2020 2019 +Nonvested at January 1, 1,208,625 1,017,945 +Granted 1,383,059 666,173 +Vested ( 641,658 ) ( 292,326 ) +Cancelled ( 235,628 ) ( 183,167 ) +Nonvested at December 31, 1,714,398 1,208,625 +The weighted-average grant date fair value of the restricted stock and restricted stock units granted was $ 0.85 and $ 22.31 during the years ended December 31, 2020 and 2019, respectively. The total amount of compensation expense related to the restricted stock and restricted stock units recorded was approximately $ 9.0 million and $ 11.7 million for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, the Company expects to record compensation expense related to restricted stock and restricted stock units of approximately $ 5.5 million over the remaining term of approximately 1.2 years. Future restricted stock and restricted stock unit grants will result in additional compensation expense. +Performance Stock Units +The Company granted performance stock units (“PSUs”) in 2019. The number of PSUs that will vest is contingent upon the Company’s achievement of certain specified targets. These awards have market conditions and were valued using a Monte Carlo simulation model. +The volatility of 49.7 % was developed based upon the historical volatility of the Company as well as the volatilities of a group of peer companies, as the Company’s trading history needed to be supplemented with additional data as it went public in 2018. The risk-free rate, which was derived using the United States’ Treasury security rates at the grant date, was 2.44 %. +2020 2019 +Nonvested at January 1, 61,900 — +Granted (1) +— 61,900 +Vested — — +Cancelled — — +Nonvested at December 31, 61,900 61,900 +(1) The Company granted PSUs in 2019 that will vest contingent upon the Company’s achievement of certain specified targets. The number of PSUs in the table reflects the target level of PSUs. +The Company did not grant PSUs in 2020. +The total amount of compensation expense related to PSUs was approximately $ 0.5 million for both the years ended December 31, 2020 and 2019. As of December 31, 2020, the Company expects to record compensation expense related to PSUs of approximately $ 0.6 million over the remaining term of approximately 1.0 year. Future PSU grants will result in additional compensation expense. +12. Commitments and Contingencies +Litigation +From time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +F-27 +Self-insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance claims. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $ 1.3 million and $ 1.8 million at December 31, 2020 and 2019, respectively, and is included under the caption “Accrued expenses” on the Company’s Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Contingent Liabilities +The Company’s contingent liabilities (Level 3) for the years ended December 31, 2020 and 2019 were as follows: +Magnum Frac Tech Total +(in thousands) +Balance at January 1, 2019 $ 24,521 $ 1,008 $ 25,529 +Payments — ( 374 ) ( 374 ) +Revaluation adjustments ( 21,912 ) 725 ( 21,187 ) +Balance at January 1, 2020 $ 2,609 $ 1,359 $ 3,968 +Payments ( 1,125 ) ( 265 ) ( 1,390 ) +Revaluation adjustments 766 ( 490 ) 276 +Termination ( 2,250 ) — ( 2,250 ) +Balance at December 31, 2020 $ — $ 604 $ 604 +The contingent consideration related to the contingent liabilities is reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include estimated gross margin related to forecasted sales of the plugs, term of the agreement, and a risk adjusted discount factor. Contingent liabilities include $ 0.2 million and $ 0.4 million reported in “Accrued expenses” at December 31, 2020 and 2019, respectively, and $ 0.4 million and $ 3.6 million reported in “Other long-term liabilities” at December 31, 2020 and 2019, respectively, in the Company’s Consolidated Balance Sheets. The impact of the revaluation adjustments is included in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Magnum Earnout +The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019. +In 2019, the Company did not meet the sales requirement of certain dissolvable plug products during the year. +Pursuant to the Magnum Purchase Agreement Amendment, which terminated the remaining Magnum Earnout and all obligations related thereto, the Company made a cash payment of $ 1.1 million and issued the Magnum Promissory Notes with an aggregated principal amount of $ 2.3 million to the sellers of Magnum. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +Frac Tech Earnout +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (“the Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. The Frac Tech Purchase Agreement, as amended, includes, among other things, the potential for additional future payments, based on certain Frac Tech revenue metrics through December 31, 2025. +F-28 +13. Taxes +The components of the provision (benefit) for income taxes for the years ended December 31, 2020 and 2019 were as follows: +Year Ended December 31, +2020 2019 +(in thousands) +Current +U.S. federal $ ( 874 ) $ ( 22 ) +U.S. state 4 452 +Foreign — 10 +Total current provision (benefit) $ ( 870 ) $ 440 +Deferred +U.S. federal $ ( 1,122 ) $ ( 4,276 ) +U.S. state ( 466 ) ( 51 ) +Foreign — — +Total deferred benefit ( 1,588 ) ( 4,327 ) +Total benefit for income taxes $ ( 2,458 ) $ ( 3,887 ) +The provision (benefit) for income taxes for the years ended December 31, 2020 and 2019 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2020 2019 +(in thousands) +Tax benefit at statutory rate $ ( 80,095 ) $ ( 46,544 ) +Foreign rate differential ( 117 ) ( 364 ) +State income taxes, net of federal benefit ( 463 ) 306 +Nondeductible expenses 608 1,057 +Impact from goodwill impairment 5,036 — +Valuation allowance 70,387 40,480 +Other 2,186 1,178 +Total benefit for income taxes $ ( 2,458 ) $ ( 3,887 ) +F-29 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2020 and 2019 were as follows: +December 31, +2020 2019 +(in thousands) +Deferred income tax assets: +Inventories $ 2,990 $ 2,094 +Goodwill and intangible assets 90,829 34,092 +Deferred tax benefit from net losses 63,844 38,501 +Stock-based compensation 5,564 5,976 +Tax credit carryforwards 680 680 +Accrued expenses 2,142 2,763 +Interest carryover 553 3,459 +Lease liability 8,607 — +Other 165 163 +Total deferred income tax assets 175,374 87,728 +Less: Valuation allowance ( 157,703 ) ( 79,912 ) +Net deferred income tax assets $ 17,671 $ 7,816 +Deferred income tax liabilities: +Property and equipment $ ( 9,283 ) $ ( 9,404 ) +ROU asset ( 8,388 ) — +Total deferred income tax liabilities ( 17,671 ) ( 9,404 ) +Net deferred income tax liability $ — $ ( 1,588 ) +As of December 31, 2020, the Company had federal and state net operating loss carryforwards (“NOLs”) of approximately $ 345.0 million. The federal NOLs related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state NOLs can be used from 10 to 20 years and vary by state. A small portion of state NOLs will begin to expire in 2023. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its NOL and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results, the Company continues to be in a three-year cumulative loss position for the year ended December 31, 2020. According to FASB ASC 740, cumulative losses in recent years represent significant negative evidence in considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its United States’ domestic and Canadian deferred tax assets. The 2020 results include an increase in the Company’s valuation allowance of approximately $ 77.8 million primarily due to the goodwill impairment recorded during the year. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a potential decrease to its effective tax rate. +The Company is subject to United States’ federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2017. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +F-30 +The Company accounts for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2020 +(in thousands) +Balance at January 1, $ 568 +Additional based on tax positions related to prior years — +Additional based on tax positions related to current year 211 +Reduction based on tax positions related to prior years — +Lapse of statute of limitations — +Balance at December 31, $ 779 +The total amount of unrecognized tax benefits at December 31, 2020 was $ 0.8 million. The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income and Comprehensive Income (Loss). As of December 31, 2020, no interest and penalties have been accrued. +14. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding during each period and the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as the potentially dilutive restricted stock, restricted stock units, and performance stock units. +Basic and diluted earnings (loss) per common share was computed as follows: +2020 2019 +(in thousands, except for share and per share amounts) +Net loss $ ( 378,948 ) $ ( 217,751 ) +Average shares outstanding 29,744,830 29,308,107 +Loss per share (basic and diluted) $ ( 12.74 ) $ ( 7.43 ) +The diluted earnings per share calculation excludes all stock options, unvested restricted stock, unvested restricted stock units, and unvested performance stock units for 2020 and 2019 because there is a net loss for each period and their inclusion would be anti-dilutive. The average number of securities that were excluded from diluted earnings (loss) per share that would potentially dilute earnings (loss) per share for the periods in which the Company experienced a net loss were as follows: +2020 2019 +Year ended December 31, 753,609 100,383 +F-31 +15. Related Party Transactions +As part of the acquisition of Crest Pumping Technologies, LLC (“Crest”) in 2014, the Company issued promissory notes totaling $ 9.4 million to former owners of Crest, including David Crombie, who is an executive officer of the Company. The principal was due on June 30, 2019 . The interest rate was based on the prime rate, the federal funds rate, or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement and was due quarterly. Mr. Crombie paid $ 1.8 million during 2016 to pay his promissory note in full. At December 31, 2018, the outstanding principal balance of the notes of the remaining individuals totaled $ 7.6 million and unpaid interest, included in “Prepaid expenses and other current assets” in the Company’s Consolidated Balance Sheets, totaled $ 10,000 . During the second quarter of 2019, the Company received the full principal balance of the notes outstanding as well as all unpaid interest. +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by Mr. Crombie. Total lease expense and building maintenance expense associated with these entities was $ 0.8 million for both the years ended December 31, 2020 and 2019. The Company also purchased equipment of $ 1.6 million and $ 1.4 million for the years ended December 31, 2020 and 2019, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $ 0.2 million and $ 0.1 million at December 31, 2020 and 2019, respectively. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with this office space, net of sub-leasing income, was $ 1.3 million and $ 1.5 million for the years ended December 31, 2020 and 2019, respectively. There were net outstanding payables due to the entity of $ 0.1 million at December 31, 2020. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2020, the outstanding principal balance payable to Mr. Frazier was $ 1.9 million. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company purchases cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Two of the Company’s directors also serve as directors of Forum. The Company was billed $ 0.5 million and $ 1.9 million for cable during the years ended December 31, 2020 and 2019, respectively. There were outstanding payables due to the entity of $ 0.1 million and $ 0.3 million at December 31, 2020 and 2019, respectively. The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed $ 4.6 million and $ 8.0 million for coiled tubing string during the years ended December 31, 2020 and 2019, respectively. There were outstanding payables due to the entity of $ 0.9 million at both December 31, 2020 and 2019. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also serves as a director of Select. The Company was billed $ 1.2 million and $ 2.1 million for chemicals during the years ended December 31, 2020 and 2019, respectively. There were outstanding payables due to this entity of $ 0.2 million and $ 0.1 million at December 31, 2020 and 2019, respectively. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 1.6 million for products and rentals and issued credit memos of $ 0.5 million during the year ended December 31, 2020. The Company billed NESR $ 0.9 million during the year ended December 31, 2019, and additionally, during the fourth quarter of 2019, the Company sold coiled tubing equipment for $ 5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $ 3.7 million and $ 6.8 million at December 31, 2020 and 2019, respectively. +On June 5, 2019, Ann G. Fox, President and Chief Executive Officer and a director of the Company, was elected as a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 5.8 million and $ 18.4 million for the years ended December 31, 2020 and 2019, respectively. There were outstanding receivables due from Devon of $ 0.4 million and $ 1.0 million at December 31, 2020 and 2019, respectively. +F-32 +16. Segment Information +On August 30, 2019, the Company sold its Production Solutions segment to Brigade. Prior to its sales of the Production Solutions segment, the Company reported its results in two segments, the Completion Solutions segment and the Production Solutions segment. As a result of the Company’s sale of its Production Solutions segment, the Company considers the Completion Solutions segment to be its operating and reporting segment. This segmentation is representative of the manner in which the Chief Operating Decision Maker (“CODM”) and its Board of Directors view the business in allocating resources and measuring financial performance. The Company considers the CODM to be its Chief Executive Officer. +Financial data through the sales of the Production Solutions segment is reported below for the Production Solutions segment. The amounts labeled “Corporate” relate to assets or capex not allocated to either the Completion Solutions segment or the Production Solutions segment. +Year Ended December 31, +2020 2019 +(in thousands) +Revenues +Completion Solutions $ 310,851 $ 774,665 +Production Solutions — 58,272 +$ 310,851 $ 832,937 +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Completion Solutions $ 302,157 $ 620,125 +Production Solutions — 49,854 +$ 302,157 $ 669,979 +Adjusted gross profit +Completion Solutions $ 8,694 $ 154,540 +Production Solutions — 8,418 +$ 8,694 $ 162,958 +General and administrative expenses 49,346 81,327 +Depreciation 32,431 50,544 +Amortization of intangibles 16,467 18,367 +Impairment of goodwill 296,196 20,273 +Impairment of intangibles — 114,804 +Impairment of property and equipment — 66,200 +(Gain) loss on revaluation of contingent liabilities 276 ( 21,187 ) +Loss on sale of subsidiaries — 15,896 +Gain on sale of property and equipment ( 2,857 ) ( 538 ) +Loss from operations $ ( 383,165 ) $ ( 182,728 ) +Interest expense 36,759 39,770 +Interest income ( 615 ) ( 860 ) +Gain on extinguishment of debt ( 37,841 ) — +Other income ( 62 ) — +Loss before income taxes $ ( 381,406 ) $ ( 221,638 ) +Benefit for income taxes ( 2,458 ) ( 3,887 ) +Net loss $ ( 378,948 ) $ ( 217,751 ) +F-33 +Capital expenditures by segment for years ended December 31, 2020 and 2019 were as follows: +Year Ended December 31, +2020 2019 +(in thousands) +Completion Solutions $ 10,147 $ 59,231 +Production Solutions — 2,790 +Corporate 7 93 +$ 10,154 $ 62,114 +Total assets by segment as of December 31, 2020 and 2019 were as follows: +December 31, +2020 2019 +(in thousands) +Completion Solutions $ 358,128 $ 739,142 +Corporate 84,472 111,753 +$ 442,600 $ 850,895 +Revenue by country for the years ended December 31, 2020 and 2019 were as follows: +Year Ended December 31, 2020 Year Ended December 31, 2019 +Amount Percentage Amount Percentage +(in thousands) (in thousands) +United States $ 309,206 99.5 % $ 814,639 97.8 % +Canada 1,645 0.5 % 18,298 2.2 % +$ 310,851 100.0 % $ 832,937 100.0 % +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2020 and 2019 were as follows: +December 31, +2020 2019 +(in thousands) +United States $ 231,294 $ 271,791 +Canada and other 2,659 4,804 +$ 233,953 $ 276,595 +F-34 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by an issuer in the reports the issuer files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time period specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in reports filed or submitted under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2020. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2020. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2020, our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2020. +Remediation of Previously Reported Material Weakness in our Internal Control Over Financial Reporting +As reported in Item 9A of Part II of our Annual Report on Form 10-K for the year ended December 31, 2019, we did not design and maintain adequate controls to address the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. Certain accounting personnel had the ability to prepare and post journal entries, as well as reconcile accounts, without an independent review by someone other than the preparer. Specifically, our internal controls were not designed or operating effectively to evidence that journal entries were appropriately recorded or were properly reviewed for validity, accuracy, and completeness. Immaterial misstatements were identified related to the inadequate segregation of accounting duties. This material weakness could have resulted in misstatement of the aforementioned accounts and disclosures that would result in a material misstatement in our annual or interim consolidated financial statements that would not have been prevented or detected on a timely basis. +In response to the material weakness described above, our management has dedicated significant time and effort to improve our internal control over financial reporting and develop a detailed action plan to fully remediate the material weakness, as follows: +• Replaced the less sophisticated accounting systems used by the majority of our newly acquired subsidiaries with the enterprise resource planning system used by the majority of our existing subsidiaries. +• Hired additional resources, including an experienced Internal Audit Director to lead our internal audit department, with responsibility for direction and oversight of all internal audit functions. +• Completed a comprehensive risk assessment of the design of internal controls, including the implementation of new internal controls as needed to ensure the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. +• Designed and implemented a monitoring control that captures key roles and responsibilities within our enterprise resource planning system with consideration of mitigating business process controls designed to reduce the risk of material misstatement related to inadequate segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. +• Removed access for certain accounting personnel to create and post journal entries and designed and implemented an internal control which has enforced a review of all journal entries by individuals without the ability to create and post. +• Instituted additional training programs for appropriate personnel regarding the application of our enterprise resource planning system. +We have completed the documentation, implementation, and testing of the corrective actions described above and, as of December 31, 2020, have concluded that the steps taken have remediated the material weakness related to the segregation of certain accounting duties related to journal entries, account reconciliations, and other accounting functions. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting as we are an “emerging growth company” as defined under the JOBS Act. In addition, management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the quarterly period ended December 31, 2020. +Item 9B. Other Information +None. +57 +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required in response to this Item will be set forth in our definitive proxy statement for the 2021 annual meeting of stockholders and is incorporated herein by reference. +Item 11. Executive Compensation +The information required in response to this Item will be set forth in our definitive proxy statement for the 2021 annual meeting of stockholders and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required in response to this Item will be set forth in our definitive proxy statement for the 2021 annual meeting of stockholders and is incorporated herein by reference. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2021 annual meeting of stockholders and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services +The information required in response to this Item will be set forth in our definitive proxy statement for the 2021 annual meeting of stockholders and is incorporated herein by reference. +58 +PART IV +Item 15. Exhibits and Financial Statement Schedules +(a) Documents Filed as Part of This Annual Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this Annual Report: +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2020 and 2019 +F- 3 +Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2020 and 2019 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable, or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number Description +2.1† +Securities Purchase Agreement, dated as of October 15, 2018, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, Frazier Family Foundation, Inc., as sellers, Warren Lynn Frazier, solely in his capacity as seller representative, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, Nine Energy Service, Inc. and certain other parties named therein (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 15, 2018). +2.2 +First Amendment to Securities Purchase Agreement, dated June 7, 2019, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, and Frazier Family Foundation, Inc., as sellers, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, and Nine Energy Service, Inc. (Incorporated by reference to Exhibit 2.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed August 12, 2019). +2.3 +Second Amendment to Securities Purchase Agreement, dated June 30, 2020, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, and Frazier Family Foundation, Inc. as sellers, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, and Nine Energy Service, Inc. (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed August 7, 2020). +2.4†^ +Membership Interest Purchase Agreement, dated August 30, 2019, by and between Brigade Energy Services LLC and Nine Energy Service, Inc. (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on September 6, 2019). +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +59 +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +4.4 +Indenture, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee (including Form of Note) (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.5 +Supplemental Indenture and Guarantee, dated as of November 23, 2018, by and among MOTI Holdco, LLC, Magnum Oil Tools GP, LLC, and Magnum Oil Tools International, LTD, Nine Energy Service, Inc. and certain other subsidiaries and Wells Fargo Bank, National Association, as a trustee (Incorporated by reference to Exhibit 4.5 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 7, 2019). +4.6 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.7 +Description of Common Stock (Incorporated by reference to Exhibit 4.7 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 10, 2020). +10.1 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +10.2+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.3+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.4+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.5+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.6+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.7+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.8+ +Form of Nine Energy Service, Inc. Performance Share Unit Grant Notice and Form of Performance Share Unit Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 8, 2019). +10.9+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.10+ +Employment Agreement between Guy Sirkes and Nine Energy Service, LLC, dated as of March 31, 2020 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.11+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.12+ +Amended and Restated Employment Agreement between Edward Bruce Morgan and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +60 +10.13+ +First Amendment to Amended and Restated Employment Agreement, by and among Nine Energy Service, LLC, Nine Energy Service, Inc. and Edward Bruce Morgan, effective as of August 30, 2019 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on September 6, 2019). +10.14+ +Second Amendment to Amended and Restated Employment Agreement, effective May 29, 2020, by and among Nine Energy Service, LLC, Nine Energy Service, Inc., and Edward Bruce Morgan (Incorporated by reference to Exhibit 10.6 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.15+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.16+ +Separation Agreement and General Release of Claims between Clinton Roeder and Nine Energy Service, LLC, dated March 31, 2020 (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.17+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.18+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and David Crombie (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.19+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Guy Sirkes (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.20+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Edward Bruce Morgan (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020) . +10.21+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Theodore R. Moore (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP. +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +101* Interactive Data Files. +___________________________________ +* Filed herewith. +** Furnished herewith. +† Certain schedules and similar attachments have been omitted pursuant to Item 601(a)(5) of Regulation S-K and will be provided to the SEC upon request. +^ Pursuant to Item 601(b)(2) of Regulation S-K, certain immaterial provisions of the agreement that would likely cause competitive harm to the Company if publicly disclosed have been redacted. The Company hereby undertakes to furnish supplementally an unredacted copy of the agreement to the SEC upon request; provided, however, that the Company may request confidential treatment pursuant to Rule 24b-2 of the Exchange Act for any documents so furnished. ++ Management contract or compensatory plan or arrangement. +61 +Item 16. Form 10-K Summary. +None. +62 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: /s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 8, 2021 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 8, 2021. +Signature Title +/s/ Ann G. Fox President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Guy Sirkes Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Guy Sirkes +/s/ S. Brett Luz Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Ernie L. Danner Chairman of the Board +Ernie L. Danner +/s/ David C. Baldwin Director +David C. Baldwin +/s/ Mark E. Baldwin Director +Mark E. Baldwin +/s/ Curtis F. Harrell Director +Curtis F. Harrell +/s/ Scott E. Schwinger Director +Scott E. Schwinger +/s/ Gary L. Thomas Director +Gary L. Thomas +/s/ Andrew L. Waite Director +Andrew L. Waite +/s/ Darryl K. Willis Director +Darryl K. Willis +63 \ No newline at end of file diff --git a/raw/filings/0001532286/2020/0001532286-21-000006/rpt_disclosure.txt b/raw/filings/0001532286/2020/0001532286-21-000006/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..1ae45404f8994667c1d12eaf2c423c5dc76885f8 --- /dev/null +++ b/raw/filings/0001532286/2020/0001532286-21-000006/rpt_disclosure.txt @@ -0,0 +1,41 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Our Board adopted a written related person transactions policy prior to the completion of our IPO, under which a “Related Person +Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or +disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or +disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to +an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Person Transactions required to be disclosed in +our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +As part of the acquisition of Crest +Pumping Technologies, LLC (“Crest”) in 2014, the Company issued promissory notes totaling $9.4 million to former owners of Crest, including David Crombie, who is an executive officer of the Company. The principal was due on +June 30, 2019. The interest rate was based on the prime rate, the federal funds rate, or LIBOR, plus a margin to be determined in connection with the Company’s credit agreement and was due quarterly. Mr. Crombie paid $1.8 million +during 2016 to pay his promissory note in full. At December 31, 2018, the outstanding principal balance of the notes of the remaining individuals totaled $7.6 million and unpaid interest, included in “Prepaid expenses and other +current assets” in the Company’s Consolidated Balance Sheets, totaled $10,000. During the second quarter of 2019, the Company received the full principal balance of the notes outstanding as well as all unpaid interest. +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by +Mr. Crombie. Total lease expense and building maintenance expense associated with these entities was $0.8 million for both the years ended December 31, 2020 and 2019. The Company also purchased of equipment of $1.6 million and +$1.4 million for the years ended December 31, 2020 and 2019, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of +$0.2 million and $0.1 million at December 31, 2020 and 2019, respectively. +In addition, the Company leases office space in +Corpus Christi and Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5% of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with this office space, net of sub-leasing income, was +$1.3 million and $1.5 million for the years ended December 31, 2020 and 2019, respectively. There were net outstanding payables due to the entity of $0.1 million at December 31, 2020. Additionally, on June 30, 2020, the +Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2020, the outstanding principal balance payable to Mr. Frazier was $1.9 million. +The Company purchases cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Forum is partially +owned by entities controlled by SCF, one of our principal stockholders. The Company was billed $0.5 million and $1.9 million for cable during the years ended December 31, 2020 and 2019, respectively. There were outstanding payables +due to the entity of $0.1 million and $0.3 million at December 31, 2020 and 2019, respectively. The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed $4.6 million and +$8.0 million for coiled tubing string during the years ended December 31, 2020 and 2019, respectively. There were outstanding payables due to the entity of $0.9 million at both December 31, 2020 and 2019. +The Company provides services to Citation Oil & Gas Corp. (“Citation”), an entity of which Curtis F. Harrell is an +executive officer. The Company billed $0.4 million for services provided to Citation during the year ended December 31, 2019. +45 +Table of Contents +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. +(“Select”). Select is partially owned by entities controlled by SCF, one of our principal stockholders. The Company was billed $1.2 million and $2.1 million for chemicals during the years ended December 31, 2020 and 2019, +respectively. There were outstanding payables due to this entity of $0.2 million and $0.1 million at December 31, 2020 and 2019, respectively. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”). NESR is partially owned by an entity +controlled by SCF, one of our principal stockholders. The Company billed NESR $1.6 million for products and rentals and issued credit memos of $0.5 million during the year ended December 31, 2020. The Company billed NESR +$0.9 million during the year ended December 31, 2019, and additionally, during the fourth quarter of 2019, the Company sold coiled tubing equipment for $5.9 million to NESR with payments due in 24 monthly equal installments beginning +on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $3.7 million and $6.8 million at December 31, 2020 and 2019, respectively. +On June 5, 2019, Ann G. Fox, President and Chief Executive Officer and a director of the Company, was elected as a director of Devon +Energy Corporation (“Devon”). The Company generated revenue from Devon of $5.8 million and $18.4 million for the years ended December 31, 2020 and 2019, respectively. 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+(Mark One) +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED DECEMBER 31 , 2021 +OR +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE TRANSITION PERIOD FROM TO +Commission File Number: 001-38347 +_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware 80-0759121 +(State or other jurisdiction of +incorporation or organization) (I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston , TX 77019 +(Address of principal executive offices) +( 281 ) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, par value $0.01 per share NINE New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer o +Non-accelerated filer ☒ Smaller reporting company ☒ +Emerging growth company ☒ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 30, 2021) was $ 48,292,605 . +The number of shares of the registrant’s common stock outstanding at March 4, 2022 was 32,855,054 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant’s Definitive Proxy Statement for its 2022 Annual Meeting of Stockholders. +TABLE OF CONTENTS +PART I +Item 1. +Business +4 +Item 1A. +Risk Factors +14 +Item 1B. +Unresolved Staff Comments +34 +Item 2. +Properties +34 +Item 3. +Legal Proceedings +34 +Item 4. +Mine Safety Disclosures +34 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +35 +Item 6. +[Reserved] +35 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +36 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +48 +Item 8. +Financial Statements and Supplementary Data +48 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 +Item 9B. +Other Information +50 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +50 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +51 +Item 11. +Executive Compensation +51 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +51 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +51 +Item 14. +Principal Accounting Fees and Services +51 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +52 +Item 16. +Form 10-K Summary +55 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +SUMMARY OF PRINCIPAL RISK FACTORS +Our business is subject to a number of risks and uncertainties. The following is a summary of the principal risk factors that could materially adversely affect our business, financial condition and results of operations. A more complete statement of those risks and uncertainties is set forth in “Risk Factors” in Item 1A of Part I of this Annual Report. +• Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile and strongly influenced by current and expected oil and natural gas prices. If the prices of oil and natural gas decline, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +• Our substantial debt obligations could have significant adverse consequences on our business and future prospects, and restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +• Inflation may adversely affect our financial position and operating results; in particular, cost inflation with labor or materials could offset any price increases for our products and services. +• If we are unable to attract and retain key employees, technical personnel, and other skilled and qualified workers, our business, financial condition, or results of operations could suffer. +• The recent coronavirus pandemic and related economic repercussions have had a significant adverse impact on our business and, depending on the duration of the pandemic and its effect on the oil and gas industry, could continue to have a material adverse effect on our business, liquidity, results of operations, and financial condition. +• We may be unable to maintain existing prices or implement price increases on our products and services, and intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +• Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +• Our operations are subject to conditions inherent in the oilfield services industry, such as equipment defects, liabilities arising from accidents or damage involving our fleet of trucks or other equipment, explosions and uncontrollable flows of gas or well fluids, and loss of well control. +• If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +• We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +• We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +• We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +• Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +• Our success may be affected by our ability to implement new technologies and services. +• Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +• Our future financial condition and results of operations could be adversely impacted by asset impairment charges. +• Increased attention to climate change and conservation measures may reduce oil and natural gas demand, and we face various risks associated with increased activism and related litigation against oil and natural gas exploration and development activities. +2 +• Seasonal and adverse weather conditions adversely affect demand for our products and services. +• We are currently out of compliance with the New York Stock Exchange’s (the “NYSE”) minimum market capitalization requirement and are at risk of the NYSE delisting our common stock, which would have an adverse impact on the trading volume, liquidity, and market price of our common stock. +3 +PART I +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2014 through December 2021, we completed approximately 24,900 cementing jobs, with an on-time rate of approximately 91%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 91% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2014 through December 2021, we deployed approximately 317,400 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. During 2021, we began running electric wireline units in our fleet, which significantly reduce carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line Wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2014 through December 2021, we completed approximately 188,500 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From April 2014 through December 2021, we have performed approximately 10,700 jobs and deployed more than 244 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the United States (the “U.S.”), including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America. Although we have no facilities outside of North America, international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rockies, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2021, our top five customers collectively accounted for approximately 29% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, NexTier Oilfield Solutions, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2021, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2021, we had 944 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”), establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. In June 2016, OSHA finalized a regulation regarding crystalline silica exposures, which included requirements that hydraulic fracturing operations implement dust controls to limit exposures to the substance by June 23, 2021. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2021, we operated a fleet in excess of 515 commercial motor vehicles. As such, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the U.S. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, the EPA and U.S. Army Corps of Engineers issued a rule defining the scope of federal jurisdiction over wetlands and other waters of the U.S., which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in December 2019. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. The EPA is undergoing a rulemaking process to redefine the definition of waters of the U.S.; in the interim, the EPA is utilizing the pre-2015 definition. To the extent a future rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA did not address the 2020 Technical Rule. +The EPA has recently taken steps to strengthen its methane standards, including most recently in November 2021, when the EPA issued a proposed rule intended to reduce methane emissions from oil and gas sources. The proposed rule would make the existing regulations in Subpart OOOOa more stringent and create a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). In addition, the proposed rule would establish “Emissions Guidelines,” creating a Subpart OOOOc that would require states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. Under the proposed rule, states would have three years to develop their compliance plan for existing sources, and the regulations for new sources would take effect immediately upon issuance of a final rule. The EPA is expected to issue both a supplemental proposed rule, which may expand or modify the current proposed rule, and final rule by the end of 2022. +As a result of these regulatory changes, the scope of any final methane regulations or the costs for complying with federal methane regulations are uncertain. However, any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA +10 +and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. Although the agreement does not create any binding obligations for nations to limit their GHG emissions, it does include pledges to voluntarily limit or reduce future emissions. On June 1, 2017, President Trump announced that the U.S. would withdraw from the Paris Agreement and completed the process of withdrawing from the Paris Agreement on November 4, 2020. However, on January 20, 2021, President Biden issued written notification to the United Nations of the United States’ intention to rejoin the Paris Agreement, which became effective on February 19, 2021. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that aims to reduce global methane emissions at least 30% below 2020 levels by 2030. Since its formal launch at the United Nations Climate Change Conference (COP26), over 100 countries have joined the pledge. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and many states have already established regional GHG “cap-and-trade” programs. The adoption of any legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. For example, on March 20, 2015, the U.S. Bureau of Land Management (the “BLM”) finalized a rule regulating hydraulic fracturing activities on federal lands, including requirements for the disclosure, wellbore integrity, and handling of flowback water; however, on December 29, 2017, the BLM issued a rescission of the hydraulic fracturing rule. This rescission and the rule as promulgated are subject to ongoing litigation. The BLM also previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. The 2016 rule and the rescission were invalidated by separate federal district courts. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic +11 +fracturing operations to publicly owned wastewater treatment plants. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York, Vermont, Maryland, and Washington have banned the use of high-volume hydraulic fracturing. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. On July 16, 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. Among other revisions, the rules redefined environmental “effects” or “impacts” as the effects “that are reasonably foreseeable and have a reasonably close causal relationship to the proposed action or alternatives.” The rule also eliminated the current “direct,” “indirect,” or “cumulative” categories of effects. The new regulations are subject to ongoing litigation in several federal district courts, which has been stayed pending an ongoing review of the 2020 rule. On October 6, 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (the “ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In August 2019, the FWS and National Marine Fisheries Service (“NMFS”) issued three rules amending implementation of the ESA regulations revising, among other things, the process for listing species and designating critical habitat. A coalition of states and environmental groups have challenged the +12 +three rules and the litigation remains pending. In addition, on December 18, 2020, the FWS amended its regulations governing critical habitat designations; the amended regulations are subject to ongoing litigation. In June 2021, the FWS and NMFS announced plans to begin rulemaking processes to rescind these rules. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. On January 7, 2021, the DOI finalized a rule limiting application of the MBTA; however the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. Future implementation of the rules implementing the Endangered Species Act and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. +13 +Item 1A. Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• the level of prices, and expectations about future prices, for oil and natural gas; +• the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• the level of global and domestic oil and natural gas production; +• the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• the cost of exploring for, developing, producing, and delivering oil and natural gas; +• available pipeline, storage, and other transportation capacity; +• worldwide political, military, and economic conditions; +• global or national health epidemics or concerns, such as the recent coronavirus outbreaks, which may reduce demand for oil, natural gas, and related products because of reduced global or national economic activity; +• lead times associated with acquiring equipment and products and availability of qualified personnel; +• the discovery rates of new oil and natural gas reserves; +• federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• economic and political conditions in oil and natural gas producing countries; +• actions of the Organization of the Petroleum Exporting Countries (“OPEC”), its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a GHG; +• the price and availability of alternative fuels and energy sources; +• global weather conditions and natural disasters; and +14 +• uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies, which are strongly influenced by current and expected oil and natural gas prices. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the past five years ending December 31, 2021, the posted price for West Texas Intermediate (“WTI”) oil has ranged from a low of $(36.98) per barrel in April 2020 to a high of $85.64 per barrel in October 2021, and the Henry Hub spot market price of gas has ranged from a low of $1.33 per MMBtu in September 2020 to a high of $23.86 per MMBtu in February 2021. The theme of capital discipline for E&P operators in the energy industry has led to a significant disconnect between commodity prices and market activity. The average WTI price for 2021 was $68.14, an increase of 74% over 2020 and $11.15 higher than 2019 and $2.91 higher than 2018. Average rig count increased by only 10% from 2020 to 2021 and was 49% lower in 2021 than 2019 and 54% lower than 2018. If prices of oil and natural gas decline or our customers do not increase capex and activity levels, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +Significant factors that are likely to affect near-term commodity prices include the extent to which members of OPEC and other oil exporting nations, including Russia, continue to reduce oil export prices and increase production; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Industry Trends and Outlook; Impact of the Coronavirus Pandemic” in Item 7 of Part II of this Annual Report. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. Even with supportive oil and natural gas prices, E&P operator activity may not materially increase, as they remain focused on operating within their capital plans. Moreover, any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, or expectations of such a drop or of prolonged weak oil and natural gas commodity price environments, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry, and inflation may adversely affect our financial position and operating results. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +Inflationary factors, such as increases in the labor costs, material costs, and overhead costs, may also adversely affect our financial position and operating results. Like others in our industry, in 2021 we faced, and we continue to face, cost inflation with both labor and materials, which could offset any price increases for our products and services. +Increased attention to climate change and conservation measures may reduce oil and natural gas demand. +Increased attention to climate change, consumer demand for alternatives to oil and natural gas, and competitiveness of +15 +alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels) could reduce demand for oil and natural gas and therefore our products and services, which would lead to a reduction in our revenues and have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +A negative shift in investor sentiment of the oil and gas industry could adversely affect our ability to raise debt and equity capital. +Certain segments of the investor community have developed negative sentiment towards investing in our industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment advisors and certain sovereign wealth funds, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Certain other stakeholders have also pressured commercial and investment banks to stop financing oil and gas production and related infrastructure projects. Such developments, including environmental activism, initiatives, and related litigation aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. These developments may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +We face various risks associated with increased activism and related litigation against oil and natural gas exploration and development activities. +Opposition toward oil and natural gas drilling and development activity has been growing globally and is particularly pronounced against companies in the oil and natural gas industry. U.S. oil and gas companies are often the target of activist efforts, campaigns, and related litigation from both individuals and non-governmental organizations regarding safety, human rights, environmental matters, sustainability, climate change, and business practices. Anti-development activists are working to, among other things, reduce access to federal and state government lands and delay or cancel certain operations such as drilling and development. If activism against oil and natural gas exploration and development persists or increases, there could be a material adverse effect on our business, financial condition, and results of operations. +Risks Related to the Coronavirus Pandemic +The coronavirus pandemic and related economic repercussions have had a significant adverse impact on our business and, depending on the duration of the pandemic and its effect on the oil and gas industry, could continue to have a material adverse effect on our business, liquidity, results of operations, and financial condition. +The coronavirus pandemic and related economic repercussions have created significant volatility, uncertainty, and turmoil in the oil and gas industry. These events have directly affected our business and have exacerbated the potential negative impact from many of the risks described in this Annual Report, including those relating to our customers’ capital spending. In addition, the decline in market conditions resulted in goodwill impairment charges of $296.2 million recorded in the first quarter of 2020. While demand for and prices of oil, NGLs, and natural gas have generally improved during 2021 and thus far in 2022 as many travel restrictions, business closures, and other restrictions have been lifted, an increase in infections or the onset of a new variant of the coronavirus could again reduce demand for and prices of oil, NGLs, and gas and thus reduce demand for our products and services. Also depending on the progression of the pandemic, previously-faced challenges may re-emerge, including, but not limited to, inefficiencies and logistical challenges surrounding potential stay-at-home orders and remote work arrangements, travel restrictions, and an inability to commute to certain facilities and job sites, as we provide services and products to our customers. +Given the nature and significance of the events described above, we are not able to enumerate all potential risks to our business; however, we believe that in addition to the impacts described above, other current and potential impacts of these recent events include, but are not limited to: +• disruption to our supply chain for raw materials essential to our business, including restrictions on importing and exporting products; +• notices from customers, suppliers, and other third parties arguing that their non-performance under our contracts with them is permitted as a result of force majeure or other reasons; +• liquidity challenges, including impacts related to delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies; +• a credit rating downgrade of our corporate debt and potentially higher borrowing costs in the future; +16 +• a need to preserve liquidity, which could result in a delay or change in our capital investment plan; +• cyber security issues, as digital technologies may become more vulnerable and experience a higher rate of cyber attacks in the current environment of remote connectivity; +• litigation risk and possible loss contingencies related to coronavirus and its impact, including with respect to commercial contracts, employee matters, and insurance arrangements; +• reduction of our workforce to adjust to market conditions, including severance payments, retention issues, and an inability to hire employees when market conditions improve; +• the challenges to working caused by the coronavirus pandemic and related restrictions, including any testing or vaccine mandates or requirements, may have an impact on our employees’ well-being and morale, which could impact employee retention, productivity, and our culture, and which could lead to a loss of workers and labor shortages; +• additional impairments along with other accounting charges as demand for our services and products decreases; +• infections and quarantining of our employees and the personnel of our customers, suppliers, and other third parties in areas in which we operate; +• changes in the regulation of the production of hydrocarbons, such as the imposition of limitations on the production of oil and gas by states or other jurisdictions, that may result in additional limits on demand for our products and services; +• actions undertaken by national, regional, and local governments and health officials to contain the virus or treat its effects; and +• a structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel, and interact, or in connection with a global recession or depression. +Given the dynamic nature of these events, we cannot reasonably estimate the period of time that the coronavirus pandemic and related market conditions will persist, the full extent of the impact they will have on our business, financial condition, results of operations, or cash flows or the pace or extent of any subsequent recovery. +Risks Related to Our Indebtedness +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +As of December 31, 2021, we had $320.3 million of 8.750% Senior Notes due 2023 (the “Senior Notes”) outstanding, and we had $15.0 million of borrowings under the 2018 ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) outstanding. In the first two months of 2022, we borrowed an additional $5.0 million under the 2018 ABL Credit Facility. Subject to the restrictions in the 2018 ABL Credit Facility and the indenture governing the Senior Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our current or future level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +• limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation +17 +to their overall size or less restrictive terms governing their indebtedness; and +• making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +Additionally, loans to us and our domestic related subsidiaries under the 2018 ABL Credit Facility make us vulnerable to increases in interest rates as our indebtedness under the 2018 ABL Credit Facility will vary with prevailing interest rates. Currently, such loans may be base rate loans or London Interbank Offered Rate (“LIBOR”) loans. LIBOR is the subject of national, international, and other regulatory guidance and proposals for reform. In July 2017, the United Kingdom’s Financial Conduct Authority (“FCA”), which regulates LIBOR, announced that it intends to phase out LIBOR, and in March 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative (a) immediately after December 31, 2021, in the case of the one-week and two-month U.S. dollar settings and (b) immediately after June 30, 2023, in the case of the remaining U.S. dollar settings. The U.S. Federal Reserve has also advised banks to cease entering into new contracts that use LIBOR as a reference rate. The Alternative Reference Rate Committee, a committee convened by the U.S. Federal Reserve that includes major market participants, has identified the Secured Overnight Financing Rate (“SOFR”), which is a new index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for LIBOR. SOFR is observed and backward-looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. At this time, it is not possible to predict how markets will respond to SOFR or other alternative reference rates, and the overall financial markets may be disrupted as a result of the phase-out or replacement of LIBOR. The consequences of these developments with respect to the phase-out of LIBOR cannot be predicted but could include an increase in the cost of our borrowings under the 2018 ABL Credit Facility. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. In addition, any debt restructuring transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +The 2018 ABL Credit Facility and the indenture governing our Senior Notes have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• incur additional indebtedness and guarantee indebtedness; +• pay dividends or make other distributions or repurchase or redeem our capital stock; +• transfer or sell assets; +18 +• make loans and investments; +• incur liens; +• enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• consolidate, merge, or sell all or substantially all of our assets; +• prepay, redeem, or repurchase certain debt; +• issue certain preferred stock or similar equity securities; +• make certain acquisitions and investments; +• engage in transactions with affiliates; and +• create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Competition and Market Risks +We may be unable to maintain existing prices or implement price increases on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The oil and natural gas industry is intensely competitive and has been characterized by price erosion for new technologies as additional competing products enter the market. In 2020 we experienced a decline in the pricing and profitability of our dissolvable plug products and, to a lesser extent, our composite plug products. Pricing toward the end of 2021 mostly stabilized; however, any future price declines, future lack of availability of materials, or future increases in prices in materials may harm our business. +19 +We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. +We are continuing to work on reducing manufacturing costs of our products, as well as introducing new and differentiated technology to improve profitability, however, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products decline further or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion services may adversely affect our business, financial condition, and results of operations. +Operational Risks +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• equipment defects; +• liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• explosions and uncontrollable flows of gas or well fluids; +• unusual or unexpected geological formations or pressures and industrial accidents; +• blowouts; +20 +• fires; +• cratering; +• loss of well control; +• collapse of the borehole; and +• damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our services could become a source of spills or release of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose substantial revenue. In addition, any litigation or claim, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public, which could cause us to lose customers and substantial revenue, make it more difficult for us to compete effectively, or obtain adequate insurance in the future. +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2021 and 2020, we spent approximately $7.4 million and $2.9 million, respectively, on capital expenditures related to maintenance, and we expect to spend approximately $15 million to $20 million on capital expenditures related to maintenance in 2022. Our equipment typically does not generate revenue while it is undergoing maintenance, upgrades, or refurbishment. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. In addition, although such projects may require material capital expenditures, there is no assurance that they will generate a positive return. +Risks Related to Our Customers and Suppliers +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase inventory obsolescence, and restrict our ability to fund our operations. +21 +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our products and services. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2021, our five largest customers collectively accounted for approximately 29% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Certain of our product lines are subject to the risk of supplier concentration, and certain of our product lines are subject to exclusive distribution arrangements, which we may not be able to maintain. +Certain of the product lines depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +In addition, we have arrangements with certain technology companies and manufacturers that give us exclusive distribution rights to certain product offerings. In some cases, we are, or may in the future will be, required to meet certain minimum volume or other requirements in order to retain our arrangement. If any of these companies or manufacturers terminate our right to sell some or all of their products, modify or terminate our exclusive distribution arrangement, or change the applicable terms and conditions of sale, our business and results of operations could be adversely affected. +Regulatory, Compliance, and Legal Risks +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects, and results of operations. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of +22 +property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act (“FLSA”), in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation, and the results or costs of any such cases may have an adverse effect on our business, operating results, and financial condition. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. In Texas, rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, GHGs, air pollution, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills of hazardous materials onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, +23 +have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the oversight of the EPA, the U.S. Department of Transportation (the “DOT”), U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution or to protect against the effects of ionizing radiation. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards (the “Tier 4” standards). The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For more information on existing regulations and regulatory initiatives relating to hydraulic fracturing, see “Regulatory Matters – Hydraulic Fracturing” in Item 1 of Part I of this Annual Report. +If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +24 +Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to GHG emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns (e.g., numerous cities, including San Francisco, CA, and Seattle, WA, have banned the use of natural gas in new construction, and other cities, including New York, NY, are considering similar initiatives). Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of GHGs in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. If such effects were to occur, they could have an adverse impact on our operations. Our ability to mitigate the adverse physical impacts of climate change depends in part upon our disaster preparedness and response and business continuity planning. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The U.S. Foreign Corrupt Practices Act (the “FCPA”), the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anticorruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. We operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, +25 +state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license, and effective December 2017, the FMCSA has mandated electronic logging devices in all interstate commercial trucks. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and GHG emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +Risks Related to Technology +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot ensure that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. Additionally, we cannot ensure that our intellectual property rights will deter or prevent competitors from creating similar purpose products for our customers. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently-developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +26 +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution proceedings, a defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. For example, in January 2022, a jury in the Western District of Texas, Waco Division, found that our BreakThru Casing Flotation Device TM infringed another party’s intellectual property rights. We intend to appeal the decision. We may not prevail in such appeal or in any dispute resolution proceedings relating to intellectual property rights, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or otherwise violate the intellectual property rights of others. Also, as a part of resolving such disputes, we may enter into cross-licenses, which could reduce the value of our existing intellectual property rights. The results or costs of any such dispute resolution proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our business, regardless of its outcome. +Our success may be affected by our ability to implement new technologies and services. Additionally, we rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our products and services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide such products and services to our customers. Although we believe other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense, delay, and potential changes to certain product components. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result of termination of our manufacturing relationships or patent infringement claims, could have a material adverse effect on our financial condition, business, and results of operations. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +Our operations are subject to cyber security risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cyber security risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cyber security attacks. These risks could have a material adverse effect on our business, financial condition, and results of operations and could lead to litigation or regulatory action against us. +27 +Risks Related to Certain Significant Stockholders +Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +SCF VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) owned approximately 28% of our outstanding common stock as of December 31, 2021. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents, and approval of acquisition offers and other significant corporate transactions. In addition, another one of our stockholders beneficially owned approximately 13% of our outstanding common stock as of December 31, 2021. This concentration of ownership by a small group of stockholders will limit other stockholders’ ability to influence corporate matters, and as a result, actions may be taken that other stockholders may not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their shares of our common stock. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with significant stockholders. +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. SCF is not subject to any obligation to maintain its ownership interest in us and may elect at any time to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies, which could adversely affect our cash flows or results of operations. +Certain of our directors may have conflicts of interest because they are also affiliates of SCF. The resolution of these conflicts of interest may not be in our or other stockholders’ best interests. +Certain of our directors, namely David C. Baldwin and Andrew L. Waite, are currently officers of SCF’s ultimate general partner. In addition, Mr. Waite is a director of National Energy Reunited Corp., a corporation in which SCF owns an approximate 9% equity interest as of December 31, 2021, and Mr. Baldwin is a director of Select Energy Services, Inc., a corporation in which SCF owns an approximate 15% equity interest as of December 31, 2021. These positions may conflict with such individuals’ duties as one of our directors regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in our or our other stockholders’ best interest. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates, and its other portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our charter further provides that no such person or party shall be liable to us by reason of the fact that such person pursues any such business opportunity or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or otherwise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approved by the holders of at least 80% of the voting power of the outstanding stock of the +28 +corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. +Risks Related to Human Capital +Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work, and our success depends, in large part, upon our ability to employ and retain key employees, technical personnel, and other skilled and qualified workers. To attract and retain qualified employees, we must compensate them at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our liquidity and competitive position, our business, financial condition or results of operations could suffer. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. This competition has become exacerbated by the increase in employee resignations currently taking place throughout the U.S. as a result of the coronavirus pandemic, which is commonly referred to as the “Great Resignation.” There has been a reduction of the available skilled labor force to service the energy industry. To the extent that there is an increase in demand for our products or services, there is no assurance that the availability of skilled labor will improve. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +Other Material Risks +We do not intend to pay dividends on our common stock, and our debt agreements place certain restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on his investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt agreements place certain restrictions on our ability to pay cash dividends. Consequently, unless we revise our dividend policy, a stockholder’s only opportunity to achieve a return on his investment in us will be by selling his common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased his shares of our common stock. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +Historically, we have experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur further operating losses and experience negative operating cash flow. +Our future financial condition and results of operations could be adversely impacted by long-lived assets or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, other intangible assets, or other assets in a short +29 +amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, other intangible assets, or other assets that reduce our net income. +In 2020, we recorded goodwill impairment charges of $296.2 million in our tools, cementing, and wireline reporting units due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in our stock price and the Level 2 fair value of our Senior Notes. +While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +Seasonal and adverse weather conditions adversely affect demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. In addition, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For the years ended December 31, 2021 and 2020, we generated approximately 0.6% and 0.5%, respectively, of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the U.S. or other countries, anti-terrorist efforts, and other armed conflicts involving the U.S. or other countries, including continued hostilities in the Middle East, may adversely affect the U.S. and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +A portion of our revenue is derived from sales to customers outside of the U.S., which exposes us to risks inherent in doing business internationally. +In 2021, we derived 4.9% of our revenue from sales to customers outside of the U.S. Sales to customers in countries other than the U.S. are subject to various risks, including: +• volatility in political, social, and economic conditions; +• social unrest, acts of terrorism, war, or other armed conflicts; +• confiscatory taxation or other adverse tax policies; +30 +• deprivation of contract rights; +• trade and economic sanctions or other restrictions imposed by the European Union, the U.S., or other countries; +• exposure under the FCPA or similar legislation, as discussed in the below risk factor; and +• currency exchange controls. +We are currently out of compliance with the NYSE minimum market capitalization requirement and are at risk of the NYSE delisting our common stock, which would have an adverse impact on the trading volume, liquidity, and market price of our common stock. +On January 5, 2022, we received written notification from the NYSE that we no longer satisfy the continued listing compliance standards set forth under Section 802.01B of the NYSE Listed Company Manual because our average global market capitalization was less than $50,000,000 over a consecutive 30 trading-day period that ended on January 3, 2022 and, at the same time, our last reported stockholders’ equity was less than $50,000,000. +In accordance with NYSE procedures, we have submitted a plan to the NYSE demonstrating how we intend to regain compliance with the NYSE’s continued listing standards within 18 months, which is being reviewed by the Listings Operations Committee of the NYSE (the “Listings Committee”). If the Listings Committee does not accept our plan, the NYSE may commence suspension and delisting procedures. If the Listings Committee accepts our plan, our common stock would continue to be listed on the NYSE during the 18-month cure period, subject to our compliance with other continued listing requirements, and we would be subject to quarterly monitoring for compliance with the plan. If we fail to regain compliance during the cure period or if we fail to meet material aspects of the plan, the NYSE may commence suspension and delisting procedures. Further, our common stock could be delisted if the average closing price of our common stock falls below $1.00 per share over a period of 30 consecutive trading days (the “minimum share price condition”) or our common stock trades at an “abnormally low” price. In April 2020, we received written notification from the NYSE that we did not satisfy the minimum share price condition. In June 2020, we regained compliance with this condition; however, there is no assurance that we will be able to continue to do so. +A delisting of our common stock from the NYSE could negatively impact us as it would likely reduce the liquidity and market price of our common stock and thus (i) reduce the number of investors willing to hold or acquire our common stock, which would negatively impact our ability to access equity markets and obtain financing, and (ii) impair our ability to provide equity incentives to our employees. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter and bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed +31 +by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. These exclusive forum provisions are not intended to apply to actions arising under the Exchange Act or the Securities Act of 1933, as amended. The Court of Chancery of the State of Delaware has recently held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL. +Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provisions of our charter and bylaws. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter or bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +Taking advantage of the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors. +We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which at least $700 million of equity securities are held by non-affiliates as of the last day of our then most recently completed second fiscal quarter); (iii) the date on which we have issued, in any three-year period, more than $1.0 billion in non-convertible debt securities; and (iv) December 31, 2023, which is the last day of the fiscal year ending after the fifth anniversary of the completion of our initial public offering (the “IPO”). An emerging growth company may take advantage of certain reduced reporting and other requirements that are otherwise applicable generally to public companies. Pursuant to these reduced disclosure requirements, emerging growth companies are not required to, among other things, comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, provide certain disclosures regarding executive compensation, hold stockholder advisory votes on executive compensation, or obtain stockholder approval of any golden parachute payments not previously approved. In addition, emerging growth companies have longer phase-in periods for the adoption of new or revised financial accounting standards. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. +We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards under Section 107 of the JOBS Act, until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our common stock price may be more volatile. +On the other hand, once we are no longer an emerging growth company, compliance with rules and regulations that do not currently apply to us as an emerging growth company will increase our legal and financial compliance costs, may make some activities more difficult, time-consuming, or costly, and will increase demand on our systems and resources. +We previously identified material weaknesses in our internal control over financial reporting. We may identify additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, which may result in material misstatements of our financial statements or cause us to fail to meet our reporting obligations. +Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In 2017, we identified material weaknesses in our internal control over financial reporting, and immaterial misstatements were identified as result. We believe that these material weaknesses have been successfully +32 +remediated. +Any newly identified material weakness could limit our ability to prevent or detect a misstatement of our accounts or disclosures that could result in a material misstatement of our annual or interim financial statements. In such case, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, we may be unable to prevent fraud, investors may lose confidence in our financial reporting, and our stock price may decline as a result. We cannot ensure that the measures we have taken to date, or any measures we may take in the future, will be sufficient to avoid potential future material weaknesses. +We may not be able to utilize a portion of our net operating loss carry forwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2021, we had federal and state income tax NOLs of approximately $436.4 million, which will begin to expire between 2022 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). +Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate (as defined in Section 382). However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in the IPO, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +33 +Item 1B. Unresolved Staff Comments +None. +Item 2. Properties +The following table describes the material facilities owned or leased by us as of December 31, 2021. +Location Basin/Region Leased or Owned Principal/Most +Significant Use +Houston, TX — Leased Corporate Headquarters/Administrative +Athens, TX — Leased Operations +Baker, MT Bakken Owned Operations/Administrative +Bergen, Norway — Leased Operations +Charleroi, PA Marcellus/Utica Leased Operations +Corpus Christi, TX — Leased Operations/Administrative +Dickinson, ND Bakken Leased Operations/Administrative +El Reno, OK SCOOP/STACK Leased Operations +Fort Worth, TX — Leased Administrative +Hobbs, NM Permian Leased Operations +Jacksboro, TX Barnett Leased Operations +Jacksboro, TX Barnett Leased Operations +Kilgore, TX Haynesville Leased Operations +Lacombe, AB, Canada WCSB Leased Operations/Administrative +Longview, TX Haynesville Owned Operations +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Mead, CO Rockies Leased Operations +Midland, TX Permian Leased Operations +Midland, TX Permian Owned Operations/Administrative +Midland, TX Permian Leased Operations/Administrative +Midland, TX Permian Leased Operations +Monahans, TX Permian Leased Operations/Administrative +Oklahoma City, OK SCOOP/STACK Leased Operations +Pleasanton, TX Eagle Ford Leased Operations +Poolville, TX — Owned Operations +Sweetwater, TX Permian Leased Operations +Tyler, TX Haynesville Leased Operations +Ulster, PA Marcellus/Utica Leased Operations +Williston, ND Bakken Owned Operations +Williston, ND Bakken Owned Operations/Administrative +Item 3. Legal Proceedings +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. For additional information related to legal proceedings, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +Item 4. Mine Safety Disclosures +Not applicable. +34 +PART II +Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Nine Energy Service, Inc.’s common stock is traded on the NYSE under the symbol “NINE.” +Holders +As of March 4, 2022, we had 45 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +None. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +The following table sets forth our repurchases of our equity securities registered under Section 12 of the Exchange Act that have occurred during the three months ended December 31, 2021: +Total Number of Shares Purchased (a) Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares That May Yet be Purchased Under the Plans or Programs +October 1, 2021 – October 31, 2021 +235 $ 1.82 — — +November 1, 2021 – November 30, 2021 +— — — — +December 1, 2021 – December 31, 2021 +— — — — +Total 235 $ 1.82 — — +(a) Reflects the number of shares we have withheld to pay taxes upon vesting of restricted stock. +Item 6. [Reserved] +35 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. +This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. +Generally, operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently. +We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +36 +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• Adjusted Gross Profit (Loss) : Adjusted gross profit (loss) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted EBITDA : We define Adjusted EBITDA as net income (loss) before interest, taxes, and depreciation and amortization, further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of contingent liabilities, (iv) loss or gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. For additional information, see “Non-GAAP Financial Measures” below. +• Return on Invested Capital (“ROIC”): We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss or gain on the sale of subsidiaries, (vi) loss or gain on the extinguishment of debt, and (vii) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. For additional information, see “Non-GAAP Financial Measures” below. +• Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Industry Trends and Outlook; Impact of the Coronavirus Pandemic +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. Despite healthier commodity prices in 2021 and thus far in 2022, the majority of public E&P companies are spending less on production growth and remaining focused on capital discipline. Even with an average WTI price of $68.14 in 2021, an increase of 74% over 2020, the average U.S. rig count in 2021 only increased 10% year over year. Overall, U.S. activity was slightly up in 2021 versus 2020. Per the Energy Information Administration (“EIA”), U.S. completions increased approximately 32% in 2021 versus 2020. The Permian Basin continues to be the most active basin in North America with approximately 47% of the total U.S. completions in 2021 according to the EIA. +Although there continues to be a disconnect between commodity price and activity levels in comparison to historical levels, we are optimistic looking into 2022 and 2023. Underinvestment in oil and gas development and an increase in overall global demand coming out of the coronavirus pandemic is creating an undersupplied market and supportive commodity prices for activity growth. Most U.S. operators completed their premium drilled but uncompleted wells inventory in 2021 and will need to drill more wells in order to maintain or increase production levels in 2022, and early indications are that North American capital spending in 2022 will increase in comparison to 2021. As a result, we currently expect net price increases +37 +across many service lines throughout 2022; however, the magnitude and timing of potential price increases will depend on a number of factors, and implementing meaningful price increases from very depressed levels is expected to remain very challenging. +Labor constraints will likely remain problematic for the industry, and we expect to have both wage and labor inflation. If activity continues to increase into 2022, we would expect labor and equipment shortages in the market, which could also lead to potential price increases across the industry. Depending on the rate and quantity of rig and frac crew additions, we expect pricing increases, and therefore profitability should increase. However, some if not most of these price increases could potentially be offset by labor and material cost inflation, as well as an inability to complete work due to labor shortages or supply chain constraints. In 2021, the majority of our pricing increases, specifically in coiled tubing and cementing were offset by cost inflation. The market remains extremely volatile as supply chains remain challenged, and labor shortages continue across the United States. +Significant factors that are likely to affect commodity prices moving forward include the extent to which members of OPEC and other oil exporting nations, including Russia, continue to reduce oil export prices and increase production; the effect of energy, monetary, and trade policies of the U.S.; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy and EPA policies; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. As noted above, even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. +In addition, the coronavirus pandemic and efforts to mitigate its effects may continue to have a material adverse impact on demand for oil, commodity prices, and our business generally. See “Risk Factors – Risks Related to the Coronavirus Pandemic” in Item 1A of Part I of this Annual Report for more information. During the pandemic, we have maintained our commitment to the safety of our employees, customers, vendors, and community at large, and we have taken, and are continuing to take, a proactive approach to navigating the pandemic. To mitigate exposure and risk, we have implemented processes and procedures across our entire organization based on federal, regional, and local guidelines and mandates, and our Health, Safety & Environment and management teams are in frequent communication with our entire employee base to ensure they are receiving updated guidelines, processes, and procedures. In response to the pandemic, we have implemented the following changes, for example: at the field level, we are working closely with our customers and vendors to update standard operating procedures, based on social distancing, hand washing, and other recommended best practices set forth by the Centers for Disease Control and Prevention; electronic assessments have been employed to check the health of employees prior to reporting to work, to ensure facilities are being properly cleaned and sanitized, and to check visitor health before arrival to our locations; internal case managers have been identified to handle all coronavirus-related cases, and all confirmed and potential cases are tracked through closure; many of our corporate and office employees are working virtually to avoid unnecessary risk and exposure; and we have significantly limited any work-related travel. We are actively monitoring updates from regulatory and government bodies and evolving our strategy accordingly in an effort to keep our workforce and communities healthy. +38 +Results of Operations +Year Ended December 31, +2021 2020 Change +(in thousands) +Revenues $ 349,419 $ 310,851 $ 38,568 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 307,992 302,157 5,835 +Adjusted gross profit $ 41,427 $ 8,694 $ 32,733 +General and administrative expenses $ 45,301 $ 49,346 $ (4,045) +Depreciation 28,905 32,431 (3,526) +Amortization of intangibles 16,116 16,467 (351) +Impairment of goodwill — 296,196 (296,196) +Loss on revaluation of contingent liabilities 460 276 184 +(Gain) loss on sale of property and equipment 660 (2,857) 3,517 +Loss from operations (50,015) (383,165) 333,150 +Non-operating expenses (income) 14,585 (1,759) 16,344 +Loss before income taxes (64,600) (381,406) 316,806 +Benefit for income taxes (25) (2,458) 2,433 +Net loss $ (64,575) $ (378,948) $ 314,373 +Revenues +Revenues increased $38.6 million, or 12%, to $349.4 million in 2021. The increase in comparison to 2020 was in line with a 10% increase in average U.S. rig count and a 32% increase in active frac crews. More specifically, tools revenue increased $21.7 million, or 27%, as completion tools stages increased by 60%. In addition, coiled tubing revenue increased $14.6 million, or 31%, as total days worked increased by 31%, and cementing revenue (including pump downs) increased by $11.6 million, or 11%, as total cement job count increased 22%, in each case in comparison to 2020. The overall increase in revenue was partially offset by a decrease in wireline revenue of $9.3 million, or 11%, as total completed wireline stages decreased by 3%, in each case, in comparison to 2020. Looking ahead, we remain optimistic on the outlook for the dissolvable plug market and its continued growth, and we currently expect that our dissolvable technology, which offers a greener solution for our customers, as well as our broader portfolio of completion tools will be a growth driver for us moving forward. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues increased $5.8 million, or 2%, to $308.0 million in 2021. The increase in comparison to 2020 was prevalent across all lines of service and was primarily related to increased activity coupled with cost inflation associated with both labor and materials as well as headcount increases. More specifically, the increase was primarily related to a $10.1 million increase in materials installed and consumed while performing services and a $3.3 million increase in repairs and maintenance and other costs, in comparison to 2020. The overall increase was partially offset by a $3.1 million decrease in bad debt expense and a $2.1 million decrease in cost of revenue type restructuring costs, in comparison to 2020. The overall increase was also partially offset by a $1.3 million decrease in employee costs between periods and $1.1 million in non-cash facility lease costs in 2020 that did not recur in 2021. +Adjusted Gross Profit (Loss) +Adjusted gross profit increased $32.8 million to $41.4 million in 2021 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses decreased $4.0 million to $45.3 million in 2021. The decrease in comparison to 2020 was primarily related to a $3.2 million decrease in employee costs mainly due to salary and stock-based compensation +39 +reductions, a $1.2 million decrease in general and administrative type restructuring costs, and a $1.0 million decrease in other general and administrative expenses such as vehicle and office costs in comparison to 2020. The overall decrease was partially offset by a $1.4 million increase in professional fees between periods. +Depreciation +Depreciation expense decreased $3.5 million to $28.9 million in 2021. The decrease in comparison to 2020 was associated with all lines of service and was primarily due to certain assets becoming fully depreciated in recent periods. +Amortization of Intangibles +We recorded $16.1 million in intangible amortization in 2021 and $16.5 million in intangible amortization in 2020, in each case, primarily attributable to technology and customer relationships. The $0.4 million decrease is related to certain intangible assets being fully amortized in 2021. +Impairment of Goodwill +In 2020, we recorded goodwill impairment charges of $296.2 million in our tools, cementing, and wireline reporting units due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in our stock price and the Level 2 fair value of our Senior Notes. These goodwill impairment charges did not recur in 2021 because goodwill was fully impaired in 2020. +(Gain) Loss on Revaluation of Contingent Liabilities +We recorded a $0.5 million loss on the revaluation of contingent liabilities in 2021 compared to a $0.3 million loss on the revaluation of contingent liabilities recorded in 2020. The $0.2 million change was primarily related to a $1.0 million increase in the value of the earnout associated with our acquisition Frac Technology AS between periods. The change was partially offset by a $0.8 million loss on the revaluation of contingent liabilities associated with the Magnum Earnout (as defined in Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report) in 2020 that did not recur in 2021. The Magnum Earnout was terminated in the second quarter of 2020. +Non-Operating Expenses (Income) +We recorded $14.6 million in non-operating expenses in 2021 compared to $1.8 million in non-operating income for 2020. The $16.4 million decrease in non-operating income was primarily related to a $20.2 million reduction in gains on the extinguishment of debt related to the repurchase of Senior Notes in 2021 compared to 2020, coupled with a $0.4 million reduction in interest and other income between periods. The overall decrease in non-operating income is partially offset by a $4.2 million reduction in interest expense mainly due to a reduced debt balance attributable to repurchases of Senior Notes in recent periods. +Provision (Benefit) for Income Taxes +Our effective tax rate was .01% for 2021 and 0.6% for 2020 . Our tax benefit for 2021 is primarily the result of our tax position in state and foreign tax jurisdictions. +Adjusted EBITDA +Adjusted EBITDA increased $31.0 million to $5.2 million for 2021. The Adjusted EBITDA increase is primarily due to the changes in revenue and expenses discussed above. See “Non-GAAP Financial Measures” below for further explanation. +Non-GAAP Financial Measures +EBITDA and Adjusted EBITDA +EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define EBITDA as net income (loss) before interest, taxes, depreciation, and amortization. +We define Adjusted EBITDA as EBITDA further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of +40 +contingent liabilities, (iv) loss or gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. +Management believes EBITDA and Adjusted EBITDA are useful because they allow us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at these measures because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. These measures should not be considered as an alternative to, or more meaningful than, net income (loss) as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from these measures are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of these measures. Our computations of these measures may not be comparable to other similarly titled measures of other companies. We believe that these are widely followed measures of operating performance. +The following table presents a reconciliation of the non-GAAP financial measures of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year Ended December 31, +2021 2020 +(in thousands) +EBITDA reconciliation: +Net loss $ (64,575) $ (378,948) +Interest expense 32,527 36,759 +Interest income (26) (615) +Benefit for income taxes (25) (2,458) +Depreciation 28,905 32,431 +Amortization of intangibles 16,116 16,467 +EBITDA $ 12,922 $ (296,364) +Adjusted EBITDA reconciliation: +EBITDA $ 12,922 $ (296,364) +Impairment of goodwill — 296,196 +Transaction and integration costs — 146 +Loss on revaluation of contingent liabilities (1) +460 276 +Gain on extinguishment of debt (17,618) (37,841) +Restructuring charges 1,588 4,907 +Stock-based compensation expense 5,406 9,744 +(Gain) loss on sale of property and equipment 660 (2,857) +Legal fees and settlements (2) +1,809 39 +Adjusted EBITDA $ 5,227 $ (25,754) +(1) Amounts relate to the revaluation of contingent liabilities associated with our 2018 acquisitions. The impact is included in our Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 – Commitments and Contingencies included Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. +41 +Return on Invested Capital +ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss or gain on the sale of subsidiaries, (vi) loss or gain on the extinguishment of debt, and (vii) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. +Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation of ROIC may not be comparable to other similarly titled measures of other companies. +The following table provides an explanation of our calculation of ROIC for the years ended December 31, 2021 and 2020: +Year Ended December 31, +2021 2020 +(in thousands) +Net loss $ (64,575) $ (378,948) +Add back: +Impairment of goodwill — 296,196 +Transaction and integration costs — 146 +Interest expense 32,527 36,759 +Interest income (26) (615) +Restructuring charges 1,588 4,907 +Gain on extinguishment of debt (17,618) (37,841) +Benefit for deferred income taxes — (1,588) +After-tax net operating loss $ (48,104) $ (80,984) +Total capital as of prior period-end: +Total stockholders’ equity $ 20,409 $ 389,877 +Total debt 348,637 400,000 +Less cash and cash equivalents (68,864) (92,989) +Total capital as of prior period-end $ 300,182 $ 696,888 +Total capital as of period-end: +Total stockholders’ equity $ (39,267) $ 20,409 +Total debt 337,436 348,637 +Less cash and cash equivalents (21,509) (68,864) +Total capital as of period-end $ 276,660 $ 300,182 +Average total capital $ 288,421 $ 498,535 +ROIC -16.7 % -16.2 % +42 +Adjusted Gross Profit (Loss) +GAAP defines gross profit (loss) as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit (loss) because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (loss) to evaluate operating performance. We prepare adjusted gross profit (loss) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (loss) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (loss) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (loss) or similarly titled measures in the same manner as we do. +The following table presents a reconciliation of adjusted gross profit (loss) to GAAP gross profit (loss). +Year Ended December 31, +2021 2020 +(in thousands) +Calculation of gross loss +Revenues $ 349,419 $ 310,851 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 307,992 302,157 +Depreciation (related to cost of revenues) 26,882 30,161 +Amortization of intangibles 16,116 16,467 +Gross loss $ (1,571) $ (37,934) +Adjusted gross profit reconciliation: +Gross loss $ (1,571) $ (37,934) +Depreciation (related to cost of revenues) 26,882 30,161 +Amortization of intangibles 16,116 16,467 +Adjusted gross profit $ 41,427 $ 8,694 +43 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash on hand, cash flows from operating activities and, if needed, external borrowings and issuances of debt securities. Our principal uses of cash are to fund capital expenditures, service our outstanding debt, fund our working capital requirements and historically, fund acquisitions. Due to our high level of variable costs and the asset-light make-up of our business, we have historically been able to quickly implement cost-cutting measures and will continue to adapt as the market dictates. We have also used cash to make open market repurchases of our debt and may, from time to time, continue to make such repurchases (including with respect to our Senior Notes) when it is opportunistic to do so to manage our debt maturity profile. In addition, we continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. +Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +In 2022, our planned capital expenditure budget, excluding possible acquisitions, is expected to be between $20.0 million to $30.0 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including expected industry activity levels and company initiatives. +At December 31, 2021, we had $21.5 million of cash and cash equivalents and $43.2 million of availability under the 2018 ABL Credit Facility, which resulted in a total liquidity position of $64.7 million. We expect our total liquidity position to continue to erode, due in large part to semi-annual interest payments ($14.0 million each) on the Senior Notes. Based on our current forecasts, we believe that cash on hand, together with cash flow from operations, and current and any potential future borrowings under the 2018 ABL Credit Facility, should be sufficient to meet our cash requirements inclusive of, but not limited to, normal operating needs, debt service obligations and planned capital expenditures and commitments for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts, which are materially dependent on improved financial performance and the ever changing market. +At December 31, 2021, we had $15.0 million of borrowings under the 2018 ABL Credit Facility and borrowed an additional $5.0 million in the first two months of 2022. Approximately $28.4 million and $23.3 million in interest payments for both the Senior Notes and the 2018 ABL Credit Facility are due in 2022 and 2023, respectively. The 2018 ABL Credit Facility will mature on October 25, 2023, or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. As of December 31, 2021, there were approximately $320.3 million aggregate principal amount of Senior Notes outstanding. The Senior Notes will mature on October 25, 2023. Our plans to satisfy these obligations include refinancing or restructuring our indebtedness, seeking additional sources of capital, selling assets, or a combination thereof. Any such transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. Our ability to successfully execute these plans is dependent on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions, and certain financial, business and other factors, many of which are beyond our control. There can be no assurance that we will succeed in executing these plans. If unsuccessful, we will not have sufficient liquidity and capital resources to repay our indebtedness when it matures, or otherwise meet our long-term cash requirements beyond the next twelve months. +Senior Notes +On October 25, 2018, we issued $400.0 million of 8.750% Senior Notes under an indenture, dated as of October 25, 2018 (the “Indenture”), by and among us, including certain of our subsidiaries, and Wells Fargo, National Association, as Trustee. As of December 31, 2021, there were approximately $320.3 million aggregate principal amount of Senior Notes outstanding. The Senior Notes bear interest at annual rate of 8.750% payable on May 1 and November 1 of each year, and the first interest payment was due on May 1, 2019. Based on current amounts outstanding as of December 31, 2021, the semi-annual interest payments are $14.0 million each. The Senior Notes are senior unsecured obligations and are fully and unconditionally guaranteed on a senior unsecured basis by each of our current domestic subsidiaries and by certain future subsidiaries. +44 +The Indenture contains covenants that limit our ability and the ability of our restricted subsidiaries to engage in certain activities. We were in compliance with the provisions of the Indenture at December 31, 2021 . +Upon an event of default, the trustee or the holders of at least 25% in aggregate principal amount of then outstanding Senior Notes may declare the Senior Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to us, any of our restricted subsidiaries that are a significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding Senior Notes to become due and payable. +We repurchased approximately $26.3 million of Senior Notes at a repurchase price of approximately $8.4 million in cash for the year ended December 31, 2021. We also repurchased approximately $53.3 million of Senior Notes at a repurchase price of approximately $14.6 million in cash for the year ended December 31, 2020. +For additional information on the Senior Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +2018 ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), that permits aggregate borrowings of up to $200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “2018 ABL Credit Facility”). The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to us and our domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75% to 1.25% and the applicable margin for LIBOR loans or CDOR loans vary from 1.75% to 2.25% in each case depending on our leverage ratio. In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below $18.75 million or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. We were in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2021. +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +At December 31, 2021, we had $15.0 million of borrowings under the 2018 ABL Credit Facility, and our availability under the 2018 ABL Credit Facility was approximately $43.2 million, net of outstanding letters of credit of $0.5 million. We borrowed an additional $5.0 million under the 2018 ABL Credit Facility in the first two months of 2022. +45 +Cash Flows +Our cash flows for the years ended December 31, 2021, and 2020 are presented below: +Year Ended December 31, +2021 2020 +(in thousands) +Operating activities $ (40,416) $ (4,901) +Investing activities (11,921) (1,778) +Financing activities 5,048 (17,385) +Impact of foreign exchange rate on cash (66) (61) +Net change in cash and cash equivalents $ (47,355) $ (24,125) +Operating Activities +Net cash used in operating activities was $40.4 million in 2021 compared to $4.9 million in net cash used in operating activities in 2020. The $35.5 million increase in net cash used in operating activities was primarily a result of a $62.2 million decrease in the change in working capital, including an increase in accounts receivable from increased product and service sales, which has the effect of lagging cash collections, in comparison to 2020. The overall increase in net cash used in operating activities was partially offset by an increase of $26.7 million in cash flow provided by operations, adjusted for any non-cash items, in comparison to 2020. +Investing Activities +Net cash used in investing activities was $11.9 million in 2021 compared to $1.8 million in net cash used in investing activities in 2020. The $10.1 million increase in net cash used in investing activities was primarily related to a $6.0 million increase in cash purchases of property and equipment in comparison to 2020, coupled with a $4.1 million decrease in proceeds from the sale of property and equipment (including insurance) between periods. +Financing Activities +Net cash provided by financing activities was $5.0 million in 2021 compared to $17.4 million in net cash used in financing activities in 2020 . The $22.4 million increase in net cash provided by financing activities was primarily related to $15.0 million in proceeds from the 2018 ABL Credit Facility in 2021 that did not occur in 2020. The overall increase in net cash provided by financing activities was also partly attributed to a $6.1 million decrease in purchases of the Senior Notes and a $1.2 million reduction in payments of contingent liabilities between periods. +Critical Accounting Estimates +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. +We consider the significant accounting policies identified below to be “critical accounting estimates” due to the following: +• The policies are dependent on estimates and assumptions made by us about matters that are inherently uncertain. +• The policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. +For additional information on our significant accounting policies, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +46 +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful life of the asset. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. Estimated useful lives requires significant judgment which is influenced by our historical experience in operating property and equipment, technological developments, and expectations of future demand. Should our estimates be too long or too short, we could report a disproportionate amount of losses or gains from sale or retirement. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. Reasonable estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The accuracy of these estimates is impacted by, among other things, the complexity of the issues and the amount of due diligence we have been able to perform. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. If the actual settlement costs, final judgments, or fines, after appeals, differ from our estimates, there may be a material adverse effect on our future financial results. +Stock-based Compensation and Fair Market Value Determination +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in “General and administrative expenses” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Fair value of all the options outstanding was measured using the Black-Scholes model. Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – We develop our expected volatility based upon a weighted average volatility of our peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +47 +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Fair value of the stock-based compensation for all of the performance share units outstanding was measured using a Monte Carlo simulation model. +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Emerging Growth Company Status +We are an “emerging growth company” as defined in the JOBS Act. Under Section 107 of the JOBS Act, as an emerging growth company, we are taking advantage of an extended transition period for the adoption of new or revised financial accounting standards, including the reduced reporting requirements and exemptions, and the longer phase-in periods for the adoption of new or revised financial accounting standards, until we are no longer an emerging growth company. Our election to use the longer phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Smaller Reporting Company Status +We are a “smaller reporting company” as defined by the SEC. As such, we are eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. Our disclosures in this Annual Report reflect these scaled requirements. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +48 +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 238 ) +F- 1 +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2021 and 2020 +F- 3 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2021 and 2020 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2021 and 2020 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +49 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of income and comprehensive income (loss), consolidated statements of stockholders’ equity, and consolidated statements of cash flow for the years then ended December 31, 2021, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. +Change in Accounting Principle +As discussed in Note 6 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2020. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Emphasis of Matter +As discussed in Note 1 to the consolidated financial statements, the Company has outstanding borrowings under its ABL Credit Facility and Senior Notes that mature in 2023. Management’s evaluation of the events and conditions and management’s plans to mitigate these matters are also described in Note 1. +/s/ PricewaterhouseCoopers LLP +Houston, TX +March 7, 2022 +We have served as the Company’s auditor since 2011. +F-1 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2021 2020 +Assets +Current assets +Cash and cash equivalents $ 21,509 $ 68,864 +Accounts receivable, net 64,025 41,235 +Income taxes receivable 1,393 1,392 +Inventories, net 42,180 38,402 +Prepaid expenses and other current assets 10,195 16,270 +Total current assets 139,302 166,163 +Property and equipment, net 86,958 102,429 +Operating lease right of use assets, net 35,117 36,360 +Finance lease right of use assets, net 1,445 1,816 +Intangible assets, net 116,408 132,524 +Other long-term assets 2,383 3,308 +Total assets $ 381,613 $ 442,600 +Liabilities and Stockholders’ Equity +Current liabilities +Accounts payable $ 28,680 $ 18,140 +Accrued expenses 18,519 17,139 +Current portion of long-term debt 2,093 844 +Current portion of operating lease obligations 6,091 6,200 +Current portion of finance lease obligations 1,070 1,092 +Total current liabilities 56,453 43,415 +Long-term liabilities +Long-term debt 332,314 342,714 +Long-term operating lease obligations 30,435 32,295 +Long-term finance lease obligations 65 1,109 +Other long-term liabilities 1,613 2,658 +Total liabilities 420,880 422,191 +Commitments and contingencies (Note 12) +Stockholders’ equity +Common stock ( 120,000,000 shares authorized at $ 0.01 par value; 32,826,325 and 31,557,809 shares issued and outstanding at December 31, 2021 and 2020 respectively) +328 316 +Additional paid-in capital 773,350 768,429 +Accumulated other comprehensive loss ( 4,535 ) ( 4,501 ) +Accumulated deficit ( 808,410 ) ( 743,835 ) +Total stockholders’ equity ( 39,267 ) 20,409 +Total liabilities and stockholders’ equity $ 381,613 $ 442,600 +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2021 2020 +Revenues +Service $ 248,618 $ 231,719 +Product 100,801 79,132 +349,419 310,851 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Service 228,290 220,960 +Product 79,702 81,197 +General and administrative expenses 45,301 49,346 +Depreciation 28,905 32,431 +Amortization of intangibles 16,116 16,467 +Impairment of goodwill — 296,196 +Loss on revaluation of contingent liabilities 460 276 +(Gain) loss on sale of property and equipment 660 ( 2,857 ) +Loss from operations ( 50,015 ) ( 383,165 ) +Interest expense 32,527 36,759 +Interest income ( 26 ) ( 615 ) +Gain on extinguishment of debt ( 17,618 ) ( 37,841 ) +Other income ( 298 ) ( 62 ) +Loss before income taxes ( 64,600 ) ( 381,406 ) +Benefit for income taxes ( 25 ) ( 2,458 ) +Net loss $ ( 64,575 ) $ ( 378,948 ) +Loss per share +Basic $ ( 2.13 ) $ ( 12.74 ) +Diluted $ ( 2.13 ) $ ( 12.74 ) +Weighted average shares outstanding +Basic 30,302,925 29,744,830 +Diluted 30,302,925 29,744,830 +Other comprehensive loss, net of tax +Foreign currency translation adjustments, net of $ 0 tax in each period +$ ( 34 ) $ ( 34 ) +Total other comprehensive loss, net of tax ( 34 ) ( 34 ) +Total comprehensive loss $ ( 64,609 ) $ ( 378,982 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(In thousands, except share amounts) +Common Stock Additional +Paid-in Accumulated +Other +Comprehensive Retained +Earnings +(Accumulated Total +Stockholders’ +Shares Amounts Capital Income (Loss) Deficit) Equity +Stockholders’ equity as of December 31, 2019 30,555,677 $ 306 $ 758,853 $ ( 4,467 ) $ ( 364,815 ) $ 389,877 +Cumulative effect adjustment of lease implementation — — — — ( 72 ) ( 72 ) +Issuance of common stock under stock compensation plan, net of forfeitures 1,151,915 11 ( 11 ) — — — +Stock-based compensation expense — — 9,744 — — 9,744 +Vesting of restricted stock ( 149,783 ) ( 1 ) ( 157 ) — — ( 158 ) +Other comprehensive loss — — — ( 34 ) — ( 34 ) +Net loss — — — — ( 378,948 ) ( 378,948 ) +Stockholders’ equity as of December 31, 2020 31,557,809 $ 316 $ 768,429 $ ( 4,501 ) $ ( 743,835 ) $ 20,409 +Issuance of common stock under stock compensation plan, net of forfeitures 1,457,626 14 ( 14 ) — — — +Stock-based compensation expense — — 5,406 — — 5,406 +Vesting of restricted stock ( 189,110 ) ( 2 ) ( 471 ) — — ( 473 ) +Other comprehensive loss — — — ( 34 ) — ( 34 ) +Net loss — — — — ( 64,575 ) ( 64,575 ) +Stockholders’ equity as of December 31, 2021 32,826,325 $ 328 $ 773,350 $ ( 4,535 ) $ ( 808,410 ) $ ( 39,267 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2021 2020 +Cash flows from operating activities +Net loss $ ( 64,575 ) $ ( 378,948 ) +Adjustments to reconcile net loss to net cash used in operating activities +Depreciation 28,905 32,431 +Amortization of intangibles 16,116 16,467 +Amortization of operating leases 8,020 8,897 +Amortization of deferred financing costs 2,602 2,836 +Provision for (recovery for) doubtful accounts ( 229 ) 2,820 +Benefit for deferred income taxes — ( 1,588 ) +Provision for inventory obsolescence 4,831 8,957 +Impairment of goodwill — 296,196 +Impairment of operating lease — 466 +Stock-based compensation expense 5,406 9,744 +Gain on extinguishment of debt ( 17,618 ) ( 37,841 ) +(Gain) loss on sale of property and equipment 660 ( 2,857 ) +Loss on revaluation of contingent liabilities 460 276 +Changes in operating assets and liabilities, net of effects from acquisitions +Accounts receivable, net ( 22,540 ) 52,914 +Inventories, net ( 8,608 ) 13,600 +Prepaid expenses and other current assets 3,350 1,368 +Accounts payable and accrued expenses 12,447 ( 25,456 ) +Income taxes receivable/payable — ( 732 ) +Other assets and liabilities ( 9,643 ) ( 4,451 ) +Net cash used in operating activities ( 40,416 ) ( 4,901 ) +Cash flows from investing activities +Proceeds from sales of property and equipment 3,492 6,402 +Proceeds from property and equipment casualty losses — 1,237 +Purchases of property and equipment ( 15,413 ) ( 9,417 ) +Net cash used in investing activities ( 11,921 ) ( 1,778 ) +Cash flows from financing activities +Proceeds from 2018 ABL Credit Facility 15,000 — +Purchases of Senior Notes ( 8,355 ) ( 14,561 ) +Payments on Magnum Promissory Notes ( 844 ) ( 281 ) +Proceeds from short-term debt 1,513 — +Payments of short-term debt ( 545 ) — +Payments on finance leases ( 1,094 ) ( 995 ) +Payments of contingent liabilities ( 154 ) ( 1,390 ) +Vesting of restricted stock ( 473 ) ( 158 ) +Net cash provided by (used in) financing activities 5,048 ( 17,385 ) +Impact of foreign currency exchange on cash ( 66 ) ( 61 ) +Net decrease in cash and cash equivalents ( 47,355 ) ( 24,125 ) +Cash and cash equivalents +F-5 +Year Ended December 31, +2021 2020 +Cash and cash equivalents at beginning of period 68,864 92,989 +Cash and cash equivalents at end of period $ 21,509 $ 68,864 +Supplemental disclosures of cash flow information: +Cash paid for interest $ 30,085 $ 34,421 +Cash refunded for income taxes $ 24 $ 540 +Termination of contingent liability related to business acquisition $ — $ 3,375 +Capital expenditures in accounts payable and accrued expenses $ 63 $ 747 +Receivable from property and equipment sale (including insurance) $ 497 $ 3,223 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies. The Company is headquartered in Houston, Texas. +The Company’s chief operating decision maker, which is its Chief Executive Officer, and its board of directors allocate resources and assess performance based on financial information presented at a consolidated level. Accordingly, the Company determined that it operates as one reportable segment, known as Completion Solutions . +Risks and Uncertainties +The Company’s business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. In 2020, the coronavirus pandemic, coupled with production disputes amongst the Organization of the Petroleum Exporting Countries and other oil producing nations, led to a massive decline in the demand for oil and a risk of a substantial increase in supply, which led to extreme activity levels and pricing declines across all of the Company’s service offerings for the entire year. Although oil and natural gas prices rebounded in 2021, the Company’s publicly-traded customers remained committed to capital discipline, and activity only moderately increased. As pricing for its products and services continued to remain depressed as a result of this level of activity, the Company focused on strategically implementing modest price increases where it was able to do so without sacrificing its market share of customers. Thus, even with further improvements in commodity prices, the Company’s business in the near or medium term may not improve materially or at all depending on, among other things, the Company’s customers’ activity plans, its ability to implement price increases, the impact of wage and labor inflation, labor shortage and supply constraints, and the Company’s ability to find and retain qualified personnel. In addition, the coronavirus pandemic continues to present a significant threat to employees’ well-being and morale, which could impact employee retention and productivity. +Liquidity +Historically, the Company has met its liquidity needs principally from cash on hand, cash flow from operations and, if needed, external borrowings and issuances of debt securities. At December 31, 2021, the Company had $ 21.5 million of cash and cash equivalents and $ 43.2 million of remaining availability under the 2018 ABL Credit Facility (as defined in Note 9 – Debt Obligations) which resulted in a total liquidity position of $ 64.7 million. The Company expects its liquidity position to continue to erode in 2022, due in large part to semi-annual interest payments of $ 14.0 million each, due on its Senior Notes (as defined in Note 9 – Debt Obligations). Based on its current forecasts, the Company believes that cash on hand, together with cash flow from operations, and current and any potential future borrowings under the 2018 ABL Credit Facility should be sufficient to meet its cash requirements inclusive of, but not limited to, normal operating needs, debt service obligations, and planned capital expenditures and commitments for at least the next twelve months from the issuance date of its consolidated financial statements. However, the Company can make no assurance regarding its ability to achieve its forecasts, which are materially dependent on improved financial performance and the ever-changing market. +At December 31, 2021, the Company had $ 15.0 million borrowings under the 2018 ABL Credit Facility and borrowed an additional $ 5.0 million in the first two months of 2022. The 2018 ABL Credit Facility will mature on October 25, 2023, or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. As of December 31, 2021, there were approximately $ 320.3 million aggregate principal amount of Senior Notes outstanding. The Senior Notes will mature on October 25, 2023. Management’s plans to satisfy these obligations include refinancing or restructuring the Company’s indebtedness, seeking additional sources of capital, selling assets, or a combination thereof. The Company’s ability to successfully execute these plans is dependent on its financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors, many of which are beyond the Company’s control. There can be no assurances the Company will succeed in executing these plans. If unsuccessful, the Company will not have sufficient liquidity and capital resources to repay its indebtedness when it matures. +F-7 +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial statements as of December 31, 2021 and 2020, and for the years ended December 31, 2021 and 2020, include the accounts of Nine and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. +Use of Estimates +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include fair value assumptions used in analyzing long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, recognition of provisions for contingencies, and stock-based compensation fair value. It is at least reasonably possible that the estimates used will change within the next year. +Revenue Recognition +The Company recognizes revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products are received by a customer’s domestic common carrier at the Company’s facility or when the product is received by the customer’s international carrier. The Company believes this recognition policy reflects the point at which the customer obtains control of the product as required by ASC 606. +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company excludes sales taxes, value added taxes, and other taxes it collects concurrent with revenue-producing activities from revenue. +The Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For domestic product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. For international product sales, the Company typically recognizes revenue when it meets its performance obligation upon receipt of the products by the customer’s international carrier. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. Service revenues represent revenue recognized over time, as the Company’s customer arrangements typically provide agreed upon hourly or daily fixed-rates, and the Company recognizes service revenue based upon the number of hours or days services have been performed. +Contracts for the Company’s products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period the Company stands ready to provide its services to its client as needed. +The Company’s payment terms vary by the type and location of its customers and type of product and service offered. The Company receives cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date the Company invoices a customer. Since the period between the delivery of the Company’s products and services and the Company’s receipt of customer payment for these products and services is not expected to exceed one year, the Company has elected not to calculate or disclose a financing component for its customer contracts. +F-8 +Contract Estimates +The Company receives reimbursements from its customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of the Company’s influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. The Company is considered a principal in these transactions and records the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of the Company’s contracts due to the dynamic nature of well operations and the services the Company provides for its customers. The Company considers contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of the Company’s contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Any contract assets are included in “Accounts receivable, net” in the Company’s Consolidated Balance Sheets. Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. The Company classifies contract liabilities as unearned income which is included in “Accrued expenses” in the Company’s Consolidated Balance Sheets. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For information regarding the Company’s revenue, see Note 3 – Revenues . +Leases +The Company determines if an arrangement is a lease at inception. To the extent an arrangement represents a lease, the Company classifies that lease as an operating lease or a finance lease under Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”). +The Company capitalizes operating leases on its Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that the Company would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2021 and 2020. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2021 and 2020. +Accounting for finance leases under ASC 842 remained unchanged from previous accounting guidance and are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2021 and 2020. +For additional information regarding the Company’s leases, see Note 6 – Leases. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the United States Dollar (“USD”). The financial position and results of +F-9 +operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) and its Consolidated Statements of Stockholders’ Equity. +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus, receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices, industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +The Company had $ 64.0 million and $ 41.2 million of “Accounts receivable, net” at December 31, 2021 and 2020, respectively. The Company maintains an allowance for doubtful accounts based on the expected collectability of accounts receivable, which is included in “Accounts receivable, net” on the Company’s Consolidated Balance Sheets. The Company had an allowance for doubtful accounts of $ 2.8 million and $ 3.4 million at December 31, 2021 and 2020, respectively. Bad debt expense recovery was $ 0.2 million for the year ended December 31, 2021, and bad debt expense was $ 2.8 million for the year ended December 31, 2020. +Concentration of Credit Risk +The Company derives a significant portion of its revenues from companies in the exploration and production (“E&P”) industry, and its customer base includes a broad range of integrated and independent domestic E&P companies and international E&P companies operating in the markets that the Company serves. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and can therefore negatively impact spending by the Company’s customers. No customer accounted for more than 10% of the revenues for the year ended December 31, 2021. One customer accounted for more than 10% of revenues for the year ended December 31, 2020. +Concentration of Supplier Risk +Purchases during the years ended December 31, 2021 and 2020 did not include purchases from any supplier that individually represented more than 10% of total operating purchases. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the assets. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. +F-10 +Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +In the first quarter of 2020, with a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as sharp declines in oil and natural gas prices, the Company determined that the carrying amount of long-lived assets (inclusive of definite-lived intangible assets and property and equipment) associated with its asset groups may not be recoverable. As such, the Company performed an impairment assessment of long-lived assets in its asset groups under Accounting Standards Codification 360, Property, Plant and Equipment at March 31, 2020, based on its best internal projections and the likelihood of various outcomes. Based on its assessment, the Company determined that the estimated future undiscounted cash flows derived from long-lived assets associated with its asset groups exceeded the carrying amount of long-lived assets associated with its asset groups, and no impairment to long-lived assets was required. +Valuation of Goodwill and Intangible Assets +Goodwill has an indefinite useful life and is not subject to amortization. Intangible assets with indefinite useful lives (specifically trademarks and trade names) are also not subject to amortization. For goodwill and intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Goodwill is reviewed for impairment by comparing the carrying value of each of the Company’s reporting unit’s net assets (including allocated goodwill) to the Level 3 fair value of the reporting unit. The Level 3 fair value of the reporting unit is determined by using the income approach (discounted cash flows of forecasted income). Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives (specifically trademarks and trade names) is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds the reporting unit’s Level 3 fair value. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. +In the first quarter of 2020, in connection with an interim goodwill impairment test, the Company recorded goodwill impairment charges of $ 296.2 million in its tools, cementing, and wireline reporting units due to sharp declines in global crude oil demand, an economic recession associated with the coronavirus pandemic, sharp declines in oil and natural gas prices, and an increased weighted average cost of capital driven by a reduction in the Company’s stock price and the Level 2 fair value of its Senior Notes. +For additional information on goodwill impairment charges, see Note 7 – Intangible Assets and Goodwill. +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee +F-11 +stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. As a result of the adoption of ASU No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Restricted Stock and Restricted Stock Units +Compensation expense is recorded for restricted stock and restricted stock units over the applicable vesting period based on the Company’s closing stock price as of the grant date. +Performance Units +Performance stock units are recorded at their fair value and expensed over their performance period. Fair value for performance stock units is measured using a Monte Carlo simulation model. +Options +Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +• The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +• Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company developed its expected volatility based upon a weighted average volatility of its peer group. +• At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +• The risk-free interest rate is based on United States’ Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Income Taxes +The Company accounts for income taxes under Accounting Standards Codification 740, Income Taxes (“ASC 740”) . Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the +F-12 +reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 9 – Debt Obligations. +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 12 – Commitments and Contingencies. +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, taking into effect, if any, the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as potentially dilutive restricted stock, restricted stock units, and performance stock units. There was no dilutive effect for the years ended December 31, 2021 and 2020 as the Company was in a net loss position for those years. For additional information on earnings (loss) per share, see Note 14 – Earnings (Loss) Per Share. +Accounting Pronouncements Recently Adopted +In March 2020, the Financial Accounting Standards Board (the “FASB”) issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , which provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. The amendments in ASU 2020-04 are effective for all entities as of March 12, 2020 through December 31, 2022. An entity may elect to apply the amendments for contract modifications as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements included in this Annual Report. +Accounting Pronouncements Not Yet Adopted +In December 2019, the FASB issued ASU 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes , which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles and clarifies and amends existing guidance to improve consistent application. ASU 2019-12 is effective for public businesses for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and plans, to adopt the new standard for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022. The Company does not expect the standard to have a material impact on its consolidated financial statements. +In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in ASU 2016-13 replace the current incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information. ASU 2016-13 is effective for Securities and Exchange Commission filers, excluding smaller reporting companies, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and plans, to adopt the new standard for the fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company does not expect the standard to have a material impact on its consolidated financial statements. +F-13 +3. Revenues +Disaggregation of Revenues +Disaggregated revenue for the years ended December 31, 2021 and 2020 was as follows: +Year Ended December 31, +2021 2020 +(in thousands) +Cement $ 114,181 $ 102,631 +Tools 100,801 79,132 +Wireline 72,436 81,684 +Coiled tubing 62,001 47,404 +Total revenues $ 349,419 $ 310,851 +Year Ended December 31, +2021 2020 +(in thousands) +Service (1) +$ 248,618 $ 231,719 +Product (1) +100,801 79,132 +Total $ 349,419 $ 310,851 +(1) The Company recognizes revenues from the sales of products at a point in time and revenues from the sales of services over time. +Performance Obligations +At December 31, 2021 and December 31, 2020, the amount of remaining performance obligations were not material. +Contract Balances +At December 31, 2021 and December 31, 2020, contract assets and contract liabilities were not material. +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $ 9.0 million and $ 13.3 million at December 31, 2021 and 2020, respectively. +Inventories, net as of December 31, 2021 and 2020 were comprised of the following: +December 31, +2021 2020 +(in thousands) +Raw materials $ 31,153 $ 33,361 +Work in progress 675 367 +Finished goods 19,323 17,952 +Inventories 51,151 51,680 +Reserve for obsolescence ( 8,971 ) ( 13,278 ) +Inventories, net $ 42,180 $ 38,402 +F-14 +5. Property and Equipment +Property and equipment amounts as of December 31, 2021 and 2020 were as follows: +December 31, +Estimated +Useful Lives 2021 2020 +(in thousands) +Operating equipment +1 to 12 years +$ 299,602 $ 296,491 +Autos and trucks +1 to 7 years +4,168 4,102 +Furniture, fixtures, and equipment +2 to 12 years +4,059 4,100 +Shop equipment +3 to 15 years +14,555 13,558 +Buildings +7 to 39 years +8,994 8,489 +Leasehold improvements +3 to 11 years +1,443 1,320 +Land indefinite 828 791 +333,649 328,851 +Less: Accumulated depreciation ( 246,691 ) ( 226,422 ) +Property and equipment, net $ 86,958 $ 102,429 +Depreciation expense was $ 28.9 million and $ 32.4 million for the years ended December 31, 2021 and 2020, respectively. +6. Leases +On December 31, 2020, the Company adopted ASC 842 with an effective date of January 1, 2020. The cumulative effect on retained earnings upon adoption was not material. Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Company’s Consolidated Balance Sheets. Lease with an initial term greater than 12 months are recognized in the Company’s Consolidated Balance Sheets based on lease classification as either operating or financing. Some of the Company’s lease agreements include lease and non-lease components for which the Company has elected to not separate for all classes of underlying assets. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may sublease its real estate to third parties, subject to certain provision of the lease, when it has no future use for the property. +Operating Leases +As a lessee, the Company’s operating lease portfolio primarily consists of operating leases for equipment, vehicles, office space, yard facilities, and employee housing. Operating lease ROU assets and operating lease obligations are recognized based on the present value of the future minimum lease payments at commencement date. As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate based on the lease information available at the commencement date in determining the present value of future payments. The incremental borrowing rate utilized is based upon the interest rate associated with the Company’s 2018 ABL Credit Facility which is utilized to fund its working capital needs and planned capital expenditures. The Company’s leases have remaining terms of one to ten years and may include options to extend or terminate the lease. The operating lease ROU assets also include any upfront lease payments made and exclude lease incentives and initial direct costs incurred. +The Company leases most of these properties under long-term (greater than one year) non-cancelable term leases many of which contain renewal options that can extend the lease term from one to five years and some of which contain escalation clauses. The Company may also enter into short-term or month-to-month operating leases. Options to renew these leases are generally not considered reasonably certain to be exercised due to the nature of the Company’s operations and the markets it serves. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease. +The Company also leases supplemental equipment, typically under cancellable short-term contracts which are less than 30 days. This equipment is typically required for a specific project and for a short duration. Due to the nature of the Company’s operations, any option to renew these short-term leases is generally not considered reasonably certain to be exercised. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease, and the lease payments during these periods are similarly excluded from the calculation of operating lease asset and lease obligation balances. +F-15 +Operating lease expense consists of rent expense related to leases that were included in ROU assets under ASC 842. The Company recognizes operating lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable operating lease payments typically include charges for property taxes and insurance, and some leases contain variable payments related to non-lease components, including common area maintenance and usage of facilities or office equipment (for example, copiers). The Company does not have variable expenses. +Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2021 and 2020. +Finance Leases +Finance leases are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2021 and 2020. +Additional Information +The following table summarizes the components of the Company’s lease expense recognized for the year ended December 31, 2021 and 2020, excluding variable lease and prepaid rent costs: +Year Ended December 31, +2021 2020 +(in thousands) +Operating lease expense +Operating lease right of use assets $ 8,020 $ 8,897 +Operating lease non right of use assets 6,201 5,795 +Total operating lease expense $ 14,221 $ 14,692 +Finance lease expense +Depreciation of right of use assets $ 399 $ 321 +Interest on lease obligations 162 257 +Total finance lease expense $ 561 $ 578 +Operating lease expense is included in the line items “Cost of revenues” and “General and administrative expenses” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2021 and 2020. +Supplemental information related to leases was as follows as of December 31, 2021 and 2020: +December 31, +2021 2020 +Operating leases +Weighted average remaining lease term 6.4 7.0 +Weighted average discount rate 5.0 % 5.0 % +Finance leases +Weighted average remaining lease term 1.0 2.0 +Weighted average discount rate 9.8 % 9.3 % +F-16 +Supplemental balance sheet information related to leases was as follows as of December 31, 2021 and 2020: +December 31, +2021 2020 +(in thousands) +Operating lease right of use assets +Operating lease right of use assets, gross $ 45,853 $ 43,061 +Less: Accumulated amortization ( 10,736 ) ( 6,701 ) +Operating lease right of use assets, net $ 35,117 $ 36,360 +Operating lease obligations +Current portion of operating lease obligations $ 6,091 $ 6,200 +Long-term operating lease obligations 30,435 32,295 +Total operating lease obligations $ 36,526 $ 38,495 +Finance lease right of use assets +Finance lease right of use assets, gross $ 2,980 $ 2,952 +Less: Accumulated depreciation ( 1,535 ) ( 1,136 ) +Finance lease right of use assets, net $ 1,445 $ 1,816 +Finance lease obligations +Current portion of finance lease obligations $ 1,070 $ 1,092 +Long-term finance lease obligations 65 1,109 +Total finance lease obligations $ 1,135 $ 2,201 +Future annual minimum lease payments as of December 31, 2021 were as follows: +Operating Lease Right of Use Obligations Finance Leases Total +(in thousands) +2022 $ 7,745 $ 1,137 $ 8,882 +2023 7,427 66 7,493 +2024 6,034 — 6,034 +2025 5,371 — 5,371 +2026 5,163 — 5,163 +Thereafter 10,940 — 10,940 +Total lease payments $ 42,680 $ 1,203 $ 43,883 +Less: present value discount ( 6,154 ) ( 68 ) ( 6,222 ) +Present value of lease obligations $ 36,526 $ 1,135 $ 37,661 +F-17 +Supplemental cash flow information related to leases for the years ended December 31, 2021 and 2020 were as follows: +Year Ended December 31, +2021 2020 +(in thousands) +Cash paid for amounts included in the measurement of lease obligations: +Operating cash flows from operating leases $ 8,124 $ 8,592 +Operating cash flows from finance leases $ 399 $ 321 +Financing cash flows from finance leases $ 1,094 $ 995 +Right of use assets obtained in exchange for lease obligations: +Operating leases $ 5,059 $ 1,099 +Finance leases $ 28 $ — +7. Intangible Assets and Goodwill +Intangible Assets +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2021 and 2020 were as follows: +December 31, 2021 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 45,187 ) $ 18,083 5.3 +Non-compete agreements 6,500 ( 5,766 ) 734 2.0 +Technology 125,110 ( 28,519 ) 96,591 11.7 +In-process research and development 1,000 — 1,000 Indefinite +Total $ 195,880 $ ( 79,472 ) $ 116,408 +December 31, 2020 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 38,084 ) $ 25,186 5.5 +Non-compete agreements 6,500 ( 5,366 ) 1,134 2.8 +Technology 125,110 ( 19,906 ) 105,204 12.7 +In-process research and development 1,000 — 1,000 Indefinite +Total $ 195,880 $ ( 63,356 ) $ 132,524 +Amortization of Intangibles +Amortization of intangibles was $ 16.1 million and $ 16.5 million for the years ended December 31, 2021 and 2020, respectively. +F-18 +Future estimated amortization of intangibles is as follows: +Year Ending December 31, (in thousands) +2022 $ 13,463 +2023 11,516 +2024 11,183 +2025 11,183 +2026 11,082 +Thereafter 56,981 +$ 115,408 +Goodwill +2020 Goodwill Impairment +With a significant reduction in exploration and production capital budgets and activity, primarily driven by sharp declines in global crude oil demand and an economic recession associated with the coronavirus pandemic, as well as, sharp declines in oil and natural gas prices, the outlook for expected future cash flows associated with the Company’s reporting units decreased dramatically in the first quarter of 2020. Based on these events, an indication of impairment associated with the Company’s reporting units occurred, triggering an interim goodwill impairment test of the Level 3 fair value of each reporting unit under Accounting Standards Codification 350, Intangibles - Goodwill and Other (“ASC 350”) at March 31, 2020. +As such, based on its Level 3 fair value determination in connection with the interim goodwill impairment test under ASC 350, the Company recorded goodwill impairment charges of $ 296.2 million in the first quarter of 2020 associated with its tools, cementing, and wireline reporting units. These charges represented a full write-off of goodwill and were due to the events described above, coupled with an increased weighted average cost of capital driven by a reduction in the Company’s stock price and the Level 2 fair value of its Senior Notes. These goodwill impairment charges are included in the line item “Impairment of goodwill” in the Company’s Consolidated Statement of Income and Comprehensive Income (Loss) for the year ended December 31, 2020. +8. Accrued Expenses +Accrued expenses as of December 31, 2021 and 2020 consisted of the following: +December 31, +2021 2020 +(in thousands) +Accrued interest 4,980 5,313 +Accrued compensation and benefits 6,897 5,430 +Accrued bonus 1,125 — +Accrued legal fees and settlements 1,076 165 +Other accrued expenses 4,441 6,231 +Accrued expenses $ 18,519 $ 17,139 +F-19 +9. Debt Obligations +The Company’s debt obligations as of December 31, 2021 and 2020 were as follows: +December 31, +2021 2020 +(in thousands) +Senior Notes $ 320,343 $ 346,668 +2018 ABL Credit Facility 15,000 — +Magnum Promissory Notes 1,125 1,969 +Other short-term debt 968 — +Total debt before deferred financing costs $ 337,436 $ 348,637 +Deferred financing costs ( 3,029 ) ( 5,079 ) +Total debt $ 334,407 $ 343,558 +Less: Current portion of long-term debt ( 2,093 ) ( 844 ) +Long-term debt $ 332,314 $ 342,714 +Senior Notes +Background +On October 25, 2018, the Company issued $ 400.0 million principal amount of 8.750 % Senior Notes due 2023 (the “Senior Notes”). The Senior Notes were issued under an indenture, dated as of October 25, 2018 (the “Indenture”), by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as Trustee. The Senior Notes bear interest at an annual rate of 8.750 % payable on May 1 and November 1 of each year, and the first interest payment was due on May 1, 2019. The Senior Notes are senior unsecured obligations of the Company and are fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s current domestic subsidiaries and by certain future subsidiaries. +The Indenture contains covenants that limit the Company’s ability and the ability of its restricted subsidiaries to engage in certain activities. The Company was in compliance with the provisions of the Indenture at December 31, 2021. +Upon an event of default, the trustee or the holders of at least 25 % in aggregate principal amount of then outstanding Senior Notes may declare the Senior Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any restricted subsidiary of the Company that is a significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding Senior Notes to become due and payable. +Unamortized deferred financing costs associated with the Senior Notes were $ 3.0 million and $ 5.1 million at December 31, 2021 and 2020, respectively. These costs are direct deductions from the carrying amount of the Senior Notes and are being amortized through interest expense through the maturity date of the Senior Notes using the effective interest method. +Extinguishment of Debt +The Company repurchased approximately $ 26.3 million of Senior Notes at a repurchase price of approximately $ 8.4 million in cash for the year ended December 31, 2021. Deferred financing costs associated with these transactions were $ 0.3 million for the year ended December 31, 2021. As a result, for the year ended December 31, 2021, the Company recorded a $ 17.6 million gain on the extinguishment of debt, which is calculated as the difference between the repurchase price and the carrying amount of the Senior Notes partially offset by the deferred financing costs. +The Company repurchased approximately $ 53.3 million of Senior Notes at a repurchase price of approximately $ 14.6 million in cash for the year ended December 31, 2020. Deferred financing costs associated with these transactions were $ 0.9 million for the year ended December 31, 2020. As a result, for the year ended December 31, 2020, the Company recorded a $ 37.8 million gain on the extinguishment of debt, which was calculated as the difference between the repurchase price and the carrying amount of the Senior Notes partially offset by the deferred financing costs. +The gain on extinguishment of debt is included as a separate line item in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2021 and 2020 . +F-20 +2018 ABL Credit Facility +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A. as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permits aggregate borrowings of up to $ 200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $ 25.0 million and a sub-limit of $ 50.0 million for letters of credit (the “2018 ABL Credit Facility”). The 2018 ABL Credit Facility will mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. +Loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75 % to 1.25 % and the applicable margin for LIBOR loans or CDOR loans vary from 1.75 % to 2.25 %, in each depending on the Company’s leverage ratio. In addition, a commitment fee of 0.50 % per annum will be charged on the average daily unused portion of the revolving commitments. +The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below $ 18.75 million or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. The Company was in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2021. +All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and the U.S. Credit Parties. +At December 31, 2021, the Company had $ 15.0 million of borrowings under the 2018 ABL Credit Facility for general corporate purposes, and its availability under the 2018 ABL Credit Facility was approximately $ 43.2 million, net of outstanding letters of credit of $ 0.5 million. The Company borrowed an additional $ 5.0 million under the 2018 ABL Credit Facility in the first two months of 2022. +Magnum Promissory Notes +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018 (as amended on June 7, 2019, the “Magnum Purchase Agreement”), the Company acquired all of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum”). The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019 (the “Magnum Earnout”). +On June 30, 2020, pursuant to an amendment to the Magnum Purchase Agreement to terminate the remaining Magnum Earnout and all obligations related thereto (the “Magnum Purchase Agreement Amendment”), the Company issued promissory notes with an aggregated principal amount of $ 2.3 million (the “Magnum Promissory Notes”) to the sellers of Magnum. The Magnum Promissory Notes bear interest at a rate of 6.0 % per annum . The principal amount of the Magnum Promissory Notes will be paid in equal quarterly installments which began January 1, 2021. The entire unpaid principal amount will be due and payable on the maturity date, which is the earlier of October 1, 2022 or the business day after the date on which the Company sells, transfers or otherwise disposes of the “E-Set” tools business to an unaffiliated third party, unless such sale, transfer or disposition is made, directly or indirectly, as part of the sale, transfer or disposition of the Dissolvable Plugs Business or due to the occurrence of a Change of Control Event (each as defined in the Magnum Purchase Agreement). +For additional information regarding the termination of the Magnum Earnout, see Note 12 – Commitments and Contingencies. +F-21 +Other Short-Term Debt +In the fourth quarter of 2021, the Company renewed certain insurance policies, and it financed the premium for its excess policy in the amount of $ 1.5 million. At December 31, 2021, the outstanding balance on this premium was $ 1.0 million. +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2021 and 2020 was as follows: +December 31, +2021 2020 +(in thousands) +Senior Notes $ 153,765 $ 156,001 +2018 ABL Credit Facility $ 15,000 $ — +Magnum Promissory Notes $ 1,125 $ 1,969 +Other short-term debt $ 968 $ — +The fair value of the Senior Notes, 2018 ABL Credit Facility, the Magnum Promissory Notes, and other short-term debt is classified as Level 2 in the fair value hierarchy. The fair value of the Senior Notes is established based on observable inputs in less active markets. The fair value of the 2018 ABL Credit Facility, the Magnum Promissory Notes, and other short-term debt approximates their carrying value. +10. Defined Contribution Plans +Background +The Company sponsors a defined contribution plan under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +From January 1, 2020 until April 25, 2020, under the Nine Energy Service 401(k) Plan (the “Nine Plan”), employee contributions were matched by the Company at 100 % of the first 5 % of the participant’s eligible compensation . Effective April 25, 2020, the Company suspended its matching contributions for employees. +Contributions +For the year ended December 31, 2021, the Company made no employer contributions under the Nine Plan. +For the year ended December 31, 2020, the Company made employer contributions of $ 1.4 million under the Nine Plan . +F-22 +11. Stock-based Compensation +Stock Options +Information about stock option activity during the years ended December 31, 2021 and 2020 was as follows: +2021 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 702,542 $ 32.63 4.5 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 92,132 ) 26.71 — — +Total outstanding 610,410 $ 33.52 3.9 $ — +Options exercisable 610,410 $ 33.52 3.9 $ — +2020 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 816,427 $ 32.51 5.8 $ — +Granted — — — — +Exercised — — — — +Forfeited ( 466 ) 31.18 — — +Expired ( 113,419 ) 31.78 — — +Total outstanding 702,542 $ 32.63 4.5 $ — +Options exercisable 702,542 $ 32.63 4.5 $ — +The intrinsic value at December 31, 2021 and 2020 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2021 and 2020, respectively. +The Company granted no options in 2021 and 2020. +There was no compensation expense recorded for the year ended December 31, 2021 and approximately $ 0.3 million for the year ended December 31, 2020. As of December 31, 2021, there is no remaining compensation expense related to options for the Company to expense. Future stock option grants will result in additional compensation expense. +Restricted Stock and Restricted Stock Units +Information about restricted stock and restricted stock unit activity during the years ended December 31, 2021 and 2020 was as follows: +2021 2020 +Nonvested at January 1, 1,714,398 1,208,625 +Granted 1,509,000 1,383,059 +Vested ( 792,704 ) ( 641,658 ) +Cancelled ( 51,374 ) ( 235,628 ) +Nonvested at December 31, 2,379,320 1,714,398 +F-23 +The weighted-average grant date fair value of the restricted stock and restricted stock units granted was $ 2.15 and $ 0.85 during the years ended December 31, 2021 and 2020, respectively. The total amount of compensation expense related to the restricted stock and restricted stock units recorded was approximately $ 4.9 million and $ 9.0 million for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, the Company expects to record compensation expense related to restricted stock and restricted stock units of approximately $ 3.7 million over the remaining term of approximately 2.0 years. Future restricted stock and restricted stock unit grants will result in additional compensation expense. +Performance Stock Units +The Company granted performance stock units (“PSUs”) in 2019. The number of PSUs that vested in the first quarter of 2022 was contingent upon the Company’s achievement of certain specified targets. These awards had market conditions and were valued using a Monte Carlo simulation model. +The volatility of 49.7 % was developed based upon the historical volatility of the Company as well as the volatilities of a group of peer companies, as the Company’s trading history needed to be supplemented with additional data as it went public in 2018. The risk-free rate, which was derived using the United States’ Treasury security rates at the grant date, was 2.44 %. +2021 2020 +Nonvested at January 1, 61,900 61,900 +Granted (1) +— — +Vested — — +Cancelled — — +Nonvested at December 31, 61,900 61,900 +(1) The Company granted PSUs in 2019 that vested in the first quarter of 2022 contingent upon the Company’s achievement of certain specified targets based on a three-year performance period ending December 31, 2021. The number of PSUs in the table reflects the target level of PSUs. +The Company did not grant PSUs in 2021 or 2020. +The total amount of compensation expense related to PSUs was approximately $ 0.5 million for both the years ended December 31, 2021 and 2020. As of December 31, 2021, the Company has no further compensation expense related to PSUs to record. Future PSU grants will result in additional compensation expense. +12. Commitments and Contingencies +Litigation +The Company records accruals related to litigation and other legal proceedings when they are either known or considered probable and can be reasonably estimated. Legal proceedings are inherently unpredictable and subject to significant uncertainties, and significant judgment is required to determine both probability and the estimated amount. Some of these uncertainties include the stage of litigation, available facts, uncertainty as to the outcome of any legal proceedings or settlement discussions, and any novel legal issues presented. Because of such uncertainties, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to pending litigation. As of December 31, 2021 and 2020, the Company recorded a $ 1.1 million and a $ 0.2 million accrual, respectively, for liabilities related to legal matters, which is included under the caption “Accrued expenses” in its Consolidated Balance Sheets. +In addition to the matter disclosed below, from time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +On May 21, 2018, a certified class action was filed in the United States District Court, District of New Mexico by Jacob Rodriguez on behalf of similarly situated employees. The class action alleged certain wage and overtime related claims and violations of the New Mexico Minimum Wage Act, which is a state law similar to the Fair Labor Standards Act. In 2021, the Company reached a settlement agreement for the class action for an aggregate $ 1.7 million plus related payroll taxes to be +F-24 +paid in four quarterly installments. +Self-insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance claims. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $ 1.0 million and $ 1.3 million at December 31, 2021 and 2020, respectively, and is included under the caption “Accrued expenses” on the Company’s Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Contingent Liabilities +The Company’s contingent liabilities (Level 3) for the years ended December 31, 2021 and 2020 were as follows: +Frac Tech Magnum Total +(in thousands) +Balance at January 1, 2020 $ 1,359 $ 2,609 $ 3,968 +Payments ( 265 ) ( 1,125 ) ( 1,390 ) +Revaluation adjustments ( 490 ) 766 276 +Termination — ( 2,250 ) ( 2,250 ) +Balance at December 31, 2020 $ 604 $ — $ 604 +Payments ( 154 ) — ( 154 ) +Revaluation adjustments 460 — 460 +Balance at December 31, 2021 $ 910 $ — $ 910 +All contingent liabilities that relate to contingent consideration are reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include estimated gross margin related to forecasted sales of the plugs, term of the agreement, and a risk adjusted discount factor. Contingent liabilities include $ 0.1 million and $ 0.2 million reported in “Accrued expenses” at December 31, 2021 and 2020, respectively, and $ 0.8 million and $ 0.4 million reported in “Other long-term liabilities” at December 31, 2021 and 2020, respectively, in the Company’s Consolidated Balance Sheets. The impact of the revaluation adjustments is included in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Frac Tech Earnout +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (“the Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. The Frac Tech Purchase Agreement, as amended, includes, among other things, the potential for additional future payments, based on certain Frac Tech revenue metrics through December 31, 2025. +Magnum Earnout +The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019. +In 2019, the Company did not meet the sales requirement of certain dissolvable plug products during the year. +In 2020, pursuant to the Magnum Purchase Agreement Amendment, which terminated the remaining Magnum Earnout and all obligations related thereto, the Company made a cash payment of $ 1.1 million and issued the Magnum Promissory Notes with an aggregated principal amount of $ 2.3 million to the sellers of Magnum. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +F-25 +13. Taxes +The components of the provision (benefit) for income taxes for the years ended December 31, 2021 and 2020 were as follows: +Year Ended December 31, +2021 2020 +(in thousands) +Current +U.S. federal $ — $ ( 874 ) +U.S. state ( 56 ) 4 +Foreign 31 — +Total current benefit $ ( 25 ) $ ( 870 ) +Deferred +U.S. federal $ — $ ( 1,122 ) +U.S. state — ( 466 ) +Foreign — — +Total deferred benefit — ( 1,588 ) +Total benefit for income taxes $ ( 25 ) $ ( 2,458 ) +The provision (benefit) for income taxes for the years ended December 31, 2021 and 2020 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2021 2020 +(in thousands) +Tax benefit at statutory rate $ ( 13,570 ) $ ( 80,095 ) +Foreign rate differential ( 41 ) ( 117 ) +State income taxes, net of federal benefit ( 44 ) ( 463 ) +Nondeductible expenses 413 608 +Impact from goodwill impairment — 5,036 +Valuation allowance 11,350 70,387 +Non-cash compensation 1,893 — +Other ( 26 ) 2,186 +Total benefit for income taxes $ ( 25 ) $ ( 2,458 ) +F-26 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2021 and 2020 were as follows: +December 31, +2021 2020 +(in thousands) +Deferred income tax assets: +Inventories $ 2,533 $ 2,990 +Goodwill and intangible assets 83,318 90,829 +Deferred tax benefit from net losses 79,690 63,844 +Stock-based compensation 4,194 5,564 +Tax credit carryforwards 695 680 +Accrued expenses 1,632 2,142 +Interest carryover 6,824 553 +Lease liability 8,162 8,607 +Other 164 165 +Total deferred income tax assets 187,212 175,374 +Less: Valuation allowance ( 170,747 ) ( 157,703 ) +Net deferred income tax assets $ 16,465 $ 17,671 +Deferred income tax liabilities: +Property and equipment $ ( 8,387 ) $ ( 9,283 ) +ROU asset ( 8,078 ) ( 8,388 ) +Total deferred income tax liabilities ( 16,465 ) ( 17,671 ) +Net deferred income tax liability $ — $ — +As of December 31, 2021, the Company had federal and state net operating loss carryforwards (“NOLs”) of approximately $ 436.4 million. The federal NOLs related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state NOLs can be used from 7 to 20 years and vary by state. A small portion of state NOLs will begin to expire in 2022. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its NOL and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results, the Company continues to be in a three-year cumulative loss position for the year ended December 31, 2021. According to ASC 740, cumulative losses in recent years represent significant negative evidence in considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its United States’ domestic and Canadian deferred tax assets. The 2021 results include an increase in the Company’s valuation allowance of approximately $ 13.0 million. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a tax benefit. +The Company is subject to United States’ federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2018. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +F-27 +The Company accounts for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2021 +(in thousands) +Balance at January 1, $ 779 +Additional based on tax positions related to prior years — +Additional based on tax positions related to current year — +Reduction based on tax positions related to prior years — +Lapse of statute of limitations — +Balance at December 31, $ 779 +The total amount of unrecognized tax benefits at December 31, 2021 was $ 0.8 million. The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income and Comprehensive Income (Loss). As of December 31, 2021, no interest and penalties have been accrued. +14. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding during each period and the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as the potentially dilutive restricted stock, restricted stock units, and performance stock units. +Basic and diluted earnings (loss) per common share was computed as follows: +Year Ended December 31, 2021 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 64,575 ) 30,302,925 $ ( 2.13 ) +Assumed exercise of stock options — — — +Unvested restricted stock and stock units — — — +Diluted $ ( 64,575 ) 30,302,925 $ ( 2.13 ) +Year Ended December 31, 2020 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 378,948 ) 29,744,830 $ ( 12.74 ) +Assumed exercise of stock options — — — +Unvested restricted stock and stock units — — — +Diluted $ ( 378,948 ) 29,744,830 $ ( 12.74 ) +The diluted earnings (loss) per share calculation excludes all stock options, unvested restricted stock, unvested restricted stock units, and unvested performance stock units for 2021 and 2020 because there is a net loss for each period and their inclusion would be anti-dilutive. The average number of securities that were excluded from diluted earnings (loss) per share that would potentially dilute earnings (loss) per share for the periods in which the Company experienced a net loss were as follows: +2021 2020 +Year ended December 31, 729,514 753,609 +F-28 +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance expense associated with these entities was $ 0.8 million for both the years ended December 31, 2021 and 2020. The Company also purchased $ 2.6 million and $ 1.6 million of products and services for the years ended December 31, 2021 and 2020, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $ 0.7 million and $ 0.2 million at December 31, 2021 and 2020, respectively. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with this office space, net of sub-leasing income, was $ 1.4 million and $ 1.3 million for the years ended December 31, 2021 and 2020, respectively. There were net outstanding payables due to this entity of $ 0.1 million at December 31, 2020. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2021 and 2020, the outstanding principal balance payable to Mr. Frazier was $ 1.1 million and $ 1.9 million, respectively. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company purchases cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Previously, two of the Company’s directors served as directors of Forum; both individuals have ended their directorships at Forum as of December 31, 2021. The Company was billed $ 0.5 million for cable for both the years ended December 31, 2021 and 2020. There were outstanding payables due to this entity of $ 0.1 million at both December 31, 2021 and 2020. The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed $ 6.2 million and $ 4.6 million for coiled tubing string during the years ended December 31, 2021 and 2020, respectively. There were outstanding payables due to this entity of $ 0.6 million and $ 0.9 million at December 31, 2021 and 2020, respectively. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also serves as a director of Select. The Company was billed $ 1.1 million and $ 1.2 million for chemicals during the years ended December 31, 2021 and 2020, respectively. There were outstanding payables due to this entity of $ 0.1 million and $ 0.2 million at December 31, 2021 and 2020, respectively. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 1.3 million for the year ended December 31, 2021. The Company billed NESR $ 1.6 million for products and rentals and issued credit memos of $ 0.5 million during the year ended December 31, 2020. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $ 5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $ 0.5 million and $ 3.7 million at December 31, 2021 and 2020, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 3.2 million and $ 5.8 million for the years ended December 31, 2021 and 2020, respectively. There were outstanding receivables due from Devon of $ 0.4 million at both December 31, 2021 and 2020. +16. Supplemental Information +Capital expenditures for years ended December 31, 2021 and 2020 were as follows: +Year Ended December 31, +2021 2020 +(in thousands) +Completion Solutions $ 14,742 $ 10,147 +Corporate 15 7 +$ 14,757 $ 10,154 +F-29 +Total assets by segment as of December 31, 2021 and 2020 were as follows: +December 31, +2021 2020 +(in thousands) +Completion Solutions $ 349,429 $ 358,128 +Corporate 32,184 84,472 +$ 381,613 $ 442,600 +Revenue by country for the years ended December 31, 2021 and 2020 were as follows: +Year Ended December 31, 2021 Year Ended December 31, 2020 +Amount Percentage Amount Percentage +(in thousands) (in thousands) +United States $ 347,445 99.4 % $ 309,206 99.5 % +Canada 1,974 0.6 % 1,645 0.5 % +$ 349,419 100.0 % $ 310,851 100.0 % +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2021 and 2020 were as follows: +December 31, +2021 2020 +(in thousands) +United States $ 200,227 $ 231,294 +Canada and other 2,139 2,659 +$ 202,366 $ 233,953 +F-30 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2021. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2021. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2021, our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting as we are an “emerging growth company” as defined under the JOBS Act. In addition, management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the quarterly period ended December 31, 2021. +Item 9B. Other Information +None. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +50 +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. +Item 11. Executive Compensation +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. +51 +PART IV +Item 15. Exhibits and Financial Statement Schedules +(a) Documents Filed as Part of This Annual Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this Annual Report: +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2021 and 2020 +F- 3 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2021 and 2020 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2021 and 2020 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable, or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number Description +2.1† +Securities Purchase Agreement, dated as of October 15, 2018, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, Frazier Family Foundation, Inc., as sellers, Warren Lynn Frazier, solely in his capacity as seller representative, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, Nine Energy Service, Inc. and certain other parties named therein (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 15, 2018). +2.2 +First Amendment to Securities Purchase Agreement, dated June 7, 2019, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, and Frazier Family Foundation, Inc., as sellers, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, and Nine Energy Service, Inc. (Incorporated by reference to Exhibit 2.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed August 12, 2019). +2.3 +Second Amendment to Securities Purchase Agreement, dated June 30, 2020, by and among Warren Lynn Frazier, Garrett Lynn Frazier 2018 DG Trust, Derrick Chase Frazier 2018 DG Trust, and Frazier Family Foundation, Inc. as sellers, MOTI Holdco, LLC and Nine Energy Canada Inc., as buyers, and Nine Energy Service, Inc. (Incorporated by reference to Exhibit 2.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed August 7, 2020). +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +52 +4.4 +Indenture, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee (including Form of Note) (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.5 +Supplemental Indenture and Guarantee, dated as of November 23, 2018, by and among MOTI Holdco, LLC, Magnum Oil Tools GP, LLC, and Magnum Oil Tools International, LTD, Nine Energy Service, Inc. and certain other subsidiaries and Wells Fargo Bank, National Association, as a trustee (Incorporated by reference to Exhibit 4.5 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 7, 2019). +4.6 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.7 +Description of Common Stock (Incorporated by reference to Exhibit 4.7 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 10, 2020). +10.1 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +10.2+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.3+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.4+ +First Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of the Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 6, 2021). +10.5+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.6+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.7+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.8+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.9+ +Form of Nine Energy Service, Inc. Performance Share Unit Grant Notice and Form of Performance Share Unit Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 8, 2019). +10.10+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.11+ +Employment Agreement between Guy Sirkes and Nine Energy Service, LLC, dated as of March 31, 2020 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.12+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.13+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.14+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +53 +10.15+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and David Crombie (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.16+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Guy Sirkes (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.17+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Theodore R. Moore (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP. +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +101* Interactive Data Files. +___________________________________ +* Filed herewith. +** Furnished herewith. +† Certain schedules and similar attachments have been omitted pursuant to Item 601(a)(5) of Regulation S-K and will be provided to the SEC upon request. ++ Management contract or compensatory plan or arrangement. +54 +Item 16. Form 10-K Summary +None. +55 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: /s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 7, 2022 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 7, 2022. +Signature Title +/s/ Ann G. Fox President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Guy Sirkes Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Guy Sirkes +/s/ S. Brett Luz Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Ernie L. Danner Chairman of the Board +Ernie L. Danner +/s/ David C. Baldwin Director +David C. Baldwin +/s/ Mark E. Baldwin Director +Mark E. Baldwin +Director +Curtis F. Harrell +/s/ Scott E. Schwinger Director +Scott E. Schwinger +Director +Gary L. Thomas +/s/ Andrew L. Waite Director +Andrew L. Waite +/s/ Darryl K. Willis Director +Darryl K. Willis +56 \ No newline at end of file diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/filing_metadata.csv b/raw/filings/0001532286/2021/0001532286-22-000006/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a96d16c2fb5895f20e43efd892880571f240e02c --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2022-03-08,2021-12-31,2022-03-07T22:36:44.000Z,0001532286-22-000006,nine-20211231.htm,10-K,9443150,1,1,https://www.sec.gov/Archives/edgar/data/1532286/000153228622000006/nine-20211231.htm,https://www.sec.gov/Archives/edgar/data/1532286/000153228622000006/,2021,2021,1 diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/item1.txt b/raw/filings/0001532286/2021/0001532286-22-000006/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..6798d6de3abd2a67238ef88dad805a306b67b6e2 --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/item1.txt @@ -0,0 +1,99 @@ +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity to have an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2014 through December 2021, we completed approximately 24,900 cementing jobs, with an on-time rate of approximately 91%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 91% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2014 through December 2021, we deployed approximately 317,400 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. During 2021, we began running electric wireline units in our fleet, which significantly reduce carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line Wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2014 through December 2021, we completed approximately 188,500 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From April 2014 through December 2021, we have performed approximately 10,700 jobs and deployed more than 244 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the United States (the “U.S.”), including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America. Although we have no facilities outside of North America, international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rockies, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2021, our top five customers collectively accounted for approximately 29% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, NexTier Oilfield Solutions, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2021, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2021, we had 944 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste. Specifically, RCRA excludes from the definition of hazardous waste produced waters and other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas. However, these oil and gas E&P wastes may still be regulated under state solid waste laws and regulations, and it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”), establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. In June 2016, OSHA finalized a regulation regarding crystalline silica exposures, which included requirements that hydraulic fracturing operations implement dust controls to limit exposures to the substance by June 23, 2021. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2021, we operated a fleet in excess of 515 commercial motor vehicles. As such, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the U.S. The discharge of pollutants into regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In September 2015, the EPA and U.S. Army Corps of Engineers issued a rule defining the scope of federal jurisdiction over wetlands and other waters of the U.S., which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in December 2019. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. The EPA is undergoing a rulemaking process to redefine the definition of waters of the U.S.; in the interim, the EPA is utilizing the pre-2015 definition. To the extent a future rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA did not address the 2020 Technical Rule. +The EPA has recently taken steps to strengthen its methane standards, including most recently in November 2021, when the EPA issued a proposed rule intended to reduce methane emissions from oil and gas sources. The proposed rule would make the existing regulations in Subpart OOOOa more stringent and create a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). In addition, the proposed rule would establish “Emissions Guidelines,” creating a Subpart OOOOc that would require states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. Under the proposed rule, states would have three years to develop their compliance plan for existing sources, and the regulations for new sources would take effect immediately upon issuance of a final rule. The EPA is expected to issue both a supplemental proposed rule, which may expand or modify the current proposed rule, and final rule by the end of 2022. +As a result of these regulatory changes, the scope of any final methane regulations or the costs for complying with federal methane regulations are uncertain. However, any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA +10 +and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. Although the agreement does not create any binding obligations for nations to limit their GHG emissions, it does include pledges to voluntarily limit or reduce future emissions. On June 1, 2017, President Trump announced that the U.S. would withdraw from the Paris Agreement and completed the process of withdrawing from the Paris Agreement on November 4, 2020. However, on January 20, 2021, President Biden issued written notification to the United Nations of the United States’ intention to rejoin the Paris Agreement, which became effective on February 19, 2021. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that aims to reduce global methane emissions at least 30% below 2020 levels by 2030. Since its formal launch at the United Nations Climate Change Conference (COP26), over 100 countries have joined the pledge. +Also, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and many states have already established regional GHG “cap-and-trade” programs. The adoption of any legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. For example, on March 20, 2015, the U.S. Bureau of Land Management (the “BLM”) finalized a rule regulating hydraulic fracturing activities on federal lands, including requirements for the disclosure, wellbore integrity, and handling of flowback water; however, on December 29, 2017, the BLM issued a rescission of the hydraulic fracturing rule. This rescission and the rule as promulgated are subject to ongoing litigation. The BLM also previously finalized in 2016 similar limitations on methane emissions from venting and flaring and leaking equipment from oil and natural gas activities on public lands, but in September 2018 issued a final rule repealing certain provisions of the 2016 rule and reinstating the pre-2016 regulations. The 2016 rule and the rescission were invalidated by separate federal district courts. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic +11 +fracturing operations to publicly owned wastewater treatment plants. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have enacted or are considering moratoria on hydraulic fracturing. For example, New York, Vermont, Maryland, and Washington have banned the use of high-volume hydraulic fracturing. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. On July 16, 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. Among other revisions, the rules redefined environmental “effects” or “impacts” as the effects “that are reasonably foreseeable and have a reasonably close causal relationship to the proposed action or alternatives.” The rule also eliminated the current “direct,” “indirect,” or “cumulative” categories of effects. The new regulations are subject to ongoing litigation in several federal district courts, which has been stayed pending an ongoing review of the 2020 rule. On October 6, 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (the “ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In August 2019, the FWS and National Marine Fisheries Service (“NMFS”) issued three rules amending implementation of the ESA regulations revising, among other things, the process for listing species and designating critical habitat. A coalition of states and environmental groups have challenged the +12 +three rules and the litigation remains pending. In addition, on December 18, 2020, the FWS amended its regulations governing critical habitat designations; the amended regulations are subject to ongoing litigation. In June 2021, the FWS and NMFS announced plans to begin rulemaking processes to rescind these rules. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. On January 7, 2021, the DOI finalized a rule limiting application of the MBTA; however the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. Future implementation of the rules implementing the Endangered Species Act and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. +13 \ No newline at end of file diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/item13.txt b/raw/filings/0001532286/2021/0001532286-22-000006/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..4d5718aa4e2aaac767c8f53bd40d357e2b2410eb --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2022 annual meeting of stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/item9a.txt b/raw/filings/0001532286/2021/0001532286-22-000006/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..c791c7b886bfbce9a236d50f810c1ccecf77be21 --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/item9a.txt @@ -0,0 +1,11 @@ +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2021. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2021. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2021, our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting as we are an “emerging growth company” as defined under the JOBS Act. In addition, management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the quarterly period ended December 31, 2021. \ No newline at end of file diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/rp_note.txt b/raw/filings/0001532286/2021/0001532286-22-000006/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..40a27fd84b64f2795aad726fd10d2e097510c98e --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/rp_note.txt @@ -0,0 +1,7 @@ +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance expense associated with these entities was $ 0.8 million for both the years ended December 31, 2021 and 2020. The Company also purchased $ 2.6 million and $ 1.6 million of products and services for the years ended December 31, 2021 and 2020, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $ 0.7 million and $ 0.2 million at December 31, 2021 and 2020, respectively. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with this office space, net of sub-leasing income, was $ 1.4 million and $ 1.3 million for the years ended December 31, 2021 and 2020, respectively. There were net outstanding payables due to this entity of $ 0.1 million at December 31, 2020. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2021 and 2020, the outstanding principal balance payable to Mr. Frazier was $ 1.1 million and $ 1.9 million, respectively. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company purchases cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Previously, two of the Company’s directors served as directors of Forum; both individuals have ended their directorships at Forum as of December 31, 2021. The Company was billed $ 0.5 million for cable for both the years ended December 31, 2021 and 2020. There were outstanding payables due to this entity of $ 0.1 million at both December 31, 2021 and 2020. The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed $ 6.2 million and $ 4.6 million for coiled tubing string during the years ended December 31, 2021 and 2020, respectively. There were outstanding payables due to this entity of $ 0.6 million and $ 0.9 million at December 31, 2021 and 2020, respectively. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also serves as a director of Select. The Company was billed $ 1.1 million and $ 1.2 million for chemicals during the years ended December 31, 2021 and 2020, respectively. There were outstanding payables due to this entity of $ 0.1 million and $ 0.2 million at December 31, 2021 and 2020, respectively. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 1.3 million for the year ended December 31, 2021. The Company billed NESR $ 1.6 million for products and rentals and issued credit memos of $ 0.5 million during the year ended December 31, 2020. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $ 5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $ 0.5 million and $ 3.7 million at December 31, 2021 and 2020, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 3.2 million and $ 5.8 million for the years ended December 31, 2021 and 2020, respectively. There were outstanding receivables due from Devon of $ 0.4 million at both December 31, 2021 and 2020. \ No newline at end of file diff --git a/raw/filings/0001532286/2021/0001532286-22-000006/rpt_disclosure.txt b/raw/filings/0001532286/2021/0001532286-22-000006/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb6ca86ff2ccb331269c885c6785cf9c3be4c3bf --- /dev/null +++ b/raw/filings/0001532286/2021/0001532286-22-000006/rpt_disclosure.txt @@ -0,0 +1,37 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Our Board adopted a written related person transactions policy prior to the completion of our IPO, under which a “Related Person +Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or +disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or +disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to +an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Person Transactions required to be disclosed in +our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +The Company leases office space, yard +facilities, and equipment and purchases building maintenance services from entities owned by Mr. Crombie. Total lease expense and building maintenance expense associated with these entities was $0.8 million for both the years ended +December 31, 2021 and 2020. The Company also purchased $2.6 million and $1.6 million of products and services for the years ended December 31, 2021 and 2020, respectively, from an entity in which Mr. Crombie is a limited +partner. There were outstanding payables due to this entity relating to equipment purchases of $0.7 million and $0.2 million at December 31, 2021 and 2020, respectively. +In addition, the Company leases office space in Corpus Christi and Midland, Texas from an entity affiliated with Warren Lynn Frazier, a +beneficial owner of more than 5% of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas +from the Company. Total rental expense associated with this office space, net of sub-leasing income, was $1.4 million and $1.3 million for the years ended December 31, 2021 and 2020, +respectively. There were net outstanding payables due to this entity of $0.1 million at December 31, 2020. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including +Mr. Frazier. At December 31, 2021 and 2020, the outstanding principal balance payable to Mr. Frazier was $1.1 million and $1.9 million, respectively. +The Company purchases cable for its wireline trucks from an entity owned by Forum Energy Technologies (“Forum”). Previously, two of +the Company’s directors served as directors of Forum; both individuals have ended their directorships at Forum as of December 31, 2021. The Company was billed $0.5 million for cable for both the years ended December 31, 2021 and +2020. There were outstanding payables due to the entity of $0.1 million at both December 31, 2021 and 2020, respectively. The Company purchases coiled tubing string from another entity owned by Forum. The Company was billed +$6.2 million and $4.6 million for coiled tubing string during the years ended December 31, 2021 and 2020, respectively. There were outstanding payables due to this entity of $0.6 million and $0.9 million at December 31, +2021 and 2020, respectively. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. +(“Select”). One of the Company’s directors also serves as a director of Select. The Company was billed $1.1 million and $1.2 million for chemicals during the years ended December 31, 2021 and 2020, respectively. There +were outstanding payables due to this entity of $0.1 million and $0.2 million at December 31, 2021 and 2020, respectively. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”). One of the Company’s directors also +serves as a director of NESR. The Company billed NESR $1.3 million and $1.6 million for products and rentals during the years ended December 31, 2021 and 2020, respectively. The Company issued credit memos of $ $0.5 million +during the year ended December 31, 2020. The Company did not issue credit memos during the year ended December 31, 2021. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $5.9 million to NESR with +payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $0.5 million and $3.7 million at December 31, +2021 and 2020, respectively. +34 +Table of Contents +On June 5, 2019, Ann G. Fox, President and Chief Executive Officer and a director of +the Company, was elected as a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $3.2 million and $5.8 million for the years ended December 31, 2021 and 2020, respectively. There were +outstanding receivables due from Devon of $0.4 million at both December 31, 2021 and 2020. +35 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/filing.txt b/raw/filings/0001532286/2022/0001532286-23-000005/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..4cdce3921a328a13fa9fc3021ecf97a87d3cd620 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/filing.txt @@ -0,0 +1,1718 @@ +nine-20221231 +false 2022 FY 0001532286 P1Y P1Y 0001532286 2022-01-01 2022-12-31 0001532286 2022-06-30 iso4217:USD 0001532286 2023-03-03 xbrli:shares 0001532286 2022-12-31 0001532286 2021-12-31 iso4217:USD xbrli:shares 0001532286 us-gaap:ServiceMember 2022-01-01 2022-12-31 0001532286 us-gaap:ServiceMember 2021-01-01 2021-12-31 0001532286 us-gaap:ProductMember 2022-01-01 2022-12-31 0001532286 us-gaap:ProductMember 2021-01-01 2021-12-31 0001532286 2021-01-01 2021-12-31 0001532286 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+_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware 80-0759121 +(State or other jurisdiction of +incorporation or organization) (I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston , TX 77019 +(Address of principal executive offices) +( 281 ) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, par value $0.01 per share NINE New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer o +Non-accelerated filer ☒ Smaller reporting company ☒ +Emerging growth company ☒ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 30, 2022) was $ 47,805,208 . +The number of shares of the registrant’s common stock outstanding at March 3, 2023 was 34,721,266 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant’s Definitive Proxy Statement for its 2023 Annual Meeting of Stockholders. +TABLE OF CONTENTS +PART I +Item 1. +Business +4 +Item 1A. +Risk Factors +14 +Item 1B. +Unresolved Staff Comments +33 +Item 2. +Properties +33 +Item 3. +Legal Proceedings +33 +Item 4. +Mine Safety Disclosures +33 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +34 +Item 6. +[Reserved] +34 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +35 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +48 +Item 8. +Financial Statements and Supplementary Data +48 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +49 +Item 9A. +Controls and Procedures +49 +Item 9B. +Other Information +49 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +49 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +50 +Item 11. +Executive Compensation +50 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +50 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +50 +Item 14. +Principal Accountant Fees and Services +50 +PART IV +Item 15. +Exhibit and Financial Statement Schedules +51 +Item 16. +Form 10-K Summary +54 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +SUMMARY OF PRINCIPAL RISK FACTORS +Our business is subject to a number of risks and uncertainties. The following is a summary of the principal risk factors that could materially adversely affect our business, financial condition and results of operations. A more complete statement of those risks and uncertainties is set forth in “Risk Factors” in Item 1A of Part I of this Annual Report. +• Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile and strongly influenced by current and expected oil and natural gas prices. If the prices of oil and natural gas decline, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. Significant factors that are likely to affect near-term commodity prices include actions by the members of the Organization of the Petroleum Exporting Countries (“OPEC”) and other oil exporting nations; U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world; and geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war, and terrorism. +• Inflation may adversely affect our financial position and operating results; in particular, cost inflation with labor or materials could offset any price increases for our products and services. +• If we are unable to attract and retain key employees, technical personnel, and other skilled and qualified workers, our business, financial condition, or results of operations could suffer. +• We may be unable to maintain existing prices or implement price increases on our products and services, and intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +• Our substantial debt obligations could have significant adverse consequences on our business and future prospects, and restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +• Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +• Our operations are subject to conditions inherent in the oilfield services industry, such as equipment defects, liabilities arising from accidents or damage involving our fleet of trucks or other equipment, explosions and uncontrollable flows of gas or well fluids, and loss of well control. +• If we are unable to accurately predict customer demand, including that of our international customers, or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +• We are dependent on customers in a single industry. The loss of one or more significant customers, including certain of our customers outside of the U.S., could adversely affect our financial condition, prospects, and results of operations. Sales to customers outside of the U.S. also exposes us to risks inherent in doing business internationally, including political, social, and economic instability and disruptions, export controls, economic sanctions, embargoes or trade restrictions, and fluctuations in foreign currency exchange rates. +• We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +• We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +• Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +• Our success may be affected by our ability to implement new technologies and services. +• Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +• Our future financial condition and results of operations could be adversely impacted by asset impairment charges. +2 +• Increased attention to climate change and conservation measures may reduce oil and natural gas demand, and we face various risks associated with increased activism and related litigation against oil and natural gas exploration and development activities. +• Seasonal and adverse weather conditions adversely affect demand for our products and services. +3 +PART I +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2022, we completed approximately 18,100 cementing jobs, with an on-time rate of approximately 90%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 90% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2022, we deployed approximately 377,100 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted and continue to convert our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line Wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2018 through December 2022, we completed approximately 140,700 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2022, we have performed approximately 5,890 jobs and deployed more than 160 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rockies, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2022, our top five customers collectively accounted for approximately 21% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, NexTier Oilfield Solutions, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2022, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2022, we had 1,212 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2022, we operated a fleet in excess of 550 commercial motor vehicles. As such, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and +9 +strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into federal and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In September 2015, the EPA and U.S. Army Corps of Engineers (“Corps”) issued a rule defining the scope of federal jurisdiction over wetlands and other waters of the U.S., which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in December 2019. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. The EPA is undergoing a two-phase rulemaking process to redefine the definition of waters of the U.S., which could be impacted by the U.S. Supreme Court’s upcoming decision in Sackett v. EPA, a case regarding the proper test in determining whether wetlands qualify as “Waters of the United States” or WOTUS. A final rule, known as “Rule 1,” was announced by the EPA and Corps in December 2022. The EPA and Corps are expected to propose a second rule, known as “Rule 2,” further refining Rule 1 by November 2023 and issue a final rule by July 2024. To the extent a future rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA did not address the 2020 Technical Rule. +On November 15, 2021, the EPA proposed a new rule intended to reduce methane emissions from oil and gas sources. The proposed rule would make the existing regulations in Subpart OOOOa more stringent and create a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). In addition, the proposed rule would establish “Emissions Guidelines,” creating a Subpart OOOOc that would require states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. Under the proposed rule, states would have three years to develop their compliance plan for existing sources, and the regulations for new sources would take effect immediately upon issuance of a final rule. On November 11, 2022, the EPA issued a proposed rule supplementing the November 2021 proposed rule. Among other things, the November 2022 supplemental proposed rule removed an emissions monitoring exemption for small wellhead-only sites and creates a new third-party monitoring program to flag large emissions events, referred to in the proposed rule as “super emitters.” The EPA is expected to issue a final rule by August 2023. +As a result of these regulatory changes, the scope of any final methane regulations or the costs for complying with +10 +federal methane regulations are uncertain. However, any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. Although the agreement did not create any binding obligations for nations to limit their GHG emissions, it did include pledges to voluntarily limit or reduce future emissions. On June 1, 2017, President Trump announced that the U.S. would withdraw from the Paris Agreement and completed the process of withdrawing from the Paris Agreement on November 4, 2020. However, on January 20, 2021, President Biden issued written notification to the United Nations of the United States’ intention to rejoin the Paris Agreement, which became effective on February 19, 2021. Pursuant to its obligations as a signatory to the Paris Agreement, the United States has set a target to reduce its GHG emissions by 50-52% by the year 2030 as compared with 2005 levels and has agreed to provide periodic updates on its progress. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. Since its formal launch at the United Nations Climate Change Conference (“COP26”), in Glasgow, at least 150 countries have joined the pledge. COP26 then concluded with the finalization of the Glasgow Climate Pact, which stated long-term global goals (including those in the Paris Agreement) to limit the increase in the global average temperature and emphasized reductions in GHG emissions. The impacts of these orders, pledges, agreements, and any legislation, regulation, regulatory initiatives, changes to existing regulation or executive actions promulgated to fulfill the United States’ commitments under the Paris Agreement, COP26, or other international conventions cannot be predicted at this time. +While the Biden Administration has pursued executive actions to address climate change, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and many states have already established regional GHG “cap-and-trade” programs, no new comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future. In addition, many state and local leaders have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at reducing GHG emissions by means of cap-and-trade programs, carbon taxes, or encouraging the use of renewable energy or alternative low-carbon fuels. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition and results of operations. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have +11 +significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Additionally, on March 21, 2022, the SEC issued a proposed rule regarding the enhancement and standardization of mandatory climate-related disclosures for investors. The proposed rule would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including, but not limited to, information about the registrant’s governance of climate-related risks and relevant risk management processes; climate-related risks that are reasonably likely to have a material impact on the registrant’s business, results of operations, or financial condition and their actual and likely climate-related impacts on the registrant’s business strategy, model, and outlook; climate-related targets, goals and transition plan (if any); certain climate-related financial statement metrics in a note to their audited financial statements; Scope 1 and Scope 2 GHG emissions; and Scope 3 GHG emissions and intensity, if material, or if the registrant has set a GHG emissions reduction target, goal or plan that includes Scope 3 GHG emissions. Although the proposed rule’s ultimate date of effectiveness and the final form and substance of these requirements is not yet known and the ultimate scope and impact on our business is uncertain, compliance with the proposed rule, if finalized, may result in increased legal, accounting and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place strain on our personnel, systems, and resources. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s Subpart OOOO regulations and proposed rules discussed above, other federal agencies have promulgated rules regulating methane. On November 30, 2022, the U.S. Bureau of Land Management (the “BLM”) proposed new regulations to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The proposed rule would require new and existing operators to submit waste minimization plans with all applications for permits to drill oil wells and includes a number of specific affirmative obligations that operators must take to avoid wasting oil or gas through venting, flaring, and leaks. The proposed rule has received over 3500 public comments, and the final rule may face challenges and legal scrutiny. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of +12 +high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. On July 16, 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. On October 6, 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule, which was finalized on April 20, 2022. The Phase 1 final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (the “ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In August 2019, the FWS and National Marine Fisheries Service issued three rules amending implementation of the ESA regulations revising, among other things, the process for listing species and designating critical habitat, which was challenged by a coalition of states and environmental groups. In addition, on December 18, 2020, the FWS amended its regulations governing critical habitat designations, which were also subject to litigation. In June and July 2022, the FWS issued final rules rescinding the regulations defining “habitat” and governing critical habitat exclusions. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. On January 7, 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The notice of proposed rulemaking is anticipated in March 2023 and is expected to be finalized by the end of 2023. Future implementation of the rules implementing the Endangered Species Act and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +13 +Item 1A. Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• the level of prices, and expectations about future prices, for oil and natural gas; +• the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• the level of global and domestic oil and natural gas production; +• the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• the cost of exploring for, developing, producing, and delivering oil and natural gas; +• available pipeline, storage, and other transportation capacity; +• worldwide political, military, and economic conditions; +• global or national health epidemics or concerns, such as the coronavirus pandemic that began in 2020, which may reduce demand for oil, natural gas, and related products because of reduced global or national economic activity; +• lead times associated with acquiring equipment and products and availability of qualified personnel; +• the discovery rates of new oil and natural gas reserves; +• federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• economic and political conditions in oil and natural gas producing countries; +• actions of OPEC, its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a GHG; +• the price and availability of alternative fuels and energy sources; +• global weather conditions and natural disasters, including those related to climate change; and +14 +• uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies, which are strongly influenced by current and expected oil and natural gas prices. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the past five years ending December 31, 2022, the posted price for West Texas Intermediate (“WTI”) oil has ranged from a low of $(36.98) per barrel in April 2020 to a high of $123.64 per barrel in March 2022, and the Henry Hub spot market price of gas has ranged from a low of $1.33 per MMBtu in September 2020 to a high of $23.86 per MMBtu in February 2021. The theme of capital discipline for E&P operators in the energy industry has led to a significant disconnect between commodity prices and market activity. The average WTI price for 2022 was $94.90, an increase of 39% over 2021 and $55.74 higher than 2020 and $37.91 higher than 2019. Average rig count increased by 51% from 2021 to 2022 and was 67% higher in 2022 than 2020. If prices of oil and natural gas decline or our customers do not increase capex and activity levels, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +Significant factors that are likely to affect near-term commodity prices include the extent to which members of OPEC and other oil exporting nations, including Russia, continue to reduce oil export prices and increase production; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Industry Trends and Outlook” in Item 7 of Part II of this Annual Report. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. Even with supportive oil and natural gas prices, E&P operator activity may not materially increase, as they remain focused on operating within their capital plans. Moreover, any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, or expectations of such a drop or of prolonged weak oil and natural gas commodity price environments, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry, and inflation may adversely affect our financial position and operating results. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +Inflationary factors, such as increases in the labor costs, material costs, and overhead costs, may also adversely affect our financial position and operating results. Like others in our industry, in 2021 and 2022 we faced, and we continue to face, cost inflation with both labor and materials, which could offset any price increases for our products and services. +Increased attention to climate change and conservation measures may expose us to climate-related transition risks, including evolving climate change legislation, fuel conservation measures, technological advances and negative shift in market perception towards the oil and natural gas industry, which could result in reduced demand for oil and natural gas. +Increased attention to climate change from governmental and regulatory bodies, investors, consumers, industry and +15 +other stakeholders, changes in consumer behavior and related demand for alternatives to oil and natural gas, societal expectations on companies to address climate change, preferences and attitudes with respect to the generation and consumption of energy, the use of hydrocarbons, and the use of products manufactured with, or powered by, hydrocarbons, may result in the enactment of climate change-related regulations, policies and initiatives (at the government, regulator, corporate and/or investor community levels), including alternative energy requirements, new fuel consumption standards, energy conservation and emissions reductions measures and responsible energy development, technological advances with respect to the generation, transmission, storage and consumption of energy, and increased availability and competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels). These developments could reduce demand for oil and natural gas and therefore our products and services, which would lead to a reduction in our revenues and have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +In addition, the enactment of climate change-related regulations, policies and initiatives (at the government, corporate and/or investor community levels) may in the future result in increases in our compliance costs and other operating costs and have other adverse effects (e.g., greater potential for governmental investigations or litigation). For further discussion regarding the risks posed to us by climate change-related regulations, policies and initiatives and by negative public perception of the oil and gas industry, see the discussions below in “Negative public perception of the oil and gas industry could adversely affect our operations and our ability raise debt and equity capital” and “Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition.” +Negative public perception of the oil and gas industry could adversely affect our operations and our ability to raise debt and equity capital. +Opposition toward the oil and natural gas industry has been growing globally and is particularly pronounced in the United States. Companies in the oil and natural gas industry are often the target of activist efforts from both individuals and non-governmental organizations regarding safety, human rights, climate change, environmental matters, sustainability, and business practices. Anti-development activists are working to, among other things, reduce access to federal and state government lands and delay or cancel certain operations such as drilling and development. Any such activism against oil and natural gas exploration and development may cause operational delays or restrictions, increased operating costs, additional regulatory burdens and increased risk of litigation. +In addition, some parties have initiated public nuisance claims under federal or state common law against certain companies involved in the production of oil and natural gas, or claims alleging that the companies have been aware of the adverse effects of climate change for some time but failed to adequately disclose such impacts to their investors or customer. Although our business is not a party to any such litigation, we could be named in actions making similar allegations, which could lead to costs and materially impact our financial condition in an adverse way. +Negative perceptions regarding our industry and reputational risks may also in the future adversely affect our ability to successfully carry out our business strategy by adversely affecting our access to capital. Certain segments of the investor community have developed negative sentiment towards investing in our industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. Parties concerned about the potential effects of climate change have directed their attention at sources of financing for energy companies, which has resulted in certain financial institutions, funds and other capital providers restricting or eliminating their investment in oil and natural gas activities. In addition, some investors, including investment advisors and certain sovereign wealth funds, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Further, certain investment banks and asset managers based both domestically and internationally have announced that they are adopting climate change guidelines for their banking and investing activities. Certain other stakeholders have also pressured commercial and investment banks to stop financing oil and gas production and related infrastructure projects. Such developments, including environmental activism, investment policies and initiatives, and related litigation aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. These developments may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +Increased scrutiny of sustainability matters could have an adverse effect on our business and damage our reputation. +In recent years, companies across all industries are facing increasing scrutiny from a variety of stakeholders, including investor advocacy groups, proxy advisory firms, certain institutional investors and lenders, investment funds and other influential investors and rating agencies, related to their environmental, social and governance (“ESG”) and sustainability practices. If we do not adapt to or comply with investor or other stakeholder expectations and standards on ESG matters (or +16 +meet sustainability goals and targets that we have set) as they continue to evolve, or if we are perceived to have not responded appropriately or quickly enough to growing concern for ESG and sustainability issues, regardless of whether there is a regulatory or legal requirement to do so, we may suffer from reputational damage and our business, financial condition and/or stock price could be materially and adversely affected. +In addition, organizations that provide information to investors on corporate governance and related matters have developed ratings processes for evaluating companies on their approach to ESG matters. Such ratings are used by some investors to inform their investment and voting decisions. Unfavorable ESG ratings could lead to increased negative investor sentiment toward us and our industry and to the diversion of investment to other industries, which could have a negative impact on our stock price and our access to and costs of capital. +Risks Related to Our Indebtedness +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +As of February 1, 2023, we had $300.0 million of 13.000% Senior Secured Notes due 2028 (the “2028 Notes”) outstanding, and we had $72.0 million of borrowings under the ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) outstanding. Subject to the restrictions in the ABL Credit Agreement (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) and the indenture governing the 2028 Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our current or future level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +• limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or less restrictive terms governing their indebtedness; and +• making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +Additionally, borrowings under the ABL Credit Facility bear interest at variable rates exposing us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remains the same, and our net income and cash available to finance our operations and other business activities would decrease. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. In addition, any debt restructuring transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. The terms of existing or future debt instruments may restrict us from adopting some of these +17 +alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +The ABL Credit Facility and the indenture governing our 2028 Notes have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• incur additional indebtedness and guarantee indebtedness; +• pay dividends or make other distributions or repurchase or redeem our capital stock; +• transfer or sell assets; +• make loans and investments; +• incur liens; +• enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• consolidate, merge, or sell all or substantially all of our assets; +• prepay, redeem, or repurchase certain debt; +• issue certain preferred stock or similar equity securities; +• make certain acquisitions and investments; +• engage in transactions with affiliates; and +• create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Competition and Market Risks +We may be unable to maintain existing prices or implement price increases on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, +18 +and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The oil and natural gas industry is intensely competitive and has been characterized by price erosion for new technologies as additional competing products enter the market. In 2020, we experienced a decline in the pricing and profitability of our dissolvable plug products and, to a lesser extent, our composite plug products due to the impacts of the coronavirus pandemic on the oil and natural gas industry. Pricing toward the end of 2021 and throughout 2022 mostly stabilized; however, any future price declines, future lack of availability of materials, or future increases in prices in materials may harm our business. +We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. +We are continuing to work on reducing manufacturing costs of our products, as well as introducing new and differentiated technology to improve profitability, however, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products decline further or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in +19 +overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion services may adversely affect our business, financial condition, and results of operations. +Operational Risks +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• equipment defects; +• liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• explosions and uncontrollable flows of gas or well fluids; +• unusual or unexpected geological formations or pressures and industrial accidents; +• blowouts; +• fires; +• cratering; +• loss of well control; +• collapse of the borehole; and +• damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our services could become a source of spills or release of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose substantial revenue. In addition, any litigation or claim, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public, which could cause us to lose customers and substantial revenue, make it more difficult for us to compete effectively, or obtain adequate insurance in the future. +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2022 and 2021, we spent approximately $13.6 million and $7.4 million, respectively, on capital expenditures related to maintenance, and we expect to spend approximately $20 million to $30 million on capital expenditures related to maintenance in 2023. Our equipment typically does not generate revenue while it is undergoing maintenance, upgrades, or refurbishment. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry +20 +may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. In addition, although such projects may require material capital expenditures, there is no assurance that they will generate a positive return. +Seasonal and adverse weather conditions and the physical risks arising from climate change may have a negative impact on our business and result of operations, including by adversely affecting demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. In addition, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. If any such effects were to occur, they could adversely affect or delay +demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services; cause us to incur +significant costs in preparing for or responding to the effects of climatic events themselves, which may not be fully insured; or +cause an adverse impact on our operations. Our ability to mitigate the adverse physical impacts of climate change depends in +part upon our disaster preparedness and response and business continuity planning. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For the years ended December 31, 2022 and 2021, we generated approximately 0.3% and 0.6%, respectively, of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Risks Related to Our Customers and Suppliers +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase inventory obsolescence, and restrict our ability to fund our operations. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +21 +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our products and services. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2022, our five largest customers collectively accounted for approximately 21% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Certain of our product lines are subject to the risk of supplier concentration, and certain of our product lines are subject to exclusive distribution arrangements, which we may not be able to maintain. +Certain of the product lines depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +In addition, we have arrangements with certain technology companies and manufacturers that give us exclusive distribution rights to certain product offerings. In some cases, we are, or may in the future will be, required to meet certain minimum volume or other requirements in order to retain our arrangement. If any of these companies or manufacturers terminate our right to sell some or all of their products, modify or terminate our exclusive distribution arrangement, or change the applicable terms and conditions of sale, our business and results of operations could be adversely affected. +Regulatory, Compliance, and Legal Risks +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects, and results of operations. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. +22 +Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act (“FLSA”), in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation, and the results or costs of any such cases may have an adverse effect on our business, operating results, and financial condition. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. Over the past several years, parts of the country have experienced extreme drought conditions. As a result of these conditions, some rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, GHGs, air pollution, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills of hazardous materials onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our +23 +costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the oversight of the EPA, the U.S. Department of Transportation (the “DOT”), the U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution or to protect against the effects of ionizing radiation. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards (the “Tier 4” standards). The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For more information on existing regulations and regulatory initiatives relating to hydraulic fracturing, see “Regulatory Matters – Hydraulic Fracturing” in Item 1 of Part I of this Annual Report. +If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to GHG emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns (e.g., numerous cities, including San Francisco, CA, and Seattle, WA, have banned the use of natural gas in new construction, and other cities, including New York, NY, are considering similar initiatives). Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of GHGs in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +24 +Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Additionally, the SEC issued a proposed rule in March 2022 that would mandate extensive disclosure of climate-related data, risks, and opportunities, including financial impacts, physical and transition risks, related governance and strategy, and GHG emissions, for certain public companies. We cannot predict the costs of implementation or any potential adverse impacts resulting from the rulemaking. However, to the extent this rulemaking is finalized as proposed, we could incur increased costs relating to the assessment and disclosure of climate-related risks. We may also face increased litigation risks related to disclosures made pursuant to the rule if finalized as proposed. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The U.S. Foreign Corrupt Practices Act (the “FCPA”), the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. We operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +25 +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license, and effective December 2017, the FMCSA has mandated electronic logging devices in all interstate commercial trucks. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and GHG emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +Risks Related to Technology +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot ensure that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. Additionally, we cannot ensure that our intellectual property rights will deter or prevent competitors from creating similar purpose products for our customers. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently-developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution or litigation proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution or litigation proceedings, a third-party defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution or litigation proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. For example, in April 2020, a third party filed a lawsuit asserting that our BreakThru Casing Flotation Device TM infringed its intellectual property rights. In January 2022, a jury in the Western District of Texas, Waco Division, found in the third party’s favor. However, we intend to appeal the jury’s verdict. We may not prevail in such appeal or in any dispute resolution proceedings relating to intellectual property rights, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or +26 +otherwise violate the intellectual property rights of others. Also, as a part of resolving such disputes, we may enter into cross-licenses or other agreements, which could reduce the value of our existing intellectual property rights. The results or costs of any such dispute resolution or litigation proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution or litigation proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our business, regardless of its outcome. +Our success may be affected by our ability to implement new technologies and services. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +Our long-term success depends, in part, on our ability to effectively address changing customer demands, as well as government regulation and required disclosure regarding ESG. These demands and regulations include, but are not limited to, the creation of ESG-related policies and procedures, the quantification of our greenhouse gas emissions and evaluation of risk and opportunities. These customer preferences and government requirements could cause us to continue to adapt our equipment and technology offerings, as well as increase internal costs to address changes in ESG requirements. If ESG-related requirements change faster than anticipated or in a manner we do not anticipate, demand for our services could be adversely affected. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +We rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our products and services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide such products and services to our customers. Although we believe other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense, delay, and potential changes to certain product components. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result of termination of our manufacturing relationships or patent infringement claims, could have a material adverse effect on our financial condition, business, and results of operations. +Our operations are subject to cyber security risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cyber security risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cyber security attacks. These risks could have a material adverse effect on our business, financial condition, and results of operations and could lead to litigation or regulatory action against us. +Risks Related to Certain Significant Stockholders +Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +SCF VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) owned approximately 27% of our outstanding common +27 +stock as of December 31, 2022. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents, and approval of acquisition offers and other significant corporate transactions. In addition, another one of our stockholders beneficially owned approximately 10% of our outstanding common stock as of December 31, 2022. This concentration of ownership by a small group of stockholders will limit other stockholders’ ability to influence corporate matters, and as a result, actions may be taken that other stockholders may not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their shares of our common stock. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with significant stockholders. +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. SCF is not subject to any obligation to maintain its ownership interest in us and may elect at any time to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies, which could adversely affect our cash flows or results of operations. +Certain of our directors may have conflicts of interest because they are also affiliates of SCF. The resolution of these conflicts of interest may not be in our or other stockholders’ best interests. +Certain of our directors, namely David C. Baldwin and Andrew L. Waite, are currently officers of SCF’s ultimate general partner. In addition, Mr. Waite is a director of National Energy Reunited Corp., a corporation in which SCF owns an approximate 9% equity interest as of December 31, 2022. These positions may conflict with such individuals’ duties as one of our directors regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in our or our other stockholders’ best interest. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates, and its other portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our charter further provides that no such person or party shall be liable to us by reason of the fact that such person pursues any such business opportunity or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or otherwise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approved by the holders of at least 80% of the voting power of the outstanding stock of the corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. +28 +Risks Related to Human Capital +Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work, and our success depends, in large part, upon our ability to employ and retain key employees, technical personnel, and other skilled and qualified workers. To attract and retain qualified employees, we must compensate them at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our liquidity and competitive position, our business, financial condition or results of operations could suffer. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. There has been a reduction of the available skilled labor force to service the energy industry. To the extent that there is an increase in demand for our products or services, there is no assurance that the availability of skilled labor will improve. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +Other Material Risks +The coronavirus pandemic and related economic repercussions have had, and may continue to have, a material adverse effect on our business, liquidity, results of operations, and financial condition. +The coronavirus pandemic and related economic repercussions created, and any resurgence of the pandemic or emergence of another global or national health epidemic or concern could again create significant volatility, uncertainty, and turmoil in the oil and gas industry and significant weakening of the demand for our services and products. Other effects included, and or may in the future include: disruption to our supply chain for raw materials essential to our business, including restrictions on importing and exporting products; disruptions to our operations due to lockdowns or other governmental restrictions or due to employee impacts from illness; liquidity challenges, including impacts related to delayed customer payments and payment defaults associated with customer liquidity issues and bankruptcies; limitations on access to sources of liquidity or higher borrowing costs due to significant volatility or disruption of the global financial markets; a need to preserve liquidity, which could result in a delay or change in our capital investment plan; cyber security issues, as digital technologies may become more vulnerable and experience a higher rate of cyber attacks in an environment of remote connectivity; reduction of our workforce to adjust to market conditions, which could result in severance payments, retention issues, and an inability to hire employees when market conditions improve; impairments along with other accounting charges as demand for our services and products decreases; changes in the regulation of the production of hydrocarbons, such as the imposition of limitations on the production of oil and gas by states or other jurisdictions, that may result in additional limits on demand for our products and services; and a structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel, and interact, or in connection with a global recession or depression. The extent to which our operating and financial results will continue to be affected by the pandemic will depend on various factors beyond our control, such as the continued severity of the pandemic, including any sustained geographic resurgence; the emergence of new variants and strains of the coronavirus; and the success of actions to contain or treat the coronavirus. The coronavirus or other pandemic, and volatile regional and global economic conditions stemming therefrom, could also aggravate our other risk factors described in this Annual Report. +We do not intend to pay dividends on our common stock, and our debt agreements place certain restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on his investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt +29 +agreements place certain restrictions on our ability to pay cash dividends. Consequently, unless we revise our dividend policy, a stockholder’s only opportunity to achieve a return on his investment in us will be by selling his common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased his shares of our common stock. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +We have in the past experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur operating losses and experience negative operating cash flow. +Our future financial condition and results of operations could be adversely impacted by long-lived assets or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, other intangible assets, or other assets in a short amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, other intangible assets, or other assets that reduce our net income. +While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the U.S. or other countries, anti-terrorist efforts, and other armed conflicts involving the U.S. or other countries, including continued hostilities in the Middle East, may adversely affect the U.S. and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +A portion of our revenue is derived from sales to customers outside of the U.S., which exposes us to risks inherent in doing business internationally. +In 2022, we derived 4.2% of our revenue from sales to customers outside of the U.S. Sales to customers in countries other than the U.S. are subject to various risks, including: +• volatility in political, social, and economic conditions; +• social unrest, acts of terrorism, war, or other armed conflicts; +• confiscatory taxation or other adverse tax policies; +• deprivation of contract rights; +• trade and economic sanctions or other restrictions imposed by the European Union, the U.S., or other countries; +30 +• exposure under the FCPA or similar legislation, as discussed in the below risk factor; and +• currency exchange controls. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter and bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. These exclusive forum provisions are not intended to apply to actions arising under the Exchange Act or the Securities Act of 1933, as amended. The Court of Chancery of the State of Delaware has recently held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL. +Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provisions of our charter and bylaws. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter or bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +Taking advantage of the reduced disclosure requirements applicable to “emerging growth companies” may make our common stock less attractive to investors. +We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which we have more than $1.07 billion in annual revenue; (ii) the date on which we become a “large accelerated filer” (the fiscal year-end on which at least $700 million of equity securities are held by non-affiliates as of the last day of our then most recently completed second fiscal quarter); (iii) the date on which we have issued, in any three-year period, more than $1.0 billion in non-convertible debt securities; and (iv) December 31, 2023, which is the last day of the fiscal year ending after the fifth anniversary of the completion of our initial public offering (the “IPO”). An emerging growth company may take advantage of certain reduced reporting and other requirements that are otherwise applicable generally to public companies. Pursuant to these reduced disclosure requirements, emerging growth companies are not required to, among other things, comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, provide certain disclosures regarding executive compensation, hold stockholder advisory votes on executive compensation, or obtain stockholder approval of any golden parachute payments not previously approved. In addition, emerging growth companies have longer phase-in periods for the +31 +adoption of new or revised financial accounting standards. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. +We intend to take advantage of all of the reduced reporting requirements and exemptions, including the longer phase-in periods for the adoption of new or revised financial accounting standards under Section 107 of the JOBS Act, until we are no longer an emerging growth company. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our common stock price may be more volatile. +On the other hand, once we are no longer an emerging growth company, compliance with rules and regulations that do not currently apply to us as an emerging growth company will increase our legal and financial compliance costs, may make some activities more difficult, time-consuming, or costly, and will increase demand on our systems and resources. +We may not be able to utilize a portion of our net operating loss carry forwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2022, we had federal and state income tax NOLs of approximately $442.2 million, which will begin to expire between 2023 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate (as defined in Section 382). However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in the IPO, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +32 +Item 1B. Unresolved Staff Comments +None. +Item 2. Properties +The following table describes the material facilities owned or leased by us as of December 31, 2022. +Location Basin/Region Leased or Owned Principal/Most Significant Use +Houston, TX — Leased Corporate Headquarters/Administrative +Athens, TX — Leased Operations +Baker, MT Bakken Owned Operations/Administrative +Bergen, Norway — Leased Operations +Charleroi, PA Marcellus/Utica Leased Operations +Corpus Christi, TX — Leased Operations/Administrative +Corpus Christi, TX — Leased Operations/Administrative +Corpus Christi, TX — Leased Administrative +Dickinson, ND Bakken Leased Operations/Administrative +El Reno, OK SCOOP/STACK Leased Operations +Fort Worth, TX — Leased Administrative +Hobbs, NM Permian Leased Operations +Jacksboro, TX Barnett Leased Operations +Jacksboro, TX Barnett Leased Operations +Kilgore, TX Haynesville Leased Operations +Lacombe, AB, Canada WCSB Leased Operations/Administrative +Longview, TX Haynesville Owned Operations +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Mead, CO Rockies Leased Operations +Midland, TX Permian Leased Operations/Administrative +Monahans, TX Permian Leased Operations/Administrative +Oklahoma City, OK SCOOP/STACK Leased Operations +Pleasanton, TX Eagle Ford Leased Operations +Poolville, TX — Owned Operations +Sweetwater, TX Permian Leased Operations +Tyler, TX Haynesville Leased Operations +Ulster, PA Marcellus/Utica Leased Operations +Williston, ND Bakken Owned Operations/Administrative +Item 3. Legal Proceedings +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. For additional information related to legal proceedings, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +Item 4. Mine Safety Disclosures +Not applicable. +33 +PART II +Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Nine Energy Service, Inc.’s common stock is traded on the New York Stock Exchange under the symbol “NINE.” +Holders +As of March 3, 2023, we had 57 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +None. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +The following table sets forth our repurchases of our equity securities registered under Section 12 of the Exchange Act that have occurred during the three months ended December 31, 2022: +Total Number of Shares Purchased (a) Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares That May Yet be Purchased Under the Plans or Programs +October 1, 2022 – October 31, 2022 +244 $ 2.64 — — +November 1, 2022 – November 30, 2022 +— — — — +December 1, 2022 – December 31, 2022 +— — — — +Total 244 $ 2.64 — — +(a) Reflects the number of shares we have withheld to pay taxes upon vesting of restricted stock. +Item 6. [Reserved] +34 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. +This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. +Generally, operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently. +We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +Recent Events +On January 30, 2023, we completed our public offering of 300,000 units with an aggregate stated amount of $300.0 million (the “Units”). Each Unit consists of $1,000 principal amount of the 2028 Notes and five shares of our common stock. We received proceeds of $279.8 million from the Units offering, after deducting underwriting discounts and commission, which was deposited with the trustee of the 8.750% Senior Notes due 2023 (the “2023 Notes”), along with $40.0 million of cash received from borrowings under the ABL Credit Facility. On January 30, 2023, we instructed the trustee of the 2023 Notes to apply such deposits toward the payment of the 2023 Notes on February 1, 2023, and we elected to discharge the indenture governing the 2023 Notes, thereby releasing us from our remaining obligations under such indenture as of January 30, 2023. +On February 1, 2023, all of the outstanding 2023 Notes were redeemed at a redemption price of 100.0% of the principal amount thereof ($307.3 million), plus accrued and unpaid interest ($6.7 million). We also wrote off the unamortized deferred financing costs associated with the 2023 Notes in conjunction with the redemption. +For additional information on our Units offering, the ABL Credit Facility, which was amended in connection with such offering, and the redemption of the 2023 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +35 +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• Adjusted Gross Profit (Loss) : Adjusted gross profit (loss) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted EBITDA : We define Adjusted EBITDA as net income (loss) before interest, taxes, and depreciation and amortization, further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of contingent liabilities, (iv) loss or gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation and cash award expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. For additional information, see “Non-GAAP Financial Measures” below. +• Return on Invested Capital (“ROIC”): We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss (gain) on the sale of subsidiaries, (vi) loss (gain) on the extinguishment of debt, and (vii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. For additional information, see “Non-GAAP Financial Measures” below. +• Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +36 +Industry Trends and Outlook +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by current and expected oil and natural gas prices. Throughout 2022, oil and natural gas prices were very supportive, with an average WTI price of $94.90 for the year, although prices began to decline during the third quarter of 2022 in response to some indications of slowing economic growth, inflation, and rising interest rates. In addition, over the last several months, we have seen a sharp decline in natural gas prices, which has and will likely continue to affect activity levels in the Northeast and Haynesville. We anticipate these effects will be felt more strongly in the Haynesville in the near-term. Industry dynamics can shift very quickly, however, and we are operating this business for the long-term. Together, the Northeast and Haynesville comprised 30% of our total 2022 revenue, and we believe that these basins are vital to supplying the global markets and are important pieces of our footprint. +In 2022, operators increased activity levels with the average U.S. rig count, according to Baker Hughes, increasing by 51% year over year. Total U.S. completions in 2022 increased by approximately 22% over 2021 according to the Energy Information Administration (the “EIA”). Activity levels, specifically rig counts, thus far in the first quarter of 2023 have been down compared to the fourth quarter of 2022, with the rig count declining by 26 rigs since the end of 2022. Nonetheless, we expect U.S. E&P capital expenditure levels to increase in 2023, although not likely at the same rate as 2022. Underinvestment in oil and gas development during the coronavirus pandemic and an increase in overall global demand coming out of the pandemic, production cuts announced by OPEC, international conflict, specifically between Russia and Ukraine, and public U.S. producers’ commitment to capital discipline rather than increased drilling, are together creating supportive market fundamentals for a longer cycle. The U.S. average drilled but uncompleted wells inventory in 2022 was down by over 40% from the average 2019 levels, and operators will need to drill more wells to maintain production levels in 2023. In a recent report, the EIA is forecasting U.S. production will increase from 11.90 mb/d in 2022 to 12.49 mb/d in 2023. +Throughout 2022, the oilfield services industry faced labor shortages, as well as equipment and supply chain constraints, which limited availability for customers. As a result, in 2022, we implemented price increases across many of our service lines. Potential price increases in 2023 will be dependent on activity increases, as well as a number of other factors, and pricing has remained mostly steady thus far in 2023 across service lines. Any price increases in 2023 could be largely or wholly offset by labor and material cost inflation, and any such price increases could also negatively impact our customers’ activity levels due to their own cost inflation. +Significant factors that are likely to affect commodity prices moving forward include actions of the members of OPEC and other oil exporting nations that relate to or impact oil production or supply; the effect of energy, monetary, and trade policies of the U.S.; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa and including recovery from the coronavirus pandemic and any resurgence thereof; changes to energy regulations and policies, including those of the EPA and other governmental bodies; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. Furthermore, although as noted above, our customers’ activity and spending levels, and thus demand for our services and products, are strongly influenced by current and expected oil and natural gas prices, even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. +37 +Results of Operations +Year Ended December 31, +2022 2021 Change +(in thousands) +Revenues $ 593,382 $ 349,419 $ 243,963 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 457,093 307,992 149,101 +Adjusted gross profit $ 136,289 $ 41,427 $ 94,862 +General and administrative expenses $ 51,653 $ 45,301 $ 6,352 +Depreciation 26,784 28,905 (2,121) +Amortization of intangibles 13,463 16,116 (2,653) +Loss on revaluation of contingent liability 454 460 (6) +Loss on sale of property and equipment 367 660 (293) +Income (loss) from operations 43,568 (50,015) 93,583 +Non-operating expenses 28,629 14,585 14,044 +Income (loss) before income taxes 14,939 (64,600) 79,539 +Provision (benefit) for income taxes 546 (25) 571 +Net income (loss) $ 14,393 $ (64,575) $ 78,968 +Revenues +Revenues increased $244.0 million, or 70%, to $593.4 million in 2022. The increase in comparison to 2021 was prevalent across all lines of service and was due to activity and pricing improvements. As compared to 2021, the average U.S. rig count increased by 51%, and completions increased by 22%. Cementing revenue (including pump downs) increased by $115.3 million, or 101%, as total cement job count increased by 50%, in comparison to 2021. In addition, coiled tubing revenue increased $56.6 million, or 91%, as total days worked increased by 37%, tools revenue increased $37.2 million, or 37%, as completion tools stages increased by 38%, and wireline revenue increased $34.9 million, or 48%, as total completed wireline stages increased by 26%, in each case, in comparison to 2021. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues increased $149.1 million, or 48%, to $457.1 million in 2022. The increase in comparison to 2021 was prevalent across all lines of service and was primarily related to increased activity coupled with cost inflation associated with both labor and materials as well as headcount increases. More specifically, the increase was related to a $79.2 million increase in materials installed and consumed while performing services, a $54.4 million increase in employee costs, and a $15.5 million increase in other costs such as repairs and maintenance, travel, and vehicle expenses, in comparison to 2021. +Adjusted Gross Profit (Loss) +Adjusted gross profit increased $94.9 million to $136.3 million in 2022 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses increased $6.4 million to $51.7 million in 2022. The increase in comparison to 2021 was primarily related to an $8.2 million increase in employee costs mainly due to increases in headcount and compensation and a $0.4 million increase in other general and administrative costs such as marketing, travel, and vehicle costs. The overall increase was partially offset by a $2.2 million decrease in professional fees in comparison to 2021. +Depreciation +Depreciation expense decreased $2.1 million to $26.8 million in 2022. The decrease in comparison to 2021 was primarily due to certain assets becoming fully depreciated in the last twelve months. +38 +Amortization of Intangibles +Intangible amortization expense decreased $2.7 million to $13.5 million in 2022 and was primarily attributable to technology and customer relationships. The decrease was related to certain intangible assets being fully amortized in 2022. +(Gain) Loss on Revaluation of Contingent Liability +We recorded a $0.5 million loss on the revaluation of contingent liability in both 2022 and 2021. The losses for both periods were related to increases of the value of the earnout associated with our acquisition Frac Technology AS. +Non-Operating Expenses (Income) +We recorded $28.6 million in non-operating expenses in 2022 compared to $14.6 million in non-operating expenses in 2021. The $14.0 million increase in non-operating expense was primarily related to a $14.8 million decrease in gains on the extinguishment of debt related to the repurchase of 2023 Notes between periods. The overall increase in non-operating expenses was partially offset by a $0.7 million increase in interest and other income between periods. +Provision (Benefit) for Income Taxes +Our effective tax rate was 3.7% for 2022 and 0.01% for 2021. Our tax provision for 2022 is primarily the result of our tax position in state and foreign tax jurisdictions. +Adjusted EBITDA +Adjusted EBITDA increased $88.5 million to $93.7 million for 2022. The Adjusted EBITDA increase was primarily due to the changes in revenue and expenses discussed above. See “Non-GAAP Financial Measures” below for further explanation. +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted EBITDA is a supplemental non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define Adjusted EBITDA as EBITDA (which is net income (loss) before interest, taxes, depreciation, and amortization) further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) loss or gain on revaluation of contingent liabilities, (iv) loss or gain on the extinguishment of debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation and cash award expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. +Management believes Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income (loss) in arriving at this measure because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. This measure should not be considered as an alternative to, or more meaningful than, net income (loss) as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from this measure are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of this measure. Our computation of this measure may not be comparable to other similarly titled measures of other companies. +39 +The following table presents a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year Ended December 31, +2022 2021 +(in thousands) +EBITDA reconciliation: +Net income (loss) $ 14,393 $ (64,575) +Interest expense 32,486 32,527 +Interest income (305) (26) +Provision (benefit) for income taxes 546 (25) +Depreciation 26,784 28,905 +Amortization of intangibles 13,463 16,116 +EBITDA $ 87,367 $ 12,922 +Adjusted EBITDA reconciliation: +EBITDA $ 87,367 $ 12,922 +Loss on revaluation of contingent liability (1) +454 460 +Gain on extinguishment of debt (2,843) (17,618) +Restructuring charges 3,393 1,588 +Stock-based compensation and cash award expense 4,914 5,406 +Loss on sale of property and equipment 367 660 +Legal fees and settlements (2) +86 1,809 +Adjusted EBITDA $ 93,738 $ 5,227 +(1) Amounts relate to the revaluation of contingent liability associated with a 2018 acquisition. The impact is included in our Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 – Commitments and Contingencies included Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. +40 +Return on Invested Capital +ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) interest expense (income), (iv) restructuring charges, (v) loss (gain) on the sale of subsidiaries, (vi) loss (gain) on the extinguishment of debt, and (vii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity (deficit) plus the book value of debt less balance sheet cash and cash equivalents. We compute the average of the current and prior period-end total capital for use in this analysis. +Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation of ROIC may not be comparable to other similarly titled measures of other companies. +The following table provides an explanation of our calculation of ROIC for the years ended December 31, 2022 and 2021: +Year Ended December 31, +2022 2021 +(in thousands) +Net income (loss) $ 14,393 $ (64,575) +Add back: +Interest expense 32,486 32,527 +Interest income (305) (26) +Restructuring charges 3,393 1,588 +Gain on extinguishment of debt (2,843) (17,618) +After-tax net operating income (loss) $ 47,124 $ (48,104) +Total capital as of prior period-end: +Total stockholders’ equity (deficit) $ (39,267) $ 20,409 +Total debt 337,436 348,637 +Less cash and cash equivalents (21,509) (68,864) +Total capital as of prior period-end $ 276,660 $ 300,182 +Total capital as of period-end: +Total stockholders’ deficit $ (23,507) $ (39,267) +Total debt 341,606 337,436 +Less cash and cash equivalents (17,445) (21,509) +Total capital as of period-end $ 300,654 $ 276,660 +Average total capital $ 288,657 $ 288,421 +ROIC 16.3 % (16.7) % +41 +Adjusted Gross Profit (Loss) +GAAP defines gross profit (loss) as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit (loss) because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (loss) to evaluate operating performance. We prepare adjusted gross profit (loss) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (loss) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (loss) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (loss) or similarly titled measures in the same manner as we do. +The following table presents a reconciliation of adjusted gross profit (loss) to GAAP gross profit (loss). +Year Ended December 31, +2022 2021 +(in thousands) +Calculation of gross profit (loss) +Revenues $ 593,382 $ 349,419 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 457,093 307,992 +Depreciation (related to cost of revenues) 24,909 26,882 +Amortization of intangibles 13,463 16,116 +Gross profit (loss) $ 97,917 $ (1,571) +Adjusted gross profit reconciliation: +Gross profit (loss) $ 97,917 $ (1,571) +Depreciation (related to cost of revenues) 24,909 26,882 +Amortization of intangibles 13,463 16,116 +Adjusted gross profit $ 136,289 $ 41,427 +42 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash on hand, cash flows from operations and, if needed, external borrowings and issuances of debt securities. Our principal uses of cash are to fund capital expenditures, service our outstanding debt, fund our working capital requirements and fund acquisitions. Due to our high level of variable costs and the asset-light make-up of our business, we have historically been able to quickly implement cost-cutting measures and will continue to adapt as the market dictates. We have also used cash to make open market repurchases of our debt and may, from time to time, continue to make such repurchases (including with respect to the 2028 Notes) when it is opportunistic to do so to manage our debt maturity profile. +We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. +Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +In 2023, our planned capital expenditure budget, excluding possible acquisitions, is expected to be between $25.0 million to $35.0 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including expected industry activity levels and company initiatives. +At December 31, 2022, we had $17.4 million of cash and cash equivalents and $66.6 million of availability under the ABL Credit Facility, which resulted in a total liquidity position of $84.0 million. On January 27, 2023, we borrowed an additional $40.0 million under the ABL Credit Facility to pay for the redemption price of the 2023 Notes and to pay for fees and expenses related to the Units offering. We believe that, based on our current forecasts, our cash on hand, together with cash flow from operations and borrowings under the ABL Credit Facility, should be sufficient to fund our capital requirements for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts, which are materially dependent on our financial performance and the ever-changing market. +2023 Notes +On October 25, 2018, we issued $400.0 million of 2023 Notes under an indenture, dated as of October 25, 2018 (the “2023 Notes Indenture”), by and among us, including certain of our subsidiaries, and Wells Fargo, National Association, as Trustee. The 2023 Notes bore interest at annual rate of 8.750% payable on May 1 and November 1 of each year. The 2023 Notes were senior unsecured obligations and were fully and unconditionally guaranteed on a senior unsecured basis by each of our current domestic subsidiaries and by certain future subsidiaries. +The 2023 Notes Indenture contained covenants that limited our ability and the ability of our restricted subsidiaries to engage in certain activities. We were in compliance with the provisions of the 2023 Notes Indenture at December 31, 2022. +We repurchased approximately $13.0 million of 2023 Notes at a repurchase price of approximately $10.1 million in cash for the year ended December 31, 2022. We also repurchased approximately $26.3 million of 2023 Notes at a repurchase price of approximately $8.4 million in cash for the year ended December 31, 2021. +On February 1, 2023, all of the outstanding 2023 Notes were redeemed at a redemption price of 100.0% of the principal amount thereof ($307.3 million), plus accrued and unpaid interest ($6.7 million), and the 2023 Notes Indenture was discharged as of January 30, 2023. +For additional information on the 2023 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +Units Offering and 2028 Notes +On January 30, 2023, we completed our public offering of Units and issued 300,000 Units with an aggregate stated amount of $300.0 million. Each Unit consists of $1,000 principal amount of the 2028 Notes and five shares of our common +43 +stock. We received proceeds of $279.8 million from the Units offering, after deducting underwriting discounts and commission, which was used to fund a portion of the redemption price of the 2023 Notes. +Each Unit will be separated into its constituent securities (the 2028 Notes and the shares of our common stock) automatically on October 27, 2023, or, if earlier, on the date, if any, on which a change of control or event of default (each as defined in the indenture governing the 2028 Notes) occurs. +A holder of Units may elect to separate its Units into its constituent securities, in whole but not in part, on or after March 31, 2023. Prior to such date, the Units may not be separated at the option of the holder. +On January 30, 2023, we, and certain of our subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes, which form a part of the Units, were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000% payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are our senior secured obligations and are guaranteed on a senior secured basis by each of our current domestic subsidiaries and by certain future subsidiaries, subject to agreed guaranty and security principles and certain exclusions. +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), we are required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0% of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100% of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit our ability and the ability of our restricted subsidiaries to engage in certain activities. +For additional information on the Units and the 2028 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), that permitted aggregate borrowings of up to $200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “ABL Credit Facility”). Pursuant to the 2018 ABL Credit Agreement, the ABL Credit Facility was set to mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the 2023 Notes if they had not been redeemed or repurchased by such date. +On January 17, 2023, we entered into the First Amendment to Credit Agreement (the “ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which amends certain terms of the 2018 ABL Credit Agreement (as amended the “ABL Credit Agreement”). The ABL Facility Amendment became effective on January 30, 2023. +Pursuant to the ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $200.0 million to $150.0 million, subject to the borrowing base, (b) changed the interest rate benchmark from London Interbank Offered Rate to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75% to 2.25% to a range of 2.00% to 2.50%, in each case depending on our leverage ratio, (c) modified the financial covenant, enhanced reporting +44 +and cash dominion triggers in the ABL Credit Facility from the existing minimum availability threshold of the greater of $18.75 million and 12.5% of the loan limit to a minimum availability threshold of (i) $12.5 million from January 30, 2023 until May 31, 2023 and (ii) the greater of $17.5 million and 12.5% of the loan limit thereafter, (d) decreased the Canadian tranche sub-limit from $25.0 million to $5.0 million, (e) decreased the letter of credit sub-limit from $50.0 million to $10.0 million and (f) made satisfaction of the Payment Conditions (as defined in the ABL Facility Amendment) a condition to an Excess Cash Flow Offer in addition to a condition to voluntary payments of the 2028 Notes. The Payment Conditions in summary are (A) no default or event of default on a pro forma basis and (B) immediately after and at all times and at all times during the 30 days prior, on a pro forma basis, (1) (x) availability under the ABL Credit Facility shall not be less than the greater of 15% of the loan limit and $22.5 million and (y) the fixed charge coverage ratio shall be at least 1.00 to 1.00 or (2) availability under the ABL Credit Facility shall not be less than the greater of 20% of the loan limit and $30.0 million. +The 2018 ABL Credit Agreement contained, and the ABL Credit Agreement contains, various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. We were in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2022. +Pursuant to the 2018 ABL Credit Agreement, all of the obligations under the ABL Credit Facility were, and pursuant to the ABL Credit Agreement, all obligations under the ABL Credit Facility are, secured by security interests (subject to permitted liens) in substantially all of the personal property of our domestic subsidiaries, excluding certain assets. The obligations under the Canadian tranche were and are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Nine Energy Canada, Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries, excluding certain assets. +Both the ABL Credit Facility and the Units collateralization were completed within 30 days after closing in accordance with the terms of the ABL Facility Amendment and the Units offering. +At December 31, 2022, we had $32.0 million of borrowings under the ABL Credit Facility, and our availability under the ABL Credit Facility was approximately $66.6 million, net of outstanding letters of credit of $1.3 million. On January 27, 2023, we borrowed an additional $40.0 million under the ABL Credit Facility to pay for the redemption price of the 2023 Notes and to pay for fees and expenses related to the Units offering. +Cash Flows +Our cash flows for the years ended December 31, 2022, and 2021 are presented below: +Year Ended December 31, +2022 2021 +(in thousands) +Operating activities $ 16,672 $ (40,416) +Investing activities (25,417) (11,921) +Financing activities 4,849 5,048 +Impact of foreign exchange rate on cash (168) (66) +Net change in cash and cash equivalents $ (4,064) $ (47,355) +Operating Activities +Net cash provided by operating activities was $16.7 million in 2022 compared to $40.4 million in net cash used in operating activities in 2021. The $57.1 million increase in net cash provided by operating activities was primarily a result of an $85.5 million increase in cash flow provided by operations, adjusted for any non-cash items, and primarily driven by an increase in revenue and income in comparison to 2021. The increase in net cash provided by operating activities was offset by a $28.4 million decrease in cash provided by working capital, including an increase in accounts receivable from increased product and service sales, which has the effect of lagging cash collections, in each case, in comparison to 2021. +Investing Activities +Net cash used in investing activities was $25.4 million in 2022 compared to $11.9 million in net cash used in investing activities in 2021. The $13.5 million increase was primarily due to a $13.1 million increase in cash purchases of property and equipment, coupled with $0.4 million decrease in proceeds from the sale of property and equipment (including insurance), in each case, in comparison to 2021. +45 +Financing Activities +Net cash provided by financing activities was $4.8 million in 2022 compared to $5.0 million in net cash provided by financing activities in 2021. The $0.2 million decrease was primarily related to a $7.0 million payment on the ABL Credit Facility in 2022 that did not occur in 2021 as well as a $2.2 million increase in payments on short-term debt in comparison to 2021. The decrease was partially offset by a $9.0 million increase in proceeds from the ABL Credit Facility in 2022 in comparison to 2021. +Critical Accounting Estimates +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. +We consider the significant accounting policies identified below to be “critical accounting estimates” due to the following: +• The policies are dependent on estimates and assumptions made by us about matters that are inherently uncertain. +• The policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. +For additional information on our significant accounting policies, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful life of the asset. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. Estimated useful lives requires significant judgment which is influenced by our historical experience in operating property and equipment, technological developments, and expectations of future demand. Should our estimates be too long or too short, we could report a disproportionate amount of losses or gains from sale or retirement. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. Reasonable estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The accuracy of these estimates is impacted by, among other things, the complexity of the issues and the amount of due diligence we have been able to perform. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the +46 +range, provision will be made for the lower amount of the range. If the actual settlement costs, final judgments, or fines, after appeals, differ from our estimates, there may be a material adverse effect on our future financial results. +Stock-based Compensation and Fair Market Value Determination +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in “General and administrative expenses” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Fair value of all the options outstanding was measured using the Black-Scholes model. Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – We develop our expected volatility based upon a weighted average volatility of our peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Fair value of the stock-based compensation for all of the performance share units as well as performance cash awards outstanding was measured using a Monte Carlo simulation model. +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Emerging Growth Company Status +We are an “emerging growth company” as defined in the JOBS Act. Under Section 107 of the JOBS Act, as an emerging growth company, we are taking advantage of an extended transition period for the adoption of new or revised financial accounting standards, including the reduced reporting requirements and exemptions, and the longer phase-in periods for the adoption of new or revised financial accounting standards, until we are no longer an emerging growth company. Our election to use the longer phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods under Section 107 of the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. +Smaller Reporting Company Status +We are a “smaller reporting company” as defined by the SEC. As such, we are eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. Our disclosures in this Annual Report reflect these scaled requirements. +47 +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 238 ) +F- 1 +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2022 and 2021 +F- 3 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2022 and 2021 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2022 and 2021 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +48 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of income and comprehensive income (loss), consolidated statements of stockholders’ equity (deficit), and consolidated statements of cash flows for the years then ended, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Houston, TX +March 7, 2023 +We have served as the Company’s auditor since 2011. +F-1 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2022 2021 +Assets +Current assets +Cash and cash equivalents $ 17,445 $ 21,509 +Accounts receivable, net 105,277 64,025 +Income taxes receivable 741 1,393 +Inventories, net 62,045 42,180 +Prepaid expenses and other current assets 11,217 10,195 +Total current assets 196,725 139,302 +Property and equipment, net 89,717 86,958 +Operating lease right of use assets, net 36,336 35,117 +Finance lease right of use assets, net 547 1,445 +Intangible assets, net 101,945 116,408 +Other long-term assets 1,564 2,383 +Total assets $ 426,834 $ 381,613 +Liabilities and Stockholders’ Equity (Deficit) +Current liabilities +Accounts payable $ 42,211 $ 28,680 +Accrued expenses 28,391 18,519 +Current portion of long-term debt 2,267 2,093 +Current portion of operating lease obligations 7,956 6,091 +Current portion of finance lease obligations 178 1,070 +Total current liabilities 81,003 56,453 +Long-term liabilities +Long-term debt 338,031 332,314 +Long-term operating lease obligations 29,370 30,435 +Long-term finance lease obligations — 65 +Other long-term liabilities 1,937 1,613 +Total liabilities 450,341 420,880 +Commitments and contingencies (Note 12) +Stockholders’ equity (deficit) +Common stock ( 120,000,000 shares authorized at $ 0.01 par value; 33,221,266 and 32,826,325 shares issued and outstanding at December 31, 2022 and 2021 respectively) +332 328 +Additional paid-in capital 775,006 773,350 +Accumulated other comprehensive loss ( 4,828 ) ( 4,535 ) +Accumulated deficit ( 794,017 ) ( 808,410 ) +Total stockholders’ equity (deficit) ( 23,507 ) ( 39,267 ) +Total liabilities and stockholders’ equity (deficit) $ 426,834 $ 381,613 +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2022 2021 +Revenues +Service $ 455,364 $ 248,618 +Product 138,018 100,801 +593,382 349,419 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Service 350,733 228,290 +Product 106,360 79,702 +General and administrative expenses 51,653 45,301 +Depreciation 26,784 28,905 +Amortization of intangibles 13,463 16,116 +Loss on revaluation of contingent liability 454 460 +Loss on sale of property and equipment 367 660 +Income (loss) from operations 43,568 ( 50,015 ) +Interest expense 32,486 32,527 +Interest income ( 305 ) ( 26 ) +Gain on extinguishment of debt ( 2,843 ) ( 17,618 ) +Other income ( 709 ) ( 298 ) +Income (loss) before income taxes 14,939 ( 64,600 ) +Provision (benefit) for income taxes 546 ( 25 ) +Net income (loss) $ 14,393 $ ( 64,575 ) +Earnings (loss) per share +Basic $ 0.47 $ ( 2.13 ) +Diluted $ 0.45 $ ( 2.13 ) +Weighted average shares outstanding +Basic 30,930,890 30,302,925 +Diluted 32,251,398 30,302,925 +Other comprehensive loss, net of tax +Foreign currency translation adjustments, net of $ 0 tax in each period +$ ( 293 ) $ ( 34 ) +Total other comprehensive loss, net of tax ( 293 ) ( 34 ) +Total comprehensive income (loss) $ 14,100 $ ( 64,609 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) +(In thousands, except share amounts) +Common Stock Additional +Paid-in Accumulated +Other +Comprehensive Retained +Earnings +(Accumulated Total +Stockholders’ Equity +Shares Amounts Capital Income (Loss) Deficit) (Deficit) +Stockholders’ equity (deficit) as of December 31, 2020 31,557,809 $ 316 $ 768,429 $ ( 4,501 ) $ ( 743,835 ) $ 20,409 +Issuance of common stock under stock compensation plan, net of forfeitures 1,457,626 14 ( 14 ) — — — +Stock-based compensation expense — — 5,406 — — 5,406 +Vesting of restricted stock and stock units ( 189,110 ) ( 2 ) ( 471 ) — — ( 473 ) +Other comprehensive loss — — — ( 34 ) — ( 34 ) +Net loss — — — — ( 64,575 ) ( 64,575 ) +Stockholders’ equity (deficit) as of December 31, 2021 32,826,325 $ 328 $ 773,350 $ ( 4,535 ) $ ( 808,410 ) $ ( 39,267 ) +Issuance of common stock under stock compensation plan, net of forfeitures 623,328 7 ( 7 ) — — — +Stock-based compensation expense — — 2,440 — — 2,440 +Vesting of restricted stock and stock units ( 228,387 ) ( 3 ) ( 777 ) — — ( 780 ) +Other comprehensive loss — — — ( 293 ) — ( 293 ) +Net income — — — — 14,393 14,393 +Stockholders’ equity (deficit) as of December 31, 2022 33,221,266 $ 332 $ 775,006 $ ( 4,828 ) $ ( 794,017 ) $ ( 23,507 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2022 2021 +Cash flows from operating activities +Net income (loss) $ 14,393 $ ( 64,575 ) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities +Depreciation 26,784 28,905 +Amortization of intangibles 13,463 16,116 +Amortization of operating leases 8,670 8,020 +Amortization of deferred financing costs 2,545 2,602 +Recovery for doubtful accounts ( 166 ) ( 229 ) +Provision for inventory obsolescence 2,966 4,831 +Stock-based compensation expense 2,440 5,406 +Gain on extinguishment of debt ( 2,843 ) ( 17,618 ) +Loss on sale of property and equipment 367 660 +Loss on revaluation of contingent liability 454 460 +Abandonment of in-process research and development 1,000 — +Changes in operating assets and liabilities +Accounts receivable, net ( 41,114 ) ( 22,540 ) +Inventories, net ( 22,968 ) ( 8,608 ) +Prepaid expenses and other current assets ( 818 ) 3,350 +Accounts payable and accrued expenses 19,476 12,447 +Income taxes receivable/payable 655 — +Other assets and liabilities ( 8,632 ) ( 9,643 ) +Net cash provided by (used in) operating activities 16,672 ( 40,416 ) +Cash flows from investing activities +Proceeds from sales of property and equipment 2,959 3,492 +Proceeds from property and equipment casualty losses 175 — +Purchases of property and equipment ( 28,551 ) ( 15,413 ) +Net cash used in investing activities ( 25,417 ) ( 11,921 ) +Cash flows from financing activities +Proceeds from ABL Credit Facility 24,000 15,000 +Payments on ABL Credit Facility ( 7,000 ) — +Purchases of 2023 Notes ( 10,081 ) ( 8,355 ) +Payments on Magnum Promissory Notes ( 1,125 ) ( 844 ) +Proceeds from short-term debt 4,086 1,513 +Payments of short-term debt ( 2,787 ) ( 545 ) +Payments on finance leases ( 1,269 ) ( 1,094 ) +Payments of contingent liability ( 195 ) ( 154 ) +Vesting of restricted stock and stock units ( 780 ) ( 473 ) +Net cash provided by financing activities 4,849 5,048 +Impact of foreign currency exchange on cash ( 168 ) ( 66 ) +Net decrease in cash and cash equivalents ( 4,064 ) ( 47,355 ) +Cash and cash equivalents +Cash and cash equivalents at beginning of period 21,509 68,864 +F-5 +Year Ended December 31, +2022 2021 +Cash and cash equivalents at end of period $ 17,445 $ 21,509 +Supplemental disclosures of cash flow information: +Cash paid for interest $ 29,708 $ 30,085 +Cash refunded for income taxes $ 116 $ 24 +Supplemental schedule of non-cash activities: +Capital expenditures in accounts payable and accrued expenses $ 3,443 $ 63 +Receivable from property and equipment sale (including insurance) $ 701 $ 497 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies. The Company is headquartered in Houston, Texas. +The Company’s chief operating decision maker, which is its Chief Executive Officer, and its board of directors allocate resources and assess performance based on financial information presented at a consolidated level. Accordingly, the Company determined that it operates as one reportable segment, known as Completion Solutions . +Risks and Uncertainties +The Company’s business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. Following an extreme decline in activity levels and pricing in 2020, the Company has been focused on strategically implementing price increases and gaining market share. In 2022, oil and natural gas prices improved, and activity levels increased compared to 2021, resulting in higher demand for the Company’s products and services. Due to a heightened competition for qualified labor, an under-supply of equipment, and other supply chain-related constraints, the Company implemented price increases in most service lines. Finding and retaining qualified labor continues to be a challenge resulting in wage inflation, offsetting some of the price increases. Going forward, the Company’s earnings will be affected by its customers’ activity plans (which are strongly influenced by commodity prices), the Company’s ability to implement further price increases, the impact of wage and labor inflation, and labor shortage and supply chain constraints. Additionally, activity levels could be affected as oilfield service providers continue to raise prices and customers are impacted by cost inflation to drill, complete, and produce oil and natural gas wells. +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial statements as of December 31, 2022 and 2021, and for the years ended December 31, 2022 and 2021, include the accounts of Nine and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. +Use of Estimates +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include fair value assumptions used in analyzing long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, recognition of provisions for contingencies, and stock-based compensation fair value. It is at least reasonably possible that the estimates used will change within the next year. +Revenue Recognition +The Company recognizes revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products are received by a customer’s domestic common carrier at the Company’s facility or when the product is received by the customer’s international carrier. The Company believes this recognition policy reflects the point at which the customer obtains control of the product as required by ASC 606. +F-7 +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company excludes sales taxes, value added taxes, and other taxes it collects concurrent with revenue-producing activities from revenue. +The Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For domestic product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. For international product sales, the Company typically recognizes revenue when it meets its performance obligation upon receipt of the products by the customer’s international carrier. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. Service revenues represent revenue recognized over time, as the Company’s customer arrangements typically provide agreed upon hourly or daily fixed-rates, and the Company recognizes service revenue based upon the number of hours or days services have been performed. +Contracts for the Company’s products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period the Company stands ready to provide its services to its client as needed. +The Company’s payment terms vary by the type and location of its customers and type of product and service offered. The Company receives cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date the Company invoices a customer. Since the period between the delivery of the Company’s products and services and the Company’s receipt of customer payment for these products and services is not expected to exceed one year, the Company has elected not to calculate or disclose a financing component for its customer contracts. +Contract Estimates +The Company receives reimbursements from its customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of the Company’s influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. The Company is considered a principal in these transactions and records the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of the Company’s contracts due to the dynamic nature of well operations and the services the Company provides for its customers. The Company considers contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of the Company’s contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Any contract assets are included in “Accounts receivable, net” in the Company’s Consolidated Balance Sheets. Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. The Company classifies contract liabilities as unearned income which is included in “Accrued expenses” in the Company’s Consolidated Balance Sheets. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For information regarding the Company’s revenue, see Note 3 – Revenues . +Leases +The Company determines if an arrangement is a lease at inception. To the extent an arrangement represents a lease, the Company classifies that lease as an operating lease or a finance lease under Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”). +The Company capitalizes operating leases on its Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent the Company’s right to use an underlying asset for the lease term, and +F-8 +lease liabilities represent the Company’s obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that the Company would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. +Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2022 and 2021. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2022 and 2021. +Finance leases are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2022 and 2021. +For additional information regarding the Company’s leases, see Note 6 – Leases. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the United States Dollar (“USD”). The financial position and results of operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) and its Consolidated Statements of Stockholders’ Equity (Deficit). +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus, receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices, industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +The Company had $ 105.3 million and $ 64.0 million of “Accounts receivable, net” at December 31, 2022 and 2021, respectively. The Company maintains an allowance for doubtful accounts based on the expected collectability of accounts receivable, which is included in “Accounts receivable, net” on the Company’s Consolidated Balance Sheets. The Company had an allowance for doubtful accounts of $ 0.2 million and $ 2.8 million at December 31, 2022 and 2021, respectively. Bad debt expense recovery was $ 0.2 million for both the years ended December 31, 2022 and 2021. +Concentration of Credit Risk +The Company derives a significant portion of its revenues from companies in the exploration and production (“E&P”) industry, and its customer base includes a broad range of integrated and independent domestic E&P companies and international E&P companies operating in the markets that the Company serves. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and +F-9 +can therefore negatively impact spending by the Company’s customers. No customer accounted for more than 10% of the revenues for the years ended December 31, 2022 and 2021. +Concentration of Supplier Risk +Purchases during the years ended December 31, 2022 and 2021 did not include purchases from any supplier that individually represented more than 10% of total operating purchases. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the assets. Equipment held under capital leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Valuation of Intangible Assets +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. +Intangible assets with indefinite useful lives are not subject to amortization. For intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +F-10 +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. As a result of the adoption of ASU No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Restricted Stock and Restricted Stock Units +Compensation expense is recorded for restricted stock and restricted stock units over the applicable vesting period based on the Company’s closing stock price as of the grant date. +Performance Stock Units and Performance Cash Awards +Performance stock units and performance cash awards are recorded at their fair value and expensed over their performance period. Fair value for performance stock units and performance cash awards is measured using a Monte Carlo simulation model. +Options +Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +• The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +• Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company developed its expected volatility based upon a weighted average volatility of its peer group. +• At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +• The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Income Taxes +The Company accounts for income taxes under Accounting Standards Codification 740, Income Taxes (“ASC 740”). Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +F-11 +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 9 – Debt Obligations. +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 12 – Commitments and Contingencies. +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, taking into effect, if any, the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as potentially dilutive restricted stock, restricted stock units, and performance stock units. There was no dilutive effect for the year ended December 31, 2021 as the Company was in a net loss position. For additional information on earnings (loss) per share, see Note 14 – Earnings (Loss) Per Share. +Accounting Pronouncements Recently Adopted +In December 2019, the Financial Accounting Standards Board (the “FASB”) issued ASU 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes , which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles and clarifies and amends existing guidance to improve consistent application. ASU 2019-12 is effective for public businesses for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and adopted, the new standard for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements included in this Annual Report. +Accounting Pronouncements Not Yet Adopted +In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in ASU 2016-13 replace the current incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information. ASU 2016-13 is effective for Securities and Exchange Commission filers, excluding smaller reporting companies, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. As an emerging growth company, the Company is permitted, and plans, to adopt the new standard for the fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company does not expect the standard to have a material impact on its financial position, results of operations, or +F-12 +liquidity. +3. Revenues +Disaggregation of Revenues +Disaggregated revenue for the years ended December 31, 2022 and 2021 was as follows: +Year Ended December 31, +2022 2021 +(in thousands) +Cement $ 229,409 $ 114,181 +Tools 138,018 100,801 +Wireline 107,352 72,436 +Coiled tubing 118,603 62,001 +Total revenues $ 593,382 $ 349,419 +The Company recognizes revenues from the sales of products at a point in time and revenues from the sales of services over time. +Performance Obligations +At December 31, 2022 and December 31, 2021, the amount of remaining performance obligations was not material. +Contract Balances +At December 31, 2022 and December 31, 2021, contract assets and contract liabilities were not material. +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $ 6.7 million and $ 9.0 million at December 31, 2022 and 2021, respectively. +Inventories, net as of December 31, 2022 and 2021 were comprised of the following: +December 31, +2022 2021 +(in thousands) +Raw materials $ 39,249 $ 31,153 +Work in progress 161 675 +Finished goods 29,345 19,323 +Inventories 68,755 51,151 +Reserve for obsolescence ( 6,710 ) ( 8,971 ) +Inventories, net $ 62,045 $ 42,180 +F-13 +5. Property and Equipment +Property and equipment amounts as of December 31, 2022 and 2021 were as follows: +December 31, +Estimated +Useful Lives 2022 2021 +(in thousands) +Operating equipment +1 to 12 years +$ 321,315 $ 299,602 +Autos and trucks +1 to 7 years +4,140 4,168 +Furniture, fixtures, and equipment +2 to 12 years +3,843 4,059 +Shop equipment +3 to 15 years +14,552 14,555 +Buildings +7 to 39 years +4,599 8,994 +Leasehold improvements +3 to 11 years +2,017 1,443 +Land indefinite 1,348 828 +351,814 333,649 +Less: Accumulated depreciation ( 262,097 ) ( 246,691 ) +Property and equipment, net $ 89,717 $ 86,958 +Depreciation expense was $ 26.8 million and $ 28.9 million for the years ended December 31, 2022 and 2021, respectively. +6. Leases +Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Company’s Consolidated Balance Sheets. Lease with an initial term greater than 12 months are recognized in the Company’s Consolidated Balance Sheets based on lease classification as either operating or financing. Some of the Company’s lease agreements include lease and non-lease components for which the Company has elected to not separate for all classes of underlying assets. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may sublease its real estate to third parties, subject to certain provision of the lease, when it has no future use for the property. +Operating Leases +As a lessee, the Company’s operating lease portfolio primarily consists of operating leases for equipment, vehicles, office space, yard facilities, and employee housing. Operating lease ROU assets and operating lease obligations are recognized based on the present value of the future minimum lease payments at commencement date. As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate based on the lease information available at the commencement date in determining the present value of future payments. The incremental borrowing rate utilized is based upon the interest rate associated with the Company’s ABL Credit Facility (as defined and described in Note 9 – Debt Obligations) which is utilized to fund its working capital needs and planned capital expenditures. The Company’s leases have remaining terms of one to ten years and may include options to extend or terminate the lease. The operating lease ROU assets also include any upfront lease payments made and exclude lease incentives and initial direct costs incurred. +The Company leases most of these properties under long-term (greater than one year) non-cancelable term leases many of which contain renewal options that can extend the lease term from one to five years and some of which contain escalation clauses. The Company may also enter into short-term or month-to-month operating leases. Options to renew these leases are generally not considered reasonably certain to be exercised due to the nature of the Company’s operations and the markets it serves. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease. +The Company also leases supplemental equipment, typically under cancellable short-term contracts which are less than 30 days. This equipment is typically required for a specific project and for a short duration. Due to the nature of the Company’s operations, any option to renew these short-term leases is generally not considered reasonably certain to be exercised. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease, and the lease payments during these periods are similarly excluded from the calculation of operating lease asset and lease obligation balances. +F-14 +Operating lease expense consists of rent expense related to leases that were included in ROU assets under ASC 842. The Company recognizes operating lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable operating lease payments typically include charges for property taxes and insurance, and some leases contain variable payments related to non-lease components, including common area maintenance and usage of facilities or office equipment (for example, copiers). The Company does not have variable expenses. +Additional Information +The following table summarizes the components of the Company’s lease expense recognized for the years ended December 31, 2022 and 2021, excluding variable lease and prepaid rent costs: +Year Ended December 31, +2022 2021 +(in thousands) +Operating lease expense +Operating lease right of use assets $ 8,670 $ 8,020 +Operating lease non right of use assets 7,697 6,201 +Total operating lease expense $ 16,367 $ 14,221 +Finance lease expense +Depreciation of right of use assets $ 385 $ 399 +Interest on lease obligations 199 162 +Total finance lease expense $ 584 $ 561 +Operating lease expense is included in the line items “Cost of revenues” and “General and administrative expenses” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2022 and 2021. +Supplemental information related to leases was as follows as of December 31, 2022 and 2021: +December 31, +2022 2021 +Operating leases +Weighted average remaining lease term 5.3 6.4 +Weighted average discount rate 5.0 % 5.0 % +Finance leases +Weighted average remaining lease term 0.4 1.0 +Weighted average discount rate 21.7 % 9.8 % +F-15 +Supplemental balance sheet information related to leases was as follows as of December 31, 2022 and 2021: +December 31, +2022 2021 +(in thousands) +Operating lease right of use assets +Operating lease right of use assets, gross $ 52,947 $ 45,853 +Less: Accumulated amortization ( 16,611 ) ( 10,736 ) +Operating lease right of use assets, net $ 36,336 $ 35,117 +Operating lease obligations +Current portion of operating lease obligations $ 7,956 $ 6,091 +Long-term operating lease obligations 29,370 30,435 +Total operating lease obligations $ 37,326 $ 36,526 +Finance lease right of use assets +Finance lease right of use assets, gross $ 1,057 $ 2,980 +Less: Accumulated depreciation ( 510 ) ( 1,535 ) +Finance lease right of use assets, net $ 547 $ 1,445 +Finance lease obligations +Current portion of finance lease obligations $ 178 $ 1,070 +Long-term finance lease obligations — 65 +Total finance lease obligations $ 178 $ 1,135 +Future annual minimum lease payments as of December 31, 2022 were as follows: +Operating Lease Right of Use Obligations Finance Leases Total +(in thousands) +2023 $ 9,599 $ 219 $ 9,818 +2024 7,994 — 7,994 +2025 7,047 — 7,047 +2026 6,474 — 6,474 +2027 5,130 — 5,130 +Thereafter 6,243 — 6,243 +Total lease payments $ 42,487 $ 219 $ 42,706 +Less: present value discount ( 5,161 ) ( 41 ) ( 5,202 ) +Present value of lease obligations $ 37,326 $ 178 $ 37,504 +F-16 +Supplemental cash flow information related to leases for the years ended December 31, 2022 and 2021 were as follows: +Year Ended December 31, +2022 2021 +(in thousands) +Cash paid for amounts included in the measurement of lease obligations: +Operating cash flows from operating leases $ 8,698 $ 8,124 +Operating cash flows from finance leases $ 385 $ 399 +Financing cash flows from finance leases $ 1,269 $ 1,094 +Right of use assets obtained in exchange for lease obligations: +Operating leases $ 8,356 $ 5,059 +Finance leases $ 336 $ 28 +7. Intangible Assets +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2022 and 2021 were as follows: +December 31, 2022 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 49,845 ) $ 13,425 4.8 +Non-compete agreements 6,500 ( 6,166 ) 334 0.8 +Technology 125,110 ( 36,924 ) 88,186 10.7 +Total $ 194,880 $ ( 92,935 ) $ 101,945 +December 31, 2021 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 45,187 ) $ 18,083 5.3 +Non-compete agreements 6,500 ( 5,766 ) 734 2.0 +Technology 125,110 ( 28,519 ) 96,591 11.7 +In-process research and development 1,000 — 1,000 Indefinite +Total $ 195,880 $ ( 79,472 ) $ 116,408 +The Company abandoned its “E-Set” tools business and related $ 1.0 million in-process research and development indefinite-lived intangible asset in the fourth quarter of 2022. +Amortization of Intangibles +Amortization of intangibles was $ 13.5 million and $ 16.1 million for the years ended December 31, 2022 and 2021, respectively. +F-17 +Future estimated amortization of intangibles is as follows: +Year Ending December 31, (in thousands) +2023 $ 11,516 +2024 11,183 +2025 11,183 +2026 11,082 +2027 10,315 +Thereafter 46,666 +$ 101,945 +8. Accrued Expenses +Accrued expenses as of December 31, 2022 and 2021 consisted of the following: +December 31, +2022 2021 +(in thousands) +Accrued interest 5,012 4,980 +Accrued compensation and benefits 10,283 6,897 +Accrued bonus 3,979 1,125 +Accrued legal fees and settlements 145 1,076 +Other accrued expenses 8,972 4,441 +Accrued expenses $ 28,391 $ 18,519 +9. Debt Obligations +The Company’s debt obligations as of December 31, 2022 and 2021 were as follows: +December 31, +2022 2021 +(in thousands) +2023 Notes (1) +$ 307,339 $ 320,343 +ABL Credit Facility (1) +32,000 15,000 +Magnum Promissory Notes (2) +— 1,125 +Other short-term debt (2) +2,267 968 +Total debt before deferred financing costs $ 341,606 $ 337,436 +Deferred financing costs ( 1,308 ) ( 3,029 ) +Total debt $ 340,298 $ 334,407 +Less: Current portion of long-term debt ( 2,267 ) ( 2,093 ) +Long-term debt $ 338,031 $ 332,314 +(1) Subsequent to December 31, 2022, the Company redeemed all of the outstanding 2023 Notes and extended the maturity date of the ABL Credit Facility from October 25, 2023 to January 29, 2027. As such, these obligations are classified as long-term on the Company’s Consolidated Balance Sheet at December 31, 2022. Refer to further disclosure within this footnote for additional information. +(2) The weighted average interest rate of short-term debt outstanding at December 31, 2022 and 2021, respectively, was 6.0 % and 5.1 %. +2023 Notes +On October 25, 2018, the Company issued $ 400.0 million principal amount of 8.750 % Senior Notes due 2023 (the “2023 Notes”). The 2023 Notes were issued under an indenture, dated as of October 25, 2018 (the “2023 Notes Indenture”), by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as Trustee. The 2023 +F-18 +Notes bore interest at an annual rate of 8.750 % payable on May 1 and November 1 of each year, commencing May 1, 2019. The 2023 Notes were senior unsecured obligations of the Company and were fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s current domestic subsidiaries and by certain future subsidiaries. +The 2023 Notes Indenture contained covenants that limited the Company’s ability and the ability of its restricted subsidiaries to engage in certain activities. The Company was in compliance with the provisions of the 2023 Notes Indenture at December 31, 2022. +Pursuant to the 2023 Notes Indenture, upon an event of default, the trustee or the holders of at least 25 % in aggregate principal amount of then outstanding 2023 Notes may declare the 2023 Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any significant subsidiary or any group of subsidiaries that, taken together, would constitute a significant subsidiary, would automatically cause all outstanding 2023 Notes to become due and payable. +Unamortized deferred financing costs associated with the 2023 Notes were $ 1.3 million and $ 3.0 million at December 31, 2022 and 2021, respectively. These costs were direct deductions from the carrying amount of the 2023 Notes and were amortized through interest expense through the maturity date of the 2023 Notes using the effective interest method. +Extinguishment of Debt +The Company repurchased approximately $ 13.0 million of 2023 Notes at a repurchase price of approximately $ 10.1 million in cash for the year ended December 31, 2022. Deferred financing costs associated with these transactions were $ 0.1 million for the year ended December 31, 2022. As a result, for the year ended December 31, 2022, the Company recorded a $ 2.8 million gain on the extinguishment of debt, which was calculated as the difference between the repurchase price and the carrying amount of the 2023 Notes partially offset by the deferred financing costs. +The Company repurchased approximately $ 26.3 million of 2023 Notes at a repurchase price of approximately $ 8.4 million in cash for the year ended December 31, 2021. Deferred financing costs associated with these transactions were $ 0.3 million for the year ended December 31, 2021. As a result, for the year ended December 31, 2021, the Company recorded a $ 17.6 million gain on the extinguishment of debt, which was calculated as the difference between the repurchase price and the carrying amount of the 2023 Notes partially offset by the deferred financing costs. +The gain on extinguishment of debt is included as a separate line item in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2022 and 2021 . +Redemption +On February 1, 2023, with proceeds received from its public offering of Units (as defined and described below) and borrowings under its ABL Credit Facility (as defined and described below), the Company redeemed all of the outstanding 2023 Notes at a redemption price of 100.0 % of outstanding principal amount thereof ($ 307.3 million), plus accrued and unpaid interest ($ 6.7 million). The Company also wrote off the unamortized deferred financing costs associated with the 2023 Notes in conjunction with the redemption. +Units Offering and 2028 Notes +Units +On January 30, 2023, the Company completed its public offering of 300,000 units with an aggregate stated amount of $ 300.0 million (the “Units”). Each Unit consists of $1,000 principal amount of the Company’s 13.000 % Senior Secured Notes due 2028 (collectively, the “2028 Notes”) and five shares of common stock of the Company. The Company received proceeds of $ 279.8 million from the Units offering, after deducting underwriting discounts and commission, which was used to fund a portion of the redemption price of the 2023 Notes. +Each Unit will be separated into its constituent securities (the 2028 Notes and shares of the Company’s common stock) automatically on October 27, 2023, or, if earlier, on the date, if any, on which a change of control or event of default (each as defined in the indenture governing the 2028 Notes) occurs. A holder of Units may elect to separate its Units into its constituent securities, in whole but not in part, on or after March 31, 2023. Prior to such date, the Units may not be separated at the option of the holder. Once a Unit has been separated into its constituent securities at the option of a holder, it cannot be recreated. +F-19 +Prior to separating the Units into its constituent securities, a holder thereof will not be able to participate in any redemption or repurchase of the 2028 Notes, and holders of the 2028 Notes must have separated their Units prior to the date of any redemption of any offer to repurchase commencement date in order to participate in such redemption or repurchase. +Holders of Units are entitled to the rights of a holder of the Company’s common stock, including, without limitation, the right to vote and consent to or receive notice as a stockholder. +2028 Notes +On January 30, 2023, the Company and certain of its subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes, which form a part of the Units, were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000 % payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are senior secured obligations of the Company and are guaranteed on a senior secured basis by each of the Company’s current domestic subsidiaries and by certain future subsidiaries, subject to agreed guaranty and security principles and certain exclusions. +Prior to February 1, 2026, the Company may, on any one or more occasions, redeem all or a part of the 2028 Notes at a redemption price equal to 100.0 % of the principal amount of the 2028 Notes redeemed, plus a “make-whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, prior to February 1, 2026, the Company may, from time to time, redeem up to 35.0 % of the aggregate principal amount of the 2028 Notes with an amount of cash not greater than the net cash proceeds of certain equity offerings at a redemption price equal to 113.0 % of the principal amount of the 2028 Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption, provided that at least 65.0 % of the aggregate principal amount of the 2028 Notes issued under the 2028 Notes Indenture remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of such equity offering. Also, prior to February 1, 2026, the Company may redeem during each 12-month period beginning on January 30, 2023, up to 10 % of the principal amount of the 2028 Notes on a redemption price equal to 103.0 % of the aggregate principal amount of the 2028 Notes being redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +On and after February 1, 2026, the Company may redeem the 2028 Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount of the 2028 Notes to be redeemed) set forth below, plus accrued and unpaid interest, if any, to, but excluding the date of redemption, if redeemed during the periods indicated: +Redemption Price +February 1, 2026 to January 31, 2027 106.500 % +February 1, 2027 to October 31, 2027 103.250 % +November 1, 2027 and thereafter 100.000 % +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), the Company is required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0 % of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100 % of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. +If the Company experiences certain changes of control, each holder of 2028 Notes may require the Company to repurchase all or a portion of its 2028 Notes for cash at a price equal to 101.0 % of the principal amount of such 2028 Notes, plus any accrued but unpaid interest, if any, to, but excluding, the date of repurchase. +F-20 +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit the Company’s ability and the ability of its restricted subsidiaries to (i) incur additional indebtedness and guarantee indebtedness; (ii) pay dividends or make other distributions of capital stock; (iii) prepay, redeem or repurchase certain debt; (iv) issue certain preferred stock or similar equity securities, (v) make loans and investments; (vi) sell assets; (vii) incur liens; (viii) enter into transactions with affiliates; (ix) enter into agreements restricting its subsidiaries’ ability to pay dividends; or (x) consolidate, merge, or sell all or substantially all of its assets. +Upon an event of default, the trustee of the 2028 Notes or the holders of at least 25 % in aggregate principal amount of then outstanding 2028 Notes may declare the 2028 Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding 2028 Notes to become due and payable. +ABL Credit Facility +Background +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A. as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permitted aggregate borrowings of up to $ 200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $ 25.0 million and a sub-limit of $ 50.0 million for letters of credit (the “ABL Credit Facility”). Pursuant to the 2018 ABL Credit Agreement, the ABL Credit Facility was set to mature on October 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the 2023 Notes if they had not been redeemed or repurchased by such date. +Pursuant to the 2018 ABL Credit Agreement, loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the ABL Credit Facility were base rate loans or London Interbank Offered Rate (“LIBOR”) loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche may be Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans varied from 0.75 % to 1.25 % and the applicable margin for LIBOR loans or CDOR loans varied from 1.75 % to 2.25 %, in each depending on the Company’s leverage ratio. In addition, a commitment fee of 0.50 % per annum was charged on the average daily unused portion of the revolving commitments. +On January 17, 2023, the Company entered into the First Amendment to Credit Agreement (the “ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which amends certain terms of the 2018 ABL Credit Agreement (as amended the “ABL Credit Agreement”). The ABL Facility Amendment became effective on January 30, 2023. +Pursuant to the ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $ 200.0 million to $ 150.0 million, subject to the borrowing base, (b) changed the interest rate benchmark from LIBOR to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75 % to 2.25 % to a range of 2.00 % to 2.50 %, in each case depending on the Company’s leverage ratio, (c) modified the financial covenant, enhanced reporting and cash dominion triggers in the ABL Credit Facility from the existing minimum availability threshold of the greater of $ 18.75 million and 12.5 % of the loan limit to a minimum availability threshold of (i) $ 12.5 million from January 30, 2023 until May 31, 2023 and (ii) the greater of $ 17.5 million and 12.5 % of the loan limit thereafter, (d) decreased the Canadian tranche sub-limit from $ 25.0 million to $ 5.0 million, (e) decreased the letter of credit sub-limit from $ 50.0 million to $ 10.0 million and (f) made satisfaction of the Payment Conditions (as defined in the ABL Facility Amendment) a condition to an Excess Cash Flow Offer in addition to a condition to voluntary payments of the 2028 Notes. The Payment Conditions in summary are (A) no default or event of default on a pro forma basis and (B) immediately after and at all times and at all times during the 30 days prior, on a pro forma basis, (1) (x) availability under the ABL Credit Facility shall not be less than the greater of 15 % of the loan limit and $ 22.5 million and (y) the fixed charge coverage ratio shall be at least 1.00 to 1.00 or (2) availability under the ABL Credit Facility shall not be less than the greater of 20 % of the loan limit and $ 30.0 million. +The 2018 ABL Credit Agreement contained and the ABL Credit Agreement contains, various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and +F-21 +transactions with affiliates. In addition, the 2018 ABL Credit Agreement contained a minimum fixed charge ratio covenant of 1.00 to 1.00 that was tested quarterly when the availability under the ABL Credit Facility dropped below $ 18.75 million or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. The Company was in compliance with all covenants under the 2018 ABL Credit Agreement as of December 31, 2022. +Pursuant to the 2018 ABL Credit Agreement, all of the obligations under the ABL Credit Facility were, and pursuant to the ABL Credit Agreement, all of the obligations under the ABL Credit Facility are secured by security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. +At December 31, 2022, the Company had $ 32.0 million outstanding borrowings under the ABL Credit Facility, and its availability under the ABL Credit Facility was approximately $ 66.6 million, net of outstanding letters of credit of $ 1.3 million. On January 27, 2023, the Company borrowed an additional $ 40.0 million under the ABL Credit Facility to pay for the redemption price of the 2023 Notes and to pay for fees and expenses related to the Units offering. +Both the ABL Credit Facility and the Units collateralization were completed within 30 days after closing in accordance with the terms of the ABL Facility Amendment and the Units offering. +Magnum Promissory Notes +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018 (as amended on June 7, 2019, the “Magnum Purchase Agreement”), the Company acquired all of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum”). The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019 (the “Magnum Earnout”). +On June 30, 2020, pursuant to an amendment to the Magnum Purchase Agreement to terminate the remaining Magnum Earnout and all obligations related thereto, the Company issued promissory notes with an aggregated principal amount of $ 2.3 million (the “Magnum Promissory Notes”) to the sellers of Magnum. The Magnum Promissory Notes bear interest at a rate of 6.0 % per annum. The principal amount of the Magnum Promissory Notes was paid in equal quarterly installments which began January 1, 2021. The remaining outstanding balance was paid on October 1, 2022. +Other Short-Term Debt +In the fourth quarter of 2022, the Company renewed certain insurance policies, and it financed the premium for its excess policy in the amount of $ 4.1 million. At December 31, 2022, the outstanding balance on this premium was $ 2.3 million. +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2022 and 2021 was as follows: +December 31, +2022 2021 +(in thousands) +2023 Notes $ 300,700 $ 153,765 +ABL Credit Facility $ 32,000 $ 15,000 +Magnum Promissory Notes $ — $ 1,125 +Other short-term debt $ 2,267 $ 968 +The fair value of the 2023 Notes, ABL Credit Facility, the Magnum Promissory Notes, and other short-term debt is classified as Level 2 in the fair value hierarchy. The fair value of the 2023 Notes is established based on observable inputs in less active markets. The fair value of the ABL Credit Facility, the Magnum Promissory Notes, and other short-term debt approximates their carrying value. +F-22 +10. Defined Contribution Plans +Background +The Company sponsors a defined contribution plan, the Nine Energy Service 401(k) Plan (the “Nine Plan”), under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +Contributions +For the years ended December 31, 2022 and 2021, the Company made no employer contributions under the Nine Plan. +11. Stock-based Compensation +Stock Options +Information about stock option activity during the years ended December 31, 2022 and 2021 was as follows: +2022 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 610,410 $ 33.52 3.9 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 22,904 ) 26.28 — — +Total outstanding 587,506 $ 33.80 3.0 $ — +Options exercisable 587,506 $ 33.80 3.0 $ — +2021 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 702,542 $ 32.63 4.5 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 92,132 ) 26.71 — — +Total outstanding 610,410 $ 33.52 3.9 $ — +Options exercisable 610,410 $ 33.52 3.9 $ — +The intrinsic value at December 31, 2022 and 2021 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2022 and 2021, respectively. +The Company granted no options in 2022 and 2021. +There was no compensation expense recorded for the years ended December 31, 2022 and 2021. As of December 31, 2022, there is no remaining compensation expense related to options for the Company to expense. Future stock option grants will result in additional compensation expense. +F-23 +Restricted Stock and Restricted Stock Units +Information about restricted stock and restricted stock unit activity during the years ended December 31, 2022 and 2021 was as follows: +2022 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2022 2,379,320 $ 2.83 +Granted 651,250 2.80 +Vested ( 1,068,092 ) 4.13 +Forfeited ( 27,922 ) 2.02 +Nonvested at December 31, 2022 1,934,556 $ 2.12 +2021 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2021 1,714,398 $ 6.69 +Granted 1,509,000 2.15 +Vested ( 792,704 ) 9.77 +Forfeited ( 51,374 ) 4.33 +Nonvested at December 31, 2021 2,379,320 $ 2.83 +The total amount of compensation expense related to the restricted stock and restricted stock units recorded was approximately $ 2.4 million and $ 4.9 million for the years ended December 31, 2022 and 2021, respectively. As of December 31, 2022, the Company expects to record compensation expense related to restricted stock and restricted stock units of approximately $ 3.0 million over the remaining term of approximately 1.9 years. Future restricted stock and restricted stock unit grants would result in additional compensation expense. +Performance Stock Units +The Company granted performance stock units (“PSUs”) in 2019. The number of PSUs that vested in the first quarter of 2022 was contingent upon the Company’s achievement of certain specified targets. These awards had market conditions and were valued using a Monte Carlo simulation model. +The volatility of 49.7 % was developed based upon the historical volatility of the Company as well as the volatilities of a group of peer companies, as the Company’s trading history needed to be supplemented with additional data as it went public in 2018. The risk-free rate, which was derived using the U.S. Treasury security rates at the grant date, was 2.44 %. +2022 2021 +Nonvested at January 1, 61,900 61,900 +Granted (1) +— — +Vested ( 42,714 ) — +Forfeited ( 19,186 ) — +Nonvested at December 31, — 61,900 +(1) The Company granted PSUs in 2019 that vested in the first quarter of 2022 contingent upon the Company’s achievement of certain specified targets based on a three-year performance period ending December 31, 2021. The nonvested PSU balance at January 1, 2021 is shown at target level. +The Company did not grant PSUs in 2022 or 2021. +There was no compensation expense related to PSUs for the year ended December 31, 2022, and for the year ended +F-24 +December 31, 2021, the total amount of compensation expense related to PSUs was approximately $ 0.5 million. As of December 31, 2022, the Company has no further compensation expense related to PSUs to record. Future PSU grants will result in additional compensation expense. +Performance Cash Awards +In May 2022, the Company granted performance cash awards (the “PCAs”) that vest based upon the Company’s achievement of certain criteria related to its relative total shareholder return (“TSR”) in comparison to TSR of members of its peer group (the “Peer Group”), as defined by the PCA grant. These awards, which the Company granted at a target achievement amount, are subject to three individual year-long performance periods (the “Performance Periods”), and payment related to each Performance Period can range from 0 % to 200 % of the target amount for that Performance Period. +The PCAs were valued on the date of grant based on the estimated fair value, which was based on numerous assumptions including the likelihood of the Company’s stock price performance achieving targeted thresholds, using a Monte Carlo simulation model. The assumptions used to value the awards included the historical volatility of the Company as well as the volatility of its Peer Group and the risk-free rate, which was derived using the U.S. Treasury security rates. +Under the relevant liability accounting, the fair values for each tranche of the PCAs are remeasured at the end of each reporting period. At December 31, 2022, the volatility for remeasurement was 123.82 %, and the risk-free rate was 4.30 %. Compensation expense related to PCAs for the year ended December 31, 2022 was approximately $ 1.8 million. As of December 31, 2022, based upon the valuation of the PCAs at year end, the Company had remaining compensation expense to recognize of $ 1.6 million. Future PCA grants will result in additional compensation expense. +12. Commitments and Contingencies +Litigation +The Company records accruals related to litigation and other legal proceedings when they are either known or considered probable and can be reasonably estimated. Legal proceedings are inherently unpredictable and subject to significant uncertainties, and significant judgment is required to determine both probability and the estimated amount. Some of these uncertainties include the stage of litigation, available facts, uncertainty as to the outcome of any legal proceedings or settlement discussions, and any novel legal issues presented. Because of such uncertainties, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to pending litigation. As of December 31, 2022 and 2021, the Company recorded a $ 0.1 million and a $ 1.1 million accrual, respectively, for liabilities related to legal matters, which is included under the caption “Accrued expenses” in its Consolidated Balance Sheets. +From time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +Self-insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance claims. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $ 1.2 million and $ 1.0 million at December 31, 2022 and 2021, respectively, and is included under the caption “Accrued expenses” on the Company’s Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Contingent Liabilities +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (“the Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) +F-25 +focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. The Frac Tech Purchase Agreement, as amended, includes, among other things, the potential for additional future payments, based on certain Frac Tech revenue metrics through December 31, 2025. +The Company’s contingent liability (Level 3) for the years ended December 31, 2022 and 2021 was as follows: +Frac Tech +(in thousands) +Balance at December 31, 2020 $ 604 +Payments ( 154 ) +Revaluation adjustments 460 +Balance at December 31, 2021 $ 910 +Payments ( 195 ) +Revaluation adjustments 454 +Balance at December 31, 2022 $ 1,169 +All contingent liabilities that relate to contingent consideration are reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include estimated gross margin related to forecasted sales of the plugs, term of the agreement, and a risk adjusted discount factor. Contingent liabilities include $ 0.4 million and $ 0.1 million reported in “Accrued expenses” at December 31, 2022 and 2021, respectively, and $ 0.8 million reported in “Other long-term liabilities” at both December 31, 2022 and 2021 in the Company’s Consolidated Balance Sheets. The impact of the revaluation adjustments is included in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +F-26 +13. Taxes +The components of the provision (benefit) for income taxes for the years ended December 31, 2022 and 2021 were as follows: +Year Ended December 31, +2022 2021 +(in thousands) +Current +U.S. federal $ — $ — +U.S. state 510 ( 56 ) +Foreign 36 31 +Total current provision (benefit) $ 546 $ ( 25 ) +Deferred +U.S. federal $ — $ — +U.S. state — — +Foreign — — +Total deferred provision (benefit) — — +Total provision (benefit) for income taxes $ 546 $ ( 25 ) +The provision (benefit) for income taxes for the years ended December 31, 2022 and 2021 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2022 2021 +(in thousands) +Tax provision (benefit) at statutory rate $ 3,137 $ ( 13,570 ) +Foreign rate differential ( 16 ) ( 41 ) +State income taxes, net of federal benefit 403 ( 44 ) +Nondeductible expenses 912 413 +Valuation allowance ( 5,823 ) 11,350 +Non-cash compensation 1,879 1,893 +Other 54 ( 26 ) +Total provision (benefit) for income taxes $ 546 $ ( 25 ) +F-27 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2022 and 2021 were as follows: +December 31, +2022 2021 +(in thousands) +Deferred income tax assets: +Inventories $ 2,298 $ 2,533 +Goodwill and intangible assets 75,617 83,318 +Deferred tax benefit from net losses 79,914 79,690 +Stock-based compensation and cash award expense 2,524 4,194 +Tax credit carryforwards 655 695 +Accrued expenses 678 1,632 +Interest carryover 13,860 6,824 +Lease liability 8,441 8,162 +Other 163 164 +Total deferred income tax assets 184,150 187,212 +Less: Valuation allowance ( 162,888 ) ( 170,747 ) +Net deferred income tax assets $ 21,262 $ 16,465 +Deferred income tax liabilities: +Property and equipment $ ( 12,974 ) $ ( 8,387 ) +ROU asset ( 8,288 ) ( 8,078 ) +Total deferred income tax liabilities ( 21,262 ) ( 16,465 ) +Net deferred income tax asset (liability) $ — $ — +As of December 31, 2022, the Company had federal and state net operating loss carryforwards (“NOLs”) of approximately $ 442.2 million. The federal NOLs related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state NOLs can be used from 7 to 20 years and vary by state. A small portion of state NOLs expired in 2022. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its NOL and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results, the Company continues to be in a three-year cumulative loss position for the year ended December 31, 2022. According to ASC 740, cumulative losses in recent years represent significant negative evidence in considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its U.S. domestic and Canadian deferred tax assets. The 2022 results include a decrease in the Company’s valuation allowance of approximately $ 7.9 million. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a tax benefit. +The Company is subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2019. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +F-28 +The Company accounts for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2022 +(in thousands) +Balance at January 1, $ 779 +Additional based on tax positions related to prior years — +Additional based on tax positions related to current year — +Reduction based on tax positions related to prior years — +Lapse of statute of limitations — +Balance at December 31, $ 779 +The total amount of unrecognized tax benefits at December 31, 2022 was $ 0.8 million. The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income and Comprehensive Income (Loss). As of December 31, 2022, no interest and penalties have been accrued. +14. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding during each period and the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as the potentially dilutive restricted stock, restricted stock units, and performance stock units. +Basic and diluted earnings (loss) per common share was computed as follows: +Year Ended December 31, 2022 +Net Income Average Shares Outstanding Earnings Per Share +(in thousands, except for share and per share amounts) +Basic $ 14,393 30,930,890 $ 0.47 +Unvested restricted stock and stock units — 1,320,508 — +Diluted $ 14,393 32,251,398 $ 0.45 +Year Ended December 31, 2021 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 64,575 ) 30,302,925 $ ( 2.13 ) +Unvested restricted stock and stock units — — — +Diluted $ ( 64,575 ) 30,302,925 $ ( 2.13 ) +The diluted earnings (loss) per share calculation excludes all stock options, unvested restricted stock, unvested restricted stock units, and unvested performance stock units for 2021 because there is a net loss for the period, and their inclusion would be anti-dilutive. The average number of securities that were excluded from diluted earnings (loss) per share that would potentially dilute earnings (loss) per share for the period in which the Company experienced a net loss was as follows: +2022 2021 +Year ended December 31, — 729,514 +F-29 +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.3 million and $ 0.9 million for the years ended December 31, 2022 and 2021, respectively. The Company also purchased $ 2.6 million of products and services for both the years ended December 31, 2022 and 2021 from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $ 0.1 million and $ 0.7 million at December 31, 2022 and 2021, respectively. +In addition, the Company currently leases office space in Corpus Christi, Texas and previously leased office space in Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was $ 1.6 million and $ 1.4 million for the years ended December 31, 2022 and 2021, respectively. There were net outstanding payables due to these entities of $ 0.1 million at December 31, 2022. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2022, there was no outstanding principal balance payable to Mr. Frazier, and the balance payable to Mr. Frazier was $ 1.1 million at December 31, 2021. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also served as a director of Select from November 2017 to November 2022. The Company was billed $ 1.5 million and $ 1.1 million for the years ended December 31, 2022 and 2021, respectively. There were outstanding payables due to Select of $ 0.1 million at both December 31, 2022 and 2021. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 0.8 million and $ 1.3 million for the years ended December 31, 2022 and 2021, respectively. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $ 5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $ 0.2 million and $ 0.5 million at December 31, 2022 and 2021, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 2.2 million and $ 3.2 million for the years ended December 31, 2022 and 2021, respectively. There were outstanding receivables due from Devon of $ 0.5 million and $ 0.4 million at December 31, 2022 and 2021, respectively. +16. Supplemental Information +Capital expenditures for years ended December 31, 2022 and 2021 were as follows: +Year Ended December 31, +2022 2021 +(in thousands) +Completion Solutions $ 32,162 $ 14,742 +Corporate 105 15 +$ 32,267 $ 14,757 +Total assets by segment as of December 31, 2022 and 2021 were as follows: +December 31, +2022 2021 +(in thousands) +Completion Solutions $ 399,546 $ 349,429 +Corporate 27,288 32,184 +$ 426,834 $ 381,613 +F-30 +Revenue by country for the years ended December 31, 2022 and 2021 were as follows: +Year Ended December 31, 2022 Year Ended December 31, 2021 +Amount Percentage Amount Percentage +(in thousands) (in thousands) +United States $ 591,614 99.7 % $ 347,445 99.4 % +Canada 1,768 0.3 % 1,974 0.6 % +$ 593,382 100.0 % $ 349,419 100.0 % +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2022 and 2021 were as follows: +December 31, +2022 2021 +(in thousands) +United States $ 189,962 $ 200,227 +Canada and other 1,700 2,139 +$ 191,662 $ 202,366 +F-31 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2022. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2022. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2022, our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2022. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting as we are an “emerging growth company” as defined under the JOBS Act. In addition, management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2022 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information +None. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +49 +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. +Item 11. Executive Compensation +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. +50 +PART IV +Item 15. Exhibit and Financial Statement Schedules +(a) Documents Filed as Part of This Annual Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this Annual Report: +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F- 2 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2022 and 2021 +F- 3 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2022 and 2021 +F- 4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2022 and 2021 +F- 5 +Notes to Consolidated Financial Statements +F- 7 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable, or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number Description +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +4.4 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.5 +Unit Agreement, dated as of January 30, 2023, by and among Nine Energy Service, Inc. and U.S. Bank Trust Company, National Association, as units trustee (including Form of Unit Certificate) (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on February 1, 2023). +4.6 +Indenture, dated as of January 30, 2023, by and among Nine Energy Service, Inc., the guarantors party thereto and U.S. Bank Trust Company, National Association, as trustee and as notes collateral agent (including Form of Note) (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on February 1, 2023). +4.7 +Description of Common Stock (Incorporated by reference to Exhibit 4.7 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 10, 2020). +51 +10.1 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +10.2 +First Amendment to Credit Agreement, dated as of January 17, 2023, among Nine Energy Service, Inc., Nine Energy Canada Inc., the guarantors party thereto, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 18, 2023). +10.3+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.4+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.5+ +First Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of the Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 6, 2021). +10.6+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.7+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.8+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.9+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.10+ +Form of Nine Energy Service, Inc. Performance Share Unit Grant Notice and Form of Performance Share Unit Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 8, 2019). +10.11+ +Form of Nine Energy Service, Inc. Cash Award Grant Notice and Form of Cash Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 5, 2022). +10.12+ +Form of Nine Energy Service, Inc. Performance-Based Cash Award Grant Notice and Form of Performance-Based Cash Award Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 4, 2022). +10.13+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.14+ +Employment Agreement between Guy Sirkes and Nine Energy Service, LLC, dated as of March 31, 2020 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.15+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.16+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.17+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.18+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and David Crombie (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +52 +10.19+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Guy Sirkes (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.20+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Theodore R. Moore (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +22.1* +List of Subsidiary Guarantors and Affiliates Whose Securities Collateralize Securities of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP. +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +101* Interactive Data Files. +___________________________________ +* Filed herewith. +** Furnished herewith. ++ Management contract or compensatory plan or arrangement. +53 +Item 16. Form 10-K Summary +None. +54 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: /s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 7, 2023 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 7, 2023. +Signature Title +/s/ Ann G. Fox President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Guy Sirkes Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Guy Sirkes +/s/ S. Brett Luz Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Ernie L. Danner Chairman of the Board +Ernie L. Danner +/s/ David C. Baldwin Director +David C. Baldwin +/s/ Mark E. Baldwin Director +Mark E. Baldwin +Director +Curtis F. Harrell +/s/ Scott E. Schwinger Director +Scott E. Schwinger +/s/ Gary L. Thomas Director +Gary L. Thomas +/s/ Andrew L. Waite Director +Andrew L. Waite +/s/ Darryl K. Willis Director +Darryl K. Willis +55 \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/filing_metadata.csv b/raw/filings/0001532286/2022/0001532286-23-000005/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..0773d9083c74ba60ce7378fd417acd0304129272 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2023-03-08,2022-12-31,2023-03-07T22:38:01.000Z,0001532286-23-000005,nine-20221231.htm,10-K,9532117,1,1,https://www.sec.gov/Archives/edgar/data/1532286/000153228623000005/nine-20221231.htm,https://www.sec.gov/Archives/edgar/data/1532286/000153228623000005/,2022,2022,1 diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/item1.txt b/raw/filings/0001532286/2022/0001532286-23-000005/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f433bda3eb787dad41adb93771d56703cf39762d --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/item1.txt @@ -0,0 +1,102 @@ +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2022, we completed approximately 18,100 cementing jobs, with an on-time rate of approximately 90%. Punctuality of service has become one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 90% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2022, we deployed approximately 377,100 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted and continue to convert our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line Wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2018 through December 2022, we completed approximately 140,700 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place), while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 24,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2022, we have performed approximately 5,890 jobs and deployed more than 160 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rockies, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2022, our top five customers collectively accounted for approximately 21% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, NexTier Oilfield Solutions, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2022, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2022, we had 1,212 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2022, we operated a fleet in excess of 550 commercial motor vehicles. As such, we are subject to a number of federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Material Regulations for interstate travel and comparable state regulations for intrastate travel. Substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and +9 +strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into federal and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In September 2015, the EPA and U.S. Army Corps of Engineers (“Corps”) issued a rule defining the scope of federal jurisdiction over wetlands and other waters of the U.S., which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in December 2019. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. The EPA is undergoing a two-phase rulemaking process to redefine the definition of waters of the U.S., which could be impacted by the U.S. Supreme Court’s upcoming decision in Sackett v. EPA, a case regarding the proper test in determining whether wetlands qualify as “Waters of the United States” or WOTUS. A final rule, known as “Rule 1,” was announced by the EPA and Corps in December 2022. The EPA and Corps are expected to propose a second rule, known as “Rule 2,” further refining Rule 1 by November 2023 and issue a final rule by July 2024. To the extent a future rule expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA did not address the 2020 Technical Rule. +On November 15, 2021, the EPA proposed a new rule intended to reduce methane emissions from oil and gas sources. The proposed rule would make the existing regulations in Subpart OOOOa more stringent and create a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). In addition, the proposed rule would establish “Emissions Guidelines,” creating a Subpart OOOOc that would require states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. Under the proposed rule, states would have three years to develop their compliance plan for existing sources, and the regulations for new sources would take effect immediately upon issuance of a final rule. On November 11, 2022, the EPA issued a proposed rule supplementing the November 2021 proposed rule. Among other things, the November 2022 supplemental proposed rule removed an emissions monitoring exemption for small wellhead-only sites and creates a new third-party monitoring program to flag large emissions events, referred to in the proposed rule as “super emitters.” The EPA is expected to issue a final rule by August 2023. +As a result of these regulatory changes, the scope of any final methane regulations or the costs for complying with +10 +federal methane regulations are uncertain. However, any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. Although the agreement did not create any binding obligations for nations to limit their GHG emissions, it did include pledges to voluntarily limit or reduce future emissions. On June 1, 2017, President Trump announced that the U.S. would withdraw from the Paris Agreement and completed the process of withdrawing from the Paris Agreement on November 4, 2020. However, on January 20, 2021, President Biden issued written notification to the United Nations of the United States’ intention to rejoin the Paris Agreement, which became effective on February 19, 2021. Pursuant to its obligations as a signatory to the Paris Agreement, the United States has set a target to reduce its GHG emissions by 50-52% by the year 2030 as compared with 2005 levels and has agreed to provide periodic updates on its progress. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. Since its formal launch at the United Nations Climate Change Conference (“COP26”), in Glasgow, at least 150 countries have joined the pledge. COP26 then concluded with the finalization of the Glasgow Climate Pact, which stated long-term global goals (including those in the Paris Agreement) to limit the increase in the global average temperature and emphasized reductions in GHG emissions. The impacts of these orders, pledges, agreements, and any legislation, regulation, regulatory initiatives, changes to existing regulation or executive actions promulgated to fulfill the United States’ commitments under the Paris Agreement, COP26, or other international conventions cannot be predicted at this time. +While the Biden Administration has pursued executive actions to address climate change, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and many states have already established regional GHG “cap-and-trade” programs, no new comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future. In addition, many state and local leaders have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at reducing GHG emissions by means of cap-and-trade programs, carbon taxes, or encouraging the use of renewable energy or alternative low-carbon fuels. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition and results of operations. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have +11 +significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Additionally, on March 21, 2022, the SEC issued a proposed rule regarding the enhancement and standardization of mandatory climate-related disclosures for investors. The proposed rule would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including, but not limited to, information about the registrant’s governance of climate-related risks and relevant risk management processes; climate-related risks that are reasonably likely to have a material impact on the registrant’s business, results of operations, or financial condition and their actual and likely climate-related impacts on the registrant’s business strategy, model, and outlook; climate-related targets, goals and transition plan (if any); certain climate-related financial statement metrics in a note to their audited financial statements; Scope 1 and Scope 2 GHG emissions; and Scope 3 GHG emissions and intensity, if material, or if the registrant has set a GHG emissions reduction target, goal or plan that includes Scope 3 GHG emissions. Although the proposed rule’s ultimate date of effectiveness and the final form and substance of these requirements is not yet known and the ultimate scope and impact on our business is uncertain, compliance with the proposed rule, if finalized, may result in increased legal, accounting and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place strain on our personnel, systems, and resources. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s Subpart OOOO regulations and proposed rules discussed above, other federal agencies have promulgated rules regulating methane. On November 30, 2022, the U.S. Bureau of Land Management (the “BLM”) proposed new regulations to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The proposed rule would require new and existing operators to submit waste minimization plans with all applications for permits to drill oil wells and includes a number of specific affirmative obligations that operators must take to avoid wasting oil or gas through venting, flaring, and leaks. The proposed rule has received over 3500 public comments, and the final rule may face challenges and legal scrutiny. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of +12 +high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. On July 16, 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. On October 6, 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule, which was finalized on April 20, 2022. The Phase 1 final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (the “ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In August 2019, the FWS and National Marine Fisheries Service issued three rules amending implementation of the ESA regulations revising, among other things, the process for listing species and designating critical habitat, which was challenged by a coalition of states and environmental groups. In addition, on December 18, 2020, the FWS amended its regulations governing critical habitat designations, which were also subject to litigation. In June and July 2022, the FWS issued final rules rescinding the regulations defining “habitat” and governing critical habitat exclusions. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. On January 7, 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The notice of proposed rulemaking is anticipated in March 2023 and is expected to be finalized by the end of 2023. Future implementation of the rules implementing the Endangered Species Act and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +13 \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/item13.txt b/raw/filings/0001532286/2022/0001532286-23-000005/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..0171d3ee182ae97ac6bf7db08bd7239e0cab3b00 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2023 annual meeting of stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/item9a.txt b/raw/filings/0001532286/2022/0001532286-23-000005/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb6b3ba8a851507235c3c65432e9ded199beb5f9 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/item9a.txt @@ -0,0 +1,11 @@ +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2022. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2022. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2022, our management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on its assessment using the COSO criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2022. +Attestation Report of the Independent Registered Public Accounting Firm +This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting as we are an “emerging growth company” as defined under the JOBS Act. In addition, management’s report on internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2022 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/rp_note.txt b/raw/filings/0001532286/2022/0001532286-23-000005/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e6c1e2079d225566c9743d239b42cff8283aac46 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/rp_note.txt @@ -0,0 +1,6 @@ +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.3 million and $ 0.9 million for the years ended December 31, 2022 and 2021, respectively. The Company also purchased $ 2.6 million of products and services for both the years ended December 31, 2022 and 2021 from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $ 0.1 million and $ 0.7 million at December 31, 2022 and 2021, respectively. +In addition, the Company currently leases office space in Corpus Christi, Texas and previously leased office space in Midland, Texas from an entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Company’s stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was $ 1.6 million and $ 1.4 million for the years ended December 31, 2022 and 2021, respectively. There were net outstanding payables due to these entities of $ 0.1 million at December 31, 2022. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2022, there was no outstanding principal balance payable to Mr. Frazier, and the balance payable to Mr. Frazier was $ 1.1 million at December 31, 2021. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). One of the Company’s directors also served as a director of Select from November 2017 to November 2022. The Company was billed $ 1.5 million and $ 1.1 million for the years ended December 31, 2022 and 2021, respectively. There were outstanding payables due to Select of $ 0.1 million at both December 31, 2022 and 2021. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 0.8 million and $ 1.3 million for the years ended December 31, 2022 and 2021, respectively. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $ 5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. Total outstanding receivables due to the Company from NESR (inclusive of the equipment sale above) were $ 0.2 million and $ 0.5 million at December 31, 2022 and 2021, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 2.2 million and $ 3.2 million for the years ended December 31, 2022 and 2021, respectively. There were outstanding receivables due from Devon of $ 0.5 million and $ 0.4 million at December 31, 2022 and 2021, respectively. \ No newline at end of file diff --git a/raw/filings/0001532286/2022/0001532286-23-000005/rpt_disclosure.txt b/raw/filings/0001532286/2022/0001532286-23-000005/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad8eb8de08d91cc58c31ae31090a9a527fa8e306 --- /dev/null +++ b/raw/filings/0001532286/2022/0001532286-23-000005/rpt_disclosure.txt @@ -0,0 +1,31 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Our Board adopted a written related person transactions policy prior to the completion of our IPO, under which a “Related Person +Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or +disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or +disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to +an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy would require that all Related Person Transactions required to be disclosed in +our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +The Company leases office space, yard +facilities, and equipment and purchases building maintenance and repair services from entities owned by Mr. Crombie, an executive officer of the Company. Total lease expense and building maintenance expense associated with these entities was +$1.3 million and $0.9 million for the years ended December 31, 2022 and 2021, respectively. The Company also purchased $2.6 million of products and services for both the years ended December 31, 2022 and 2021 from an entity +in which Mr. Crombie is a limited partner. There were outstanding payables due to this entity relating to equipment purchases of $0.1 million and $0.7 million at December 31, 2022 and 2021, respectively. +In addition, the Company currently leases office space in Corpus Christi, Texas and previously leased office space in Midland, Texas from an +entity affiliated with Warren Lynn Frazier, a beneficial owner of more than 5% of the Company’s common stock. In the third quarter of 2020, another entity affiliated with Mr. Frazier began to +sub-lease a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was +$1.6 million and $1.4 million for the years ended December 31, 2022 and 2021, respectively. There were net outstanding payables due to these entities of $0.1 million at December 31, 2022. Additionally, on June 30, 2020, +the Company issued the promissory notes to Mr. Frazier and the other sellers of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd., which the Company acquired in October 2018. At December 31, +2022, there was no outstanding principal balance payable to Mr. Frazier, and the balance payable to Mr. Frazier was $1.1 million at December 31, 2021. +The Company purchases chemical additives used in cementing from Select Energy Services, Inc. (“Select”). SCF, a beneficial owner of +more than 5% of the Company’s common stock, owns more than 10% of the common stock of Select as of December 2022. In addition, Mr. David Baldwin, a director of the Company, served as a director of Select from November 2017 to November +2022. The Company was billed $1.5 million and $1.1 million for chemicals during the years ended December 31, 2022 and 2021, respectively. There were outstanding payables due to Select of $0.1 million at both December 31, +2022 and 2021. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”). Mr. Waite, a director +of the Company, has served as a director of NESR since May 2018. The Company billed NESR $0.8 million and $1.3 million for products and rentals during the years ended December 31, 2022 and 2021, respectively. During the fourth quarter +of 2019, the Company sold coiled tubing equipment for $5.9 million to NESR with payments due in 24 monthly equal installments beginning on January 31, 2020. The outstanding receivables due to the Company from NESR (inclusive of the +equipment sales above) were $0.2 million and $0.5 million at December 31, 2022 and 2021, respectively. +The Company +generated revenue from Devon Energy Corporation (“Devon”) of $2.2 million and $3.2 million for the years ended December 31, 2022 and 2021, respectively. Ms. Fox, a director and executive officer of the Company, has +served as a director of Devon since June 2019. There were outstanding receivables due from Devon of $0.5 million and $0.4 million at December 31, 2022 and 2021, respectively. +44 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/filing.txt b/raw/filings/0001532286/2023/0001532286-24-000004/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..475c564b7a089662c890aa0a016608a85157c2ac --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/filing.txt @@ -0,0 +1,1720 @@ +nine-20231231 +false 2023 FY 0001532286 P1Y P1Y 0001532286 2023-01-01 2023-12-31 0001532286 2023-06-30 iso4217:USD 0001532286 2024-03-04 xbrli:shares 0001532286 2023-12-31 0001532286 2022-12-31 iso4217:USD xbrli:shares 0001532286 us-gaap:ServiceMember 2023-01-01 2023-12-31 0001532286 us-gaap:ServiceMember 2022-01-01 2022-12-31 0001532286 us-gaap:ProductMember 2023-01-01 2023-12-31 0001532286 us-gaap:ProductMember 2022-01-01 2022-12-31 0001532286 2022-01-01 2022-12-31 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0001532286 country:CA 2022-12-31 0001532286 nine:ATMProgramMember nine:AgentMember 2023-11-06 2023-11-06 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +WASHINGTON, D.C. 20549 +______________________________________________________________________________________ +FORM 10-K +_____________________________________________________________________________________ +(Mark One) +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED DECEMBER 31 , 2023 +OR +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE TRANSITION PERIOD FROM TO +Commission File Number: 001-38347 +_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware 80-0759121 +(State or other jurisdiction of +incorporation or organization) (I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston , TX 77019 +(Address of principal executive offices) +( 281 ) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, par value $0.01 per share NINE New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer ☒ +Non-accelerated filer o Smaller reporting company ☒ +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. x +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 30, 2023) was $ 92,875,087 . +The number of shares of the registrant’s common stock outstanding at March 4, 2024 was 35,324,861 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant’s Definitive Proxy Statement for its 2024 Annual Meeting of Stockholders. +TABLE OF CONTENTS +PART I +Item 1. +Business +4 +Item 1A. +Risk Factors +15 +Item 1B. +Unresolved Staff Comments +33 +Item 1C. +Cybersecurity +33 +Item 2. +Properties +34 +Item 3. +Legal Proceedings +34 +Item 4. +Mine Safety Disclosures +34 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +35 +Item 6. +[Reserved] +35 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +36 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +49 +Item 8. +Financial Statements and Supplementary Data +49 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +51 +Item 9A. +Controls and Procedures +51 +Item 9B. +Other Information +51 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +51 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +52 +Item 11. +Executive Compensation +52 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +52 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +52 +Item 14. +Principal Accountant Fees and Services +52 +PART IV +Item 15. +Exhibit and Financial Statement Schedules +53 +Item 16. +Form 10-K Summary +56 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +SUMMARY OF PRINCIPAL RISK FACTORS +Our business is subject to a number of risks and uncertainties. The following is a summary of the principal risk factors that could materially adversely affect our business, financial condition, and results of operations. A more complete statement of those risks and uncertainties is set forth in “Risk Factors” in Item 1A of Part I of this Annual Report. +• Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile and strongly influenced by current and expected oil and natural gas prices. If the prices of oil and natural gas decline, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. Significant factors that are likely to affect near-term commodity prices include actions by the members of the Organization of the Petroleum Exporting Countries (“OPEC”) and other oil exporting nations; U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world; and geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war, and terrorism, particularly in Russia, Ukraine, and the Middle East. +• Inflation may adversely affect our financial position and operating results; in particular, cost inflation with labor or materials could offset any price increases for our products and services. +• If we are unable to attract and retain key employees, technical personnel, and other skilled and qualified workers, our business, financial condition, or results of operations could suffer. +• We may be unable to maintain existing prices or implement price increases on our products and services, and intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +• Our substantial debt obligations could have significant adverse consequences on our business and future prospects, and restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +• Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +• Our operations are subject to conditions inherent in the oilfield services industry, such as equipment defects, liabilities arising from accidents or damage involving our fleet of trucks or other equipment, explosions and uncontrollable flows of gas or well fluids, and loss of well control. +• If we are unable to accurately predict customer demand, including that of our international customers, or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +• We are dependent on customers in a single industry. The loss of one or more significant customers, including certain of our customers outside of the U.S., could adversely affect our financial condition, prospects, and results of operations. Sales to customers outside of the U.S. also exposes us to risks inherent in doing business internationally, including political, social, and economic instability and disruptions, export controls, economic sanctions, embargoes or trade restrictions, and fluctuations in foreign currency exchange rates. +• We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +• We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +• Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +• Our success may be affected by our ability to implement new technologies and services. +• If our systems for protecting against cybersecurity risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cybersecurity attacks. +2 +• Our future financial condition and results of operations could be adversely impacted by asset impairment charges. +• Increased scrutiny of sustainability matters could have an adverse effect on our business and damage our reputation. +• Increased attention to climate change and conservation measures may reduce oil and natural gas demand, and we face various risks associated with increased activism and related litigation against oil and natural gas exploration and development activities. +• Seasonal and adverse weather conditions adversely affect demand for our products and services. +3 +PART I +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2023, we completed approximately 22,000 cementing jobs, with an on-time rate of approximately 89%. Punctuality of service is one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. Our tool portfolio also includes a multi-cycle barrier valve to address the international, conventional markets. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2023, we deployed approximately 470,600 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted several of our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2018 through December 2023, we completed approximately 163,600 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place) while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 27,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2023, we have performed approximately 7,100 jobs and deployed more than 191 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rocky Mountains, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2023, our top five customers collectively accounted for approximately 21% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, Patterson-UTI Energy, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2023, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2023, we had 1,157 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations as well as Canada’s new anti-forced labor law. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2023, we operated a fleet in excess of 590 commercial motor vehicles. As such, we are subject to regulation as a motor carrier by the U.S. Department of Transportation (the “DOT”) and analogous state agencies and their applicable federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Materials Regulations for interstate travel promulgated by the FMCSA under the DOT and comparable state regulations for intrastate travel. These regulatory authorities exercise broad powers, governing activities such as the authorization to engage in motor carrier operations, regulatory safety, equipment testing, driver requirements and specifications, and insurance requirements. In connection with these rules, substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States (“WOTUS”) and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers (the “Corps”) or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In 2015, the EPA and the Corps issued a rule defining the scope of federal jurisdiction over WOTUS, which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in 2020. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. In January 2023, the EPA and the Corps issued a final rule that based the definition of WOTUS on the pre-2015 definition. Separately, in May 2023, the U.S. Supreme Court’s decision in Sackett v. EPA narrowed federal jurisdiction over wetlands to “traditional navigable waters” and wetlands or other waters that have a “continuous surface connection” with, or are otherwise indistinguishable from, traditional navigable waters. In September 2023, the EPA and the Corps published a direct-to-final rule that conforms the regulatory definition of WOTUS to the Supreme Court’s May 2023 decision in Sackett . However, litigation opposing the September 2023 final rule remains ongoing and substantial uncertainty exists with respect to future implementation of the September 2023 rule and the scope of the Clean Water Act’s jurisdiction more generally. To the extent a future rule or court decision expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA resolution did not address the 2020 Technical Rule. +In December 2023, the EPA issued a final rule, under the CAA’s New Source Performance Standards, intended to reduce methane emissions from new and existing oil and gas sources. The new rule makes the existing regulations in Subpart OOOOa more stringent and creates a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources that commenced construction, modification, or reconstruction after December 6, 2022, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). The new rule phases out flaring through Subpart OOOOb, which prohibits routine flaring from new oil wells after the phase-in period, and through a new Subpart OOOOc, which prohibits flaring absent a showing of technical infeasibility for existing wells with documented methane emissions of 40 tons per year or +10 +more. In addition, the final rule establishes “Emissions Guidelines” in Subpart OOOOc, which requires states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. The final rule gives states, along with federal tribes that wish to regulate existing sources, two years to develop and submit their plans for reducing methane emissions from existing sources. The final emissions guidelines under Subpart OOOOc provide three years from the plan submission deadline for existing sources (i.e., sources constructed prior to December 6, 2022) to comply. +Although there may be an adverse financial impact (including compliance costs, potential permitting delays and increased regulatory requirements) associated with these regulatory changes, the extent and magnitude of impacts cannot be reliably or accurately estimated due to the present uncertainty regarding any additional measures and how they will be implemented. Any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. In February 2021, the United States rejoined the Paris Agreement and announced that it was setting a target to reduce U.S. GHG emissions by 50-52% by the year 2030 as compared with 2005 levels and agreed to provide periodic updates on its progress. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. Since its formal launch at the United Nations 26th Conference of the Parties, over 150 countries have joined the pledge. At the 27th Conference of the Parties, President Biden announced the EPA’s supplemental proposed rule to reduce methane emissions from existing oil and gas sources and agreed, in conjunction with the European Union and a number of other partner countries, to develop standards for monitoring and reporting methane emissions to help create a market for low methane-intensity natural gas. At the 28th Conference of the Parties, member countries agreed to the first “global stocktake,” which calls on countries to contribute to global efforts, including a tripling of renewable energy capacity and doubling energy efficiency improvements by 2030, accelerating efforts toward the phase-down of unabated coal power, phasing out inefficient fossil fuel subsidies, and transitioning away from fossil fuels in energy systems. The impacts of these orders, pledges, agreements, and any legislation, regulation, regulatory initiatives, changes to existing regulation or executive actions cannot be predicted at this time. +While the Biden Administration has pursued executive actions to address climate change, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, but no new comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future, and energy legislation and other regulatory initiatives have been proposed that are relevant to GHG emissions issues. For example, the Inflation Reduction Act of 2022, which appropriates significant funding for renewable energy initiatives and, for the first time, imposes a fee on GHG emissions from certain oil and gas facilities, was signed into law in August 2022. The Inflation Reduction Act amends the CAA to include a Methane Emissions and Waste Reduction Incentive Program, which requires the EPA to impose a “waste emissions charge” on certain natural gas and oil sources that are already required to report under the EPA’s Greenhouse Gas Reporting Program. To implement the program, the Inflation Reduction Act requires revisions to GHG reporting regulations for +11 +petroleum and natural gas systems (Subpart W) by 2024. In July 2023, the EPA proposed to expand the scope of the Greenhouse Gas Reporting Program for petroleum and natural gas facilities, as required by the Inflation Reduction Act. Among other things, the proposed rule would expand the emissions events that are subject to reporting requirements to include “other large release events” and apply reporting requirements to certain new sources and sectors. The rule is expected to be finalized in the spring of 2024 and become effective on January 1, 2025, in advance of the deadline for GHG reporting for 2024 (March 2025). In January 2024, the EPA proposed a rule implementing the Inflation Reduction Act’s methane emissions charge. The proposed rule includes potential methodologies for calculating the amount by which a facility’s reported methane emissions are below or exceed the waste emissions thresholds and contemplates approaches for implementing certain exemptions created by the Inflation Reduction Act. The methane emissions charge imposed under the Methane Emissions and Waste Reduction Incentive Program for 2024 would be $900 per ton emitted over annual methane emissions thresholds and would increase to $1,200 in 2025 and $1,500 in 2026. The emissions fee and funding provisions of the law could increase operating costs within the oil and gas industry and accelerate the transition away from fossil fuels, which could in turn adversely affect our and our customers’ business and results of operations. In addition, many U.S. state and local governments have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at tracking and reducing GHG emissions by means of carbon taxes, policies or incentives to encourage the use of renewable energy or alternative low-carbon fuels, the development of GHG inventories, and cap-and-trade programs that typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting GHGs. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Regulations requiring the disclosure of GHG emissions, and other climate-related information or information substantiating climate-related claims, are also increasingly being adopted or proposed at the federal and state level. For example, the SEC issued a proposed rule in March 2022 regarding the enhancement and standardization of mandatory climate-related disclosures for investors. The proposed rule would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including, but not limited to, information about the registrant’s governance of climate-related risks and relevant risk management processes; climate-related risks that are reasonably likely to have a material impact on the registrant’s business, results of operations, or financial condition and their actual and likely climate-related impacts on the registrant’s business strategy, model, and outlook; climate-related targets, goals and transition plan (if any); certain climate-related financial statement metrics in a note to their audited financial statements; Scope 1 and Scope 2 GHG emissions; and Scope 3 GHG emissions and intensity, if material, or if the registrant has set a GHG emissions reduction target, goal or plan that includes Scope 3 GHG emissions. Although the proposed rule’s ultimate date of effectiveness and the final form and substance of these requirements is not yet known and the ultimate scope and impact on our business is uncertain, compliance with the proposed rule, if finalized, may result in increased legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place strain on our personnel, systems, and resources. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s new Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. In November 2022, the U.S. Bureau of Land Management (the “BLM”) proposed new regulations to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The proposed rule +12 +would require new and existing operators to submit waste minimization plans with all applications for permits to drill oil wells and includes a number of specific affirmative obligations that operators must take to avoid wasting oil or gas through venting, flaring, and leaks. A final rule was expected by January 2024 but has not been issued to date, and such final rule, once published, may face challenges and legal scrutiny. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have also implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. In July 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. In October 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule, which was finalized in April 2022. The Phase 1 final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. In July 2023, the Council on Environmental Quality proposed a Phase 2 rule that would accelerate NEPA reviews while maintaining consideration of relevant environmental, climate change, +13 +and environmental justice effects. The final rule is expected in April 2024. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. In January 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The notice of proposed rulemaking was anticipated in November 2023, with final action expected in April 2024, but the FWS instead announced in November 2023 that it had received additional technical comments that need further review. As a result, future amendments to the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +14 +Item 1A. Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• the level of prices, and expectations about future prices, for oil and natural gas; +• the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• the level of global and domestic oil and natural gas production; +• the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• the cost of exploring for, developing, producing, and delivering oil and natural gas; +• available pipeline, storage, and other transportation capacity; +• worldwide political, military, and economic conditions; +• lead times associated with acquiring equipment and products and availability of qualified personnel; +• the discovery rates of new oil and natural gas reserves; +• federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• economic and political conditions in oil and natural gas producing countries; +• actions of OPEC, its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a GHG; +• the price and availability of alternative fuels and energy sources; +• global weather conditions and natural disasters, including those related to the physical effects of climate change; and +• uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +15 +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies, which are strongly influenced by current and expected oil and natural gas prices. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the five years ending December 31, 2023, the posted price for West Texas Intermediate (“WTI”) oil has ranged from a low of $(36.98) per barrel in April 2020 to a high of $123.64 per barrel in March 2022, and the Henry Hub spot market price of gas has ranged from a low of $1.33 per MMBtu in September 2020 to a high of $23.86 per MMBtu in February 2021. Moreover, the theme of capital discipline for E&P operators in the energy industry has led to a disconnect between commodity prices and market activity. The average WTI price for 2023 was $77.58, an increase of 36% over the average WTI price in 2019; however, the average rig count decreased by 27% over that same period. If prices of oil and natural gas decline or our customers do not increase capex and activity levels, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +Significant factors that are likely to affect near-term commodity prices include actions of members of OPEC and other oil exporting nations, including Russia, relating to oil export prices and production levels; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Industry Trends and Outlook” in Item 7 of Part II of this Annual Report. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. Even with supportive oil and natural gas prices, E&P operator activity may not materially increase, as they remain focused on operating within their capital plans. Moreover, any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, or expectations of such a drop or of prolonged weak oil and natural gas commodity price environments, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry, and inflation may adversely affect our financial position and operating results. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +Inflationary factors, such as increases in the labor costs, material costs, and overhead costs, may also adversely affect our financial position and operating results. Like others in our industry, we faced, and we continue to face, cost inflation with both labor and materials, which could offset any price increases for our products and services. +Increased attention to climate change and conservation measures may expose us to climate-related transition risks, including evolving climate change legislation, fuel conservation measures, technological advances, and negative shift in market perception towards the oil and natural gas industry, which could result in reduced demand for oil and natural gas. +Increased attention to climate change from governmental and regulatory bodies, investors, consumers, industry and other stakeholders, changes in consumer behavior and related demand for alternatives to oil and natural gas, societal expectations on companies to address climate change, preferences and attitudes with respect to the generation and consumption of energy, the use of hydrocarbons, and the use of products manufactured with, or powered by, hydrocarbons, may result in the +16 +enactment of climate change-related regulations, policies and initiatives (at the government, regulator, corporate and/or investor community levels), including alternative energy requirements, new fuel consumption standards, energy conservation and emissions reductions measures and responsible energy development, technological advances with respect to the generation, transmission, storage and consumption of energy, and increased availability and competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels). These developments could reduce demand for oil and natural gas and therefore our products and services, which would lead to a reduction in our revenues and have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +In addition, the enactment of climate change-related regulations, policies, and initiatives (at the government, corporate and/or investor community levels) may in the future result in increases in our compliance costs and other operating costs and have other adverse effects (e.g., greater potential for governmental investigations or litigation). For further discussion regarding the risks posed to us by climate change-related regulations, policies, and initiatives and by negative public perception of the oil and gas industry, see the discussions below in “Negative public perception of the oil and gas industry could adversely affect our operations and our ability raise debt and equity capital” and “Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition.” +Negative public perception of the oil and gas industry could adversely affect our operations and our ability to raise debt and equity capital. +Opposition toward the oil and natural gas industry has been growing globally and is particularly pronounced in the United States. Companies in the oil and natural gas industry are often the target of activist efforts from both individuals and non-governmental organizations or subject to pressure from other stakeholders regarding safety, human rights, climate change and other environmental matters, sustainability, and business practices. Anti-development activists are working to, among other things, reduce access to federal and state government lands and delay or cancel certain operations such as drilling and development. Any such activism against oil and natural gas exploration and development may cause operational delays or restrictions, increased operating costs, additional regulatory burdens, and increased risk of litigation. +In addition, some parties have initiated public nuisance claims under federal or state common law against certain companies involved in the production of oil and natural gas, or claims alleging that the companies have been aware of the adverse effects of climate change for some time but failed to adequately disclose such impacts to their investors or customers. Although our business is not a party to any such litigation, we could be named in actions making similar allegations, which could lead to costs and materially impact our financial condition in an adverse way. +Negative perceptions regarding our industry and reputational risks may also in the future adversely affect our ability to successfully carry out our business strategy by adversely affecting our access to capital. Certain segments of the investor community have developed negative sentiment towards investing in our industry. Parties concerned about the potential effects of climate change have directed their attention at sources of financing for energy companies, including by promoting divestment of fossil fuel equities and pressuring lenders to limit funding and insurance underwriters to limit coverage to companies engaged in the extraction of fossil fuel reserves, which has resulted in certain financial institutions, funds, and other capital providers restricting or eliminating their investment in oil and natural gas activities. In addition, some investors, including investment advisors and certain sovereign wealth funds, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Further, certain investment banks and asset managers based both domestically and internationally have announced that they are adopting climate change guidelines for their banking and investing activities. Certain other stakeholders have also pressured commercial and investment banks to stop financing oil and gas production and related infrastructure projects. Institutional lenders who provide financing to energy companies have also become more attentive to sustainable lending practices, and some may elect not to provide traditional energy producers or companies that support such producers with funding. Such developments, including environmental activism, investment policies and initiatives, and related litigation aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. These developments may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +Increased scrutiny of sustainability matters could have an adverse effect on our business and damage our reputation. +In recent years, companies across all industries are facing increasing scrutiny from a variety of stakeholders, including investor advocacy groups, proxy advisory firms, certain institutional investors and lenders, investment funds and other influential investors and rating agencies, related to their environmental, social and governance (“ESG”) and sustainability practices. If we do not adapt to or comply with investor or other stakeholder expectations and standards on ESG matters (or +17 +meet sustainability goals and targets that we have set) as they continue to evolve, or if we are perceived to have not responded appropriately or quickly enough to growing concern for ESG and sustainability issues, regardless of whether there is a regulatory or legal requirement to do so, we may suffer from reputational damage and our business, financial condition and/or stock price could be materially and adversely affected. +In addition, organizations that provide information to investors on corporate governance and related matters have developed ratings processes for evaluating companies on their approach to ESG matters. Such ratings are used by some investors to inform their investment and voting decisions. Unfavorable ESG ratings could lead to increased negative investor sentiment toward us and our industry and to the diversion of investment to other industries, which could have a negative impact on our stock price and our access to and costs of capital. +Risks Related to Our Indebtedness +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +At December 31, 2023, we had $300.0 million of 13.000% Senior Secured Notes due 2028 (the “2028 Notes”) outstanding, and we had $57.0 million of borrowings under the ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) outstanding. Subject to the restrictions in the ABL Credit Agreement (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) and the indenture governing the 2028 Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our current or future level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +• limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or less restrictive terms governing their indebtedness; and +• making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +Additionally, borrowings under the ABL Credit Facility bear interest at variable rates exposing us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remains the same, and our net income and cash available to finance our operations and other business activities would decrease. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. In addition, any debt restructuring transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. The terms of existing or future debt instruments may restrict us from adopting some of these +18 +alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +The ABL Credit Facility and the indenture governing our 2028 Notes have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• incur additional indebtedness and guarantee indebtedness; +• pay dividends or make other distributions or repurchase or redeem our capital stock; +• transfer or sell assets; +• make loans and investments; +• incur liens; +• enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• consolidate, merge, or sell all or substantially all of our assets; +• prepay, redeem, or repurchase certain debt; +• issue certain preferred stock or similar equity securities; +• make certain acquisitions and investments; +• engage in transactions with affiliates; and +• create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Competition and Market Risks +We may be unable to maintain existing prices or implement price increases on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, +19 +and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The completion services industry is intensely competitive. We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. +We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. Furthermore, our industry has generally experienced price erosion for new technologies as additional competing products enter the market. We are continuing to work on reducing manufacturing costs of our products, as well as introducing new and differentiated technology to improve profitability; however, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products decline further or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion services may adversely affect our business, financial condition, and results of operations. +20 +Operational Risks +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• equipment defects; +• liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• explosions and uncontrollable flows of gas or well fluids; +• unusual or unexpected geological formations or pressures and industrial accidents; +• blowouts; +• fires; +• cratering; +• loss of well control; +• collapse of the borehole; and +• damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our services could become a source of spills or release of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose substantial revenue. In addition, any litigation or claim, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public, which could cause us to lose customers and substantial revenue, make it more difficult for us to compete effectively, or obtain adequate insurance in the future. +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2023 and 2022, we spent approximately $12.6 million and $13.6 million, respectively, on capital expenditures related to maintenance. Our equipment typically does not generate revenue while it is undergoing maintenance, upgrades, or refurbishment. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. In addition, although such projects may require material capital expenditures, there is no assurance that they will generate a positive return. +21 +Seasonal and adverse weather conditions and the physical risks arising from climate change may have a negative impact on our business and result of operations, including by impacting operations, increasing costs, and adversely affecting demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. In addition, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, extreme temperatures, and other climatic events. If any such effects were to occur, they could adversely affect or delay demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services; cause us to incur significant costs in preparing for or responding to the effects of climatic events themselves, which may not be fully insured; adversely impact our or our customers’ operations, workforce, supply chain or distribution chain; or potentially lead to increased costs for insurance coverages in the aftermath of such effects. Our ability to mitigate the adverse physical impacts of climate change depends in part upon our disaster preparedness and response and business continuity planning. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For both the years ended December 31, 2023 and 2022, we generated approximately 0.3% of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Risks Related to Our Customers and Suppliers +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase inventory obsolescence, and restrict our ability to fund our operations. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our +22 +customers’ spending for our products and services. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2023, our five largest customers collectively accounted for approximately 21% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Certain of our product lines are subject to the risk of supplier concentration, and certain of our product lines are subject to exclusive distribution arrangements, which we may not be able to maintain. +Certain of the product lines depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +In addition, we have arrangements with certain technology companies and manufacturers that give us exclusive distribution rights to certain product offerings. In some cases, we are, or may in the future will be, required to meet certain minimum volume or other requirements in order to retain our arrangement. If any of these companies or manufacturers terminate our right to sell some or all of their products, modify or terminate our exclusive distribution arrangement, or change the applicable terms and conditions of sale, our business and results of operations could be adversely affected. +Regulatory, Compliance, and Legal Risks +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects, and results of operations. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in +23 +the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act (“FLSA”), in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation, and the results or costs of any such cases may have an adverse effect on our business, operating results, and financial condition. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. Over the past several years, parts of the country have experienced extreme drought conditions. As a result of these conditions, some rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, GHGs, air pollution, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills of hazardous materials onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +24 +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the oversight of the EPA, the DOT, the U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution or to protect against the effects of ionizing radiation. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards (the “Tier 4” standards). The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For more information on existing regulations and regulatory initiatives relating to hydraulic fracturing, see “Regulatory Matters – Hydraulic Fracturing” in Item 1 of Part I of this Annual Report. +If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to GHG emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns (e.g., numerous cities, including San Francisco, CA, and Seattle, WA, have banned the use of natural gas in new construction, and other cities, including New York, NY, are considering similar initiatives). Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of GHGs in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Additionally, regulations requiring the disclosure of GHG emissions and other climate-related information are increasingly being adopted or proposed at the federal and state level. For example, the SEC issued a proposed rule in March +25 +2022 that would mandate extensive disclosure of climate-related data, risks, and opportunities, including financial impacts, physical and transition risks, related governance and strategy, and GHG emissions, for certain public companies. We cannot predict the costs of implementation or any potential adverse impacts resulting from the rulemaking. However, to the extent this rulemaking is finalized as proposed, we could incur increased costs relating to the assessment and disclosure of climate-related risks. We may also face increased litigation risks related to disclosures made pursuant to the rule if finalized as proposed. In addition, enhanced climate disclosure requirements could accelerate the trend of certain stakeholders and lenders restricting or seeking more stringent conditions with respect to their investments in certain carbon-intensive sectors. See “Business – Regulatory Matters – Climate Change” for more information on existing and proposed climate change regulation. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The U.S. Foreign Corrupt Practices Act (the “FCPA”), the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. We operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +26 +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in December 2016, the DOT finalized minimum training standards for new drivers seeking a commercial driver’s license; in December 2017, the FMCSA mandated electronic logging devices in all interstate commercial trucks; and in June 2020, the FMCSA revised its Hours-of-Service Rule to modify break requirements for drivers and the number of hours they may drive in adverse conditions. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and GHG emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +Risks Related to Technology +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot ensure that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. Additionally, we cannot ensure that our intellectual property rights will deter or prevent competitors from creating similar purpose products for our customers. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently-developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution or litigation proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution or litigation proceedings, a third-party defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution or litigation proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. For example, in April 2020, a third party filed a lawsuit asserting that our BreakThru Casing Flotation Device TM infringed its intellectual property rights, and in January 2022, a jury in the Western District of Texas, Waco Division, found in the third party’s favor. However, we intend to appeal the jury’s verdict. We may not prevail in such appeal or in any other proceedings relating to intellectual property rights, and our intellectual property rights may be found +27 +invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or otherwise violate the intellectual property rights of others, in which case we may be required to pay damages or other compensation to the other party (which could be costly) and/or cease use of such intellectual property. Also, as a part of resolving such disputes, we may enter into licenses, cross-licenses or other agreements, which could reduce the value of our existing intellectual property rights. The results or costs of any such dispute resolution or litigation proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution or litigation proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our business, regardless of its outcome. +Our success may be affected by our ability to implement new technologies and services. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +Our long-term success depends, in part, on our ability to effectively address changing customer demands, as well as government regulation and required disclosure regarding ESG. These demands and regulations include, but are not limited to, the creation of ESG-related policies and procedures, the quantification of our greenhouse gas emissions and evaluation of risk and opportunities. These customer preferences and government requirements could cause us to continue to adapt our equipment and technology offerings, as well as increase internal costs to address changes in ESG requirements. If ESG-related requirements change faster than anticipated or in a manner we do not anticipate, demand for our services could be adversely affected. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be affected. +We rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our products and services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide such products and services to our customers. Although we believe other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense, delay, and potential changes to certain product components. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result of termination of our manufacturing relationships or patent infringement claims, could have a material adverse effect on our financial condition, business, and results of operations. +Our operations are subject to cybersecurity risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cybersecurity risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cybersecurity attacks. These risks could have a material adverse effect on our business, financial condition, and results of operations and could lead to litigation or regulatory action against us. +28 +Risks Related to Certain Significant Stockholders +Significant ownership of our common stock by certain stockholders could adversely affect our other stockholders. +SCF VII, L.P. and SCF-VII(A), L.P. (collectively, “SCF”) owned approximately 26% of our outstanding common stock as of December 31, 2023. In addition, certain of our directors are currently employed by SCF. Consequently, SCF is able to strongly influence all matters that require approval by our stockholders, including the election and removal of directors, changes to our organizational documents, and approval of acquisition offers and other significant corporate transactions. In addition, another one of our stockholders beneficially owned approximately 8% of our outstanding common stock as of December 31, 2023. This concentration of ownership by a small group of stockholders will limit other stockholders’ ability to influence corporate matters, and as a result, actions may be taken that other stockholders may not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their shares of our common stock. This concentration of stock ownership may also adversely affect the trading price of our common stock to the extent investors perceive a disadvantage in owning stock of a company with significant stockholders. +A significant reduction by SCF of its ownership interests in us could adversely affect us. +We believe that SCF’s substantial ownership interest in us provides them with an economic incentive to assist us to be successful. SCF is not subject to any obligation to maintain its ownership interest in us and may elect at any time to sell all or a substantial portion of or otherwise reduce its ownership interest in us. If SCF sells all or a substantial portion of its ownership interest in us, it may have less incentive to assist in our success and its affiliates that serve as members of our board of directors may resign. Such actions could adversely affect our ability to successfully implement our business strategies, which could adversely affect our cash flows or results of operations. +Certain of our directors may have conflicts of interest because they are also affiliates of SCF. The resolution of these conflicts of interest may not be in our or other stockholders’ best interests. +Andrew L. Waite, one of our directors, is currently an officer of SCF’s ultimate general partner. In addition, Mr. Waite is a director of National Energy Reunited Corp., a corporation in which SCF owns an approximate 9% equity interest as of December 31, 2023. These positions may conflict with such individuals’ duties as one of our directors regarding business dealings and other matters between SCF and us. The resolution of these conflicts may not always be in our or our other stockholders’ best interest. +SCF and its affiliates are not limited in their ability to compete with us, and the corporate opportunity provisions in our charter could enable SCF to benefit from corporate opportunities that may otherwise be available to us. +SCF and its affiliates have investments in other oilfield service companies that may compete with us, and SCF and its affiliates may invest in such other companies in the future. SCF, its other affiliates, and its other portfolio companies are referred to herein as the “SCF Group.” Conflicts of interest could arise in the future between us, on the one hand, and the SCF Group, on the other hand, concerning among other things, potential competitive business activities or business opportunities. +Our charter provides that, to the fullest extent permitted by applicable law, we renounce any interest or expectancy in any business opportunity that involves any aspect of the energy equipment or services business or industry and that may be from time to time presented to SCF or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Our charter further provides that no such person or party shall be liable to us by reason of the fact that such person pursues any such business opportunity or fails to offer any such business opportunity to us. As a result, any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity may become aware, from time to time, of certain business opportunities, such as acquisition opportunities, and may direct such opportunities to other businesses in which they have invested, in which case we may not become aware of or otherwise have the ability to pursue such opportunity. Further, such businesses may choose to compete with us for these opportunities. As a result, by renouncing our interest and expectancy in any business opportunity that may be from time to time presented to any member of an SCF Group entity or any of our directors or officers who is also an employee, partner, member, manager, officer, or director of any SCF Group entity, our business or prospects could be adversely affected if attractive business opportunities are procured by such parties for their own benefit rather than for ours. Our charter provides that any amendment to or adoption of any provision inconsistent with our charter’s provisions governing the renouncement of business opportunities must be approved by the holders of at least 80% of the voting power of the outstanding stock of the corporation entitled to vote thereon. Any actual or perceived conflicts of interest with respect to the foregoing could have an +29 +adverse impact on the trading price of our common stock. +Risks Related to Human Capital +Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work, and our success depends, in large part, upon our ability to employ and retain key employees, technical personnel, and other skilled and qualified workers. To attract and retain qualified employees, we must compensate them at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our liquidity and competitive position, our business, financial condition, or results of operations could suffer. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. There has been a reduction of the available skilled labor force to service the energy industry. To the extent that there is an increase in demand for our products or services, there is no assurance that the availability of skilled labor will improve. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +Other Material Risks +We do not intend to pay dividends on our common stock, and our debt agreements place restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on his investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt agreements place restrictions on our ability to pay cash dividends. Consequently, currently, a stockholder’s only opportunity to achieve a return on his investment in us will be by selling his common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased his shares of our common stock. +The market price of our common stock could be adversely affected by, and our stockholders may experience dilution as a result of, sales of substantial amounts of common stock in the public or private markets, including sales by the Company or other large holders. +The sale of a substantial number of shares of our common stock by the Company or a holder of a substantial number of shares of our common stock in the public markets could have a material adverse effect on the price of our common stock and dilute our stockholders. In November 2023, we entered an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Sandler & Co. (the “Agent”). Pursuant to the Equity Distribution Agreement, we may, from time to time, sell, shares of our common stock having an aggregate offering price of up to $30.0 million through the Agent acting as the Company’s sales agent (the “ATM Program”) . Under the Equity Distribution Agreement, we will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made and any price below which sales may not be made. Subject to the terms and conditions of the Equity Distribution Agreement and such parameters, the Agent may sell the shares by any method deemed to be an “at the market offering” as defined by Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), including sales made directly on or through the New York Stock Exchange. The Agent may also sell shares in negotiated transactions at market prices prevailing at the time of sale or at prices related to such prevailing market prices and/or any other method permitted by law, subject to our prior written consent. +30 +In addition to any shares issued through the ATM Program, we may issue shares of our common stock or equity securities senior to our common stock in the future for a number of reasons, including to finance our operations and growth plans or to adjust our ratio of debt-to-equity. We cannot predict the size of future issuances or sales of our common stock or the effect, if any, that future issuances and sales of shares of our common stock could have on the market price of our common stock. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +We have in the past experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur operating losses and experience negative operating cash flow. +Our future financial condition and results of operations could be adversely impacted by long-lived assets or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, other intangible assets, or other assets in a short amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, other intangible assets, or other assets that reduce our net income. +While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the U.S. or other countries, anti-terrorist efforts, and other armed conflicts involving the U.S. or other countries, including continued hostilities in the Middle East, may adversely affect the U.S. and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +A portion of our revenue is derived from sales to customers outside of the U.S., which exposes us to risks inherent in doing business internationally. +In 2023, we derived 4.7% of our revenue from sales to customers outside of the U.S. Sales to customers in countries other than the U.S. are subject to various risks, including: +• volatility in political, social, and economic conditions; +• social unrest, acts of terrorism, war, or other armed conflicts; +• confiscatory taxation or other adverse tax policies; +• deprivation of contract rights; +• trade and economic sanctions or other restrictions imposed by the European Union, the U.S., or other countries; +31 +• exposure under the FCPA or similar legislation, as discussed in the below risk factor; and +• currency exchange controls. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter and bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. These exclusive forum provisions are not intended to apply to actions arising under the Exchange Act or the Securities Act. The Court of Chancery of the State of Delaware has recently held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL. +Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provisions of our charter and bylaws. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter or bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +We may not be able to utilize a portion of our net operating loss carry forwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2023, we had federal and state income tax NOLs of approximately $471.8 million, which will begin to expire between 2024 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual +32 +limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in our initial public offering in 2018, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +Item 1B. Unresolved Staff Comments +None. +Item 1C. Cybersecurity +Risk Management and Strategy +Identifying, assessing, and managing cybersecurity risks is an important component of our overall enterprise risk management program. Our cybersecurity programs have been developed based on the National Institute of Standards and Technology Cybersecurity Framework and seek to protect the Company against cybersecurity risks. Among other things, these programs generally involve maturity evaluations and assessments by third parties, vulnerability scanning, employee testing and training, technical and business team-focused tabletop exercises, business continuity planning, incident response planning and data security assessments of third-party service providers as a part of vendor management. +Identified Risks +As of the date of this Annual Report, we are not aware of any cybersecurity threats that have materially affected or are reasonably likely to materially affect us, including our business strategy, results of operations, or financial condition. However, we face certain ongoing risks from cybersecurity threats that, if realized, may, among other things, cause material disruptions to our operations, which may materially affect us, including our business strategy, results of operations and/or financial condition. For more information about these risks, see the risk factor titled “ Our operations are subject to cybersecurity risks that could have a material adverse effect on our results of operations and financial condition ” under Item 1A of Part I of this Annual Report. +Board Oversight and Management ’ s Role +Our Board considers cybersecurity risk as part of its risk oversight function and has assigned oversight of cybersecurity risk management to the Audit Committee. The Audit Committee regularly receives reports from our management, including the SC (defined below) and our senior IT leadership, and third parties on cybersecurity matters. The Audit Committee reports to the full Board regarding its activities, including those related to cybersecurity. In addition, the Board receives reports addressing cybersecurity as part of our overall enterprise risk management program and to the extent cybersecurity matters are addressed therein, in regular business updates. +We have established a Security Committee (the “SC”), comprised of senior departmental leadership including our Chief Financial Officer, Senior Vice President and General Counsel, Vice President – IT, Vice President – Internal Audit, and Vice President – Corporate Operations, each of whom has between 10 to 20 years of experience managing risks at the Company and at similar companies, including risks arising from cybersecurity threats. The SC meets quarterly to discuss and review cybersecurity concerns that arise during the year. The SC also identifies areas that should be addressed and reviews and updates security policies, as necessary. The SC has primary management oversight responsibility for assessing and managing risks from cybersecurity threats. +Our senior IT leadership is responsible for the day-to-day management and development of appropriate cybersecurity programs, including as may be required by applicable law or regulation. Our senior IT leadership monitors the prevention, detection, mitigation, and remediation of cybersecurity incidents as part of the cybersecurity programs described above, works closely with the SC, and reports regular updates to the Audit Committee. Our IT team is led by our Vice President – IT, who has over 12 years of experience managing global IT operations, including strategy, applications, infrastructure, information security, support, and execution. +33 +Item 2. Properties +The following table describes the material facilities owned or leased by us as of December 31, 2023. +Location Basin/Region Leased or Owned Principal/Most Significant Use +Houston, TX — Leased Corporate Headquarters/Administrative +Athens, TX — Leased Operations +Baker, MT Bakken Owned Operations/Administrative +Bergen, Norway — Leased Operations +Charleroi, PA Marcellus/Utica Leased Operations +Corpus Christi, TX — Leased Operations/Administrative +Corpus Christi, TX — Leased Administrative +Dickinson, ND Bakken Leased Operations/Administrative +El Reno, OK SCOOP/STACK Leased Operations +Fort Worth, TX — Leased Administrative +Hobbs, NM Permian Leased Operations +Jacksboro, TX Barnett Leased Operations +Jacksboro, TX Barnett Leased Operations +Kilgore, TX Haynesville Leased Operations +Lacombe, AB, Canada WCSB Leased Operations/Administrative +Longview, TX Haynesville Owned Operations +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Mead, CO Rockies Leased Operations +Midland, TX Permian Leased Operations/Administrative +Monahans, TX Permian Leased Operations/Administrative +Oklahoma City, OK SCOOP/STACK Leased Operations +Pleasanton, TX Eagle Ford Leased Operations +Poolville, TX — Owned Operations +Sweetwater, TX Permian Leased Operations +Tyler, TX Haynesville Leased Operations +Ulster, PA Marcellus/Utica Leased Operations +Williston, ND Bakken Owned Operations/Administrative +Item 3. Legal Proceedings +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. For additional information related to legal proceedings, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +Item 4. Mine Safety Disclosures +Not applicable. +34 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Nine Energy Service, Inc.’s common stock is traded on the New York Stock Exchange under the symbol “NINE.” +Holders +As of March 4, 2024, we had 59 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +None. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +Item 6. [Reserved] +35 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. +This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. +Generally, operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently. +We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +36 +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• Adjusted Gross Profit (Loss) : Adjusted gross profit (loss) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted EBITDA : We define Adjusted EBITDA as EBITDA (which is net income (loss) before interest, taxes, and depreciation and amortization) further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units (as defined and described below) offering and other refinancing activities, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on the extinguishment of debt, (vi) loss or gain on the sale of subsidiaries, (vii) restructuring charges, (viii) stock-based compensation and cash award expense, (ix) loss or gain on sale of property and equipment, and (x) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted Return on Invested Capital (“Adjusted ROIC”): We define Adjusted ROIC as adjusted after-tax net operating profit (loss), divided by average total capital. We define adjusted after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities,(iv) interest expense (income), (v) restructuring charges, (vi) loss (gain) on the sale of subsidiaries, (vii) loss (gain) on the extinguishment of debt, and (viii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We compute and use the average of the current and prior period-end total capital in determining Adjusted ROIC. Previously, in our SEC filings press releases and other investor materials issued prior to December 31, 2023, we referred to (a) Adjusted ROIC as ROIC and (b) adjusted after-tax net operating profit (loss) as after-tax net operating profit (loss). We have made no changes to the manner in which these measures are calculated and have only revised the titles of these measures to more clearly identify them as non-GAAP measures. For additional information, see “Non-GAAP Financial Measures” below. +• Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Industry Trends and Outlook +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by current and expected oil and natural gas prices. In recent years, oil and natural gas prices have been extremely volatile, and commodity prices continued to be volatile in 2023, with both oil and natural gas prices significantly lower than 2022, leading to lower activity levels, particularly in the natural gas regions. The average WTI price in 2023 declined by approximately 18% versus 2022, and the average natural gas price declined by approximately 61% over that same time period. Since the end of 2022, the U.S. rig count declined by 157 rigs, or approximately 20%, through the end of 2023. With the decline in commodity +37 +prices and overall activity levels in 2023, we received pricing pressure from customers across service lines and basins, impacting both our revenue and margins. +For 2024, most public operators appear to be keeping activity and capital expenditure levels relatively flat year over year, and with where commodity prices are today, private operators are not likely to increase activity. As such, although the market can change quickly, we do not foresee any activity increases in the near-term, and thus far in 2024, we have experienced activity levels and pricing that is generally consistent with that of the last quarter of 2023. +We remain cautiously optimistic on the long-term outlook for the energy sector, and we believe there is potential upside for North American activity levels. OPEC has maintained production cuts, and public U.S. producers remaining committed to capital discipline, rather than increasing drilling, could help lessen the impact of any supply surplus. Additionally, the conflicts between Russia and Ukraine and in the Middle East provide increased uncertainty regarding global supply. +Significant factors that are likely to affect commodity prices moving forward include actions of the members of OPEC and other oil exporting nations that relate to or impact oil production or supply; the effect of energy, monetary, and trade policies of the U.S.; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy regulations and policies, including those of the EPA and other governmental bodies; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. Furthermore, although as noted above, our customers’ activity and spending levels, and thus demand for our services and products, are strongly influenced by current and expected oil and natural gas prices, even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. +Results of Operations +Year Ended December 31, +2023 2022 Change Percentage Change +(in thousands, except percentage change) +Revenues $ 609,526 $ 593,382 $ 16,144 3 % +Cost of revenues (exclusive of depreciation and amortization shown separately below) 490,750 457,093 33,657 7 % +Adjusted gross profit $ 118,776 $ 136,289 $ (17,513) (13) % +General and administrative expenses $ 59,817 $ 51,653 $ 8,164 16 % +Depreciation 29,141 26,784 2,357 9 % +Amortization of intangibles 11,516 13,463 (1,947) (14) % +Loss on revaluation of contingent liability 437 454 (17) (4) % +Loss on sale of property and equipment 292 367 (75) (20) % +Income from operations 17,573 43,568 (25,995) (60) % +Non-operating expenses 49,201 28,629 20,572 72 % +Income (loss) before income taxes (31,628) 14,939 (46,567) (312) % +Provision for income taxes 585 546 39 7 % +Net income (loss) $ (32,213) $ 14,393 $ (46,606) (324) % +Revenues +Revenues increased $16.1 million, or 3%, to $609.5 million in 2023; while the average U.S. rig count remained relatively flat in comparison to 2022, the overall increase in revenues was attributable to a number of factors, including increased activity and changes in product mix. More specifically, wireline revenue increased $9.6 million, or 9%, due to increased activity, as total completed wireline stages increased 4%. In addition, although completion tools stages decreased 6% in comparison to 2022, tools revenue increased $7.2 million, or 5%, due to a significant international sale made to a customer during 2023 that did not occur in 2022, as well as a change in product mix between periods. Coiled tubing revenue also increased $4.0 million, or 3%, due to increased activity, as total days worked increased by 3%. The overall increase was +38 +partially offset with a decrease in cementing revenue (including pump downs) of $4.7 million, or 2%, due to an 11% decrease in total jobs in comparison to 2022. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues increased $33.7 million, or 7%, to $490.8 million in 2023. The increase in comparison to 2022 was primarily driven by increased activity in wireline and coiled tubing, coupled with cost inflation over all lines of service associated with both labor and materials. More specifically, the increase was due to a $16.3 million increase in employee related costs, a $13.8 million increase in materials installed and consumed while performing services, a $3.1 million increase in repairs and maintenance, and a $0.5 million increase in other costs such as vehicle expense and travel, in comparison to 2022. +Adjusted Gross Profit (Loss) +Adjusted gross profit decreased $17.5 million to $118.8 million in 2023 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses increased $8.2 million to $59.8 million in 2023. The increase was primarily due to $6.4 million in costs associated with the Units offering in 2023 that did not occur in 2022. The increase was also partially attributed to a $1.7 million increase in marketing and communication costs in comparison to 2022. +Depreciation +Depreciation expense increased $2.4 million to $29.1 million in 2023. The increase in comparison to 2022 was primarily due to an increase in capital expenditures over the last two years. +Amortization of Intangibles +Amortization of intangibles, which was primarily comprised of technology and customer relationships, decreased $1.9 million to $11.5 million in 2023. The decrease in comparison to 2022 was due to certain intangible assets being fully amortized over the last twelve months. +(Gain) Loss on Revaluation of Contingent Liability +We recorded a $0.4 million loss on the revaluation of contingent liability in 2023 compared to a $0.5 million loss in 2022. The losses for both periods were related to increases of the value of the earnout associated with our acquisition Frac Technology AS. +(Gain) Loss on Sale of Property and Equipment +We recorded a loss on sale of property and equipment of $0.3 million in 2023 compared to a loss on sale of property and equipment of $0.4 million in 2022. The $0.1 million change was primarily attributed to an increase in certain damaged equipment that was fully disposed of in 2022 in comparison to 2023. +Non-Operating Expenses (Income) +Non-operating expenses increased $20.6 million to $49.2 million in 2023. The increase in comparison to 2022 was primarily due to an increased interest rate on our senior notes (from 8.750% on the 2023 Notes (as defined and described below) to 13.000% on the 2028 Notes). The increase was also partially due to a $2.8 million gain on the extinguishment of debt related to the repurchase of our 2023 Notes in 2022 that did not recur in 2023. +Provision (Benefit) for Income Taxes +Our effective tax rate was (1.8)% for 2023 and 3.7% for 2022. Our tax provision for 2023 is primarily the result of our tax position in state and foreign tax jurisdictions. +Adjusted EBITDA +Adjusted EBITDA decreased $20.8 million to $73.0 million for 2023. The Adjusted EBITDA decrease was primarily due to the changes in revenue and expenses discussed above. See “Non-GAAP Financial Measures” below for further explanation. +39 +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted EBITDA is a non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define Adjusted EBITDA as EBITDA (which is net income (loss) before interest, taxes, depreciation, and amortization) further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on the extinguishment of debt, (vi) loss or gain on the sale of subsidiaries, (vii) restructuring charges, (viii) stock-based compensation and cash award expense, (ix) loss or gain on sale of property and equipment, and (x) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. +Management believes Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure and helps identify underlying trends in our operations that could otherwise be distorted by the effect of impairments, acquisitions and dispositions and costs that are not reflective of the ongoing performance of our business. We exclude the items listed above from net income (loss) in arriving at this measure because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. This measure should not be considered as an alternative to, or more meaningful than, net income (loss) as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from this measure are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of this measure. Our computation of this measure may not be comparable to other similarly titled measures of other companies. +40 +The following table presents a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss): +Year Ended December 31, +2023 2022 +(in thousands) +Net income (loss) $ (32,213) $ 14,393 +Interest expense 51,119 32,486 +Interest income (1,270) (305) +Provision for income taxes 585 546 +Depreciation 29,141 26,784 +Amortization of intangibles 11,516 13,463 +EBITDA $ 58,878 $ 87,367 +Adjusted EBITDA reconciliation: +EBITDA $ 58,878 $ 87,367 +Loss on revaluation of contingent liability (1) +437 454 +Gain on extinguishment of debt — (2,843) +Certain refinancing costs (2) +6,396 — +Restructuring charges 2,027 3,393 +Stock-based compensation and cash award expense 4,867 4,914 +Loss on sale of property and equipment 292 367 +Legal fees and settlements (3) +69 86 +Adjusted EBITDA $ 72,966 $ 93,738 +(1) Amounts relate to the revaluation of contingent liability associated with a 2018 acquisition. The impact is included in our Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 – Commitments and Contingencies included Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and expenses relating to our Units offering and other refinancing activities, including cash incentive compensation to employees following the successful completion of the Units offering, that were not capitalized. +(3) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. +41 +Adjusted Return on Invested Capital +Adjusted ROIC is a non-GAAP financial measure. We define Adjusted ROIC as adjusted after-tax net operating profit (loss), divided by average total capital. We define adjusted after-tax net operating profit (loss), which is a non-GAAP financial measure, as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities, (iv) interest expense (income), (v) restructuring charges, (vi) loss (gain) on the sale of subsidiaries, (vii) loss (gain) on the extinguishment of debt, and (viii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity (deficit) plus the book value of debt less balance sheet cash and cash equivalents. We compute and use the average of the current and prior period-end total capital in determining Adjusted ROIC. Previously, in our SEC filings press releases and other investor materials issued prior to December 31, 2023, we referred to (a) Adjusted ROIC as ROIC and (b) adjusted after-tax net operating profit (loss) as after-tax net operating profit (loss). We have made no changes to the manner in which these measures are calculated and have only revised the titles of these measures to more clearly identify them as non-GAAP measures. +Management believes Adjusted ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses Adjusted ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although Adjusted ROIC is commonly used as a measure of capital efficiency, definitions of Adjusted ROIC differ, and our computation of Adjusted ROIC may not be comparable to other similarly titled measures of other companies. +42 +The following table provides our calculation of Adjusted ROIC for the years ended December 31, 2023 and 2022. The following table also presents ROIC (defined as net income (loss), divided by average total capital) and a reconciliation of the non-GAAP financial measure of adjusted after-tax net operating profit (loss) to the most directly comparable GAAP measure of net income (loss), in each case for the years ended December 31, 2023 and 2022. +Year Ended December 31, +2023 2022 +(in thousands) +Net income (loss) $ (32,213) $ 14,393 +Add back: +Interest expense 51,119 32,486 +Interest income (1,270) (305) +Certain refinancing costs (1) +6,396 — +Restructuring charges 2,027 3,393 +Gain on extinguishment of debt — (2,843) +Adjusted after-tax net operating income $ 26,059 $ 47,124 +Total capital as of prior period-end: +Total stockholders’ deficit $ (23,507) $ (39,267) +Total debt 341,606 337,436 +Less cash and cash equivalents (17,445) (21,509) +Total capital as of prior period-end $ 300,654 $ 276,660 +Total capital as of period-end: +Total stockholders’ deficit $ (35,630) $ (23,507) +Total debt 359,859 341,606 +Less cash and cash equivalents (30,840) (17,445) +Total capital as of period-end $ 293,389 $ 300,654 +Average total capital $ 297,022 $ 288,657 +ROIC (10.8) % 5.0 % +Adjusted ROIC 8.8 % 16.3 % +(1) Amounts represent fees and expenses relating to our Units offering and other refinancing activities, including cash incentive compensation to employees following the successful completion of the Units offering, that were not capitalized. +43 +Adjusted Gross Profit (Loss) +GAAP defines gross profit (loss) as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit (loss) because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management uses adjusted gross profit (loss) to evaluate operating performance. We prepare adjusted gross profit (loss) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (loss) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (loss) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (loss) or similarly titled measures in the same manner as we do. +The following table presents a reconciliation of adjusted gross profit (loss) to GAAP gross profit (loss). +Year Ended December 31, +2023 2022 +(in thousands) +Calculation of gross profit: +Revenues $ 609,526 $ 593,382 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 490,750 457,093 +Depreciation (related to cost of revenues) 27,101 24,909 +Amortization of intangibles 11,516 13,463 +Gross profit $ 80,159 $ 97,917 +Adjusted gross profit reconciliation: +Gross profit $ 80,159 $ 97,917 +Depreciation (related to cost of revenues) 27,101 24,909 +Amortization of intangibles 11,516 13,463 +Adjusted gross profit $ 118,776 $ 136,289 +44 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash on hand, cash flows from operations and, if needed, external borrowings and issuances of debt securities. Our principal uses of cash are to fund capital expenditures, service our outstanding debt, and fund our working capital requirements. Due to our high level of variable costs and the asset-light make-up of our business, we have historically been able to quickly implement cost-cutting measures and will continue to adapt as the market dictates. We have also used cash to make open market repurchases of our debt and may, from time to time, continue to make such repurchases when it is opportunistic to do so to manage our debt maturity profile. +We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. +Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +In 2024, our planned capital expenditure budget, excluding possible acquisitions, is expected to be between $15.0 million to $25.0 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including expected industry activity levels and company initiatives. +At December 31, 2023, we had $30.8 million of cash and cash equivalents and $28.1 million of availability under the ABL Credit Facility, which resulted in a total liquidity position of $58.9 million. Our liquidity position will continue to be impacted by the semi-annual interest payments ($19.5 million based on amounts outstanding as December 31, 2023) to the holders of the 2028 Notes, which began on August 1, 2023. We believe that, based on our current forecasts, our cash on hand, together with cash flow from operations and borrowings under the ABL Credit Facility, should be sufficient to fund our capital requirements for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts, which are materially dependent on our financial performance and the ever-changing market. +ATM Program +On November 6, 2023, we entered into the Equity Distribution Agreement with Piper Sandler & Co., as the Agent, pursuant to which we may, from time to time, sell shares of our common stock having an aggregate offering price of up to $30.0 million t hrough the Agent acting as the Company’s sales agent . The Agent will receive a commission equal to 3.0% of the gross sale price of any shares sold under the Equity Distribution Agreement. +Under the Equity Distribution Agreement, we will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made and any price below which sales may not be made. During the quarter ended December 31, 2023, no sales were made under the Equity Distribution Agreement. +Units Offering and 2028 Notes +On January 30, 2023, we completed our public offering of 300,000 units with an aggregate stated amount of $300.0 million (the “Units”). Each Unit consisted of $1,000 principal amount of the 2028 Notes and five shares of our common stock (the “Common Stock”). We received proceeds of $279.8 million from the Units offering, after deducting underwriting discounts and commission, which was used to fund a portion of the redemption price of our 8.750% Senior Notes due 2023 (the “2023 Notes”). Each Unit separated into its constituent securities (the 2028 Notes and the shares of our Common Stock) automatically on October 27, 2023. +On January 30, 2023, we, and certain of our subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes, which formed a part of the Units, were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000% payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are our senior secured obligations and are guaranteed on a senior secured basis by each of our current domestic subsidiaries and will be so guaranteed by certain future subsidiaries, subject to agreed guaranty and security principles and certain exclusions. +45 +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), we are required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0% of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100% of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. For the Excess Cash Flow Offer Date of November 14, 2023, the Excess Cash Flow Amount was $0 and, as such, no Excess Cash Flow Offer was made. +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit our ability and the ability of our restricted subsidiaries to engage in certain activities. We were in compliance with the provision of the 2028 Notes Indenture at December 31, 2023. +For additional information on the Units and the 2028 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +2023 Notes +On October 25, 2018, we issued $400.0 million of 2023 Notes under an indenture, dated as of October 25, 2018 (the “2023 Notes Indenture”), by and among us, including certain of our subsidiaries, and Wells Fargo, National Association, as trustee. The 2023 Notes bore interest at annual rate of 8.750% payable on May 1 and November 1 of each year. The 2023 Notes were senior unsecured obligations and were fully and unconditionally guaranteed on a senior unsecured basis by each of our current domestic subsidiaries. +On February 1, 2023, all of the outstanding 2023 Notes were redeemed at a redemption price of 100.0% of the principal amount thereof ($307.3 million), plus accrued and unpaid interest ($6.7 million), and the 2023 Notes Indenture was discharged as of January 30, 2023. +We repurchased approximately $13.0 million of 2023 Notes at a repurchase price of approximately $10.1 million in cash for the year ended December 31, 2022. +For additional information on the 2023 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), that permitted aggregate borrowings of up to $200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “ABL Credit Facility”). Pursuant to the 2018 ABL Credit Agreement, the ABL Credit Facility was set to mature on October 25, 2023 or, if earlier, on the date that was 180 days before the scheduled maturity date of the 2023 Notes if they had not been redeemed or repurchased by such date. +On January 17, 2023, we entered into the First Amendment to Credit Agreement (the “ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which amends certain terms of the 2018 ABL Credit Agreement (as amended the “ABL Credit Agreement”). The ABL Facility Amendment became effective on January 30, 2023. +Pursuant to the ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $200.0 million to $150.0 million, subject to +46 +the borrowing base (the “Loan Limit”), (b) changed the interest rate benchmark from London Interbank Offered Rate to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75% to 2.25% to a range of 2.00% to 2.50%, in each case depending on our leverage ratio, (c) modified the financial covenant, enhanced reporting and cash dominion triggers in the ABL Credit Facility from the existing minimum availability threshold of the greater of $18.75 million and 12.5% of the Loan Limit to a minimum availability threshold of (i) $12.5 million from January 30, 2023 until May 31, 2023 and (ii) the greater of $17.5 million and 12.5% of the Loan Limit thereafter, (d) decreased the Canadian tranche sub-limit from $25.0 million to $5.0 million, (e) decreased the letter of credit sub-limit from $50.0 million to $10.0 million and (f) made satisfaction of the Payment Conditions (as defined in the ABL Facility Amendment) a condition to an Excess Cash Flow Offer in addition to a condition to voluntary payments of the 2028 Notes. The Payment Conditions in summary are (A) no default or event of default on a pro forma basis and (B) immediately after and at all times and at all times during the 30 days prior, on a pro forma basis, (1) (x) availability under the ABL Credit Facility shall not be less than the greater of 15% of the Loan Limit and $22.5 million and (y) the fixed charge coverage ratio shall be at least 1.00 to 1.00 or (2) availability under the ABL Credit Facility shall not be less than the greater of 20% of the Loan Limit and $30.0 million. +The ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. We were in compliance with all covenants under the ABL Credit Agreement as of December 31, 2023. +Pursuant to the ABL Credit Agreement, all of the obligations under the ABL Credit Facility are secured by security interests (subject to permitted liens) in substantially all of the personal property of our domestic subsidiaries, excluding certain assets. The obligations under the Canadian tranche are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Nine Energy Canada, Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries, excluding certain assets. +Both the ABL Credit Facility and the Units collateralization were completed within 30 days after closing of the Units offering in accordance with the terms of the ABL Facility Amendment and the 2028 Notes Indenture. +At December 31, 2023, we had $57.0 million of borrowings under the ABL Credit Facility, and our availability under the ABL Credit Facility was approximately $28.1 million, net of outstanding letters of credit of $1.1 million. On February 14, 2024, we repaid approximately $5.0 million of our outstanding borrowings under the ABL Credit Facility. +Cash Flows +Our cash flows for the years ended December 31, 2023, and 2022 are presented below: +Year Ended December 31, +2023 2022 +(in thousands) +Operating activities $ 45,509 $ 16,672 +Investing activities (23,157) (25,417) +Financing activities (8,893) 4,849 +Impact of foreign exchange rate on cash (64) (168) +Net change in cash and cash equivalents $ 13,395 $ (4,064) +Operating Activities +Net cash provided by operating activities was $45.5 million in 2023 compared to $16.7 million in net cash provided by operating activities in 2022. The $28.8 million increase in net cash provided by operating activities was primarily a result of a $64.9 million increase in cash provided by working capital, including an increase in accounts receivable from increased product and service sales between periods. The increase in net cash provided by operating activities was offset by a $36.1 million decrease in cash flow provided by operations, adjusted for any non-cash items, primarily driven by a decrease in income in comparison to 2022. +Investing Activities +Net cash used in investing activities was $23.2 million in 2023 compared to $25.4 million in net cash used in investing activities in 2022. The $2.2 million decrease was primarily due to a $4.0 million decrease in cash purchases of property and +47 +equipment, partially offset by a $1.7 million decrease in proceeds from the sale of property and equipment (including insurance), in each case, in comparison to 2022. +Financing Activities +Net cash used in financing activities was $8.9 million in 2023 compared to $4.8 million in net cash provided in 2022. The $13.7 million change was primarily attributed to the $307.3 million redemption of the 2023 Notes and $6.3 million in debt issuance costs associated with the Units offering in 2023 that did not occur in 2022. The increase in net cash used was also partly attributed to an $8.0 million increase in payments on the ABL Credit Facility and an increase of $1.3 million in payments on short-term debt, each in comparison to 2022. The overall increase in net cash used was largely offset by $279.8 million in proceeds received from the Units offering in 2023 that did not occur in 2022. The overall increase in net cash used was also partially offset by an increase of $16.0 million in proceeds received in connection with the ABL Credit Facility, a decrease of $1.1 million of payments on finance leases, and a decrease of $0.8 million in the vesting of restricted stock, each in comparison to 2022, as well as $10.1 million of purchases of the 2023 Notes and $1.1 million of payments of the Magnum Promissory Notes (as defined in Note 9 – Debt Obligations) in 2022 that did not recur in 2023. +Critical Accounting Estimates +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. +We consider the significant accounting policies identified below to be “critical accounting estimates” due to the following: +• The policies are dependent on estimates and assumptions made by us about matters that are inherently uncertain. +• The policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. +For additional information on our significant accounting policies, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful life of the asset. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. Estimated useful lives requires significant judgment which is influenced by our historical experience in operating property and equipment, technological developments, and expectations of future demand. Should our estimates be too long or too short, we could report a disproportionate amount of losses or gains from sale or retirement. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income and Comprehensive Income (Loss). +48 +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. Reasonable estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The accuracy of these estimates is impacted by, among other things, the complexity of the issues and the amount of due diligence we have been able to perform. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. If the actual settlement costs, final judgments, or fines, after appeals, differ from our estimates, there may be a material adverse effect on our future financial results. +Stock-based Compensation and Fair Market Value Determination +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in “General and administrative expenses” in our Consolidated Statements of Income and Comprehensive Income (Loss). +Fair value of all the options outstanding was measured using the Black-Scholes model. Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – We develop our expected volatility based upon a weighted average volatility of our peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Fair value of the stock-based compensation for all of the performance share units as well as the fair value of the performance cash awards was measured using a Monte Carlo simulation model. +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Smaller Reporting Company Status +We are a “smaller reporting company” as defined by the SEC. As such, we are eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. Our disclosures in this Annual Report reflect these scaled requirements. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +49 +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 238 ) +F- 1 +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F- 3 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2023 and 2022 +F- 4 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2023 and 2022 +F- 5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2023 and 2022 +F- 6 +Notes to Consolidated Financial Statements +F- 8 +50 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2023 and 2022, and the related consolidated statements of income and comprehensive income (loss), of stockholders’ equity (deficit), and of cash flows for the years then ended, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +F-1 +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue Recognition +As described in Note 2 to the consolidated financial statements, the Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. The Company recognized total revenues of $609.5 million for the year ended December 31, 2023. +The principal consideration for our determination that performing procedures relating to revenue recognition is a critical audit matter is a high degree of auditor effort in performing procedures related to the Company’s revenue recognition. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the recording of revenue upon shipment of the product or completion of the service. These procedures also included, among others, (i) evaluating revenue transactions, on a sample basis, by (a) testing the issuance and settlement of invoices and credit memos; (b) tracing transactions not settled to a detailed listing of accounts receivable; (c) testing revenue transactions recorded but not yet invoiced by obtaining and inspecting proof of service; and (d) testing transactions recorded near period end to evaluate whether they were recorded in the appropriate period; (ii) testing, on a sample basis, outstanding customer invoice balances at year end by obtaining and inspecting source documents, including invoices, proof of service, and subsequent cash receipts, where applicable; and (iii) evaluating terms and conditions within master service agreements, on a sample basis. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +March 7, 2024 +We have served as the Company’s auditor since 2011. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2023 2022 +Assets +Current assets +Cash and cash equivalents $ 30,840 $ 17,445 +Accounts receivable, net 88,449 105,277 +Income taxes receivable 490 741 +Inventories, net 54,486 62,045 +Prepaid expenses and other current assets 9,368 11,217 +Total current assets 183,633 196,725 +Property and equipment, net 82,366 89,717 +Operating lease right of use assets, net 42,056 36,336 +Finance lease right of use assets, net 51 547 +Intangible assets, net 90,429 101,945 +Other long-term assets 3,449 1,564 +Total assets $ 401,984 $ 426,834 +Liabilities and Stockholders’ Equity (Deficit) +Current liabilities +Accounts payable $ 33,379 $ 42,211 +Accrued expenses 36,171 28,391 +Current portion of long-term debt 2,859 2,267 +Current portion of operating lease obligations 10,314 7,956 +Current portion of finance lease obligations 31 178 +Total current liabilities 82,754 81,003 +Long-term liabilities +Long-term debt 320,520 338,031 +Long-term operating lease obligations 32,594 29,370 +Other long-term liabilities 1,746 1,937 +Total liabilities 437,614 450,341 +Commitments and contingencies (Note 12) +Stockholders’ equity (deficit) +Common stock ( 120,000,000 shares authorized at $ 0.01 par value; 35,324,861 and 33,221,266 shares issued and outstanding at December 31, 2023 and 2022 respectively) +353 332 +Additional paid-in capital 795,106 775,006 +Accumulated other comprehensive loss ( 4,859 ) ( 4,828 ) +Accumulated deficit ( 826,230 ) ( 794,017 ) +Total stockholders’ equity (deficit) ( 35,630 ) ( 23,507 ) +Total liabilities and stockholders’ equity (deficit) $ 401,984 $ 426,834 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2023 2022 +Revenues +Service $ 464,233 $ 455,364 +Product 145,293 138,018 +609,526 593,382 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Service 379,365 350,733 +Product 111,385 106,360 +General and administrative expenses 59,817 51,653 +Depreciation 29,141 26,784 +Amortization of intangibles 11,516 13,463 +Loss on revaluation of contingent liability 437 454 +Loss on sale of property and equipment 292 367 +Income from operations 17,573 43,568 +Interest expense 51,119 32,486 +Interest income ( 1,270 ) ( 305 ) +Gain on extinguishment of debt — ( 2,843 ) +Other income ( 648 ) ( 709 ) +Income (loss) before income taxes ( 31,628 ) 14,939 +Provision for income taxes 585 546 +Net income (loss) $ ( 32,213 ) $ 14,393 +Earnings (loss) per share +Basic $ ( 0.97 ) $ 0.47 +Diluted $ ( 0.97 ) $ 0.45 +Weighted average shares outstanding +Basic 33,282,234 30,930,890 +Diluted 33,282,234 32,251,398 +Other comprehensive loss, net of tax +Foreign currency translation adjustments, net of $ 0 tax in each period +$ ( 31 ) $ ( 293 ) +Total other comprehensive loss, net of tax ( 31 ) ( 293 ) +Total comprehensive income (loss) $ ( 32,244 ) $ 14,100 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) +(In thousands, except share amounts) +Common Stock Additional +Paid-in Accumulated +Other +Comprehensive Retained +Earnings +(Accumulated Total +Stockholders’ Equity +Shares Amounts Capital Income (Loss) Deficit) (Deficit) +Stockholders’ equity (deficit) as of December 31, 2021 32,826,325 $ 328 $ 773,350 $ ( 4,535 ) $ ( 808,410 ) $ ( 39,267 ) +Issuance of common stock under stock compensation plan, net of forfeitures 623,328 7 ( 7 ) — — — +Stock-based compensation expense — — 2,440 — — 2,440 +Vesting of restricted stock and stock units ( 228,387 ) ( 3 ) ( 777 ) — — ( 780 ) +Other comprehensive loss — — — ( 293 ) — ( 293 ) +Net income — — — — 14,393 14,393 +Stockholders’ equity (deficit) as of December 31, 2022 33,221,266 $ 332 $ 775,006 $ ( 4,828 ) $ ( 794,017 ) $ ( 23,507 ) +Issuance of common stock associated with the 2028 Units offering 1,500,000 15 17,939 — — 17,954 +Issuance of common stock under stock compensation plan, net of forfeitures 603,078 6 ( 6 ) — — — +Stock-based compensation expense — — 2,169 — — 2,169 +Vesting of restricted stock and stock units 517 — ( 2 ) — — ( 2 ) +Other comprehensive loss — — — ( 31 ) — ( 31 ) +Net loss — — — — ( 32,213 ) ( 32,213 ) +Stockholders’ equity (deficit) as of December 31, 2023 35,324,861 $ 353 $ 795,106 $ ( 4,859 ) $ ( 826,230 ) $ ( 35,630 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2023 2022 +Cash flows from operating activities +Net income (loss) $ ( 32,213 ) $ 14,393 +Adjustments to reconcile net income (loss) to net cash provided by operating activities +Depreciation 29,141 26,784 +Amortization of intangibles 11,516 13,463 +Amortization of operating leases 12,524 8,670 +Amortization of deferred financing costs 7,413 2,545 +Provision for (recovery of) doubtful accounts 333 ( 166 ) +Provision for inventory obsolescence 2,320 2,966 +Stock-based compensation expense 2,169 2,440 +Gain on extinguishment of debt — ( 2,843 ) +Loss on sale of property and equipment 292 367 +Loss on revaluation of contingent liability 437 454 +Abandonment of in-process research and development — 1,000 +Changes in operating assets and liabilities +Accounts receivable, net 16,489 ( 41,114 ) +Inventories, net 5,219 ( 22,968 ) +Prepaid expenses and other current assets 1,148 ( 818 ) +Accounts payable and accrued expenses 1,058 19,476 +Income taxes receivable/payable 252 655 +Operating lease obligations ( 12,344 ) ( 8,698 ) +Other assets and liabilities ( 245 ) 66 +Net cash provided by operating activities 45,509 16,672 +Cash flows from investing activities +Proceeds from sales of property and equipment 606 2,959 +Proceeds from property and equipment casualty losses 840 175 +Purchases of property and equipment ( 24,603 ) ( 28,551 ) +Net cash used in investing activities ( 23,157 ) ( 25,417 ) +Cash flows from financing activities +Proceeds from Units offering, net of discount 279,750 — +Redemption of 2023 Notes ( 307,339 ) — +Cost of debt issuance ( 6,290 ) — +Proceeds from ABL Credit Facility 40,000 24,000 +Payments on ABL Credit Facility ( 15,000 ) ( 7,000 ) +Purchases of 2023 Notes — ( 10,081 ) +Payments on Magnum Promissory Notes — ( 1,125 ) +Proceeds from short-term debt 4,733 4,086 +Payments of short-term debt ( 4,141 ) ( 2,787 ) +Payments on finance leases ( 217 ) ( 1,269 ) +Payments of contingent liability ( 387 ) ( 195 ) +Vesting of restricted stock and stock units ( 2 ) ( 780 ) +Net cash provided by (used in) financing activities ( 8,893 ) 4,849 +F-6 +Year Ended December 31, +2023 2022 +Impact of foreign currency exchange on cash ( 64 ) ( 168 ) +Net increase (decrease) in cash and cash equivalents 13,395 ( 4,064 ) +Cash and cash equivalents +Cash and cash equivalents at beginning of period 17,445 21,509 +Cash and cash equivalents at end of period $ 30,840 $ 17,445 +Supplemental disclosures of cash flow information: +Cash paid for interest $ 31,431 $ 29,708 +Cash paid (refunded) for income taxes $ 563 $ ( 116 ) +Supplemental schedule of non-cash activities: +Capital expenditures in accounts payable and accrued expenses $ 1,107 $ 3,443 +Receivable from property and equipment sale (including insurance) $ — $ 701 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies. The Company is headquartered in Houston, Texas. +The Company’s chief operating decision maker (the “CODM”), which is its Chief Executive Officer, and its board of directors allocate resources and assess performance based on financial information presented at a consolidated level. Accordingly, the Company determined that it operates as one reportable segment, known as Completion Solutions . +Risks and Uncertainties +The Company’s business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by current and expected oil and natural gas prices. Following an extreme decline in activity levels and pricing in 2020, the Company has been focused on strategically implementing price increases and gaining market share. In 2022, oil and natural gas prices improved, and activity levels increased, compared to 2021, resulting in higher demand for the Company’s products and services, and the Company implemented price increases in most service lines. In 2023, commodity prices were significantly lower compared to 2022, resulting in the rig count declining by over 157 rigs since the end of 2022. Going forward, the Company’s earnings will be affected by its customers’ activity plans (which are strongly influenced by commodity prices), the Company’s ability to maintain current pricing levels, the impact of wage and labor inflation, and labor shortage and supply chain constraints. +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial statements as of December 31, 2023 and 2022, and for the years ended December 31, 2023 and 2022, include the accounts of Nine and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. +Use of Estimates +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include fair value assumptions used in analyzing long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, recognition of provisions for contingencies, and stock-based compensation fair value. It is at least reasonably possible that the estimates used will change within the next year. +Reclassifications +Certain reclassifications have been made to prior period amounts to conform to the current period financial statement presentation. These reclassifications relate to presenting “Operating lease obligations” as a separate line item in the Company’s Consolidated Statements of Cash Flows as well as presenting “Canada and other” separately in Note 3 – Revenues. +Revenue Recognition +The Company recognizes revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products +F-8 +are received by a customer’s domestic common carrier at the Company’s facility or, for international sales, when the product is shipped to the customer’s exporter. The Company believes this recognition policy reflects the point at which the customer obtains control of the product as required by ASC 606. +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company excludes sales taxes, value added taxes, and other taxes it collects concurrent with revenue-producing activities from revenue. +The Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. Service revenues represent revenue recognized over time, as the Company’s customer arrangements typically provide agreed upon hourly or daily fixed-rates, and the Company recognizes service revenue based upon the number of hours or days services have been performed. +Contracts for the Company’s products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period the Company stands ready to provide its services to its client as needed. +The Company’s payment terms vary by the type and location of its customers and type of product and service offered. The Company receives cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date the Company invoices a customer. Since the period between the delivery of the Company’s products and services and the Company’s receipt of customer payment for these products and services is not expected to exceed one year, the Company has elected not to calculate or disclose a financing component for its customer contracts. +Contract Estimates +The Company receives reimbursements from its customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of the Company’s influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. The Company is considered a principal in these transactions and records the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of the Company’s contracts due to the dynamic nature of well operations and the services the Company provides for its customers. The Company considers contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of the Company’s contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Any contract assets are included in “Accounts receivable, net” in the Company’s Consolidated Balance Sheets. Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. The Company classifies contract liabilities as unearned income which is included in “Accrued expenses” in the Company’s Consolidated Balance Sheets. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For information regarding the Company’s revenue, see Note 3 – Revenues. +Leases +The Company determines if an arrangement is a lease at its inception. To the extent an arrangement represents a lease, the Company classifies that lease as an operating lease or a finance lease under Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”). +F-9 +The Company capitalizes operating leases on its Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that the Company would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. +Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2023 and 2022. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2023 and 2022. +Finance leases are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2023 and 2022. +For additional information regarding the Company’s leases, see Note 6 – Leases. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian subsidiary are calculated based on its functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the United States Dollar (“USD”). The financial position and results of operations of the Company’s Canadian subsidiary are measured using the local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) and its Consolidated Statements of Stockholders’ Equity (Deficit). +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus, receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices and industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for doubtful accounts when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +The Company had $ 88.4 million and $ 105.3 million of “Accounts receivable, net” at December 31, 2023 and 2022, respectively. The Company maintains an allowance for doubtful accounts based on the expected collectability of accounts receivable, which is included in “Accounts receivable, net” on the Company’s Consolidated Balance Sheets. The Company had an allowance for doubtful accounts of $ 0.6 million and $ 0.2 million at December 31, 2023 and 2022, respectively. Bad debt expense was $ 0.3 million for the year ended December 31, 2023, and bad debt expense recovery was $ 0.2 million for the year ended December 31, 2022. +Concentration of Credit Risk +The Company derives a significant portion of its revenues from companies in the exploration and production (“E&P”) industry, and its customer base includes a broad range of integrated and independent domestic E&P companies and international E&P companies operating in the markets that the Company serves. While current energy prices are important +F-10 +contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and can therefore negatively impact spending by the Company’s customers. No customer accounted for more than 10% of the revenues for the years ended December 31, 2023 and 2022. +Concentration of Supplier Risk +Purchases during the years ended December 31, 2023 and 2022 did not include purchases from any supplier that individually represented more than 10% of total operating purchases. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the assets. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +Valuation of Intangible Assets +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. +Intangible assets with indefinite useful lives are not subject to amortization. For intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated +F-11 +Statements of Income and Comprehensive Income (Loss). +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. As a result of the adoption of ASU No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Restricted Stock and Restricted Stock Units +Compensation expense is recorded for restricted stock and restricted stock units over the applicable vesting period based on the Company’s closing stock price as of the grant date. +Performance Stock Units and Performance Cash Awards +Performance stock units and performance cash awards are recorded at their fair value and expensed over their performance period. Fair value for performance stock units and performance cash awards is measured using a Monte Carlo simulation model. +Options +Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +• The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +• Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company developed its expected volatility based upon a weighted average volatility of its peer group. +• At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +• The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Income Taxes +The Company accounts for income taxes under Accounting Standards Codification 740, Income Taxes (“ASC 740”). Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +F-12 +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 9 – Debt Obligations. +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 12 – Commitments and Contingencies. +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, taking into effect, if any, the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as potentially dilutive restricted stock, restricted stock units, and performance stock units. There was no dilutive effect for the year ended December 31, 2023 as the Company was in a net loss position. For additional information on earnings (loss) per share, see Note 14 – Earnings (Loss) Per Share. +Accounting Pronouncements Recently Adopted +In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments which requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in ASU 2016-13 replace the current incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information. ASU 2016-13 was effective for Securities and Exchange Commission filers, excluding smaller reporting companies, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. As an emerging growth company at the time of adoption, the Company was permitted to adopt the new standard for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The adoption of ASU 2016-13 in the first quarter of 2023 did not have a material impact on the Company’s consolidated financial statements included in this Annual Report on Form 10-K. +Accounting Pronouncements Not Yet Adopted +In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The new guidance requires disclosures of significant segment expenses provided to the CODM and included in reported measures of segment profit and loss. The guidance requires interim and annual disclosures about a reportable segment’s profit or loss and assets. Additionally, the guidance requires disclosure of other segment items by reportable segment including a description of its composition. The amendments in ASU 2023-07 are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, on a retrospective basis. The Company is currently evaluating the impact that this guidance will have on the disclosures within its consolidated financial statements. +In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The amendments require disclosure of specific categories in the rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold and further disaggregation of income taxes paid for +F-13 +individually significant jurisdictions. The ASU is effective for fiscal years beginning after December 15, 2024. The Company is currently evaluating the impact that this guidance will have on the disclosures within its consolidated financial statements. +3. Revenues +The Company recognizes revenues from the sales of products at a point in time and revenues from the sales of services over time. +Disaggregation of Revenues +Disaggregated revenue for the years ended December 31, 2023 and 2022 was as follows: +Year Ended December 31, +2023 2022 +(in thousands) +Cement $ 224,761 $ 229,409 +Tools 145,293 138,018 +Coiled tubing 122,554 118,603 +Wireline 116,918 107,352 +Total revenues $ 609,526 $ 593,382 +Revenue by country for the years ended December 31, 2023 and 2022 were as follows: +Year Ended December 31, 2023 Year Ended December 31, 2022 +Amount Percentage Amount Percentage +(in thousands) (in thousands) +United States $ 602,343 98.8 % $ 587,873 99.1 % +Canada and other 7,183 1.2 % 5,509 0.9 % +$ 609,526 100.0 % $ 593,382 100.0 % +Performance Obligations +At December 31, 2023 and December 31, 2022, the amount of remaining performance obligations was not material. +Contract Balances +At December 31, 2023 and December 31, 2022, contract assets and contract liabilities were not material. +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $ 6.2 million and $ 6.7 million at December 31, 2023 and 2022, respectively. +F-14 +Inventories, net as of December 31, 2023 and 2022 were comprised of the following: +December 31, +2023 2022 +(in thousands) +Raw materials $ 31,235 $ 39,249 +Work in progress 542 161 +Finished goods 28,867 29,345 +Inventories 60,644 68,755 +Reserve for obsolescence ( 6,158 ) ( 6,710 ) +Inventories, net $ 54,486 $ 62,045 +5. Property and Equipment +Property and equipment amounts as of December 31, 2023 and 2022 were as follows: +December 31, +Estimated +Useful Lives 2023 2022 +(in thousands) +Operating equipment +1 to 12 years +$ 318,553 $ 321,315 +Autos and trucks +1 to 7 years +3,392 4,140 +Furniture, fixtures, and equipment +2 to 12 years +2,469 3,843 +Shop equipment +3 to 15 years +14,220 14,552 +Buildings +7 to 39 years +5,690 4,599 +Leasehold improvements +3 to 11 years +2,279 2,017 +Land indefinite 1,561 1,348 +348,164 351,814 +Less: Accumulated depreciation ( 265,798 ) ( 262,097 ) +Property and equipment, net $ 82,366 $ 89,717 +Depreciation expense was $ 29.1 million and $ 26.8 million for the years ended December 31, 2023 and 2022, respectively. +Capital expenditures for years ended December 31, 2023 and 2022 were as follows: +Year Ended December 31, +2023 2022 +(in thousands) +Completion Solutions $ 22,337 $ 32,162 +Corporate — 105 +$ 22,337 $ 32,267 +6. Leases +Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Company’s Consolidated Balance Sheets. Lease with an initial term greater than 12 months are recognized in the Company’s Consolidated Balance Sheets based on lease classification as either operating or financing. Some of the Company’s lease agreements include lease and non-lease components for which the Company has elected to not separate for all classes of underlying assets. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may sublease its real estate to third parties, subject to certain provision of the lease, when it has no future use for the property. +F-15 +Operating Leases +As a lessee, the Company’s operating lease portfolio primarily consists of operating leases for equipment, vehicles, office space, yard facilities, and employee housing. Operating lease ROU assets and operating lease obligations are recognized based on the present value of the future minimum lease payments at commencement date. As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate based on the lease information available at the commencement date in determining the present value of future payments. The incremental borrowing rate utilized is based upon the interest rate associated with the Company’s ABL Credit Facility (as defined and described in Note 9 – Debt Obligations) which is utilized to fund its working capital needs and planned capital expenditures. The Company’s leases have remaining terms of one to ten years and may include options to extend or terminate the lease. The operating lease ROU assets also include any upfront lease payments made and exclude lease incentives and initial direct costs incurred. +The Company leases most of these properties under long-term (greater than one year) non-cancelable term leases many of which contain renewal options that can extend the lease term from one to five years and some of which contain escalation clauses. The Company may also enter into short-term or month-to-month operating leases. Options to renew these leases are generally not considered reasonably certain to be exercised due to the nature of the Company’s operations and the markets it serves. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease. +The Company also leases supplemental equipment, typically under cancellable short-term contracts which are less than 30 days. This equipment is typically required for a specific project and for a short duration. Due to the nature of the Company’s operations, any option to renew these short-term leases is generally not considered reasonably certain to be exercised. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease, and the lease payments during these periods are similarly excluded from the calculation of operating lease asset and lease obligation balances. +Operating lease expense consists of rent expense related to leases that were included in ROU assets under ASC 842. The Company recognizes operating lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable operating lease payments typically include charges for property taxes and insurance, and some leases contain variable payments related to non-lease components, including common area maintenance and usage of facilities or office equipment (for example, copiers). The Company does not have variable expenses. +Additional Information +The following table summarizes the components of the Company’s lease expense recognized for the years ended December 31, 2023 and 2022, excluding variable lease and prepaid rent costs: +Year Ended December 31, +2023 2022 +(in thousands) +Operating lease expense +Operating lease right of use assets $ 12,524 $ 8,670 +Operating lease non right of use assets 6,810 7,697 +Total operating lease expense $ 19,334 $ 16,367 +Finance lease expense +Depreciation of right of use assets $ 89 $ 385 +Interest on lease obligations 69 199 +Total finance lease expense $ 158 $ 584 +Operating lease expense is included in the line items “Cost of revenues” and “General and administrative expenses” in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2023 and 2022. +F-16 +Supplemental information related to leases was as follows as of December 31, 2023 and 2022: +December 31, +2023 2022 +Operating leases +Weighted average remaining lease term 4.3 5.3 +Weighted average discount rate 5.8 % 5.0 % +Finance leases +Weighted average remaining lease term 0.7 0.4 +Weighted average discount rate 25.1 % 21.7 % +Supplemental balance sheet information related to leases was as follows as of December 31, 2023 and 2022: +December 31, +2023 2022 +(in thousands) +Operating lease right of use assets +Operating lease right of use assets, gross $ 65,026 $ 52,947 +Less: Accumulated amortization ( 22,970 ) ( 16,611 ) +Operating lease right of use assets, net $ 42,056 $ 36,336 +Operating lease obligations +Current portion of operating lease obligations $ 10,314 $ 7,956 +Long-term operating lease obligations 32,594 29,370 +Total operating lease obligations $ 42,908 $ 37,326 +Finance lease right of use assets +Finance lease right of use assets, gross $ 70 $ 1,057 +Less: Accumulated depreciation ( 19 ) ( 510 ) +Finance lease right of use assets, net $ 51 $ 547 +Finance lease obligations +Current portion of finance lease obligations $ 31 $ 178 +Long-term finance lease obligations — — +Total finance lease obligations $ 31 $ 178 +F-17 +Future annual minimum lease payments as of December 31, 2023 were as follows: +Operating Lease Right of Use Obligations Finance Leases Total +(in thousands) +2024 $ 12,470 $ 46 $ 12,516 +2025 11,571 — 11,571 +2026 9,998 — 9,998 +2027 7,169 — 7,169 +2028 5,588 — 5,588 +Thereafter 1,567 — 1,567 +Total lease payments $ 48,363 $ 46 $ 48,409 +Less: present value discount ( 5,455 ) ( 15 ) ( 5,470 ) +Present value of lease obligations $ 42,908 $ 31 $ 42,939 +Supplemental cash flow information related to leases for the years ended December 31, 2023 and 2022 were as follows: +Year Ended December 31, +2023 2022 +(in thousands) +Cash paid for amounts included in the measurement of lease obligations: +Operating cash flows from operating leases $ 12,344 $ 8,698 +Operating cash flows from finance leases $ 89 $ 385 +Financing cash flows from finance leases $ 217 $ 1,269 +Right of use assets obtained in exchange for lease obligations: +Operating leases $ 15,955 $ 8,356 +Finance leases $ 70 $ 336 +7. Intangible Assets +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2023 and 2022 were as follows: +December 31, 2023 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 52,622 ) $ 10,648 3.8 +Non-compete agreements 6,500 ( 6,500 ) — 0.0 +Technology 125,110 ( 45,329 ) 79,781 9.7 +Total $ 194,880 $ ( 104,451 ) $ 90,429 +F-18 +December 31, 2022 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 49,845 ) $ 13,425 4.8 +Non-compete agreements 6,500 ( 6,166 ) 334 0.8 +Technology 125,110 ( 36,924 ) 88,186 10.7 +Total $ 194,880 $ ( 92,935 ) $ 101,945 +The Company abandoned its “E-Set” tools business and related $ 1.0 million in-process research and development indefinite-lived intangible asset in the fourth quarter of 2022. +Amortization of Intangibles +Amortization of intangibles was $ 11.5 million and $ 13.5 million for the years ended December 31, 2023 and 2022, respectively. +Future estimated amortization of intangibles is as follows: +Year Ending December 31, (in thousands) +2024 $ 11,183 +2025 11,183 +2026 11,082 +2027 10,315 +2028 8,000 +Thereafter 38,666 +$ 90,429 +8. Accrued Expenses +Accrued expenses as of December 31, 2023 and 2022 consisted of the following: +December 31, +2023 2022 +(in thousands) +Accrued interest $ 17,216 $ 5,012 +Accrued compensation and benefits 9,784 10,283 +Accrued bonus 1,169 3,979 +Accrued legal fees and settlements 68 145 +Other accrued expenses 7,934 8,972 +Accrued expenses $ 36,171 $ 28,391 +F-19 +9. Debt Obligations +The Company’s debt obligations as of December 31, 2023 and 2022 were as follows: +December 31, +2023 2022 +(in thousands) +2028 Notes $ 300,000 $ — +2023 Notes (1) +— 307,339 +ABL Credit Facility (1) +57,000 32,000 +Other short-term debt (2) +2,859 2,267 +Total debt before deferred financing costs $ 359,859 $ 341,606 +Deferred financing costs ( 36,480 ) ( 1,308 ) +Total debt $ 323,379 $ 340,298 +Less: Current portion of long-term debt ( 2,859 ) ( 2,267 ) +Long-term debt $ 320,520 $ 338,031 +(1) Subsequent to December 31, 2022, the Company redeemed all of the outstanding 2023 Notes and extended the maturity date of the ABL Credit Facility from October 25, 2023 to January 29, 2027. As such, these obligations are classified as long-term on the Company’s Consolidated Balance Sheet at December 31, 2022. Refer to further disclosure within this footnote for additional information. +(2) The weighted average interest rate of short-term debt outstanding at December 31, 2023 and 2022, respectively, was 8.2 % and 6.0 %. +Units Offering and 2028 Notes +Units +On January 30, 2023, the Company completed its public offering of 300,000 units with an aggregate stated amount of $ 300.0 million (the “Units”). Each Unit consisted of $1,000 principal amount of the Company’s 13.000 % Senior Secured Notes due 2028 (collectively, the “2028 Notes”) and five shares of common stock (the “Common Stock”) of the Company. The Company received proceeds of $ 279.8 million from the Units offering, after deducting underwriting discounts and commission, which was used to fund a portion of the redemption price of the 2023 Notes (as defined and described below). These proceeds were allocated to the 2028 Notes and the Common Stock based on their relative fair value at the time of issuance. +Each Unit separated into its constituent securities (the 2028 Notes and shares of Common Stock) automatically on October 27, 2023. A holder of Units could have elected to separate its Units into its constituent securities, in whole but not in part, on or after March 31, 2023. Prior to such date, the Units could not be separated at the option of the holder. +In the first quarter of 2023, the Company recorded approximately $ 41.7 million of deferred financing costs in connection with the Units offering. These costs are direct deductions from the carrying amount of the 2028 Notes and are being amortized through interest expense through the maturity date of the 2028 Notes using the effective interest method. The unamortized portion of these deferred financing costs was $ 36.5 million at December 31, 2023 . +2028 Notes +On January 30, 2023, the Company and certain of its subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes, which form a part of the Units, were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000 % payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are senior secured obligations of the Company and are guaranteed on a senior secured basis by each of the Company’s current domestic subsidiaries and will be so guaranteed by certain future subsidiaries, in each case, subject to agreed guaranty and security principles and certain exclusions. +Prior to February 1, 2026, the Company may, on any one or more occasions, redeem all or a part of the 2028 Notes at a redemption price equal to 100.0 % of the principal amount of the 2028 Notes redeemed, plus a “make-whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, prior to February 1, 2026, the Company may, from time to time, redeem up to 35.0 % of the aggregate principal amount of the 2028 Notes with an amount of +F-20 +cash not greater than the net cash proceeds of certain equity offerings at a redemption price equal to 113.0 % of the principal amount of the 2028 Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption, provided that at least 65.0 % of the aggregate principal amount of the 2028 Notes originally issued under the 2028 Notes Indenture on January 30, 2023 remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of such equity offering. Also, prior to February 1, 2026, the Company may redeem during each 12-month period beginning on January 30, 2023, up to 10 % of the aggregate principal amount of the 2028 Notes outstanding at a redemption price equal to 103.0 % of the aggregate principal amount of the 2028 Notes being redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +On and after February 1, 2026, the Company may redeem the 2028 Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount of the 2028 Notes to be redeemed) set forth below, plus accrued and unpaid interest, if any, to, but excluding the date of redemption, if redeemed during the periods indicated: +Redemption Price +February 1, 2026 to January 31, 2027 106.500 % +February 1, 2027 to October 31, 2027 103.250 % +November 1, 2027 and thereafter 100.000 % +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), the Company is required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0 % of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100 % of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. +If the Company experiences certain changes of control, each holder of 2028 Notes may require the Company to repurchase all or a portion of its 2028 Notes for cash at a price equal to 101.0 % of the principal amount of such 2028 Notes, plus any accrued but unpaid interest, if any, to, but excluding, the date of repurchase. +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit the Company’s ability and the ability of its restricted subsidiaries to (i) incur additional indebtedness and guarantee indebtedness; (ii) pay dividends or make other distributions of capital stock; (iii) prepay, redeem or repurchase certain debt; (iv) issue certain preferred stock or similar equity securities, (v) make loans and investments; (vi) sell assets; (vii) incur liens; (viii) enter into transactions with affiliates; (ix) enter into agreements restricting its subsidiaries’ ability to pay dividends; or (x) consolidate, merge, or sell all or substantially all of its assets. The Company was in compliance with the provision of the 2028 Notes Indenture at December 31, 2023. +Upon an event of default, the trustee of the 2028 Notes or the holders of at least 25 % in aggregate principal amount of then outstanding 2028 Notes may declare the 2028 Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding 2028 Notes to become due and payable. +2023 Notes +On October 25, 2018, the Company issued $ 400.0 million principal amount of 8.750 % Senior Notes due 2023 (the “2023 Notes”). The 2023 Notes were issued under an indenture, dated as of October 25, 2018, by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as trustee. The 2023 Notes bore interest at an annual rate of 8.750 % payable on May 1 and November 1 of each year, commencing May 1, 2019. The 2023 Notes were senior +F-21 +unsecured obligations of the Company and were fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s domestic subsidiaries. +On February 1, 2023, with proceeds received from its public offering of Units and borrowings under its ABL Credit Facility (as defined and described below), the Company redeemed all of the outstanding 2023 Notes at a redemption price of 100.0 % of outstanding principal amount thereof ($ 307.3 million), plus accrued and unpaid interest ($ 6.7 million). The Company also wrote off unamortized deferred financing costs in the amount of $ 1.2 million associated with the 2023 Notes in conjunction with the redemption. +ABL Credit Facility +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A., as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permitted aggregate borrowings of up to $ 200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $ 25.0 million and a sub-limit of $ 50.0 million for letters of credit (the “ABL Credit Facility”). Pursuant to the 2018 ABL Credit Agreement, the ABL Credit Facility was set to mature on October 25, 2023 or, if earlier, on the date that was 180 days before the scheduled maturity date of the 2023 Notes if they had not been redeemed or repurchased by such date. +Pursuant to the 2018 ABL Credit Agreement, loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the ABL Credit Facility were base rate loans or London Interbank Offered Rate (“LIBOR”) loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche were Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans varied from 0.75 % to 1.25 %, and the applicable margin for LIBOR loans or CDOR loans varied from 1.75 % to 2.25 %, in each case depending on the Company’s leverage ratio. In addition, a commitment fee of 0.50 % per annum was charged on the average daily unused portion of the revolving commitments. +On January 17, 2023, the Company entered into the First Amendment to Credit Agreement (the “ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which amends certain terms of the 2018 ABL Credit Agreement (as amended the “ABL Credit Agreement”). The ABL Facility Amendment became effective on January 30, 2023. +Pursuant to the ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $ 200.0 million to $ 150.0 million, subject to the borrowing base (the “Loan Limit”), (b) changed the interest rate benchmark from LIBOR to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75 % to 2.25 % to a range of 2.00 % to 2.50 %, in each case depending on the Company’s leverage ratio, (c) modified the financial covenant, enhanced reporting and cash dominion triggers in the ABL Credit Facility from the existing minimum availability threshold of the greater of $ 18.75 million and 12.5 % of the Loan Limit to a minimum availability threshold of (i) $ 12.5 million from January 30, 2023 until May 31, 2023 and (ii) the greater of $ 17.5 million and 12.5 % of the Loan Limit thereafter, (d) decreased the Canadian tranche sub-limit from $ 25.0 million to $ 5.0 million, (e) decreased the letter of credit sub-limit from $ 50.0 million to $ 10.0 million and (f) made satisfaction of the Payment Conditions (as defined in the ABL Facility Amendment) a condition to an Excess Cash Flow Offer in addition to a condition to voluntary payments of the 2028 Notes. The Payment Conditions in summary are (A) no default or event of default on a pro forma basis and (B) immediately after and at all times during the 30 days prior, on a pro forma basis, (1) (x) availability under the ABL Credit Facility shall not be less than the greater of 15 % of the Loan Limit and $ 22.5 million and (y) the fixed charge coverage ratio shall be at least 1.00 to 1.00 or (2) availability under the ABL Credit Facility shall not be less than the greater of 20 % of the Loan Limit and $ 30.0 million. +The ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and transactions with affiliates. In addition, the ABL Credit Agreement contains a financial covenant requiring a minimum fixed charge ratio of 1.00 to 1.00 that is tested quarterly when (a) the availability under the ABL Credit Facility drops below (i) at any time on or before May 31, 2023, $ 12.5 million and (ii) at any time thereafter, the greater of $ 17.5 million and 12.5 % of the Loan Limit or (b) a default has occurred. This financial covenant applies until the availability exceeds the applicable threshold for 30 consecutive days and no default is ongoing. The Company was in compliance with all covenants under the ABL Credit Agreement as of December 31, 2023 . +F-22 +Pursuant to the ABL Credit Agreement, all of the obligations under the ABL Credit Facility are secured by security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. +Both the ABL Credit Facility and the Units collateralization were completed within 30 days after closing of the Units offering in accordance with the terms of the ABL Facility Amendment and the 2028 Notes Indenture. +At December 31, 2023, the Company had $ 57.0 million outstanding borrowings under the ABL Credit Facility, and its availability under the ABL Credit Facility was approximately $ 28.1 million, net of outstanding letters of credit of $ 1.1 million. On February 14, 2024, the Company repaid approximately $ 5.0 million of its outstanding borrowings under the ABL Credit Facility. +Magnum Promissory Notes +On October 25, 2018, pursuant to the terms of a Securities Purchase Agreement, dated October 15, 2018 (as amended on June 7, 2019, the “Magnum Purchase Agreement”), the Company acquired all of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd. (such entities collectively, “Magnum”). The Magnum Purchase Agreement included the potential for additional future payments in cash of (i) up to 60 % of net income (before interest, taxes, and certain gains or losses) for the “E-Set” tools business in 2019 through 2026 and (ii) up to $ 25.0 million based on sales of certain dissolvable plug products in 2019 (the “Magnum Earnout”). +On June 30, 2020, pursuant to an amendment to the Magnum Purchase Agreement to terminate the remaining Magnum Earnout and all obligations related thereto, the Company issued promissory notes with an aggregate principal amount of $ 2.3 million (the “Magnum Promissory Notes”) to the sellers of Magnum. The Magnum Promissory Notes bore interest at a rate of 6.0 % per annum. The principal amount of the Magnum Promissory Notes was paid in equal quarterly installments which began January 1, 2021. The remaining outstanding balance was paid on October 1, 2022. +Other Short-Term Debt +From time to time, the Company renews certain insurance policies and finances the premium for its excess policy. The outstanding balance on these premiums was $ 2.9 million and $ 2.3 million at December 31, 2023 and 2022, respectively. +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2023 and 2022 was as follows: +December 31, +2023 2022 +(in thousands) +2028 Notes $ 264,750 $ — +2023 Notes $ — $ 300,700 +ABL Credit Facility $ 57,000 $ 32,000 +Other short-term debt $ 2,859 $ 2,267 +The fair value of the 2028 Notes, 2023 Notes, ABL Credit Facility, and other short-term debt is classified as Level 2 in the fair value hierarchy. The fair value of the 2028 Notes and the 2023 Notes is established based on observable inputs in less active markets. The fair value of the ABL Credit Facility and other short-term debt approximates their carrying value. +10. Defined Contribution Plans +Background +The Company sponsors a defined contribution plan, the Nine Energy Service 401(k) Plan (the “Nine Plan”), under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +During the year ended December 31, 2022, the Company did not match employee contributions. +Effective January 1, 2023, employee contributions were matched by the Company at 100 % of the first 3 % and 50 % of the remaining up to 5 % of the participant’s eligible compensation. +F-23 +Contributions +For the year ended December 31, 2023, the Company made employer contributions of $ 2.0 million under the Nine Plan. +For the year ended December 31, 2022, the Company made no employer contributions under the Nine Plan. +11. Stock-based Compensation +Stock Options +Information about stock option activity during the years ended December 31, 2023 and 2022 was as follows: +2023 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 587,506 $ 33.80 3.0 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 52,015 ) 26.50 — — +Total outstanding 535,491 $ 34.51 2.2 $ — +Options exercisable 535,491 $ 34.51 2.2 $ — +2022 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 610,410 $ 33.52 3.9 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 22,904 ) 26.28 — — +Total outstanding 587,506 $ 33.80 3.0 $ — +Options exercisable 587,506 $ 33.80 3.0 $ — +The intrinsic value at December 31, 2023 and 2022 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2023 and 2022, respectively. +The Company granted no options in 2023 and 2022. +There was no compensation expense recorded for the years ended December 31, 2023 and 2022. As of December 31, 2023, there is no remaining compensation expense related to options for the Company to expense. Future stock option grants will result in additional compensation expense. +F-24 +Restricted Stock and Restricted Stock Units +Information about restricted stock and restricted stock unit activity during the years ended December 31, 2023 and 2022 was as follows: +2023 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2023 1,934,556 $ 2.12 +Granted 662,845 3.51 +Vested ( 1,063,090 ) 1.85 +Forfeited ( 59,767 ) 2.63 +Nonvested at December 31, 2023 1,474,544 $ 2.92 +2022 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2022 2,379,320 $ 2.83 +Granted 651,250 2.80 +Vested ( 1,068,092 ) 4.13 +Forfeited ( 27,922 ) 2.02 +Nonvested at December 31, 2022 1,934,556 $ 2.12 +The total amount of compensation expense related to the restricted stock and restricted stock units recorded was approximately $ 2.2 million and $ 2.4 million for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, the Company expects to record compensation expense related to restricted stock and restricted stock units of approximately $ 3.0 million over the remaining term of approximately 1.8 years. Future restricted stock and restricted stock unit grants would result in additional compensation expense. +Performance Cash Awards +In May 2022 and May 2023, the Company granted performance cash awards (the “PCAs”) that vest based upon the Company’s achievement of certain criteria related to its relative total shareholder return (“TSR”) in comparison to TSR of members of its peer group (the “Peer Group”), as defined by the PCA grant. These awards, which the Company granted at a target achievement amount, are subject to three individual year-long performance periods (the “Performance Periods”), and payment related to each Performance Period can range from 0 % to 200 % of the target amount for that Performance Period. +The PCAs were valued on the date of grant based on the estimated fair value, which was based on numerous assumptions including the likelihood of the Company’s stock price performance achieving targeted thresholds, using a Monte Carlo simulation model. The assumptions used to value the awards included the historical volatility of the Company as well as the volatility of its Peer Group and the risk-free rate, which was derived using the U.S. Treasury security rates. +Under the relevant liability accounting, the Level 3 fair values for each tranche of the PCAs are remeasured at the end of each reporting period and was $ 2.0 million and $ 3.4 million at December 31, 2023 and 2022, respectively. +The following information is related to the Company’s May 2023 grant of PCAs at December 31, 2023. +December 31, 2023 +Volatility for remeasurement 118.62 % +Risk-free rate 4.11 % +F-25 +The following information is related to the Company’s May 2022 grant of PCAs at December 31, 2023 and December 31, 2022. +December 31, 2023 December 31, 2022 +Volatility for remeasurement 98.16 % 123.82 % +Risk-free rate 4.55 % 4.30 % +Expense related to performance cash was $ 1.3 million and $ 1.8 million for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, there was $ 1.1 million of remaining compensation expense related to performance cash for the Company to expense. Future PCA grants will result in additional compensation expense. +12. Commitments and Contingencies +Litigation +The Company records accruals related to litigation and other legal proceedings when they are either known or considered probable and can be reasonably estimated. Legal proceedings are inherently unpredictable and subject to significant uncertainties, and significant judgment is required to determine both probability and the estimated amount. Some of these uncertainties include the stage of litigation, available facts, uncertainty as to the outcome of any legal proceedings or settlement discussions, and any novel legal issues presented. Because of such uncertainties, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to pending litigation. As of both December 31, 2023 and 2022, the Company recorded a $ 0.1 million accrual for liabilities related to legal matters, which is included under the caption “Accrued expenses” in its Consolidated Balance Sheets. +From time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +Self-insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance claims. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $ 1.6 million and $ 1.2 million at December 31, 2023 and 2022, respectively, and is included under the caption “Accrued expenses” on the Company’s Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +Contingent Liabilities +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (“the Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. The Frac Tech Purchase Agreement, as amended, includes, among other things, the potential for additional future payments, based on certain Frac Tech revenue metrics through December 31, 2025. +F-26 +The Company’s contingent liability (Level 3) for the years ended December 31, 2023 and 2022 was as follows: +Frac Tech +(in thousands) +Balance at December 31, 2021 $ 910 +Payments ( 195 ) +Revaluation adjustments 454 +Balance at December 31, 2022 $ 1,169 +Payments ( 387 ) +Revaluation adjustments 437 +Balance at December 31, 2023 $ 1,219 +All contingent liabilities that relate to contingent consideration are reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include forecasted sales of the plugs, terms of the agreement, a risk-adjusted discount factor (ranging from 4.5 % to 5.7 %), and a credit-adjusted rate (ranging from 11.5 % to 11.6 %). Contingent liabilities include $ 0.8 million and $ 0.4 million reported in “Accrued expenses” at December 31, 2023 and 2022, respectively, and $ 0.4 million and $ 0.8 million reported in “Other long-term liabilities” at December 31, 2023 and 2022, respectively, in the Company’s Consolidated Balance Sheets. The impact of the revaluation adjustments is included in the Company’s Consolidated Statements of Income and Comprehensive Income (Loss). +13. Taxes +The components of the provision (benefit) for income taxes for the years ended December 31, 2023 and 2022 were as follows: +Year Ended December 31, +2023 2022 +(in thousands) +Current +U.S. federal $ — $ — +U.S. state 502 510 +Foreign 83 36 +Total current provision $ 585 $ 546 +Deferred +U.S. federal $ — $ — +U.S. state — — +Foreign — — +Total deferred provision (benefit) — — +Total provision for income taxes $ 585 $ 546 +F-27 +The provision (benefit) for income taxes for the years ended December 31, 2023 and 2022 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2023 2022 +(in thousands) +Tax provision (benefit) at statutory rate $ ( 6,642 ) $ 3,137 +Foreign rate differential ( 7 ) ( 16 ) +State income taxes, net of federal benefit 397 403 +Nondeductible expenses 2,137 912 +Valuation allowance 5,158 ( 5,823 ) +Non-cash compensation ( 515 ) 1,879 +Other 57 54 +Total provision for income taxes $ 585 $ 546 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2023 and 2022 were as follows: +December 31, +2023 2022 +(in thousands) +Deferred income tax assets: +Inventories $ 1,931 $ 2,298 +Goodwill and intangible assets 67,860 75,617 +Deferred tax benefit from net losses 85,708 79,914 +Stock-based compensation and cash award expense 2,260 2,524 +Tax credit carryforwards 660 655 +Accrued expenses 872 678 +Interest carryover 20,814 13,860 +Lease liability 9,757 8,441 +Other 489 163 +Total deferred income tax assets 190,351 184,150 +Less: Valuation allowance ( 168,034 ) ( 162,888 ) +Net deferred income tax assets $ 22,317 $ 21,262 +Deferred income tax liabilities: +Property and equipment $ ( 12,745 ) $ ( 12,974 ) +ROU asset ( 9,572 ) ( 8,288 ) +Total deferred income tax liabilities ( 22,317 ) ( 21,262 ) +Net deferred income tax asset (liability) $ — $ — +As of December 31, 2023, the Company had federal and state net operating loss carryforwards (“NOLs”) of approximately $ 471.8 million. The federal NOLs related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state NOLs can be used from 7 to 20 years and vary by state. A small portion of state NOLs expired in 2023. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its NOL and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results, the Company continues to be in a three-year cumulative loss position for the year ended December 31, 2023. According to ASC 740, cumulative losses in recent years represent significant negative evidence in +F-28 +considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its U.S. domestic and Canadian deferred tax assets. The 2023 results include an increase in the Company’s valuation allowance of approximately $ 5.1 million. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a tax benefit. +The Company is subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2020. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +The Company accounts for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. A reconciliation of the beginning and ending amount of uncertain tax positions is as follows: +2023 +(in thousands) +Balance at January 1, $ 779 +Change in prior year tax positions ( 235 ) +Change in current year tax positions — +Cash settlements with taxing authorities — +Lapse of statute of limitations — +Balance at December 31, $ 544 +The total amount of unrecognized tax benefits at December 31, 2023 was $ 0.5 million. The total balance of unrecognized tax benefit would impact the Company’s future effective income tax rate if recognized. During 2023, the Company released approximately $ 0.2 million of the unrecognized tax benefit due to a decrease in federal refund expected from a prior year. The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income and Comprehensive Income (Loss). As of December 31, 2023, no interest and penalties have been accrued. +14. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of Common Stock outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding during each period and the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Common Stock for each of the periods presented as well as the potentially dilutive restricted stock, restricted stock units, and performance stock units. +Basic and diluted earnings (loss) per share of Common Stock was computed as follows: +Year Ended December 31, 2023 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 32,213 ) 33,282,234 $ ( 0.97 ) +Unvested restricted stock and stock units — — — +Diluted $ ( 32,213 ) 33,282,234 $ ( 0.97 ) +Year Ended December 31, 2022 +Net Income Average Shares Outstanding Earnings Per Share +(in thousands, except for share and per share amounts) +Basic $ 14,393 30,930,890 $ 0.47 +Unvested restricted stock and stock units — 1,320,508 — +Diluted $ 14,393 32,251,398 $ 0.45 +F-29 +The diluted earnings (loss) per share calculation excludes all stock options, unvested restricted stock, unvested restricted stock units, and unvested performance stock units for 2023 because there is a net loss for the period, and their inclusion would be anti-dilutive. The average number of securities that were excluded from diluted earnings (loss) per share that would potentially dilute earnings (loss) per share for the period in which the Company experienced a net loss was as follows: +2023 +Year ended December 31, 1,113,033 +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.3 million for both the years ended December 31, 2023 and 2022. The Company also purchased $ 2.9 million and $ 2.6 million of products and services for the years ended December 31, 2023 and 2022, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $ 0.2 million and $ 0.1 million at December 31, 2023 and 2022, respectively. +In addition, the Company completed leasing office space in Corpus Christi, Texas at the end of 2023 and previously leased office space in Midland, Texas from an entity (the “Leasing Entity”) affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Common Stock. From the third quarter of 2020 through mid-2022, another entity affiliated with Mr. Frazier sub-leased a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was $ 1.2 million and $ 1.6 million for the years ended December 31, 2023 and 2022, respectively. There were no net outstanding payables due to the Leasing Entity at December 31, 2023 and $ 0.1 million of net outstanding payables at December 31, 2022. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2023, there was no outstanding principal balance payable to Mr. Frazier as the balance payable to Mr. Frazier of $ 1.1 million at December 31, 2021 was paid during 2022. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 1.5 million and $ 0.8 million for the years ended December 31, 2023 and 2022, respectively. Total outstanding receivables due to the Company from NESR were $ 0.4 million and $ 0.2 million at December 31, 2023 and 2022, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 3.0 million and $ 2.2 million for the years ended December 31, 2023 and 2022, respectively. There were outstanding receivables due from Devon of $ 0.7 million and $ 0.5 million at December 31, 2023 and 2022, respectively. +16. Other Supplemental Information +Total Assets by Segment +Total assets by segment as of December 31, 2023 and 2022 were as follows: +December 31, +2023 2022 +(in thousands) +Completion Solutions $ 359,205 $ 399,546 +Corporate 42,779 27,288 +$ 401,984 $ 426,834 +F-30 +Long-lived Assets by Country +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2023 and 2022 were as follows: +December 31, +2023 2022 +(in thousands) +United States $ 171,453 $ 189,962 +Canada and other 1,342 1,700 +$ 172,795 $ 191,662 +ATM Program +On November 6, 2023, the Company entered into an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Sandler & Co. (the “Agent”). Pursuant to the Equity Distribution Agreement, the Company may, from time to time, sell shares of Common Stock having an aggregate offering price of up to $ 30.0 million through the Agent acting as the Company’s sales agent. The Agent will receive a commission equal to 3.0 % of the gross sale price of any shares sold under the Equity Distribution Agreement. Under the Equity Distribution Agreement, the Company will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made and any price below which sales may not be made. During the quarter ended December 31, 2023, no sales were made under the Equity Distribution Agreement. +F-31 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2023. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2023. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2023, our management assessed the effectiveness of our internal control over financial reporting based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on its assessment using the criteria established by COSO, management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +The effectiveness of our internal control over financial reporting as of December 31, 2023 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-1 of this Annual Report and which is included in Item 8 of Part II of this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information +None. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +51 +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. +Item 11. Executive Compensation +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. +52 +PART IV +Item 15. Exhibit and Financial Statement Schedules +(a) Documents Filed as Part of This Annual Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this Annual Report: +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F- 3 +Consolidated Statements of Income and Comprehensive Income (Loss) for the Years Ended December 31, 2023 and 2022 +F- 4 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2023 and 2022 +F- 5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2023 and 2022 +F- 6 +Notes to Consolidated Financial Statements +F- 8 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable, or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number Description +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +4.4 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.5 +Indenture, dated as of January 30, 2023, by and among Nine Energy Service, Inc., the guarantors party thereto and U.S. Bank Trust Company, National Association, as trustee and as notes collateral agent (including Form of Note) (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on February 1, 2023). +4.6 +Description of Common Stock (Incorporated by reference to Exhibit 4.7 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 10, 2020). +10.1 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +53 +10.2 +First Amendment to Credit Agreement, dated as of January 17, 2023, among Nine Energy Service, Inc., Nine Energy Canada Inc., the guarantors party thereto, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 18, 2023). +10.3+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.4+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.5+ +First Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of the Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 6, 2021). +10.6+ +Second Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 8, 2023). +10.7+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.8+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.9+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.10+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.11+ +Form of Nine Energy Service, Inc. Performance Share Unit Grant Notice and Form of Performance Share Unit Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 8, 2019). +10.12+ +Form of Nine Energy Service, Inc. Cash Award Grant Notice and Form of Cash Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 5, 2022). +10.13+ +Form of Nine Energy Service, Inc. Performance-Based Cash Award Grant Notice and Form of Performance-Based Cash Award Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 4, 2022). +10.14+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.15+ +Employment Agreement between Guy Sirkes and Nine Energy Service, LLC, dated as of March 31, 2020 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.16+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.17+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.18+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.19+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and David Crombie (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.20+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Guy Sirkes (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +54 +10.21+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Theodore R. Moore (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +22.1* +List of Subsidiary Guarantors and Affiliates Whose Securities Collateralize Securities of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP. +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +97.1* +Nine Energy Service, Inc. Clawback Policy. +101* Interactive Data Files. +___________________________________ +* Filed herewith. +** Furnished herewith. ++ Management contract or compensatory plan or arrangement. +55 +Item 16. Form 10-K Summary +None. +56 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: /s/ Ann G. Fox +Ann G. Fox +President and Chief Executive Officer +Date: March 7, 2024 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 7, 2024. +Signature Title +/s/ Ann G. Fox President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Guy Sirkes Senior Vice President and Chief Financial Officer (Principal Financial Officer) +Guy Sirkes +/s/ S. Brett Luz Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Ernie L. Danner Chairman of the Board +Ernie L. Danner +Director +Mark E. Baldwin +/s/ Curtis F. Harrell Director +Curtis F. Harrell +/s/ Scott E. Schwinger Director +Scott E. Schwinger +/s/ Gary L. Thomas Director +Gary L. Thomas +/s/ Andrew L. Waite Director +Andrew L. Waite +/s/ Darryl K. Willis Director +Darryl K. Willis +57 \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/filing_metadata.csv b/raw/filings/0001532286/2023/0001532286-24-000004/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..9fe5a7228ab7bc547ea9faa705912d62392de1af --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2024-03-08,2023-12-31,2024-03-07T22:42:13.000Z,0001532286-24-000004,nine-20231231.htm,10-K,9075715,1,1,https://www.sec.gov/Archives/edgar/data/1532286/000153228624000004/nine-20231231.htm,https://www.sec.gov/Archives/edgar/data/1532286/000153228624000004/,2023,2023,1 diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/item1.txt b/raw/filings/0001532286/2023/0001532286-24-000004/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..92e9b5d9688429425e488a28d435bd7eea5c5ed2 --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/item1.txt @@ -0,0 +1,103 @@ +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2023, we completed approximately 22,000 cementing jobs, with an on-time rate of approximately 89%. Punctuality of service is one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. Our tool portfolio also includes a multi-cycle barrier valve to address the international, conventional markets. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2023, we deployed approximately 470,600 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted several of our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite and dissolvable frac plugs through our wireline units. From January 2018 through December 2023, we completed approximately 163,600 wireline stages with a success rate of approximately 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place) while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 27,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2023, we have performed approximately 7,100 jobs and deployed more than 191 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rocky Mountains, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2023, our top five customers collectively accounted for approximately 21% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, Patterson-UTI Energy, KLX Energy Services Holdings, Innovex, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2023, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2023, we had 1,157 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations as well as Canada’s new anti-forced labor law. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported or disposed or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +At December 31, 2023, we operated a fleet in excess of 590 commercial motor vehicles. As such, we are subject to regulation as a motor carrier by the U.S. Department of Transportation (the “DOT”) and analogous state agencies and their applicable federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Materials Regulations for interstate travel promulgated by the FMCSA under the DOT and comparable state regulations for intrastate travel. These regulatory authorities exercise broad powers, governing activities such as the authorization to engage in motor carrier operations, regulatory safety, equipment testing, driver requirements and specifications, and insurance requirements. In connection with these rules, substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States (“WOTUS”) and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers (the “Corps”) or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In 2015, the EPA and the Corps issued a rule defining the scope of federal jurisdiction over WOTUS, which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in 2020. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. In January 2023, the EPA and the Corps issued a final rule that based the definition of WOTUS on the pre-2015 definition. Separately, in May 2023, the U.S. Supreme Court’s decision in Sackett v. EPA narrowed federal jurisdiction over wetlands to “traditional navigable waters” and wetlands or other waters that have a “continuous surface connection” with, or are otherwise indistinguishable from, traditional navigable waters. In September 2023, the EPA and the Corps published a direct-to-final rule that conforms the regulatory definition of WOTUS to the Supreme Court’s May 2023 decision in Sackett . However, litigation opposing the September 2023 final rule remains ongoing and substantial uncertainty exists with respect to future implementation of the September 2023 rule and the scope of the Clean Water Act’s jurisdiction more generally. To the extent a future rule or court decision expands the range of properties subject to the Clean Water Act’s jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In September 2020, the EPA finalized two sets of amendments to the 2016 Subpart OOOOa standards. The first, known as the 2020 Technical Rule, reduced the 2016 rule’s fugitive emissions monitoring requirements and expanded exceptions to pneumatic pump requirements, among other changes. The second, known as the 2020 Policy Rule, rescinded the methane-specific requirements for certain oil and natural gas sources in the production and processing segments. On January 20, 2021, President Biden issued an Executive Order directing the EPA to rescind the 2020 Technical Rule by September 2021 and consider revising the 2020 Policy Rule. On June 30, 2021, President Biden signed a Congressional Review Act (the “CRA”) resolution passed by Congress that revoked the 2020 Policy Rule. The CRA resolution did not address the 2020 Technical Rule. +In December 2023, the EPA issued a final rule, under the CAA’s New Source Performance Standards, intended to reduce methane emissions from new and existing oil and gas sources. The new rule makes the existing regulations in Subpart OOOOa more stringent and creates a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources that commenced construction, modification, or reconstruction after December 6, 2022, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). The new rule phases out flaring through Subpart OOOOb, which prohibits routine flaring from new oil wells after the phase-in period, and through a new Subpart OOOOc, which prohibits flaring absent a showing of technical infeasibility for existing wells with documented methane emissions of 40 tons per year or +10 +more. In addition, the final rule establishes “Emissions Guidelines” in Subpart OOOOc, which requires states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. The final rule gives states, along with federal tribes that wish to regulate existing sources, two years to develop and submit their plans for reducing methane emissions from existing sources. The final emissions guidelines under Subpart OOOOc provide three years from the plan submission deadline for existing sources (i.e., sources constructed prior to December 6, 2022) to comply. +Although there may be an adverse financial impact (including compliance costs, potential permitting delays and increased regulatory requirements) associated with these regulatory changes, the extent and magnitude of impacts cannot be reliably or accurately estimated due to the present uncertainty regarding any additional measures and how they will be implemented. Any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. In February 2021, the United States rejoined the Paris Agreement and announced that it was setting a target to reduce U.S. GHG emissions by 50-52% by the year 2030 as compared with 2005 levels and agreed to provide periodic updates on its progress. In addition, in September 2021, President Biden publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. Since its formal launch at the United Nations 26th Conference of the Parties, over 150 countries have joined the pledge. At the 27th Conference of the Parties, President Biden announced the EPA’s supplemental proposed rule to reduce methane emissions from existing oil and gas sources and agreed, in conjunction with the European Union and a number of other partner countries, to develop standards for monitoring and reporting methane emissions to help create a market for low methane-intensity natural gas. At the 28th Conference of the Parties, member countries agreed to the first “global stocktake,” which calls on countries to contribute to global efforts, including a tripling of renewable energy capacity and doubling energy efficiency improvements by 2030, accelerating efforts toward the phase-down of unabated coal power, phasing out inefficient fossil fuel subsidies, and transitioning away from fossil fuels in energy systems. The impacts of these orders, pledges, agreements, and any legislation, regulation, regulatory initiatives, changes to existing regulation or executive actions cannot be predicted at this time. +While the Biden Administration has pursued executive actions to address climate change, the U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, but no new comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future, and energy legislation and other regulatory initiatives have been proposed that are relevant to GHG emissions issues. For example, the Inflation Reduction Act of 2022, which appropriates significant funding for renewable energy initiatives and, for the first time, imposes a fee on GHG emissions from certain oil and gas facilities, was signed into law in August 2022. The Inflation Reduction Act amends the CAA to include a Methane Emissions and Waste Reduction Incentive Program, which requires the EPA to impose a “waste emissions charge” on certain natural gas and oil sources that are already required to report under the EPA’s Greenhouse Gas Reporting Program. To implement the program, the Inflation Reduction Act requires revisions to GHG reporting regulations for +11 +petroleum and natural gas systems (Subpart W) by 2024. In July 2023, the EPA proposed to expand the scope of the Greenhouse Gas Reporting Program for petroleum and natural gas facilities, as required by the Inflation Reduction Act. Among other things, the proposed rule would expand the emissions events that are subject to reporting requirements to include “other large release events” and apply reporting requirements to certain new sources and sectors. The rule is expected to be finalized in the spring of 2024 and become effective on January 1, 2025, in advance of the deadline for GHG reporting for 2024 (March 2025). In January 2024, the EPA proposed a rule implementing the Inflation Reduction Act’s methane emissions charge. The proposed rule includes potential methodologies for calculating the amount by which a facility’s reported methane emissions are below or exceed the waste emissions thresholds and contemplates approaches for implementing certain exemptions created by the Inflation Reduction Act. The methane emissions charge imposed under the Methane Emissions and Waste Reduction Incentive Program for 2024 would be $900 per ton emitted over annual methane emissions thresholds and would increase to $1,200 in 2025 and $1,500 in 2026. The emissions fee and funding provisions of the law could increase operating costs within the oil and gas industry and accelerate the transition away from fossil fuels, which could in turn adversely affect our and our customers’ business and results of operations. In addition, many U.S. state and local governments have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at tracking and reducing GHG emissions by means of carbon taxes, policies or incentives to encourage the use of renewable energy or alternative low-carbon fuels, the development of GHG inventories, and cap-and-trade programs that typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting GHGs. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Regulations requiring the disclosure of GHG emissions, and other climate-related information or information substantiating climate-related claims, are also increasingly being adopted or proposed at the federal and state level. For example, the SEC issued a proposed rule in March 2022 regarding the enhancement and standardization of mandatory climate-related disclosures for investors. The proposed rule would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including, but not limited to, information about the registrant’s governance of climate-related risks and relevant risk management processes; climate-related risks that are reasonably likely to have a material impact on the registrant’s business, results of operations, or financial condition and their actual and likely climate-related impacts on the registrant’s business strategy, model, and outlook; climate-related targets, goals and transition plan (if any); certain climate-related financial statement metrics in a note to their audited financial statements; Scope 1 and Scope 2 GHG emissions; and Scope 3 GHG emissions and intensity, if material, or if the registrant has set a GHG emissions reduction target, goal or plan that includes Scope 3 GHG emissions. Although the proposed rule’s ultimate date of effectiveness and the final form and substance of these requirements is not yet known and the ultimate scope and impact on our business is uncertain, compliance with the proposed rule, if finalized, may result in increased legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place strain on our personnel, systems, and resources. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s new Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. In November 2022, the U.S. Bureau of Land Management (the “BLM”) proposed new regulations to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The proposed rule +12 +would require new and existing operators to submit waste minimization plans with all applications for permits to drill oil wells and includes a number of specific affirmative obligations that operators must take to avoid wasting oil or gas through venting, flaring, and leaks. A final rule was expected by January 2024 but has not been issued to date, and such final rule, once published, may face challenges and legal scrutiny. As a result, future implementation of methane rules by the BLM is uncertain at this time. However, given the long-term trend towards increasing regulation, future federal regulation of methane and other GHG emissions from the oil and gas industry remains a possibility. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have also implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. In July 2020, the Council on Environmental Quality revised NEPA’s implementing regulations in an effort to streamline approvals for projects. In October 2021, the Council on Environmental Quality announced its Phase 1 rule, the first of two planned rules to roll back the 2020 rule, which was finalized in April 2022. The Phase 1 final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. In July 2023, the Council on Environmental Quality proposed a Phase 2 rule that would accelerate NEPA reviews while maintaining consideration of relevant environmental, climate change, +13 +and environmental justice effects. The final rule is expected in April 2024. To the extent that our customers’ current activities, as well as proposed plans, on federal lands require governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions upon the development of oil and natural gas projects. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. In January 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The notice of proposed rulemaking was anticipated in November 2023, with final action expected in April 2024, but the FWS instead announced in November 2023 that it had received additional technical comments that need further review. As a result, future amendments to the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +14 \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/item13.txt b/raw/filings/0001532286/2023/0001532286-24-000004/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..7bbc704ce0f4580e9649a2d493e1129de7270f9b --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2024 annual meeting of stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/item9a.txt b/raw/filings/0001532286/2023/0001532286-24-000004/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..d418af0444ec09b8253c551b8e106926c9fda362 --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2023. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2023. +Management’s Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2023, our management assessed the effectiveness of our internal control over financial reporting based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on its assessment using the criteria established by COSO, management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +The effectiveness of our internal control over financial reporting as of December 31, 2023 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-1 of this Annual Report and which is included in Item 8 of Part II of this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/rp_note.txt b/raw/filings/0001532286/2023/0001532286-24-000004/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..24b9afcbaf986a29981876d8e3c36dd2204abae0 --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/rp_note.txt @@ -0,0 +1,5 @@ +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.3 million for both the years ended December 31, 2023 and 2022. The Company also purchased $ 2.9 million and $ 2.6 million of products and services for the years ended December 31, 2023 and 2022, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $ 0.2 million and $ 0.1 million at December 31, 2023 and 2022, respectively. +In addition, the Company completed leasing office space in Corpus Christi, Texas at the end of 2023 and previously leased office space in Midland, Texas from an entity (the “Leasing Entity”) affiliated with Warren Lynn Frazier, a beneficial owner of more than 5 % of the Common Stock. From the third quarter of 2020 through mid-2022, another entity affiliated with Mr. Frazier sub-leased a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was $ 1.2 million and $ 1.6 million for the years ended December 31, 2023 and 2022, respectively. There were no net outstanding payables due to the Leasing Entity at December 31, 2023 and $ 0.1 million of net outstanding payables at December 31, 2022. Additionally, on June 30, 2020, the Company issued the Magnum Promissory Notes to the sellers of Magnum, including Mr. Frazier. At December 31, 2023, there was no outstanding principal balance payable to Mr. Frazier as the balance payable to Mr. Frazier of $ 1.1 million at December 31, 2021 was paid during 2022. For additional information regarding the Magnum Promissory Notes, see Note 9 – Debt Obligations. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where one of the Company’s directors serves as a director. The Company billed NESR $ 1.5 million and $ 0.8 million for the years ended December 31, 2023 and 2022, respectively. Total outstanding receivables due to the Company from NESR were $ 0.4 million and $ 0.2 million at December 31, 2023 and 2022, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 3.0 million and $ 2.2 million for the years ended December 31, 2023 and 2022, respectively. There were outstanding receivables due from Devon of $ 0.7 million and $ 0.5 million at December 31, 2023 and 2022, respectively. \ No newline at end of file diff --git a/raw/filings/0001532286/2023/0001532286-24-000004/rpt_disclosure.txt b/raw/filings/0001532286/2023/0001532286-24-000004/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..3a4c97c532972fd3c76d72573f83f8bd67df4c56 --- /dev/null +++ b/raw/filings/0001532286/2023/0001532286-24-000004/rpt_disclosure.txt @@ -0,0 +1,9 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +The Board has adopted a written related person transactions policy, under which a “Related Person Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy requires that all Related Person Transactions required to be disclosed in our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $1.3 million for both the years ended December 31, 2023 and 2022. The Company also purchased $2.9 million and $2.6 million of products and services for the years ended December 31, 2023 and 2022, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $0.2 million and $0.1 million at December 31, 2023 and 2022, respectively. +In addition, the Company completed leasing office space in Corpus Christi, Texas at the end of 2023 and previously leased office space in Midland, Texas from an entity (the “Leasing Entity”) affiliated with Warren Lynn Frazier, who is a 5% Stockholder. From the third quarter of 2020 through mid-2022, another entity affiliated with Mr. Frazier sub-leased a portion of such space in Corpus Christi, Texas from the Company. Total rental expense associated with these office spaces, net of sub-leasing income, was $1.2 million and $1.6 million for the years ended December 31, 2023 and 2022, respectively. There were no net outstanding payables due to the Leasing Entity at December 31, 2023 and $0.1 million at December 31, 2022. +On June 30, 2020, the Company issued promissory notes with an aggregated principal amount of $2.3 million (the “Magnum Promissory Notes”) to the sellers of Magnum Oil Tools International, LTD, Magnum Oil Tools GP, LLC, and Magnum Oil Tools Canada Ltd., including Warren Lynn Frazier, who is a 5% Stockholder. The Magnum Promissory Notes bear interest at a rate of 6.0% per annum. At December 31, 2023, there was no outstanding principal balance payable to Mr. Frazier as the balance payable to Mr. Frazier of $1.1 million at December 31, 2021 was paid during 2022. For additional information regarding the Magnum Promissory Notes, see Note 9 to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023. +The Company provides products and rentals to National Energy Reunited Corp. (“NESR”), where Andrew L. Waite, one of the Company’s directors, serves as a director. The Company billed NESR $1.5 million and $0.8 million for the years ended December 31, 2023 and 2022, respectively. During the fourth quarter of 2019, the Company sold coiled tubing equipment for $5.9 million to NESR with payments due in 24 monthly equal installments on January 31, 2020. Total outstanding receivables due to the Company from NESR were $0.4 million and $0.2 million at December 31, 2023 and 2022, respectively. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $3.0 million and $2.2 million for the years ended December 31, 2023 and 2022, respectively. 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+______________________________________________________________________________________ +FORM 10-K +_____________________________________________________________________________________ +(Mark One) +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED DECEMBER 31 , 2024 +OR +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE TRANSITION PERIOD FROM TO +Commission File Number: 001-38347 +_____________________________________________________________________________________ +Nine Energy Service, Inc. +(Exact name of registrant as specified in its charter) +_____________________________________________________________________________________ +Delaware 80-0759121 +(State or other jurisdiction of +incorporation or organization) (I.R.S. Employer +Identification No.) +2001 Kirby Drive, Suite 200 +Houston , TX 77019 +(Address of principal executive offices) +( 281 ) 730-5100 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common Stock, par value $0.01 per share NINE New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +_____________________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o Accelerated filer o +Non-accelerated filer ☒ Smaller reporting company ☒ +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. x +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x +The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing sales price on the New York Stock Exchange on June 28, 2024) was $ 50,112,683 . +The number of shares of the registrant’s common stock outstanding at March 3, 2025 was 42,348,643 . +DOCUMENTS INCORPORATED BY REFERENCE +Information called for in Part III of this Annual Report on Form 10-K is incorporated by reference to the registrant’s Definitive Proxy Statement for its 2025 Annual Meeting of Stockholders. +TABLE OF CONTENTS +PART I +Item 1. +Business +4 +Item 1A. +Risk Factors +15 +Item 1B. +Unresolved Staff Comments +33 +Item 1C. +Cybersecurity +33 +Item 2. +Properties +34 +Item 3. +Legal Proceedings +34 +Item 4. +Mine Safety Disclosures +35 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +36 +Item 6. +[Reserved] +36 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +37 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +49 +Item 8. +Financial Statements and Supplementary Data +49 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 +Item 9B. +Other Information +50 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +50 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +51 +Item 11. +Executive Compensation +51 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +51 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +51 +Item 14. +Principal Accountant Fees and Services +51 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +52 +Item 16. +Form 10-K Summary +55 +CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS +This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans, and objectives of management are forward-looking statements. When used in this Annual Report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. +All forward-looking statements speak only as of the date of this Annual Report; we disclaim any obligation to update these statements unless required by law, and we caution you not to place undue reliance on them. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this Annual Report are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. +We disclose important known factors that could cause our actual results to differ materially from our expectations under “Risk Factors” in Item 1A of Part I and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report. Additional risks or uncertainties that are not currently known to us, that we currently deem to be immaterial, or that could apply to any company could also materially adversely affect our business, financial condition, or future results. +These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. +1 +SUMMARY OF PRINCIPAL RISK FACTORS +Our business is subject to a number of risks and uncertainties. The following is a summary of the principal risk factors that could materially adversely affect our business, financial condition, and results of operations. A more complete statement of those risks and uncertainties is set forth in “Risk Factors” in Item 1A of Part I of this Annual Report. +• Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile and strongly influenced by current and expected oil and natural gas prices. If the prices of oil and natural gas decline, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. Significant factors that are likely to affect near-term commodity prices include geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war, and terrorism in oil producing countries or regions, particularly the Middle East, Russia, South America, and Africa; actions by the members of the Organization of the Petroleum Exporting Countries (“OPEC”) and other oil exporting nations that relate to or impact oil production and supply; weather conditions; the effect of U.S. energy, monetary, and trade policies; and the pace of economic growth in the U.S. and throughout the world. +• Inflation may adversely affect our financial position and operating results; in particular, cost inflation with labor or materials could offset any price increases for our products and services. +• If we are unable to attract and retain key employees, technical personnel, and other skilled and qualified workers, our business, financial condition, or results of operations could suffer. +• We may be unable to maintain existing prices or implement price increases on our products and services, and intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +• Our substantial debt obligations could have significant adverse consequences on our business and future prospects, and restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +• Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +• Our operations are subject to conditions inherent in the oilfield services industry, such as equipment defects, liabilities arising from accidents or damage involving our fleet of trucks or other equipment, explosions and uncontrollable flows of gas or well fluids, and loss of well control. +• If we are unable to accurately predict customer demand, including that of our international customers, or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +• We are dependent on customers in a single industry. The loss of one or more significant customers, including certain of our customers outside of the U.S., could adversely affect our financial condition, prospects, and results of operations. Sales to customers outside of the U.S. also exposes us to risks inherent in doing business internationally, including political, social, and economic instability and disruptions, export controls, economic sanctions, embargoes or trade restrictions, and fluctuations in foreign currency exchange rates. +• We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +• We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +• Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +• Our success may be affected by our ability to implement new technologies and services. +2 +• If our systems for protecting against cybersecurity risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cybersecurity attacks. +• Our future financial condition and results of operations could be adversely impacted by asset impairment charges. +• Increased scrutiny of sustainability matters could have an adverse effect on our business and damage our reputation. +• Increased attention to climate change and conservation measures may reduce oil and natural gas demand, and we face various risks associated with increased activism and related litigation against oil and natural gas exploration and development activities. +• Seasonal and adverse weather conditions adversely affect demand for our products and services. +• We are currently out of compliance with the New York Stock Exchange’s (the “NYSE”) minimum market capitalization requirement and are at risk of the NYSE delisting our common stock, which would have an adverse impact on the trading volume, liquidity, and market price of our common stock. +3 +PART I +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite, hybrid, or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite, hybrid, or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite, hybrid, and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2024, we completed approximately 26,000 cementing jobs, with an on-time rate of approximately 89%. Punctuality of service is one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite, hybrid, and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. Our tool portfolio also includes a multi-cycle barrier valve to address the international, conventional markets. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2024, we deployed approximately 557,700 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted several of our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite, hybrid, and dissolvable frac plugs through our wireline units. From January 2018 through December 2024, we completed approximately 189,500 wireline stages with a success rate of over 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place) while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 27,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2024, we have performed approximately 8,300 jobs and deployed more than 218 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rocky Mountains, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2024, our top five customers collectively accounted for approximately 25% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, Patterson-UTI Energy, KLX Energy Services Holdings, Innovex International, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2024, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our and/or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years, many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2024, we had 1,077 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations as well as Canada’s new anti-forced labor law. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported, disposed, or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +As of December 31, 2024, we operated a fleet in excess of 580 commercial motor vehicles. As such, we are subject to regulation as a motor carrier by the U.S. Department of Transportation (the “DOT”) and analogous state agencies and their applicable federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Materials Regulations for interstate travel promulgated by the FMCSA under the DOT and comparable state regulations for intrastate travel. These regulatory authorities exercise broad powers, governing activities such as the authorization to engage in motor carrier operations, regulatory safety, equipment testing, driver requirements and specifications, and insurance requirements. In connection with these rules, substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States (“WOTUS”) and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers (the “Corps”) or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In 2015, the EPA and the Corps issued a rule defining the scope of federal jurisdiction over WOTUS, which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in 2020. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. In January 2023, the EPA and the Corps issued a final rule that based the definition of WOTUS on the pre-2015 definition. Separately, in May 2023, the U.S. Supreme Court’s decision in Sackett v. EPA narrowed federal jurisdiction over wetlands to “traditional navigable waters” and wetlands or other waters that have a “continuous surface connection” with, or are otherwise indistinguishable from, traditional navigable waters. In September 2023, the EPA and the Corps published a direct-to-final rule that conforms the regulatory definition of WOTUS to the Supreme Court’s May 2023 decision in Sackett . However, roughly half of the states and other plaintiffs are continuing to challenge the September 2023 rule, and the EPA and the Corps are using the pre-2015 definition of WOTUS in these states while litigation continues. As a result, substantial uncertainty exists with respect to future implementation of the September 2023 rule and the scope of Clean Water Act jurisdiction generally. In addition, in an April 2020 decision defining the scope of the Clean Water Act that was issued days after the NWPR was published, the U.S. Supreme Court held that, in certain cases, discharges from a point source to a WOTUS through groundwater require a permit if the discharge is the “functional equivalent” of a direct discharge. The Court rejected the EPA and the Corps’ assertion that groundwater should be totally excluded from the Clean Water Act. In November 2023, the EPA issued draft guidance describing the functional equivalent analysis and the information that should be used to determine which discharges through groundwater may require a permit. However, in January 2025, President Trump issued executive orders directing (i) the EPA and the Corps to identify planned or potential actions that could be subject to emergency treatment under Section 404 of the Clean Water Act and (ii) the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions, including all existing regulations and guidance documents, that are unduly burdensome on the identification, development, or use of domestic energy resources. Accordingly, future implementation and enforcement of these rules and policies is uncertain at this time. To the extent a future rule or court decision expands Clean Water Act jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In December 2023, the EPA issued a final rule, under the CAA’s New Source Performance Standards, intended to reduce methane emissions from new and existing oil and gas sources. The new rule makes the existing regulations in Subpart OOOOa more stringent and creates a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources that commenced construction, modification, or reconstruction after December 6, 2022, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). The new rule phases out +10 +flaring through Subpart OOOOb, which prohibits routine flaring from new oil wells after the phase-in period, and through a new Subpart OOOOc, which prohibits flaring absent a showing of technical infeasibility for existing wells with documented methane emissions of 40 tons per year or more. In addition, the final rule establishes “Emissions Guidelines” in Subpart OOOOc, which requires states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. The final rule gives states, along with federal tribes that wish to regulate existing sources, until March 2026 to develop and submit their plans for reducing methane emissions from existing sources. The final emissions guidelines under Subpart OOOOc provide until 2029 for existing sources (i.e., sources constructed prior to December 6, 2022) to comply. The final rule is subject to ongoing litigation but remains in effect. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the final rule remains uncertain at this time. +Although there may be an adverse financial impact (including compliance costs, potential permitting delays and increased regulatory requirements) associated with these regulatory changes, the extent and magnitude of impacts cannot be reliably or accurately estimated due to the present uncertainty regarding any additional measures and how they will be implemented. Any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. In November 2020, under the first Trump Administration, the U.S. withdrew from the Paris Agreement; however, various corporations, investors, and U.S. state and local governments continued to publicly pledge to further the goals of the Paris Agreement. In February 2021, under the Biden Administration, the United States rejoined the Paris Agreement and set a target to reduce U.S. GHG emissions by 50-52% by the year 2030 as compared with 2005 levels. In addition, in September 2021, the Biden Administration publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. At the 27th Conference of the Partie s, the United States agreed, in conjunction with the European Union and a number of other partner countries, to develop standards for monitoring and reporting methane emissions to help create a market for low methane-intensity natural gas. At the 28th Conference of the Parties, member countries agreed to the first “global stocktake,” which calls on countries to contribute to global efforts, including a tripling of renewable energy capacity and doubling energy efficiency improvements by 2030, accelerating efforts toward the phase-down of unabated coal power, phasing out inefficient fossil fuel subsidies, and transitioning away from fossil fuels in energy systems. Most recently, at the 29th Conference of the Parties, delegates approved rules to operationalize international carbon markets under Article 6 of the Paris Agreement, including a new Paris Agreement Crediting Mechanism to trade UN-approved carbon credits. However, in January 2025, President Trump issued an executive order directing the immediate notice to the United Nations of the United States’ withdrawal from the Paris Agreement and all other agreements made under the United Nations Framework Convention on Climate Change. The full impact of these actions remains unclear at this time. However, various state and local governments in the U.S. have publicly committed to furthering the goals of the Paris Agreement. +11 +The U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, but no comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future, and energy legislation and other regulatory initiatives have been proposed that are relevant to GHG emissions issues. For example, the Inflation Reduction Act of 2022, which appropriates significant funding for renewable energy initiatives and, for the first time, imposes a fee on GHG emissions from certain oil and gas facilities, was signed into law in August 2022. The Inflation Reduction Act amends the CAA to include a Methane Emissions and Waste Reduction Incentive Program, which requires the EPA to impose a “Waste Emissions Charge” on certain natural gas and oil sources that are already required to report under the EPA’s Greenhouse Gas Reporting Program. To implement the program, in May 2024, the EPA finalized revisions to the Greenhouse Gas Reporting Program for petroleum and natural gas facilities. The emissions reported under the Greenhouse Gas Reporting Program will be the basis for any payments under the Methane Emissions Reduction Program. However, petitions for reconsideration to the EPA are pending and litigation in the D.C. Circuit Court of Appeals has commenced. In November 2024, the EPA finalized a rule implementing the Inflation Reduction Act’s Waste Emissions Charge, which became effective on January 1, 2025. The fee imposed under the Methane Emissions and Waste Reduction Incentive Program for 2024 is $900 per ton emitted over annual methane emissions thresholds and increases to $1,200 in 2025 and $1,500 in 2026. In January 2025, industry associations challenged the Waste Emissions Charge rule in the D.C. Circuit Court of Appeals. The emissions fee and funding provisions of the law could increase operating costs within the oil and gas industry and accelerate the transition away from fossil fuels, which could in turn adversely affect our and our customers’ business and results of operations. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. In addition, based on the timing of the rule’s finalization and statements from congressional Republicans, the Waste Emissions Charge rule is potentially vulnerable to repeal by Congress under the Congressional Review Act, and the Inflation Reduction Act may also be subject to amendment or repeal through Congressional budget reconciliation. However, many U.S. state and local governments have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at tracking and reducing GHG emissions by means of carbon taxes, policies or incentives to encourage the use of renewable energy or alternative low-carbon fuels, the development of GHG inventories, and cap-and-trade programs that typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting GHGs. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. In June 2024, the U.S. Supreme Court issued a ruling in Loper Bright Enterprises v. Raimondo that ended the use of the Chevron doctrine when courts analyze federal regulations. The Chevron doctrine required courts to defer to the reasonable interpretation of agencies when deciding if a regulation reflected the intent of Congress. While the end of Chevron is likely to introduce new complexity for federal agencies and administration of climate change policy and regulatory programs, many of these initiatives are expected to continue. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Regulations requiring the disclosure of GHG emissions, and other climate-related information or information substantiating climate-related claims, are also increasingly being adopted or proposed at the federal and state level. For example, at the state level, California enacted legislation in October 2023 that will ultimately require certain companies that do business in California to publicly disclose their Scopes 1, 2, and 3 GHG emissions, with third-party assurance of such data, and issue public reports on their climate-related financial risk and related mitigation measures. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such +12 +activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s new Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. In April 2024, the U.S. Bureau of Land Management (the “BLM”) finalized a rule to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The final rule took effect in June 2024. However, in May 2024, the states of North Dakota, Texas, Montana, Wyoming, and Utah challenged the rule. In September 2024, the U.S. District Court for the District of North Dakota granted a motion prohibiting the BLM from enforcing the rule against those states pending the outcome of the litigation. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the final rule remains uncertain at this time. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. To date, the EPA has taken no further action in response to the 2016 report. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have also implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if +13 +necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. In July 2020, the Council on Environmental Quality (“CEQ”) revised NEPA’s implementing regulations in an effort to streamline approvals for projects. In October 2021, the Council on Environmental Quality announced its Phase I rule, the first of two planned rules to roll back the 2020 rule, which was finalized in April 2022. The Phase I final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. In May 2024, CEQ finalized the Phase II rule, which accelerates NEPA reviews while maintaining consideration of relevant environmental, climate change, and environmental justice effects of a proposed project. Several states and environmental groups have challenged the Phase II rule in federal district court. The CEQ’s changes could result in increased NEPA review timelines for projects involving agency action regarding federal lands, federal funds, or federal permits or approvals. Additionally, in November 2024, a federal appeals court found that CEQ lacks statutory authority to issue NEPA regulations binding on other federal agencies. However, the court’s holding was confined to striking down the agencies’ action under review on separate grounds, and CEQ’s Phase I and II rules remain in effect. However, in January 2025, President Trump issued an executive order requiring CEQ to provide guidance on implementing NEPA and to propose rescinding and replacing CEQ’s NEPA regulations with implementing regulations at the agency level. The executive order also instructs federal agencies to adhere to only the relevant legislated requirements for environmental reviews and to prioritize efficiency and certainty over any other objectives in such reviews. In February 2025, CEQ sent an interim final rule to the White House Office of Management and Budget that would immediately withdraw the NEPA implementing regulations. The potential impact of further changes to the NEPA regulations and statutory text therefore remains uncertain and could have an effect on our customers’ business and operations, which could ultimately result in decreased demand for our services. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (“ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In April 2024, the FWS finalized three rules that revise regulations regarding listing and reclassification of species and designation of critical habitat. These rules also clarify definitions that impact interagency cooperation and reinstated the general application of the “blanket rule” option for protecting newly listed threatened species. These rules were challenged in August 2024 in the Northern District of California. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. In January 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The DOI has not yet issued a proposed rule. However, in January 2025, President Trump issued an executive order declaring a national energy emergency under the National Emergencies Act. As part of that executive order, agencies were directed to use, to the maximum extent permissible, the ESA regulation on consultations in emergencies to facilitate the domestic energy supply. The executive order also requires the quarterly convening of the Endangered Species Act Committee to ensure prompt and efficient review of all submissions for potential actions that could facilitate energy development. President Trump also issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the rules impacting the ESA and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +14 +Item 1A. Risk Factors +We face many challenges and risks in the industry in which we operate. You should carefully consider each of the following risk factors and all of the other information set forth in this Annual Report, including under the section titled “Cautionary Note Regarding Forward-Looking Statements.” The risks and uncertainties described are not the only ones we face. Additional risk factors not presently known to us or which we currently consider immaterial may also adversely affect our business, financial condition, or future results. If any of these risks were actually to occur, our business, financial condition, or results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline, and a stockholder could lose all or part of its investment. +Risks Related to Our Industry +Our business is cyclical and depends on capital spending and well completions by the onshore oil and natural gas industry, and the level of such activity is volatile. Our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control. +Our business is cyclical, and we depend on our customers’ willingness to make operating and capital expenditures to explore for, develop, and produce oil and natural gas, which, in turn, largely depends on prevailing industry and financial market conditions that are influenced by numerous factors beyond our control, including: +• the level of prices, and expectations about future prices, for oil and natural gas; +• the domestic and foreign supply of, and demand for, oil and natural gas and related products; +• the level of global and domestic oil and natural gas production; +• the supply of, and demand for, hydraulic fracturing and other oilfield services and equipment; +• governmental regulations, including the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves; +• the cost of exploring for, developing, producing, and delivering oil and natural gas; +• available pipeline, storage, and other transportation capacity; +• worldwide political, military, and economic conditions; +• lead times associated with acquiring equipment and products and availability of qualified personnel; +• the discovery rates of new oil and natural gas reserves; +• federal, state, and local regulation of hydraulic fracturing and other oilfield service activities, as well as E&P activities, including public pressure on governmental bodies and regulatory agencies to regulate our industry; +• economic and political conditions in oil and natural gas producing countries; +• actions of OPEC, its members, and other state-controlled oil companies relating to oil price and production levels, including announcements of potential changes to such levels; +• advances in exploration, development, and production technologies or in technologies affecting energy consumption; +• activities by non-governmental organizations to restrict the exploration, development, and production of oil and natural gas so as to minimize emissions of carbon dioxide, a GHG; +• the price and availability of alternative fuels and energy sources; +• global weather conditions and natural disasters, including those related to the physical effects of climate change; and +• uncertainty in capital and commodities markets and the ability of oil and natural gas producers to access capital. +15 +A decline in oil and natural gas commodity prices may adversely affect the demand for our products and services and the rates we are able to charge. +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies, which are strongly influenced by current and expected oil and natural gas prices. Volatility or weakness in oil and natural gas commodity prices (or the perception that oil and natural gas commodity prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. Historically, oil and natural gas commodity prices have been extremely volatile. During the five years ending December 31, 2024, the posted price for West Texas Intermediate (“WTI”) oil has ranged from a low of $(36.98) per barrel in April 2020 to a high of $123.64 per barrel in March 2022, and the Henry Hub spot market price of gas has ranged from a low of $1.21 per MMBtu in November 2024 to a high of $23.86 per MMBtu in February 2021. The average WTI price for 2024 was $76.63. Moreover, the theme of capital discipline for E&P operators in the energy industry has led to a disconnect between commodity prices and market activity. If prices of oil and natural gas decline or our customers do not increase capex and activity levels, our business, financial condition, results of operations, cash flows, and prospects may be materially and adversely affected. +Significant factors that are likely to affect near-term commodity prices include actions of members of OPEC and other oil exporting nations, including Russia, relating to oil export prices and production levels; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly Russia, the Middle East, South America and Africa; changes to energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. For additional information, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Industry Trends and Outlook” in Item 7 of Part II of this Annual Report. +The products and services we provide are, to a substantial extent, deferrable in the event oil and natural gas companies reduce capital expenditures. As a result, we may experience lower utilization of, and may be unable to increase rates or be forced to lower our rates for, our equipment and services in weak oil and natural gas commodity price environments. Even with supportive oil and natural gas prices, E&P operator activity may not materially increase, as they remain focused on operating within their capital plans. Moreover, any substantial and unexpected drop in commodity prices in the future, even if the drop is relatively short-lived, or expectations of such a drop or of prolonged weak oil and natural gas commodity price environments, could similarly affect our customers’ expectations and capital spending, which could result in a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +Reduced discovery rates of new oil and natural gas reserves in our market areas as a result of decreased capital spending may also have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent the reduced number of wells for us to service more than offsets increasing completion activity and intensity. +Our business could be adversely affected by a decline in general economic conditions or a weakening of the broader energy industry, and inflation may adversely affect our financial position and operating results. +A prolonged economic slowdown or recession, adverse events relating to the energy industry, or regional, national, or global economic conditions and factors, particularly a slowdown in the E&P industry, could negatively impact our operations and therefore adversely affect our results. The risks associated with our business are more acute during periods of economic slowdown or recession because such periods may be accompanied by decreased exploration and development spending by our customers, decreased demand for oil and natural gas, and decreased prices for oil and natural gas. +Inflationary factors, such as increases in the labor costs, material costs, and overhead costs, may also adversely affect our financial position and operating results. Like others in our industry, we faced, and we continue to face, cost inflation with both labor and materials, which could offset any price increases for our products and services. +Increased attention to climate change and conservation measures may expose us to climate-related transition risks, including evolving climate change legislation, fuel conservation measures, technological advances, and negative shift in market perception towards the oil and natural gas industry, which could result in reduced demand for oil and natural gas. +Increased attention to climate change from governmental and regulatory bodies, investors, consumers, industry and other stakeholders, changes in consumer behavior and related demand for alternatives to oil and natural gas, societal expectations on companies to address climate change, preferences and attitudes with respect to the generation and consumption of energy, the use of hydrocarbons, and the use of products manufactured with, or powered by, hydrocarbons, may result in the enactment of climate change-related regulations, policies and initiatives (at the government, regulator, corporate and/or investor +16 +community levels), including alternative energy requirements, new fuel consumption standards, energy conservation and emissions reductions measures and responsible energy development, technological advances with respect to the generation, transmission, storage and consumption of energy, and increased availability and competitiveness of alternative energy sources (such as wind, solar geothermal, tidal, fuel cells, and biofuels). These developments could reduce demand for oil and natural gas and therefore our products and services, which would lead to a reduction in our revenues and have a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. +In addition, the enactment of climate change-related regulations, policies, and initiatives (at the government, corporate, and/or investor community levels) may in the future result in increases in our compliance costs and other operating costs and have other adverse effects (e.g., greater potential for governmental investigations or litigation). For further discussion regarding the risks posed to us by climate change-related regulations, policies, and initiatives and by negative public perception of the oil and gas industry, see the discussions below in “Negative public perception of the oil and gas industry could adversely affect our operations and our ability raise debt and equity capital” and “Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition.” +Negative public perception of the oil and gas industry could adversely affect our operations and our ability to raise debt and equity capital. +Opposition toward the oil and natural gas industry has been growing globally and is particularly pronounced in the United States. Companies in the oil and natural gas industry are often the target of activist efforts from both individuals and non-governmental organizations or subject to pressure from other stakeholders regarding safety, human rights, climate change and other environmental matters, sustainability, and business practices. Anti-development activists are working to, among other things, reduce access to federal and state government lands and delay or cancel certain operations such as drilling and development. Any such activism against oil and natural gas exploration and development may cause operational delays or restrictions, increased operating costs, additional regulatory burdens, and increased risk of litigation. +In addition, some parties have initiated public nuisance claims under federal or state common law against certain companies involved in the production of oil and natural gas, or claims alleging that the companies have been aware of the adverse effects of climate change for some time but failed to adequately disclose such impacts to their investors or customers. Although our business is not a party to any such litigation, we could be named in actions making similar allegations, which could lead to costs and materially impact our financial condition in an adverse way. +Negative perceptions regarding our industry and reputational risks may also in the future adversely affect our ability to successfully carry out our business strategy by adversely affecting our access to capital. Certain segments of the investor community have developed negative sentiment towards investing in our industry. Parties concerned about the potential effects of climate change have directed their attention at sources of financing for energy companies, including by promoting divestment of fossil fuel equities and pressuring lenders to limit funding and insurance underwriters to limit coverage to companies engaged in the extraction of fossil fuel reserves, which has resulted in certain financial institutions, funds, and other capital providers restricting or eliminating their investment in oil and natural gas activities. In addition, some investors, including investment advisors and certain sovereign wealth funds, pension funds, university endowments, and family foundations, have stated policies to disinvest in the oil and gas sector based on their social and environmental considerations. Further, certain investment banks and asset managers based both domestically and internationally have announced that they are adopting climate change guidelines for their banking and investing activities. Certain other stakeholders have also pressured commercial and investment banks to stop financing oil and gas production and related infrastructure projects. Institutional lenders who provide financing to energy companies have also become more attentive to sustainable lending practices, and some may elect not to provide traditional energy producers or companies that support such producers with funding. Such developments, including environmental activism, investment policies and initiatives, and related litigation aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. These developments may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +Increased scrutiny of sustainability matters could have an adverse effect on our business and damage our reputation. +In recent years, companies across all industries are facing increasing scrutiny from a variety of stakeholders, including investor advocacy groups, proxy advisory firms, certain institutional investors and lenders, investment funds and other influential investors and rating agencies, related to their environmental, social, and governance (“ESG”) and sustainability practices. If we do not adapt to or comply with investor or other stakeholder expectations and standards on ESG matters (or meet sustainability goals and targets that we have set) as they continue to evolve, or if we are perceived to have not responded +17 +appropriately or quickly enough to growing concern for ESG and sustainability issues, regardless of whether there is a regulatory or legal requirement to do so, we may suffer from reputational damage and our business, financial condition and/or stock price could be materially and adversely affected. +In addition, the Company’s efforts to research, establish, accomplish, and accurately report on the implementation of our sustainability strategy, including any specific sustainability objectives, may also create additional operational risks and expenses and expose us to reputational, legal, and other risks. While we create and publish voluntary disclosures regarding sustainability matters from time to time, some of the statements in those voluntary disclosures may be based on hypothetical expectations and assumptions that may or may not be representative of current or actual risks or events or forecasts of expected risks or events, including the costs associated therewith. Such expectations and assumptions are necessarily uncertain and may be prone to error or subject to misinterpretation given the long timelines involved and the lack of an established single approach to identifying, measuring, and reporting on many sustainability matters. +Our operations, projects, and growth opportunities require us to have strong relationships with various key stakeholders, including our shareholders, employees, suppliers, customers, local communities, and others. We may face pressure from stakeholders, many of whom are focused on climate change, to prioritize sustainable energy practices, reduce our carbon footprint, and promote sustainability while at the same time remaining a successfully operating public company. If we do not successfully manage expectations across these varied stakeholder interests, it could erode stakeholder trust and thereby affect our brand and reputation. Such erosion of confidence could negatively impact our business through decreased demand and growth opportunities, delays in projects, increased legal action and regulatory oversight, adverse press coverage and other adverse public statements, difficulty hiring and retaining top talent, difficulty obtaining necessary approvals and permits from governments and regulatory agencies on a timely basis and on acceptable terms, and difficulty securing investors and access to capital. +In addition, organizations that provide information to investors on corporate governance and related matters have developed ratings processes for evaluating companies on their approach to ESG matters. Such ratings are used by some investors to inform their investment and voting decisions. Unfavorable ESG ratings could lead to increased negative investor sentiment toward us and our industry and to the diversion of investment to other industries, which could have a negative impact on our stock price and our access to and costs of capital. +Risks Related to Our Indebtedness +Our substantial debt obligations could have significant adverse consequences on our business and future prospects. +As of December 31, 2024, we had $300.0 million of 13.000% Senior Secured Notes due 2028 (the “2028 Notes”) outstanding, and we had $47.0 million of borrowings outstanding under the ABL Credit Facility (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report). Subject to the restrictions in the ABL Credit Agreement (as defined and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 of Part II of this Annual Report) and the indenture governing the 2028 Notes, we may incur substantial additional indebtedness (including secured indebtedness) in the future. Our current or future level of indebtedness could have significant adverse consequences on our business and future prospects, including in the following ways: +• requiring us to dedicate a substantial portion of our cash flow from operations to service our existing debt, thereby reducing the cash available to finance our operations and other business activities; +• limiting management’s discretion in operating our business and our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• increasing our vulnerability to downturns and adverse developments in our business and the economy generally; +• limiting our ability to access the capital markets to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, or acquisitions or to refinance existing indebtedness; +• placing us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or less restrictive terms governing their indebtedness; and +• making it more difficult for us to satisfy our obligations under our debt instruments and increase the risk that we may default on our debt obligations. +18 +Additionally, borrowings under the ABL Credit Facility bear interest at variable rates exposing us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remains the same, and our net income and cash available to finance our operations and other business activities would decrease. +We may not be able to generate sufficient cash to service all of our indebtedness. +Our ability to make scheduled payments with respect to our indebtedness depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business, and other factors beyond our control. If our cash flows and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital, or restructure or refinance indebtedness. These alternative measures may not be successful and may not permit us to meet scheduled debt service obligations. For example, we may not be able to consummate dispositions, and the proceeds of any such disposition may not be adequate to meet any debt service obligations then due. Also, our ability to restructure or refinance indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict business operations. In addition, any debt restructuring transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. +If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments. In addition, any failure to make payments on outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. +Restrictions in our debt agreements could limit our growth and our ability to engage in certain activities. +The ABL Credit Facility and the indenture governing our 2028 Notes have, and future financing agreements could have, restrictive covenants that could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our debt agreements contain restrictive covenants that limit our ability to, among other things: +• incur additional indebtedness and guarantee indebtedness; +• pay dividends or make other distributions or repurchase or redeem our capital stock; +• transfer or sell assets; +• make loans and investments; +• incur liens; +• enter into agreements that restrict dividends or other payments from any non-guarantor restricted subsidiaries to us; +• consolidate, merge, or sell all or substantially all of our assets; +• prepay, redeem, or repurchase certain debt; +• issue certain preferred stock or similar equity securities; +• make certain acquisitions and investments; +• engage in transactions with affiliates; and +• create unrestricted subsidiaries. +The restrictions in our debt agreements could also impact our ability to obtain capital to withstand a downturn in our +19 +business or the economy in general, or to otherwise conduct necessary corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations that the restrictive covenants under our debt arrangements may impose on us. +A breach of any covenant in our debt agreements will result in a default under the applicable agreement and an event of default under such agreement if there is no grace period or if such default is not cured during any applicable grace period. An event of default, if not waived, could result in acceleration of the indebtedness outstanding under the applicable agreement and an event of default with respect to, and an acceleration of, the indebtedness outstanding under any other debt agreements to which we are a party. Any such accelerated indebtedness would become immediately due and payable. If that occurs, we may not be able to make all of the required payments or borrow sufficient funds to refinance such indebtedness. Even if new financing were available at that time, it may not be on terms that are acceptable to us. +Competition and Market Risks +We may be unable to maintain existing prices or implement price increases on our products and services. +We periodically seek to increase the prices on our products and services to offset rising costs and to generate higher returns for our stockholders. However, we operate in a very competitive industry and as a result, we are not always successful in raising or maintaining our existing prices. Volatility in oil and natural gas prices can impact our customers’ activity levels, and current energy prices are important contributors to cash flow for our customers and their actual or perceived ability to fund exploration and development activities, which may limit our ability to increase or maintain prices. Additionally, during periods of increased market demand, a significant amount of new service capacity, including new well service rigs, wireline units, and coiled tubing units, may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase prices. +Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset rising costs. In periods of high demand for oilfield services, a tighter labor market may result in higher labor costs. During such periods, our labor costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our pricing and to increase our pricing as costs increase could have a material adverse effect on our business, financial position, results of operations, and cash flows. +Intense competition in the markets for our dissolvable plug products may lead to pricing pressures, reduced sales, or reduced market share. +The completion services industry is intensely competitive. We compete with major domestic and international oilfield services companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we do. +We have experienced pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. Likewise, our customers may seek pricing declines more precipitously than our ability to reduce costs, leaving us unable to achieve or maintain pricing to our customers at a level sufficient to cover our costs. Furthermore, our industry has generally experienced price erosion for new technologies as additional competing products enter the market. We are continuing to work on reducing manufacturing costs of our products, as well as introducing new and differentiated technology to improve profitability; however, there can be no assurance that we will be able to do so in the future. If the amounts we are able to charge customers for our dissolvable plug products decline further or are insufficient to cover our costs, that could have a material adverse effect on our financial condition, results of operations, and cash flows. +Our current and potential competitors may have longer operating histories, significantly greater financial or technical resources, and greater name recognition than we do. +The oilfield services industry is highly competitive and fragmented and includes several large companies that compete in many of the markets we serve, as well as numerous small companies that compete with us on a local basis. The oilfield services industry competes primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. We believe the principal competitive factors in the market areas we serve include price, equipment quality, supply chains, balance sheet strength and financial condition, product and service quality, safety record, availability of crews and equipment, and technical proficiency. +Many of our existing and potential competitors have substantially greater financial, technical, manufacturing, and other resources than we do. The greater size of many of our competitors provides them with cost advantages as a result of their +20 +economies of scale and their ability to obtain volume discounts and purchase raw materials at lower prices. As a result, such competitors may have stronger bargaining power with their suppliers and have an advantage over us in pricing as well as securing a sufficient supply of raw materials during times of shortage. Many of our competitors also have better brand name recognition, stronger presence in more geographic markets, more established distribution networks, larger customer bases, more in-depth knowledge of the target markets, and the ability to provide a much broader array of products and services. Some of our competitors may also be able to devote greater resources to the research and development, promotion, and sale of their products and better withstand the evolving industry standards and changes in market conditions as compared to us. Our operations may be adversely affected if our competitors introduce new products or services with better features, performance, prices, or other characteristics than our products and services or expand into service areas where we operate. Our operations may also be adversely affected if our competitors are able to respond more quickly to new or emerging technologies and services and changes in customer requirements. +Competitive pressures could reduce our market share or require us to reduce the price of our services and products, particularly during industry downturns, either of which would harm our business and operating results. Significant increases in overall market capacity have also caused active price competition and led to lower pricing and utilization levels for our services and products. The competitive environment has intensified since the industry downturn that began in late 2014, which caused an oversupply of, and reduced demand for, oilfield services, and we have seen substantial reductions in the prices we can charge for our services and products. Any significant future increase in overall market capacity for completion services may adversely affect our business, financial condition, and results of operations. +Operational Risks +Our operations are subject to conditions inherent in the oilfield services industry. +Conditions inherent in the oil and natural gas industry can cause personal injury or loss of life, disruption or suspension in operations, damage to geological formations, damage to facilities, substantial revenue loss, business interruption, and damage to, or destruction of, property, equipment, and the environment. Such risks may include, but are not limited to: +• equipment defects; +• liabilities arising from accidents or damage involving our fleet of trucks and other equipment; +• explosions and uncontrollable flows of gas or well fluids; +• unusual or unexpected geological formations or pressures and industrial accidents; +• blowouts; +• fires; +• cratering; +• loss of well control; +• collapse of the borehole; and +• damaged or lost equipment. +Defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these defects or other performance problems. In addition, our services could become a source of spills or release of fluids, including chemicals used during hydraulic fracturing activities, at the site where such services are performed, or could result in the discharge of such fluids into underground formations that were not targeted for fracturing or well completion activities, such as potable aquifers, or at third-party properties. These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution, and other environmental damages and could result in a variety of claims, losses, and remedial obligations that could have an adverse effect on our business and results of operations. The existence, frequency, and severity of such incidents could affect operating costs, insurability, and relationships with customers, employees, and regulators. In particular, our customers may elect not to purchase our services if they view our safety record as unacceptable or otherwise experience material defects in our products or performance problems, which could cause us to lose substantial revenue. In addition, any litigation or claim, even if fully indemnified or insured, could negatively affect our reputation with our customers and the public, which could cause us to lose customers and substantial revenue, make it more difficult for us to compete effectively, or obtain adequate +21 +insurance in the future. +Our assets require capital for maintenance, upgrades, and refurbishment, and we may require capital expenditures for new equipment. +Our equipment requires capital investment in maintenance, upgrades, and refurbishment to maintain their competitiveness. For the years ended December 31, 2024 and 2023, we spent approximately $10.4 million and $12.6 million, respectively, on capital expenditures related to maintenance. Our equipment typically does not generate revenue while it is undergoing maintenance, upgrades, or refurbishment. Any maintenance, upgrade, or refurbishment project for our assets could increase our indebtedness or reduce cash available for other opportunities. Further, such projects may require proportionally greater capital investments as a percentage of total asset value, which may make such projects difficult to finance on acceptable terms. To the extent we are unable to fund such projects, we may have less equipment available for service or our equipment may not be attractive to potential or current customers. Additionally, competition or advances in technology within our industry may require us to update our products and services. Such demands on our capital or reductions in demand and the increase in cost to maintain labor necessary for such maintenance and improvement, in each case, could have a material adverse effect on our business, liquidity position, financial condition, prospects, and results of operations and may increase costs. In addition, although such projects may require material capital expenditures, there is no assurance that they will generate a positive return. +Seasonal and adverse weather conditions and the physical risks arising from climate change may have a negative impact on our business and result of operations, including by impacting operations, increasing costs, and adversely affecting demand for our products and services. +Weather can have a significant impact on demand for our services and products as consumption of energy is seasonal, and any variation from normal weather patterns or cooler or warmer summers and winters can have a significant impact on demand. In addition, adverse weather conditions, such as hurricanes, tropical storms, and severe cold weather, may interrupt or curtail our operations or our customers’ operations, cause supply disruptions, and damage our equipment and facilities, which may or may not be insured. In addition, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods, extreme temperatures, and other climatic events. If any such effects were to occur, they could adversely affect or delay demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services; cause us to incur significant costs in preparing for or responding to the effects of climatic events themselves, which may not be fully insured; adversely impact our or our customers’ operations, workforce, supply chain or distribution chain; or potentially lead to increased costs for insurance coverages in the aftermath of such effects. Our ability to mitigate the adverse physical impacts of climate change depends in part upon our disaster preparedness and response and business continuity planning. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., Michigan, North Dakota, Wyoming, and western Canada, our customers may delay operations, or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. For both the years ended December 31, 2024 and 2023, we generated approximately 0.3% of our revenue from our operations in western Canada. Lastly, throughout the year heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. +In addition, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Risks Related to Our Customers and Suppliers +If we are unable to accurately predict customer demand or if customers cancel their orders on short notice, we may hold excess or obsolete inventory, which would reduce gross margins. Conversely, insufficient inventory would result in lost revenue opportunities and potentially loss of market share and damaged customer relationships. +We often place orders with our suppliers based on forecasts of customer demand. Anticipating customer demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused on cash preservation and tighter inventory management. Our forecasts of customer demand are based on multiple assumptions, each of which may introduce errors into the forecasts. If we overestimate customer demand, we may allocate resources to the purchase of material or manufactured products that we may not be able to sell when we expect to, if at all. As a result, we would hold excess or obsolete inventory, which would reduce gross margin and adversely affect financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would miss revenue opportunities and potentially lose market share and damage our customer relationships. In addition, any future significant cancellations or deferrals of orders or the return of previously sold products could materially and adversely affect profit margins, increase +22 +inventory obsolescence, and restrict our ability to fund our operations. +We are exposed to the credit risk of our customers, and the deterioration of the financial condition of our customers could adversely affect our financial results. +We are subject to the risk of loss resulting from nonpayment or nonperformance by our customers, many of whose operations are concentrated solely in the domestic and Canadian E&P industry, which, as described above, is subject to volatility and, therefore, credit risk. Our credit procedures and policies may not be adequate to fully reduce customer credit risk. If we are unable to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use our equipment could have a material adverse effect on our business, financial condition, prospects, and/or results of operations. In the course of our business, we hold accounts receivable from our customers. In the event of the financial distress or bankruptcy of a customer, we could lose all or a portion of such outstanding accounts receivable associated with that customer. Further, if a customer was to enter into bankruptcy, it could also result in the cancellation of all or a portion of our service contracts with such customer at significant expense or loss of expected revenues to us. +In addition, during times when the oil or natural gas markets weaken, our customers are more likely to experience financial difficulties, including being unable to access debt or equity financing, which could result in a reduction in our customers’ spending for our products and services. +We are dependent on customers in a single industry. The loss of one or more significant customers could adversely affect our financial condition, prospects, and results of operations. +Our customers are engaged in the oil and natural gas E&P business, which has been historically volatile. For the year ended December 31, 2024, our five largest customers collectively accounted for approximately 25% of total revenues. If we were to lose several key alliances over a relatively short period of time or if one of our largest customers fails to pay or delays in paying a significant amount of our outstanding receivables, we could experience an adverse impact on our business, financial condition, results of operations, cash flows, and prospects. Additionally, the E&P industry is characterized by frequent consolidation activity. Changes in ownership of our customers may result in the loss of, or reduction in, business from those customers, which could materially and adversely affect our business, financial condition, results of operations, and prospects. +Certain of our product lines are subject to the risk of supplier concentration, and certain of our product lines are subject to exclusive distribution arrangements, which we may not be able to maintain. +Certain of the product lines depend on a limited number of third-party suppliers and vendors. As a result of this concentration in some supply chains, our business and operations could be negatively affected if certain key suppliers were to experience significant disruptions affecting the price, quality, availability, or timely delivery of their products. The partial or complete loss of any one of those key suppliers, or a significant adverse change in the relationship with any such suppliers, through consolidation or otherwise, may limit our ability to manufacture and sell certain of our product lines. +In addition, we have arrangements with certain technology companies and manufacturers that give us exclusive distribution rights to certain product offerings. In some cases, we are, or may in the future will be, required to meet certain minimum volume or other requirements in order to retain our arrangement. If any of these companies or manufacturers terminate our right to sell some or all of their products, modify or terminate our exclusive distribution arrangement, or change the applicable terms and conditions of sale, our business and results of operations could be adversely affected. +Tariffs and other trade measures could adversely affect our business, results of operations, financial position, and cash flows. +The cost of raw materials, parts, and components that are manufactured and supplied for our operations may be adversely affected by tariffs imposed by the U.S. government on products imported into the United States and tariffs or other retaliatory trade measures imposed by other jurisdictions. Tariffs and other trade restrictions could also disrupt our supply chain and logistics, restrict or limit the availability of materials or supplies, and cause adverse financial impacts due to volatility in foreign exchange rates and interest rates or inflationary pressures on raw materials and energy. We may not be able to fully mitigate the impact of these increased costs or pass price increases on to our customers. While tariffs and other retaliatory trade measures imposed by other countries on U.S. goods have not yet had a significant impact on our business or results of operations, we cannot predict further developments, and such existing or future tariffs could have a material adverse effect on our results of operations, financial position, and cash flows. Recently, the United States has proposed changes in trade policies that include export control restrictions, the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the United States, increased economic sanctions on individuals, companies, or countries, and other government +23 +regulations affecting trade between the United States and other countries where we have business relationships, including with suppliers, and a number of other nations have proposed similar measures directed at trade with the United States in response. As a result of these developments, there may be greater restrictions and economic disincentives on international trade that could adversely affect our business. It may be time-consuming and expensive for us to alter our business operations to adapt to or comply with any such changes, and any failure to do so could have a material adverse effect on our business, results of operations, and financial position. +Regulatory, Compliance, and Legal Risks +Oilfield anti-indemnity provisions enacted by many states may restrict or prohibit a party’s indemnification of us. +We typically enter into agreements with our customers governing the provision of our services, which usually include certain indemnification provisions for losses resulting from operations. Such agreements may require each party to indemnify the other against certain claims regardless of the negligence or other fault of the indemnified party; however, many states place limitations on contractual indemnity agreements, particularly agreements that indemnify a party against the consequences of its own negligence. Furthermore, certain states, including Louisiana, New Mexico, Texas, and Wyoming, have enacted statutes generally referred to as “oilfield anti-indemnity acts” expressly prohibiting certain indemnity agreements contained in or related to oilfield services agreements. Such oilfield anti-indemnity acts may restrict or void a party’s indemnification of us, which could have a material adverse effect on our business, financial condition, prospects, and results of operations. +We may be subject to claims for personal injury and property damage or other litigation, which could materially adversely affect our financial condition, prospects, and results of operations. +Our services are subject to inherent risks that can cause personal injury or loss of life, damage to or destruction of property, equipment, or the environment, or the suspension of our operations. As the wells we service continue to become more complex, our exposure to such inherent risks becomes greater as downhole risks increase exponentially with an increase in complexity and lateral length. Our operations are also exposed to risks of labor organizing and risks of claims for alleged employment-related liabilities, including risks of claims related to alleged wrongful termination or discrimination, wage payment practices, retaliation claims, and other human resource related matters. Litigation arising from operations where our facilities are located, or our services are provided, may cause us to be named as a defendant in lawsuits asserting potentially large claims, including claims for exemplary damages. For example, transportation of heavy equipment creates the potential for our trucks to become involved in roadway accidents, which in turn could result in personal injury or property damages lawsuits being filed against us. +We maintain what we believe is customary and reasonable insurance to protect our business against most potential losses, but such insurance may not be adequate to cover our liabilities, especially as the inherent risks in our operations increase with increasing well complexity, and we are not fully insured against all risks, including alleged employment-related liabilities. Further, our insurance has deductibles or self-insured retentions and contains certain coverage exclusions. The current trend in the insurance industry is towards larger deductibles and self-insured retentions. In addition, insurance may not be available in the future at rates that we consider reasonable and commercially justifiable, compelling us to have larger deductibles or self-insured retentions to effectively manage expenses. As a result, we could become subject to material uninsured liabilities or situations where we have high deductibles or self-insured retentions that expose us to liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +In recent years, oilfield services companies have been the subject of a significant volume of wage and hour-related litigation, including claims brought under the Fair Labor Standards Act (“FLSA”), in which employee pay practices have been challenged. We have been named as defendants in these lawsuits, and we do not maintain insurance for alleged wage and hour-related litigation. Some of these cases remain outstanding and are in various states of negotiation and/or litigation, and the results or costs of any such cases may have an adverse effect on our business, operating results, and financial condition. The frequency and significance of wage- or other employment-related claims may affect expenses, costs, and relationships with employees and regulators. Additionally, we could become subject to material uninsured liabilities that could have a material adverse effect on our business, financial condition, prospects, or results of operations. +Delays or restrictions in obtaining, or inability to obtain or renew, permits or authorizations by our customers for their operations or by us for our operations could impair our business. +In most states, our operations and the operations of our customers require permits or authorizations from one or more governmental agencies or other third parties to perform drilling and completion and production activities, including hydraulic fracturing. Such permits or approvals are typically required by state agencies, but federal and local governmental permits may also be required. We are also required to obtain federal, state, local, and/or third-party permits and authorizations in some +24 +jurisdictions in connection with our wireline services and trucking operations. The requirements for permits or authorizations vary depending on the location where the associated activities will be conducted. As with most permitting and authorization processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit or approval to be issued, and the conditions which may be imposed in connection with the granting of the permit. Over the past several years, parts of the country have experienced extreme drought conditions. As a result of these conditions, some rural water districts have begun to impose restrictions on water use and may require permits for water used in drilling and completion activities. In addition, some of our customers’ drilling and completion activities may take place on federal land or Native American lands, requiring leases and other approvals from the federal government or Native American tribes to conduct such drilling and completion activities. Permitting, authorization, or renewal delays, the inability to obtain new permits, or the revocation of current permits could cause a loss of revenue and potentially have a materially adverse effect on our business, financial condition, prospects, or results of operations. +We are subject to federal, state, and local laws and regulations regarding issues of health, safety, and protection of the environment. Under these laws and regulations, we may become liable for penalties, damages, or costs of remediation or other corrective measures. Any changes in laws or government regulations could increase our costs of doing business. +Our operations are subject to stringent federal, state, local, and tribal laws and regulations relating to, among other things, protection of natural resources, clean air and drinking water, wetlands, endangered species, GHGs, air pollution, the environment, occupational health and safety, chemical use and storage, waste management, waste disposal, and transportation of waste and other hazardous and nonhazardous materials. Our operations involve risks of environmental liability, including leakage from an operator’s casing during our operations or accidental spills of hazardous materials onto or into surface or subsurface soils, surface water, or groundwater. Some environmental laws and regulations may impose strict liability, joint and several liability, or both. In some situations, we could be exposed to liability as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, third parties without regard to whether we caused or contributed to the conditions. Additionally, environmental concerns, including clean air, drinking water contamination, and seismic activity, have prompted investigations that could lead to the enactment of regulations, limitations, restrictions, or moratoria that could potentially have a material adverse impact on our business. Actions arising under these laws and regulations could result in the shutdown of our operations, fines and penalties (administrative, civil, and/or criminal), revocations of permits to conduct business, expenditures for remediation or other corrective measures, and/or claims for liability for property damage, exposure to hazardous materials, exposure to hazardous waste, nuisance, or personal injuries. Sanctions for noncompliance with applicable environmental laws and regulations may also include the assessment of administrative, civil, and/or criminal penalties, revocation of permits and temporary or permanent cessation of operations in a particular location, and issuance of corrective action orders. Such claims or sanctions and related costs could cause us to incur substantial costs or losses and could have a material adverse effect on our business, financial condition, prospects, and results of operations. Additionally, an increase in regulatory requirements or limitations, restrictions, or moratoria on oil and natural gas exploration and completion activities at a federal, state, or local level could significantly delay or interrupt our operations, limit the amount of work we can perform, increase our costs of compliance, or increase the cost of our services, thereby possibly having a material adverse impact on our financial condition. +If we do not perform our operations in accordance with government, industry, customer, or our own stringent occupational safety, health, and environmental standards, we could lose business from our customers, many of whom have an increased focus on environmental and safety issues. +We are subject to the oversight of the EPA, the DOT, the U.S. Nuclear Regulation Commission, Bureau of Alcohol, Tobacco, Firearms and Explosives, OSHA, and state regulatory agencies that regulate operations to prevent air, soil, and water pollution or to protect against the effects of ionizing radiation. The energy extraction sector is one of the sectors designated for increased enforcement by the EPA, which will continue to regulate our industry in the years to come, potentially resulting in additional regulations that could have a material adverse impact on our business, prospects, or financial condition. +The EPA regulates air emissions from all engines, including off-road diesel engines that are used by us to power equipment in the field under the CAA Tier 4 emission standards (the “Tier 4” standards). The Tier 4 standards require substantial reductions in emissions of particulate matter and nitrous oxide from off-road diesel engines. Such emission reductions can be achieved through the use of appropriate control technologies. Under these U.S. emission control regulations, we could be limited in the number of certain off-road diesel engines we can purchase if we are unable to find a sufficient number of Tier 4-compliant engines from manufacturers. Further, these emission control regulations could result in increased capital and operating costs. +Changes in environmental laws and regulations could lead to material increases in our costs, and liability exposure, for future environmental compliance and remediation. Additionally, if we expand the size or scope of our operations, we could be subject to regulatory requirements that are more stringent than the requirements under which we are currently allowed to +25 +operate or require additional authorizations to continue operations. Compliance with this additional regulatory burden could increase our operating or other costs. +Federal, state, and local legislative and regulatory initiatives relating to hydraulic fracturing could prohibit, restrict, or limit hydraulic fracturing operations, or increase our operating costs. +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For more information on existing regulations and regulatory initiatives relating to hydraulic fracturing, see “Regulatory Matters – Hydraulic Fracturing” in Item 1 of Part I of this Annual Report. +If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, and also to attendant permitting delays, increased operating and compliance costs, and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +Existing or future laws and regulations related to GHGs and climate change could have a negative impact on our business and may result in additional compliance obligations with respect to the release, capture, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. +Changes in environmental requirements related to GHG emissions and climate change may negatively impact demand for our products and services. For example, oil and natural gas E&P may decline as a result of environmental requirements, including land use policies responsive to environmental concerns (e.g., numerous cities, including in Colorado, New York, Massachusetts, and Maryland, have, to varying degrees, banned the use of natural gas in new construction, and other cities are considering similar initiatives). Federal, state, and local agencies have been evaluating climate-related legislation and other regulatory initiatives that would restrict emissions of GHGs in areas in which we conduct business. Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws and regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas. +Likewise, such restrictions may result in additional compliance obligations with respect to the release, capture, sequestration, and use of GHGs that could have a material adverse effect on our business, results of operations, prospects, and financial condition. Additionally, regulations requiring the disclosure of GHG emissions and other climate-related information are increasingly being adopted or proposed at the federal and state level. For example, California enacted legislation in October 2023 that will ultimately require certain companies that do business in California to publicly disclose their Scopes 1, 2, and 3 GHG emissions, with third party assurance of such data, and issue public reports on their climate-related financial risk and related mitigation measures. Any enhanced climate disclosure obligations could result in increased compliance burden and operating costs as well as increased litigation risk related to the required disclosures. In addition, enhanced climate disclosure requirements could accelerate the trend of certain stakeholders and lenders restricting or seeking more stringent conditions with respect to their investments in certain carbon-intensive sectors. See “Business – Regulatory Matters – Climate Change” for more information on existing and proposed climate change regulation. +Studies by either state or federal agencies demonstrating a correlation between earthquakes and oil and natural gas activities could result in increased regulatory and operational burdens. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operation, which in turn could decrease demand for our products and services and have a material adverse effect on our business. +26 +We are subject to complex U.S. and foreign laws and regulations governing anti-corruption and export controls and economic sanctions . +The U.S. Foreign Corrupt Practices Act (the “FCPA”), the U.K. Bribery Act (“UKBA”), Canada’s Corruption of Foreign Public Officials Act (the “CFPOA”), and similar anti-bribery and anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or improperly providing anything of value for the purpose of obtaining or retaining business. We operate and make sales in parts of the world that may be viewed as higher risk for corruption or may have experienced some corruption in the past, and in some instances, strict compliance with the FCPA, UKBA, CFPOA, and similar anti-bribery laws may conflict with local practices. We are also subject to export control and economic sanctions laws and regulations, including those implemented by the U.S. Office of Foreign Assets Control, the U.S. Department of State, the U.S. Department of Commerce, the European Union and its member states, Her Majesty’s Treasury of the United Kingdom, and other relevant sanctions authorities. These measures can prohibit or restrict transactions and dealings with certain designated persons and in certain countries in which we conduct business. Despite efforts to ensure compliance, there can be no assurance that our directors, officers, employees, agents, and third-party intermediaries will comply with such laws and regulations. We can be held liable for violations under such laws and regulations either due to our acts or omissions or due to the acts or omissions of others, including intermediaries and agents working on our behalf. +If we fail to comply with applicable laws and regulations, including those referred to above, we may be subject to criminal and civil penalties or other sanctions, which could harm our reputation and have a material adverse impact on our business, financial condition, results of operations, and prospects. Any investigation of any actual or alleged violations of such laws could also harm our reputation or have an adverse impact on our business, financial condition, results of operations, and prospects. Additionally, we could face other third-party claims by agents, stockholders, debt holders, or other interest holders or constituents of our company. Our customers in relevant jurisdictions could seek to impose penalties or take other actions adverse to our interests, and we may be required to dedicate significant time and resources to investigate and resolve allegations of misconduct, regardless of the merit of such allegations. Furthermore, compliance with this additional regulatory burden could increase our operating or other costs. +Changes in transportation regulations may increase our costs and negatively impact our results of operations. +We are subject to various transportation regulations including as a motor carrier by the DOT and by various federal, state, and tribal agencies, whose regulations include certain permit requirements of highway and safety authorities. These regulatory authorities exercise broad powers over our trucking operations, generally governing such matters as the authorization to engage in motor carrier operations, safety, equipment testing, driver requirements and specifications, and insurance requirements. Certain motor vehicle operators are required to register with the DOT. This registration requires an acceptable operating record. The DOT periodically conducts compliance reviews and may revoke registration privileges based on certain safety performance criteria, and a revocation could result in a suspension of operations. Since 2010, the DOT has pursued its Compliance, Safety, Accountability (“CSA”) program in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System (“SMS”), which analyzes all safety violations recorded by federal and state law enforcement personnel to determine a carrier’s safety performance. The SMS is intended to allow the DOT to identify carriers with safety issues and intervene to address those problems. +The trucking industry is subject to possible regulatory and legislative changes that may impact our operations, such as changes in fuel emissions limits, hours of service regulations that govern the amount of time a driver may drive or work in any specific period, and limits on vehicle weight and size. For example, in June 2020, the FMCSA revised its Hours-of-Service Rule to modify break requirements for drivers and the number of hours they may drive in adverse conditions; and in November 2024, the FMCSA’s rules were updated to require state driver licensing agencies to query the Clearinghouse before issuing, renewing, or upgrading a commercial driver’s license to confirm compliance with FMCSA rules. As the federal government continues to develop and propose regulations relating to fuel quality, engine efficiency, and GHG emissions, we may experience an increase in costs related to truck purchases and maintenance, impairment of equipment productivity, a decrease in the residual value of vehicles, unpredictable fluctuations in fuel prices, and an increase in operating expenses. Increased truck traffic may contribute to deteriorating road conditions in some areas where our operations are performed. Our operations, including routing and weight restrictions, could be affected by road construction, road repairs, detours, and state and local regulations and ordinances restricting access to certain roads. Proposals to increase federal, state, or local taxes, including taxes on motor fuels, are also made from time to time, and any such increase would increase our operating costs. Also, state and local regulation of permitted routes and times on specific roadways could adversely affect our operations. We cannot predict whether, or in what form, any legislative or regulatory changes or municipal ordinances applicable to our logistics operations will be enacted and to what extent any such legislation or regulations could increase our costs or otherwise adversely affect our business or operations. +27 +Risks Related to Technology +Our success may be affected by the use and protection of our proprietary technology as well as our ability to enter into license agreements. There are limitations to our intellectual property rights and, thus, our right to exclude others from the use of our proprietary technology. +Our success may be affected by our development and implementation of new product designs and improvements and by our ability to protect, obtain, and maintain intellectual property assets related to these developments. We rely on a combination of patents and trade secret laws to establish and protect this proprietary technology. We have received patents and have filed patent applications with respect to certain aspects of our technology, and we generally rely on patent protection with respect to our proprietary technology, as well as a combination of trade secrets and copyright law, employee and third-party non-disclosure agreements, and other protective measures to protect intellectual property rights pertaining to our products and technologies. In addition, we are a party to and rely on several arrangements with third parties, which give us exclusive distribution rights to certain product offerings with desirable intellectual property assets, and we may enter into similar arrangements in the future. Such measures may not provide meaningful protection of our trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. We cannot ensure that competitors will not infringe upon, misappropriate, violate, or challenge our intellectual property rights in the future. Additionally, we cannot ensure that our intellectual property rights will deter or prevent competitors from creating similar purpose products for our customers. If we are not able to adequately protect or enforce our intellectual property rights, such intellectual property rights may not provide significant value to our business, results of operations, or financial condition. +Moreover, our rights in our confidential information, trade secrets, and confidential know-how will not prevent third parties from independently developing similar technologies or duplicating such technologies. Publicly available information (e.g., information in issued patents, published patent applications, and scientific literature) can be used by third parties to independently develop technology, and we cannot provide assurance that this independently-developed technology will not be equivalent or superior to our proprietary technology. In addition, while we have patented some of our key technologies, we do not patent all of our proprietary technology, even when regarded as patentable. The process of seeking patent protection can be long and expensive. There can be no assurance that patents will be issued from currently pending or future applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Further, with respect to exclusive third-party arrangements, these arrangements could be terminated, which would result in our inability to provide the services and/or products covered by such arrangements. +We may be adversely affected by disputes regarding intellectual property rights, and the value of our intellectual property rights is uncertain. +We may become involved in dispute resolution or litigation proceedings from time to time to protect and enforce our intellectual property rights. In these dispute resolution or litigation proceedings, a third-party defendant may assert that our intellectual property rights are invalid or unenforceable. Third parties from time to time may also initiate dispute resolution or litigation proceedings against us by asserting that our businesses infringe, impair, misappropriate, dilute, or otherwise violate another party’s intellectual property rights. For example, in April 2020, a third party filed a lawsuit asserting that our BreakThru Casing Flotation Device TM infringed its intellectual property rights, and in January 2022, a jury in the Western District of Texas, Waco Division, found in the third party’s favor. However, we intend to appeal the jury’s verdict. We may not prevail in such appeal or in any other proceedings relating to intellectual property rights, and our intellectual property rights may be found invalid or unenforceable or our products and services may be found to infringe, impair, misappropriate, dilute, or otherwise violate the intellectual property rights of others, in which case we may be required to pay damages or other compensation to the other party (which could be costly) and/or cease use of such intellectual property. Also, as a part of resolving such disputes, we may enter into licenses, cross-licenses, or other agreements, which could reduce the value of our existing intellectual property rights. The results or costs of any such dispute resolution or litigation proceedings may have an adverse effect on our business, operating results, and financial condition. Any dispute resolution or litigation proceeding concerning intellectual property could be protracted and costly, is inherently unpredictable, and could have an adverse effect on our business, regardless of its outcome. +Our success may be affected by our ability to implement new technologies and services. +Our success may be affected by the ongoing development and implementation of new product designs, methods, and improvements, and our ability to protect, obtain, and maintain intellectual property assets related to these developments. If we are not able to obtain patent or other protection of our technology, it may not be economical for us to continue to develop systems, services, and technologies to meet evolving industry requirements at prices acceptable to our customers. Further, we may face competitive pressure to develop, implement, or acquire certain new technologies at a substantial cost. Although we take measures to ensure that we use advanced technologies, changes in technology or improvements in our competitors’ +28 +equipment could make our equipment less competitive or require significant capital investments to keep our equipment competitive. +Our long-term success depends, in part, on our ability to effectively address changing customer demands, as well as government regulation and required disclosure regarding ESG. These demands and regulations include, but are not limited to, the creation of ESG-related policies and procedures, the quantification of our greenhouse gas emissions, and evaluation of risk and opportunities. These customer preferences and government requirements could cause us to continue to adapt our equipment and technology offerings, as well as increase internal costs to address changes in ESG requirements. If ESG-related requirements change faster than anticipated or in a manner we do not anticipate, demand for our services could be adversely affected. +Some of our competitors are large national and multinational companies that may be able to devote greater financial, technical, manufacturing, and marketing resources to research and development of new systems, services, and technologies and may have a larger number of manufacturers for their products or ability to manufacture their own products. As competitors and others use or develop new or comparable technologies in the future, we may lose market share or be placed at a competitive disadvantage if we are not able to develop and implement new technologies or products on a timely basis or at an acceptable cost. If we are unable to compete effectively given these risks, our business and results of operations could be adversely affected. +We rely on a limited number of manufacturers to produce the proprietary products used in the provision of our services, which exposes us to risks. +We currently rely on a limited number of manufacturers for production of the proprietary products used in the provision of our products and services. Termination of the manufacturing relationship with any of these manufacturers could affect our ability to provide such products and services to our customers. Although we believe other alternate sources of supply for our proprietary products exist, we would need to establish relationships with new manufacturers, which could potentially involve significant expense, delay, and potential changes to certain product components. Any protracted curtailment or interruptions of the supply of any of our key products, whether or not as a result of termination of our manufacturing relationships or patent infringement claims, could have a material adverse effect on our financial condition, business, and results of operations. +Our operations are subject to cybersecurity risks that could have a material adverse effect on our results of operations and financial condition. +The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability, and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Our IT systems are subject to possible breaches and other threats that could cause us harm. If our systems for protecting against cybersecurity risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, customer or business data; interruption of business operations; or additional costs to prevent, respond to, or mitigate cybersecurity attacks. These risks could have a material adverse effect on our business, financial condition, and results of operations and could lead to litigation or regulatory action against us. +Risks Related to Human Capital +Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future. +Our future success depends in substantial part on our ability to hire and retain our executive officers and other key personnel. In particular, we are highly dependent on certain of our executive officers, particularly our President and Chief Executive Officer, Ann G. Fox, and the Chief Operating Officer, David Crombie. These individuals possess extensive expertise, talent, and leadership, and they are critical to our success. The diminution or loss of the services of these individuals, or other integral key personnel affiliated with entities that we acquire in the future, could have a material adverse effect on our business. Furthermore, we may not be able to enforce all of the provisions in any employment agreement we have entered into with certain of our executive officers, and such employment agreements may not otherwise be effective in retaining such individuals. In addition, we may not be able to retain key employees of entities that we acquire in the future, which may impact our ability to successfully integrate or operate the assets we acquire. +29 +We may be unable to employ, or maintain the employment of, a sufficient number of key employees, technical personnel, and other skilled and qualified workers. +The delivery of our services and products requires personnel with specialized skills and experience, including personnel who can perform physically demanding work, and our success depends, in large part, upon our ability to employ and retain key employees, technical personnel, and other skilled and qualified workers. To attract and retain qualified employees, we must compensate them at market levels. If we are unable to continue to attract and retain qualified employees or do so at rates necessary to maintain our liquidity and competitive position, our business, financial condition, or results of operations could suffer. Workers may choose to pursue employment with our competitors or in fields that offer a more desirable work environment as a result of the volatility in the oilfield service industry and the demanding nature of our work. There has been a reduction of the available skilled labor force to service the energy industry. To the extent that there is an increase in demand for our products or services, there is no assurance that the availability of skilled labor will improve. If we are unable to employ and retain skilled workers, our capacity and profitability could be diminished, and our growth potential could be impaired. +Other Material Risks +We do not intend to pay dividends on our common stock, and our debt agreements place restrictions on our ability to do so. Consequently, a stockholder’s only opportunity to achieve a return on his investment is if the price of our common stock appreciates. +We do not plan to declare dividends on shares of our common stock in the foreseeable future. Additionally, our debt agreements place restrictions on our ability to pay cash dividends. Consequently, currently, a stockholder’s only opportunity to achieve a return on his investment in us will be by selling his common stock at a price greater than the stockholder paid for it. There is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price at which a stockholder purchased his shares of our common stock. +The market price of our common stock could be adversely affected by, and our stockholders may experience dilution as a result of, sales of substantial amounts of common stock in the public or private markets, including sales by the Company or other large holders. +The sale of a substantial number of shares of our common stock by the Company or a holder of a substantial number of shares of our common stock in the public markets could have a material adverse effect on the price of our common stock and dilute our stockholders. In November 2023, we entered an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Sandler & Co. (the “Agent”). Pursuant to the Equity Distribution Agreement, we may, from time to time, sell, shares of our common stock having an aggregate offering price of up to $30.0 million through the Agent acting as the Company’s sales agent (the “ATM Program”). Under the Equity Distribution Agreement, we will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made, and any price below which sales may not be made. Subject to the terms and conditions of the Equity Distribution Agreement and such parameters, the Agent may sell the shares by any method deemed to be an “at the market offering” as defined by Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), including sales made directly on or through the NYSE. The Agent may also sell shares in negotiated transactions at market prices prevailing at the time of sale or at prices related to such prevailing market prices and/or any other method permitted by law, subject to our prior written consent. In addition to any shares issued through the ATM Program, we may issue shares of our common stock or equity securities senior to our common stock in the future for a number of reasons, including to finance our operations and growth plans or to adjust our ratio of debt-to-equity. We cannot predict the size of future issuances or sales of our common stock or the effect, if any, that future issuances and sales of shares of our common stock could have on the market price of our common stock. +We have operated at a loss in the past, and there is no assurance of our profitability in the future. +We have in the past experienced periods of low demand for our products and services and have incurred operating losses. In the future, we may not be able to reduce our costs, increase our revenues, or reduce our debt service obligations sufficiently to achieve or maintain profitability and generate positive operating income. Under such circumstances, we may incur operating losses and experience negative operating cash flow. +Our future financial condition and results of operations could be adversely impacted by long-lived assets or other asset impairment charges. +Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment, such as those relating to revenue growth rates, future cash flows, and future market conditions. Future events or new information, including +30 +regarding the general economic environment, E&P activity levels, our financial performance and trends, and our strategies and business plans, may change management’s valuation of long-lived assets, other intangible assets, or other assets in a short amount of time. In particular, prolonged periods of decreased demand, low utilization, changes in technology or market conditions, or sales and other dispositions of assets for amounts less than their carrying value may cause us to recognize impairment charges relating to our long-lived assets, other intangible assets, or other assets that reduce our net income. +While we believe our estimates and assumptions used in impairment tests are reasonable, we cannot provide assurance that additional impairment charges in the future will not be required, especially if an economic downturn occurs and continues for a lengthy period or becomes severe or if our acquisitions and investments fail to achieve expected returns. Significant impairment charges as a result of a decline in market conditions or otherwise could have a material adverse effect on our financial condition or results of operations in future periods. +A terrorist attack or armed conflict could harm our business. +The occurrence or threat of terrorist attacks in the U.S. or other countries, anti-terrorist efforts, and other armed conflicts involving the U.S. or other countries, including continued hostilities in the Middle East, may adversely affect the U.S. and global economies and could prevent us from meeting financial and other obligations. We could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if wells, operations sites, or other related facilities are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas, which, in turn, could also reduce the demand for our products and services. Oil and natural gas-related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect our results of operations, impair our ability to raise capital, or otherwise adversely impact our ability to realize certain business strategies. +A portion of our revenue is derived from sales to customers outside of the U.S., which exposes us to risks inherent in doing business internationally. +In 2024, we derived 4.6% of our revenue from sales to customers outside of the U.S. Sales to customers in countries other than the U.S. are subject to various risks, including: +• volatility in political, social, and economic conditions; +• social unrest, acts of terrorism, war, or other armed conflicts; +• confiscatory taxation or other adverse tax policies; +• deprivation of contract rights; +• trade and economic sanctions or other restrictions; +• the imposition of duties and tariffs and other trade barriers; +• exposure under the FCPA or similar legislation, as discussed in the below risk factor; and +• currency exchange controls. +We are currently out of compliance with the NYSE minimum market capitalization requirement and are at risk of the NYSE delisting our common stock; such a delisting could negatively impact us as it would likely reduce the liquidity and market price of our common stock, which in turn would, among other things, negatively impact our ability to raise equity financing. +On October 21, 2024, we received written notification (the “Notice”) from the NYSE that we no longer satisfy the continued listing compliance standards set forth under Section 802.01B of the NYSE Listed Company Manual (the “NYSE Manual”) because our average global market capitalization was less than $50,000,000 over a consecutive 30 trading-day period that ended on October 18, 2024 and, at the same time, our last reported stockholders’ equity was less than $50,000,000. +In accordance with NYSE procedures, we had 45 days from receipt of the Notice to submit a plan to the NYSE demonstrating how we intend to regain compliance with the NYSE’s continued listing standards within 18 months of our receipt of the Notice. We developed and submitted a plan to bring the Company into compliance with the listing standards within the required timeframe (the “Plan”), which was reviewed by the Listings Operations Committee of the NYSE (the +31 +“Listings Committee”). The Listings Committee accepted our Plan, and our common stock will continue to be listed on the NYSE during the 18-month cure period, subject to our compliance with other continued listing requirements, and we will be subject to quarterly review for compliance with the Plan. If we fail to meet material aspects of the Plan or any quarterly milestones contained in the Plan, the NYSE may commence suspension and delisting procedures. If we fail to regain compliance with Section 802.01B of the NYSE Manual at the end of the cure period, the NYSE will commence suspension and delisting procedures. The NYSE may also commence suspension and delisting procedures if the average closing price of our common stock falls below $1.00 per share over a period of 30 consecutive trading days (the “minimum share price condition”) or our common stock trades at an “abnormally low” price. In April 2020, we received written notification from the NYSE that we did not satisfy the minimum share price condition; although we regained compliance with this condition in June 2020, there is no assurance that we will be able to continue to do so. +A delisting of our common stock from the NYSE could negatively impact us as it would likely reduce the liquidity and market price of our common stock and thus (i) reduce the number of investors willing to hold or acquire our common stock, which would negatively impact our ability to access equity markets and obtain financing and (ii) impair our ability to provide equity incentives to our employees. +Our charter and bylaws contain provisions that could delay, discourage, or prevent a takeover attempt even if a takeover might be beneficial to our stockholders, and such provisions may adversely affect the market price of our common stock. +Provisions contained in our charter and bylaws could make it more difficult for a third party to acquire us. Our charter and bylaws also impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our charter authorizes our board of directors to determine the rights, preferences, privileges, and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our capital stock. These rights may have the effect of delaying or deterring a change of control of our company. Additionally, for example, our bylaws (i) establish limitations on the removal of directors and on the ability of our stockholders to call special meetings, (ii) include advance notice requirements for nominations for election to our board of directors and for proposing matters that can be acted upon at stockholder meetings, (iii) provide that our board of directors is expressly authorized to adopt, or to alter or repeal, our bylaws, and (iv) provide for a classified board of directors, consisting of three classes of approximately equal size, each class serving staggered three-year terms, so that only approximately one-third of our directors will be elected each year. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. +Our charter and bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees, or agents. +Our charter and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, employees, or agents to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our charter or our bylaws, or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine, in each such case subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. These exclusive forum provisions are not intended to apply to actions arising under the Exchange Act or the Securities Act. The Court of Chancery of the State of Delaware has recently held that a Delaware corporation can only use its constitutive documents to bind a plaintiff to a particular forum where the claim involves rights or relationships that were established by or under the DGCL. +Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the forum selection provisions of our charter and bylaws. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees, or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our charter or bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations. +We may not be able to utilize a portion of our net operating loss carry forwards (“NOLs”) to offset future taxable income for U.S. federal or state tax purposes, which could adversely affect our net income and cash flows. +As of December 31, 2024, we had federal and state income tax NOLs of approximately $498.7 million, which will +32 +begin to expire between 2025 and 2034. Utilization of these NOLs depends on many factors, including our future taxable income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of an NOL that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). Determining the limitations under Section 382 is technical and highly complex. An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of the corporation’s stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, with respect to a corporation following its recognition of an NOL, utilization of such NOL would be subject to an annual limitation under Section 382, generally determined by multiplying the value of the corporation’s stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382. However, this annual limitation would be increased under certain circumstances by recognized built-in gains of the corporation existing at the time of the ownership change. In the case of an NOL that arose in a taxable year beginning before January 1, 2018, any unused annual limitation with respect to an NOL generally may be carried over to later years, subject to the expiration of such NOL 20 years after it arose. +The issuance of additional stock in our initial public offering in 2018, combined with ownership shifts over the rolling three-year period, resulted in an ownership change under Section 382, and we may be prevented from fully utilizing our NOLs prior to their expiration. Future changes in our stock ownership or future regulatory changes could also limit our ability to utilize our NOLs. To the extent we are not able to offset future taxable income with our NOLs, our net income and cash flows may be adversely affected. +Item 1B. Unresolved Staff Comments +None. +Item 1C. Cybersecurity +Risk Management and Strategy +Identifying, assessing, and managing cybersecurity risk s is an important component of our overall enterprise risk management program. Our cybersecurity programs have been developed based on the National Institute of Standards and Technology Cybersecurity Framework and seek to protect us against cybersecurity risks. Among other things, these programs generally involve maturity evaluations and assessments by third parties, vulnerability scanning, employee testing and training, technical and business team-focused tabletop exercises, business continuity planning, incident response planning, and d ata security assessments of third-party service providers as a part of vendor management. +Identified Risks +As of the date of this Annual Report, we are not aware of any cybersecurity threats that have materially affected or are reasonably likely to materially affect us, including our business strategy, results of operations, or financial condition. However, we face certain ongoing risks from cybersecurity threats that, if realized, may, among other things, cause material disruptions to our operations, which may materially affect us, including our business strategy, results of operations and/or financial condition. For more information about these risks, see the risk factor titled “Our operations are subject to cybersecurity risks that could have a material adverse effect on our results of operations and financial condition” under Item 1A of Part I of this Annual Report. +Board Oversight and Management ’ s Role +Our Board of Directors (the “Board”) considers cybersecurity risk as part of its risk oversight function and has assigned oversight of cybersecurity risk management to the Audit Committee. The Audit Committee regularly receives reports from our management, including the SC (defined below) and our senior IT leadership and third parties on cybersecurity matters. The Audit Committee reports to the Board regarding its activities, including those related to cybersecurity. In addition, the Board receives reports addressing cybersecurity as part of our overall enterprise risk management program and to the extent cybersecurity matters are addressed therein, in regular business updates. +We have established a Security Committee (the “SC”), comprised of senior departmental leadership including our Chief Financial Officer, Executive Vice President and General Counsel, Senior Vice President – Strategic Development and Investor Relations, Vice President – IT, Vice President – Internal Audit, and Vice President – Corporate Operations, each of whom has between 10 to 20 years of experience managing risks at the Company and at similar companies, including risks arising from cybersecurity threats. The SC meets quarterly to discuss and review cybersecurity concerns that arise during the +33 +year. The SC also identifies areas that should be addressed and reviews and updates security policies, as necessary. The SC has primary management oversight responsibility for assessing and managing risks from cybersecurity threats. +Our senior IT leadership is responsible for the day-to-day management and development of appropriate cybersecurity programs, including as may be required by applicable law or regulation. Our senior IT leadership monitors the prevention, detection, mitigation, and remediation of cybersecurity incidents as part of the cybersecurity programs described above, works closely with the SC, and reports regular updates to the Audit Committee. Our IT team is led by our Vice President – IT, who has over 13 years of experience managing global IT operations, including strategy, applications, infrastructure, information security, support, and execution. +Item 2. Properties +The following table describes the material facilities owned or leased by us as of December 31, 2024. +Location Basin/Region Leased or Owned Principal/Most Significant Use +Houston, TX — Leased Corporate Headquarters/Administrative +Athens, TX — Leased Operations +Baker, MT Bakken Owned Operations/Administrative +Bergen, Norway — Leased Operations +Charleroi, PA Marcellus/Utica Leased Operations +Corpus Christi, TX — Leased Operations/Administrative +Corpus Christi, TX — Leased Administrative +Dickinson, ND Bakken Leased Operations/Administrative +El Reno, OK SCOOP/STACK Leased Operations +Fort Worth, TX — Leased Administrative +Hobbs, NM Permian Leased Operations +Jacksboro, TX Barnett Leased Operations +Jacksboro, TX Barnett Leased Operations +Kilgore, TX Haynesville Leased Operations +Lacombe, AB, Canada WCSB Leased Operations/Administrative +Longview, TX Haynesville Owned Operations +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Marietta, OH Marcellus/Utica Leased Operations/Administrative +Mead, CO Rockies Leased Operations +Midland, TX Permian Leased Operations/Administrative +Monahans, TX Permian Leased Operations/Administrative +Oklahoma City, OK SCOOP/STACK Leased Operations +Pleasanton, TX Eagle Ford Leased Operations +Poolville, TX — Owned Operations +Sweetwater, TX Permian Leased Operations +Tyler, TX Haynesville Leased Operations +Ulster, PA Marcellus/Utica Leased Operations +Williston, ND Bakken Owned Operations/Administrative +Item 3. Legal Proceedings +From time to time, we have various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, we believe any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our business, operating results, or financial condition. For additional information related to legal proceedings, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +34 +Item 4. Mine Safety Disclosures +Not applicable. +35 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Nine Energy Service, Inc.’s common stock is traded on the NYSE under the symbol “NINE.” +Holders +As of March 3, 2025, we had 58 stockholders of record. The number of record holders does not include persons who held shares of our common stock in nominee or “street name” accounts through brokers. +Dividend Policy +We do not anticipate declaring or paying any cash dividends to holders of our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to fund our operations and to develop and grow our business. Our future dividend policy is within the discretion of our board of directors and will depend upon various factors our board of directors deems relevant, including our results of operations, financial condition, capital requirements, and investment opportunities, as well as any restrictions on our ability to pay cash dividends. +Recent Sales of Unregistered Securities +None. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers +None. +Item 6. [Reserved] +36 +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Financial Statements and Supplementary Data” in Item 8 of Part II of this Annual Report. +This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under “Risk Factors” in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. +Overview +Company Description +We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. +Generally, operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently. +We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. +We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +How We Generate Revenue and the Costs of Conducting Our Business +We generate our revenues by providing completion services to E&P customers across all major onshore basins in both the U.S. and Canada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. +The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. +37 +How We Evaluate Our Operations +We evaluate our performance based on a number of financial and non-financial measures, including the following: +• Revenue : We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. +• Adjusted Gross Profit (Loss) : Adjusted gross profit (loss) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). Costs of revenues include direct and indirect labor costs, costs of materials, maintenance of equipment, fuel and transportation freight costs, contract services, crew cost, and other miscellaneous expenses. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted EBITDA : We define Adjusted EBITDA as EBITDA (which is net income (loss) before interest, taxes, and depreciation and amortization) further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units (as defined and described below) offering and other refinancing activities, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on the extinguishment of debt, (vi) loss or gain on the sale of subsidiaries, (vii) restructuring charges, (viii) stock-based compensation and cash award expense, (ix) loss or gain on sale of property and equipment, and (x) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. For additional information, see “Non-GAAP Financial Measures” below. +• Adjusted Return on Invested Capital (“Adjusted ROIC”): We define Adjusted ROIC as adjusted after-tax net operating profit (loss), divided by average total capital. We define adjusted after-tax net operating profit (loss) as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities, (iv) interest expense (income), (v) restructuring charges, (vi) loss (gain) on the sale of subsidiaries, (vii) loss (gain) on the extinguishment of debt, and (viii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity (deficit) plus the book value of debt less balance sheet cash and cash equivalents. We compute and use the average of the current and prior period-end total capital in determining Adjusted ROIC. For additional information, see “Non-GAAP Financial Measures” below. +• Safety : We measure safety by tracking the total recordable incident rate (“TRIR”), which is reviewed on a monthly basis. TRIR is a measure of the rate of recordable workplace injuries, defined below, normalized and stated on the basis of 100 workers for an annual period. The factor is derived by multiplying the number of recordable injuries in a calendar year by 200,000 (i.e., the total hours for 100 employees working 2,000 hours per year) and dividing this value by the total hours actually worked in the year. A recordable injury includes occupational death, nonfatal occupational illness, and other occupational injuries that involve loss of consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. +Industry Trends and Outlook +Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by current and expected oil and natural gas prices. In recent years, oil and natural gas prices have been extremely volatile, and commodity prices continued to be volatile in 2024. During 2024, natural gas prices continued to be extremely depressed, with average natural gas prices of $2.19 for 2024, which is 14% lower than average prices in 2023, which had already declined by over 60% as compared to 2022. This sustained lower natural gas price environment resulted in decreased activity and lower rig counts, especially in natural gas-levered basins like the Haynesville. The Haynesville rig count declined by 30% between 2024 and 2023, from 44 rigs at the end of the year in 2023 to 31 rigs at the end of 2024. This decline was in addition to the previously sustained decline of 28 rigs, or 39%, between 2023 and 2022, from 72 rigs at the end of the year in 2022 to 44 rigs at the end of 2023. The decline in rig count between the end of the year 2024 and the end of the year 2022 was approximately 57%. It also led to pricing pressure from customers, impacting both revenue and margins. During the third quarter of 2024, WTI prices dropped below $70 compared to the highest price in 2024 of $87.69, due to OPEC and other oil exporting nations potentially +38 +bringing production back. The ongoing conflict in the Middle East and demand from China, if weaker than expected, could have an impact on oil prices moving forward as well. Nonetheless, as discussed below, activity levels have remained relatively stable in oil-levered basins. +Due to the spot-market nature of our business, our revenue and profitability generally moves very similarly to rig, frac, and stage counts in U.S. rig count. Since the end of 2023, the U.S. rig count declined by around 33 rigs, or approximately 5%, through the end of 2024. This is following a rig count decline of over 150 rigs from the end of 2022 to the end of 2023, creating an already depressed oil and gas market. In 2024, most public operators with acreage in oil-levered basins, like the Permian, kept activity and capital expenditure levels relatively flat year-over-year. However, both private and public operators with acreage in gas-levered basins, like the Haynesville and in the Northeast, maintained low activity levels in conjunction with low natural gas prices. +During the second half of 2024, despite a declining rig count environment, we outperformed market drivers and improved our revenue in both the third and fourth quarter sequentially. This improvement was driven in large part by market share gains achieved by our cementing division, which we believe differentiated itself in the market with its advanced cementing slurries and excellent wellsite execution. We also had market share gains in our completion tools division that positively impacted earnings in the fourth quarter of 2024. We did have minimal negative impacts in the fourth quarter of 2024 due to typical budget exhaustion, weather, and holiday slow-downs, specifically in the Northeast. With our recent market share gains, our customers re-setting capital budgets, and supportive commodity prices, we anticipate revenue and profitability for the first quarter of 2025 will be up compared to the fourth quarter of 2024. +We remain cautiously optimistic on the outlook for the energy sector, and we believe there is potential upside for North American activity levels, especially if natural gas prices remain supportive. We also believe that there could be a moderate increase in activity in 2025 over fourth quarter of 2024 levels if commodity prices are supportive and customer budgets are reset and believe that we are well-positioned to capitalize on an improving market, should it materialize. +Significant factors that are likely to affect commodity prices moving forward include geopolitical and economic developments in the U.S. and globally, including conflicts, instability, acts of war or terrorism in oil producing countries or regions, particularly the Middle East, Russia, South America and Africa; actions of the members of OPEC and other oil exporting nations that relate to or impact oil production or supply; weather conditions; the effect of energy, monetary, and trade policies of the U.S.; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; changes to energy regulations and policies, including those of the EPA and other governmental bodies; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. Furthermore, although as noted above, our customers’ activity and spending levels, and thus demand for our services and products, are strongly influenced by current and expected oil and natural gas prices, even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. +39 +Results of Operations +Year Ended December 31, +2024 2023 Change Percentage Change +(in thousands, except percentage change) +Revenues $ 554,104 $ 609,526 $ (55,422) (9) % +Cost of revenues (exclusive of depreciation and amortization shown separately below) 456,729 490,750 (34,021) (7) % +Adjusted gross profit $ 97,375 $ 118,776 $ (21,401) (18) % +General and administrative expenses $ 51,298 $ 59,817 $ (8,519) (14) % +Depreciation 25,594 29,141 (3,547) (12) % +Amortization of intangibles 11,183 11,516 (333) (3) % +Loss on revaluation of contingent liability 104 437 (333) (76) % +Loss on sale of property and equipment 256 292 (36) (12) % +Income from operations 8,940 17,573 (8,633) (49) % +Non-operating expenses 49,824 49,201 623 1 % +Loss before income taxes (40,884) (31,628) (9,256) 29 % +Provision for income taxes 198 585 (387) (66) % +Net loss $ (41,082) $ (32,213) $ (8,869) 28 % +Revenues +Revenues decreased $55.4 million, or 9%, to $554.1 million in 2024. The decrease in comparison to 2023 was prevalent across all lines of service and was primarily due to pricing decreases coupled with changes in market conditions as the average U.S. rig count for 2024 decreased 5%, in comparison to 2023. More specifically, cement revenue (including pump downs) decreased $24.7 million, or 11%, coiled tubing revenue decreased $12.2 million, or 10%, and wireline revenue also decreased $5.6 million, or 5%, all due to pricing pressure throughout the year, in comparison to 2023. In addition, tools revenue decreased $12.9 million, or 9%, due to a decrease of 11% in stages, in comparison to 2023. +Cost of Revenues (Exclusive of Depreciation and Amortization) +Cost of revenues decreased $34.0 million, or 7%, to $456.7 million in 2024. The decrease in comparison to 2023 was primarily driven by a reduction in activity for certain lines of service as described under “Revenues.” More specifically, the decrease was due to a $15.4 million decrease in materials installed and consumed while performing services, a $12.5 million decrease in employee related costs, and a $6.1 million decrease in other costs such as repair and maintenance, vehicle expense, and travel, in comparison to 2023. +Adjusted Gross Profit (Loss) +Adjusted gross profit decreased $21.4 million to $97.4 million in 2024 as a result of the factors described above under “Revenues” and “Cost of Revenues.” +General and Administrative Expenses +General and administrative expenses decreased $8.5 million to $51.3 million in 2024. The decrease in comparison to 2023 was primarily related to $6.4 million in costs associated with the Units offering in 2023 that did not occur in 2024. The decrease was also partially attributed to an $0.7 million decrease in employee costs, a $0.8 million decrease in marketing expenses, and a $0.6 million decrease in professional fees, each in comparison to 2023. +Depreciation +Depreciation expense decreased $3.5 million to $25.6 million in 2024. The decrease in comparison to 2023 was primarily due to a decrease in capital expenditures across certain lines of service over the last twelve months. +40 +Amortization of Intangibles +Amortization of intangibles, which was comprised of technology and customer relationships, decreased $0.3 million to $11.2 million in 2024. The decrease in comparison to 2023 was due to certain intangible assets being fully amortized over the last twelve months. +(Gain) Loss on Revaluation of Contingent Liability +We recorded a $0.1 million loss on the revaluation of contingent liability in 2024 compared to a $0.4 million loss in 2023. The losses for both periods were related to increases in the fair value of the earnout associated with our acquisition Frac Technology AS. +Non-Operating Expenses (Income) +Non-operating expenses increased $0.6 million to $49.8 million in 2024. The increase in comparison to 2023 was primarily attributed to a $0.4 million decrease in interest income earned on cash in 2024, as our average cash balance in 2024 decreased in comparison to 2024, coupled with a $0.2 million increase in interest expense on the 2028 Notes in 2024 compared to interest expense on the 2023 Notes (as defined and described below) and the 2028 Notes in 2023. +Provision (Benefit) for Income Taxes +Our effective tax rate was (0.5)% for 2024 and (1.8)% for 2023. Our tax provision for 2024 was primarily attributed to our income tax position in state and foreign tax jurisdictions. +Net Income (Loss) and Adjusted EBITDA +Net loss increased $8.9 million, or 28%, to $41.1 million, and Adjusted EBITDA decreased $19.8 million, or 27%, to $53.2 million for 2024. The changes were primarily due to the fluctuations in revenue and expenses discussed above. See “Non-GAAP Financial Measures” below for further information regarding Adjusted EBITDA. +Non-GAAP Financial Measures +Adjusted EBITDA +Adjusted EBITDA is a non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. +We define Adjusted EBITDA as EBITDA (which is net income (loss) before interest, taxes, depreciation, and amortization) further adjusted for (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on the extinguishment of debt, (vi) loss or gain on the sale of subsidiaries, (vii) restructuring charges, (viii) stock-based compensation and cash award expense, (ix) loss or gain on sale of property and equipment, and (x) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. +Management believes Adjusted EBITDA provides useful information to us and our investors regarding our financial condition and results of operations because it allows us and them to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure and helps identify underlying trends in our operations that could otherwise be distorted by the effect of impairments, acquisitions and dispositions, and costs that are not reflective of the ongoing performance of our business. We exclude the items listed above from net income (loss) in arriving at this measure because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. +Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, net income (loss) as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) or as an indicator of our operating performance. Certain items excluded from Adjusted EBITDA are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of Adjusted EBITDA. Our computation of Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. +41 +The following table presents a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss) for the years ended December 31, 2024 and 2023: +Year Ended December 31, +2024 2023 +(in thousands) +Net loss $ (41,082) $ (32,213) +Interest expense 51,321 51,119 +Interest income (849) (1,270) +Provision for income taxes 198 585 +Depreciation 25,594 29,141 +Amortization of intangibles 11,183 11,516 +EBITDA $ 46,365 $ 58,878 +Adjusted EBITDA reconciliation: +EBITDA $ 46,365 $ 58,878 +Loss on revaluation of contingent liability (1) +104 437 +Certain refinancing costs (2) +— 6,396 +Restructuring charges 701 2,027 +Stock-based compensation expense 2,946 2,169 +Cash award expense 2,832 2,698 +Loss on sale of property and equipment 256 292 +Legal fees and settlements (3) +— 69 +Adjusted EBITDA $ 53,204 $ 72,966 +(1) Amounts relate to the revaluation of contingent liability associated with a 2018 acquisition. The impact is included in our Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 – Commitments and Contingencies included in Item 8 of Part II of this Annual Report. +(2) Amounts represent fees and expenses relating to our multiple Units offering and other refinancing activities, including cash incentive compensation to employees following the successful completion of the initial Units offering, that were not capitalized. +(3) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. +42 +Adjusted Return on Invested Capital +Adjusted ROIC is a non-GAAP financial measure. We define Adjusted ROIC as adjusted after-tax net operating profit (loss), divided by average total capital. We define adjusted after-tax net operating profit (loss), which is a non-GAAP financial measure, as net income (loss) plus (i) goodwill, intangible asset, and/or property and equipment impairment charges, (ii) transaction and integration costs related to acquisitions, (iii) fees and expenses relating to our Units offering and other refinancing activities, (iv) interest expense (income), (v) restructuring charges, (vi) loss (gain) on the sale of subsidiaries, (vii) loss (gain) on the extinguishment of debt, and (viii) the provision (benefit) for deferred income taxes. We define total capital as book value of equity (deficit) plus the book value of debt less balance sheet cash and cash equivalents. We compute and use the average of the current and prior period-end total capital in determining Adjusted ROIC. +Management believes Adjusted ROIC provides useful information to us and our investors regarding our financial condition and results of operations because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses Adjusted ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although Adjusted ROIC is commonly used as a measure of capital efficiency, definitions of Adjusted ROIC differ, and our computation of Adjusted ROIC may not be comparable to other similarly titled measures of other companies. +The following table provides our calculation of Adjusted ROIC for the years ended December 31, 2024 and 2023. The following table also presents ROIC (defined as net income (loss), divided by average total capital) and a reconciliation of the non-GAAP financial measure of adjusted after-tax net operating profit (loss) to the most directly comparable GAAP measure of net income (loss), in each case for the years ended December 31, 2024 and 2023. +Year Ended December 31, +2024 2023 +(in thousands) +Net loss $ (41,082) $ (32,213) +Add back: +Interest expense 51,321 51,119 +Interest income (849) (1,270) +Certain refinancing costs (1) +— 6,396 +Restructuring charges 701 2,027 +Adjusted after-tax net operating income $ 10,091 $ 26,059 +Total capital as of prior period-end: +Total stockholders’ deficit $ (35,630) $ (23,507) +Total debt 359,859 341,606 +Less cash and cash equivalents (30,840) (17,445) +Total capital as of prior period-end $ 293,389 $ 300,654 +Total capital as of period-end: +Total stockholders’ deficit $ (66,064) $ (35,630) +Total debt 350,580 359,859 +Less cash and cash equivalents (27,880) (30,840) +Total capital as of period-end $ 256,636 $ 293,389 +Average total capital $ 275,013 $ 297,022 +ROIC (14.9) % (10.8) % +Adjusted ROIC 3.7 % 8.8 % +(1) Amounts represent fees and expenses relating to our Units offering and other refinancing activities, including cash incentive compensation to employees following the successful completion of the Units offering, that were not capitalized. +43 +Adjusted Gross Profit (Loss) +GAAP defines gross profit (loss) as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (loss) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit (loss) because we do not include the impact of depreciation and amortization, which represent non-cash expenses. +Management believes adjusted gross profit (loss) provides useful information to us and our investors regarding our financial condition and results of operation and helps management evaluate our operating performance by eliminating the impact of depreciation and amortization, which we do not consider indicative of our core operating performance. Adjusted gross profit (loss) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP. Adjusted gross profit (loss) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (loss) or similarly titled measures in the same manner as we do. +The following table presents a reconciliation of adjusted gross profit (loss) to GAAP gross profit (loss) for the years ended December 31, 2024 and 2023. +Year Ended December 31, +2024 2023 +(in thousands) +Calculation of gross profit: +Revenues $ 554,104 $ 609,526 +Cost of revenues (exclusive of depreciation and amortization shown separately below) 456,729 490,750 +Depreciation (related to cost of revenues) 25,095 27,101 +Amortization of intangibles 11,183 11,516 +Gross profit $ 61,097 $ 80,159 +Adjusted gross profit reconciliation: +Gross profit $ 61,097 $ 80,159 +Depreciation (related to cost of revenues) 25,095 27,101 +Amortization of intangibles 11,183 11,516 +Adjusted gross profit $ 97,375 $ 118,776 +44 +Liquidity and Capital Resources +Sources and Uses of Liquidity +Historically, we have met our liquidity needs principally from cash on hand, cash flows from operations and, if needed, external borrowings and issuances of debt securities. Our principal uses of cash are to fund capital expenditures, service our outstanding debt, and fund our working capital requirements. Due to our high level of variable costs and the asset-light make-up of our business, we have historically been able to quickly implement cost-cutting measures and will continue to adapt as the market dictates. For example, earlier this year, we implemented certain cost reduction and supply chain initiatives. These ongoing initiatives have helped reduce some of our largest material costs, and starting at the end of the second quarter of 2024, we began to see positive impacts on our profitability as a result of such efforts. We have also used cash to make open market repurchases of our debt and may, from time to time, continue to make such repurchases when it is opportunistic to do so to manage our debt maturity profile. +For 2025, our planned capital expenditure budget, excluding possible acquisitions, is expected to be between $15 million to $25 million. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including expected industry activity levels and company initiatives. For example, our planned capital expenditure budget, excluding possible acquisitions, for 2024 was initially expected to be between $15.0 million and $25.0 million and was subsequently reduced to be between $10.0 million and $15.0 million in conjunction with market declines and to preserve liquidity until the market returns to more normalized levels. Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. +We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital, which we cannot guarantee. +As of December 31, 2024, we had $27.9 million of cash and cash equivalents and $24.2 million of availability under the ABL Credit Facility, which resulted in a total liquidity position of $52.1 million. Our liquidity position will continue to be impacted by the semi-annual interest payments ($19.5 million based on amounts outstanding as December 31, 2024) to the holders of the 2028 Notes, which began on August 1, 2023. We believe that, based on our current forecasts, our cash on hand, together with cash flow from operations and borrowings under the ABL Credit Facility, should be sufficient to fund our capital requirements for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts, which are materially dependent on our financial performance and the ever-changing market. +ATM Program +On November 6, 2023, we entered into the Equity Distribution Agreement with Piper Sandler & Co., as the Agent, pursuant to which we may, from time to time, sell shares of our common stock having an aggregate offering price of up to $30.0 million t hrough the Agent acting as the Company’s sales agent . The Agent will receive a commission equal to 3.0% of the gross sale price of any shares sold under the Equity Distribution Agreement. +Under the Equity Distribution Agreement, we will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made, and any price below which sales may not be made. During the three months ended December 31, 2024, no shares were sold under the Equity Distribution Agreement. During the year ended December 31, 2024, 5,380,164 shares were sold under the Equity Distribution Agreement, which generated net proceeds to us of $8.2 million after deducting commissions of $0.3 million. +Units Offering and 2028 Notes +On January 30, 2023, we completed our public offering of 300,000 units with an aggregate stated amount of $300.0 million (the “Units”). Each Unit consisted of $1,000 principal amount of the 2028 Notes and five shares of our common stock. We received proceeds of $279.8 million from the Units offering, after deducting underwriting discounts and commission, which, together with borrowings under the ABL Credit Facility, was used to fund the redemption of our 8.750% Senior Notes due 2023 (the “2023 Notes”). On February 1, 2023, we redeemed all of the 2023 Notes at a redemption price of 100.0% of outstanding principal amount thereof ($307.3 million), plus accrued and unpaid interest ($6.7 million). +45 +Each Unit separated into its constituent securities (the 2028 Notes and the shares of our common stock) automatically on October 27, 2023. A holder of Units could have elected to separate its Units into its constituent, in whole but not in part, on or after March 31, 2023. Prior to such date, the Units could not be separated at the option of the holder. +On January 30, 2023, we, and certain of our subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000% payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are our senior secured obligations and are guaranteed on a senior secured basis by each of our current domestic subsidiaries and will be so guaranteed by certain future subsidiaries, subject to agreed guaranty and security principles and certain exclusions. +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), we are required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0% of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100% of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. For the Excess Cash Flow Offer Date of November 14, 2024, the Excess Cash Flow Amount was $0 and, as such, no Excess Cash Flow Offer was made. +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit our ability and the ability of our restricted subsidiaries to engage in certain activities. We were in compliance with the provision of the 2028 Notes Indenture on December 31, 2024. +For additional information on the Units and the 2028 Notes, see Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +ABL Credit Facility +On October 25, 2018, we entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), that permitted aggregate borrowings of up to $200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for letters of credit (the “ABL Credit Facility”). +On January 17, 2023, we entered into the First Amendment to Credit Agreement (the “First ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which became effective on January 30, 2023. Pursuant to the First ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the First ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $200.0 million to $150.0 million, subject to the borrowing base, (b) changed the interest rate benchmark from London Interbank Offered Rate to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75% to 2.25% to a range of 2.00% to 2.50%, in each case depending on our leverage ratio, (c) decreased the Canadian tranche sub-limit from $25.0 million to $5.0 million, and (d) decreased the letter of credit sub-limit from $50.0 million to $10.0 million. Certain other changes to the terms of the ABL Credit Facility as a result of the First ABL Facility Amendment are summarized in Note 9 – Debt Obligations included in Item 8 of Part II of this Annual Report. +On June 7, 2024, we entered into the Second Amendment to Credit Agreement (together with the First ABL Facility Amendment, the “ABL Facility Amendments”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, to change the interest rate benchmark for borrowings denominated in Canadian dollars from Canadian Dollar Offered Rate (CDOR) to a rate based on the Canadian Overnight Repo Rate Average (CORRA), effective as of June 14, 2024. +46 +The 2018 ABL Credit Agreement, as amended by the ABL Facility Amendments (the “ABL Credit Agreement”) contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. We were in compliance with all covenants under the ABL Credit Agreement as of December 31, 2024. +Pursuant to the ABL Credit Agreement, all of the obligations under the ABL Credit Facility are secured by security interests (subject to permitted liens) in substantially all of the personal property of our domestic subsidiaries, excluding certain assets. The obligations under the Canadian tranche are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Nine Energy Canada, Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries, excluding certain assets. +As of December 31, 2024, we had $47.0 million of borrowings under the ABL Credit Facility, and our availability under the ABL Credit Facility was approximately $24.2 million, net of outstanding letters of credit of $2.2 million. +Cash Flows +Our cash flows for the years ended December 31, 2024, and 2023 are presented below: +Year Ended December 31, +2024 2023 +(in thousands) +Operating activities $ 13,195 $ 45,509 +Investing activities (14,178) (23,157) +Financing activities (1,683) (8,893) +Impact of foreign exchange rate on cash (294) (64) +Net change in cash and cash equivalents $ (2,960) $ 13,395 +Operating Activities +Net cash provided by operating activities was $13.2 million in 2024 compared to $45.5 million in net cash provided by operating activities in 2023. The decrease was primarily attributed to a $20.5 million decrease in cash provided by working capital, driven mainly by a $9.8 million decrease in cash provided by accounts receivable collections in comparison to 2023. The decrease was also partially attributed to a $11.8 million decrease in cash provided by operations driven mainly by an increased net loss in comparison to 2023. +Investing Activities +Net cash used in investing activities was $14.2 million in 2024 compared to $23.2 million in net cash used in investing activities in 2023. The decrease was attributed to a $9.8 million decrease in cash purchases of property and equipment, partially offset by a $0.8 million decrease in proceeds from the sale of property and equipment (including insurance), each in comparison to 2023. +Financing Activities +Net cash used in financing activities was $1.7 million in 2024 compared to $8.9 million in net cash used in 2023. The decrease was primarily attributed to the $307.3 million redemption of the 2023 Notes as well as $6.3 million in debt issuance costs associated with the Units offering in 2023, neither of which reoccurred in 2024. The decrease in net cash used was also partially due to $8.2 million in proceeds received from the issuance of common stock under our ATM program in 2024 that did not occur in 2023. Additionally, the decrease was partly attributed to a $2.0 million reduction in payments on the ABL Credit Facility between periods as well as an increase of $1.0 million in proceeds from short term debt, each in comparison to 2023. The overall decrease in net cash used was largely offset by $279.8 million in proceeds received from the Units offering in 2023, that did not reoccur in 2024. The decrease was also offset by a $37.0 million reduction in proceeds from the ABL Credit Facility between periods, as well as a $0.9 million increase in payments on short term debt between periods. +Critical Accounting Estimates +The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related +47 +disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions used in preparation of our financial statements. +We consider the significant accounting policies identified below to be “critical accounting estimates” due to the following: +• The policies are dependent on estimates and assumptions made by us about matters that are inherently uncertain. +• The policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. +For additional information on our significant accounting policies, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful life of the asset. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term and the estimated useful life of the asset. Estimated useful lives requires significant judgment, which is influenced by our historical experience in operating property and equipment, technological developments, and expectations of future demand. Should our estimates be too long or too short, we could report a disproportionate amount of losses or gains from sale or retirement. +Valuation of Long-Lived Assets +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. We believe that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in our Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). +Recognition of Provisions for Contingencies +In the ordinary course of business, we are subject to various claims, suits, and complaints. We, in consultation with internal and external advisors, will provide for a contingent loss in the financial statements if it is probable that a liability has been incurred at the date of the financial statements and the amount can be reasonably estimated. Reasonable estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The accuracy of these estimates is impacted by, among other things, the complexity of the issues and the amount of due diligence we have been able to perform. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within the range, provision will be made for the lower amount of the range. If the actual settlement costs, final judgments, or fines, after appeals, differ from our estimates, there may be a material adverse effect on our future financial results. +Stock-based Compensation and Fair Market Value Determination +We account for awards of stock-based compensation at fair value on the date granted to employees and recognize the compensation expense in the financial statements over the requisite service period. Forfeitures are recorded as they occur. All stock-based compensation expense is recorded using the straight-line method and is included in “General and administrative expenses” in our Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). +Fair value of all the options outstanding was measured using the Black-Scholes model. Determining the appropriate fair value model and calculating the fair value of options requires the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options, and the expected dividend yield +48 +of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. The Black-Scholes option pricing model requires estimates of key assumptions based on both historical information and management judgment regarding market factors and trends. +Expected Life – The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +Expected Volatility – We develop our expected volatility based upon a weighted average volatility of our peer group. +Risk-free Interest Rate – The risk-free interest rates for options granted are based on the average of five year and seven year constant maturity Treasury bond rates whose term is consistent with the expected term of an option from the date of grant. +Expected Term – The expected term is based on the midpoint between the vesting date and contractual term of an option. The expected term represents the period that our stock-based awards are expected to be outstanding. +Expected Dividend Yield – We do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. +Fair value of the stock-based compensation for all of the performance share units as well as the fair value of the performance cash awards was measured using a Monte Carlo simulation model. +Recent Accounting Pronouncements +For additional information on recent accounting pronouncements, see Note 2 – Significant Accounting Policies included in Item 8 of Part II of this Annual Report. +Smaller Reporting Company Status +We are a “smaller reporting company” as defined by the SEC. As such, we are eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. Our disclosures in this Annual Report reflect these scaled requirements. +Item 7A. Quantitative and Qualitative Disclosures About Market Risk +As a “smaller reporting company,” as defined under the Exchange Act, we are not required to provide the information required by this Item. +Item 8. Financial Statements and Supplementary Data +Index to Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 238 ) +F- 1 +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F- 3 +Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the Years Ended December 31, 2024 and 2023 +F- 4 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2024 and 2023 +F- 5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2024 and 2023 +F- 6 +Notes to Consolidated Financial Statements +F- 8 +49 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Stockholders of Nine Energy Service, Inc. +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of Nine Energy Service, Inc. and its subsidiaries (the “Company”) as of December 31, 2024 and 2023, and the related consolidated statements of income (loss) and comprehensive income (loss), of stockholders’ equity (deficit) and of cash flows for the years then ended, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2024 and 2023, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control – Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +F-1 +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Revenue Recognition +As described in Note 2 to the consolidated financial statements, the Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. The Company recognized total revenues of $554.1 million for the year ended December 31, 2024. +The principal consideration for our determination that performing procedures relating to revenue recognition is a critical audit matter is a high degree of auditor effort in performing procedures related to the Company’s revenue recognition. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the recording of revenue upon shipment of the product or over the time the service is performed. These procedures also included, among others (i) testing, on a sample basis, revenue recognized by obtaining and inspecting source documents, such as invoices, credit memos, proof of shipment or service, and cash receipts or tracing transactions not settled to a detailed listing of accounts receivable; (ii) testing, on a sample basis, revenue transactions recorded but not yet invoiced by obtaining and inspecting proof of shipment or service; (iii) testing, on a sample basis, revenue transactions recorded near period end to evaluate whether they were recorded in the appropriate period; (iv) confirming, on a sample basis, outstanding customer invoice balances as of December 31, 2024 and, for confirmations not returned, obtaining and inspecting source documents, such as proof of shipment or service and subsequent cash receipts; and (v) evaluating, on a sample basis, terms and conditions within master service agreements. +/s/ PricewaterhouseCoopers LLP +Houston, Texas +March 5, 2025 +We have served as the Company’s auditor since 2011. +F-2 +NINE ENERGY SERVICE, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share amounts) +December 31, +2024 2023 +Assets +Current assets +Cash and cash equivalents $ 27,880 $ 30,840 +Accounts receivable, net 81,157 88,449 +Income taxes receivable 284 490 +Inventories, net 50,781 54,486 +Prepaid expenses 9,982 8,869 +Other current assets 380 499 +Total current assets 170,464 183,633 +Property and equipment, net 70,518 82,366 +Operating lease right of use assets, net 37,252 42,056 +Finance lease right of use assets, net 29 51 +Intangible assets, net 79,246 90,429 +Other long-term assets 2,567 3,449 +Total assets $ 360,076 $ 401,984 +Liabilities and Stockholders’ Equity (Deficit) +Current liabilities +Accounts payable $ 36,052 $ 33,379 +Accrued expenses 30,676 36,171 +Current portion of long-term debt 3,580 2,859 +Current portion of operating lease obligations 11,216 10,314 +Current portion of finance lease obligations 21 31 +Total current liabilities 81,545 82,754 +Long-term liabilities +Long-term debt 317,264 320,520 +Long-term operating lease obligations 26,710 32,594 +Other long-term liabilities 621 1,746 +Total liabilities 426,140 437,614 +Commitments and contingencies (Note 12) +Stockholders’ equity (deficit) +Common stock ( 120,000,000 shares authorized at $ 0.01 par value; 42,348,643 and 35,324,861 shares issued and outstanding at December 31, 2024 and 2023 respectively) +423 353 +Additional paid-in capital 806,231 795,106 +Accumulated other comprehensive loss ( 5,406 ) ( 4,859 ) +Accumulated deficit ( 867,312 ) ( 826,230 ) +Total stockholders’ equity (deficit) ( 66,064 ) ( 35,630 ) +Total liabilities and stockholders’ equity (deficit) $ 360,076 $ 401,984 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) +(In thousands, except share and per share amounts) +Year Ended December 31, +2024 2023 +Revenues +Service $ 421,738 $ 464,233 +Product 132,366 145,293 +554,104 609,526 +Cost and expenses +Cost of revenues (exclusive of depreciation and amortization shown separately below) +Service 355,636 379,365 +Product 101,093 111,385 +General and administrative expenses 51,298 59,817 +Depreciation 25,594 29,141 +Amortization of intangibles 11,183 11,516 +Loss on revaluation of contingent liability 104 437 +Loss on sale of property and equipment 256 292 +Income from operations 8,940 17,573 +Interest expense 51,321 51,119 +Interest income ( 849 ) ( 1,270 ) +Other income ( 648 ) ( 648 ) +Loss before income taxes ( 40,884 ) ( 31,628 ) +Provision for income taxes 198 585 +Net loss $ ( 41,082 ) $ ( 32,213 ) +Loss per share +Basic $ ( 1.11 ) $ ( 0.97 ) +Diluted $ ( 1.11 ) $ ( 0.97 ) +Weighted average shares outstanding +Basic 37,172,635 33,282,234 +Diluted 37,172,635 33,282,234 +Other comprehensive loss, net of tax +Foreign currency translation adjustments, net of $ 0 tax in each period +$ ( 547 ) $ ( 31 ) +Total other comprehensive loss, net of tax ( 547 ) ( 31 ) +Total comprehensive loss $ ( 41,629 ) $ ( 32,244 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) +(In thousands, except share amounts) +Common Stock Additional +Paid-in Accumulated +Other +Comprehensive Retained +Earnings +(Accumulated Total +Stockholders’ Equity +Shares Amounts Capital Income (Loss) Deficit) (Deficit) +Stockholders’ equity (deficit) as of December 31, 2022 33,221,266 $ 332 $ 775,006 $ ( 4,828 ) $ ( 794,017 ) $ ( 23,507 ) +Issuance of common stock associated with the Units offering 1,500,000 15 17,939 — — 17,954 +Issuance of common stock under stock compensation plan, net of forfeitures 603,078 6 ( 6 ) — — — +Stock-based compensation expense — — 2,169 — — 2,169 +Vesting of restricted stock and stock units 517 — ( 2 ) — — ( 2 ) +Other comprehensive loss — — — ( 31 ) — ( 31 ) +Net loss — — — — ( 32,213 ) ( 32,213 ) +Stockholders’ equity (deficit) as of December 31, 2023 35,324,861 $ 353 $ 795,106 $ ( 4,859 ) $ ( 826,230 ) $ ( 35,630 ) +Issuance of common stock under stock compensation plan, net of forfeitures 1,643,618 16 ( 16 ) — — — +Stock-based compensation expense — — 2,946 — — 2,946 +Issuance of common stock under ATM program 5,380,164 54 8,195 — — 8,249 +Vesting of restricted stock and stock units — — — — — — +Other comprehensive loss — — — ( 547 ) — ( 547 ) +Net loss — — — — ( 41,082 ) ( 41,082 ) +Stockholders’ equity (deficit) as of December 31, 2024 42,348,643 $ 423 $ 806,231 $ ( 5,406 ) $ ( 867,312 ) $ ( 66,064 ) +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +NINE ENERGY SERVICE, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2024 2023 +Cash flows from operating activities +Net loss $ ( 41,082 ) $ ( 32,213 ) +Adjustments to reconcile net loss to net cash provided by operating activities +Depreciation 25,594 29,141 +Amortization of intangibles 11,183 11,516 +Amortization of operating leases 13,256 12,524 +Amortization of deferred financing costs 7,602 7,413 +Provision for doubtful accounts 526 333 +Provision for inventory obsolescence 1,738 2,320 +Stock-based compensation expense 2,946 2,169 +Loss on sale of property and equipment 256 292 +Loss on revaluation of contingent liability 104 437 +Changes in operating assets and liabilities +Accounts receivable, net 6,724 16,489 +Inventories, net 1,710 5,219 +Prepaid expenses and other current assets ( 995 ) 1,148 +Accounts payable and accrued expenses ( 2,092 ) 1,058 +Income taxes receivable/payable 212 252 +Operating lease obligations ( 13,080 ) ( 12,344 ) +Other assets and liabilities ( 1,407 ) ( 245 ) +Net cash provided by operating activities 13,195 45,509 +Cash flows from investing activities +Proceeds from sales of property and equipment 585 606 +Proceeds from property and equipment casualty losses — 840 +Purchases of property and equipment ( 14,763 ) ( 24,603 ) +Net cash used in investing activities ( 14,178 ) ( 23,157 ) +Cash flows from financing activities +Proceeds from issuance of common stock under ATM program 8,249 — +Proceeds from Units offering, net of discount — 279,750 +Redemption of 2023 Notes — ( 307,339 ) +Cost of debt issuance — ( 6,290 ) +Proceeds from ABL Credit Facility 3,000 40,000 +Payments on ABL Credit Facility ( 13,000 ) ( 15,000 ) +Proceeds from short-term debt 5,762 4,733 +Payments of short-term debt ( 5,041 ) ( 4,141 ) +Principle payments on finance leases ( 49 ) ( 217 ) +Payments of contingent liability ( 604 ) ( 387 ) +Vesting of restricted stock and stock units — ( 2 ) +Net cash used in financing activities ( 1,683 ) ( 8,893 ) +Impact of foreign currency exchange on cash ( 294 ) ( 64 ) +Net (decrease) increase in cash and cash equivalents ( 2,960 ) 13,395 +Cash and cash equivalents +F-6 +Year Ended December 31, +2024 2023 +Cash and cash equivalents at beginning of period 30,840 17,445 +Cash and cash equivalents at end of period $ 27,880 $ 30,840 +Supplemental disclosures of cash flow information: +Cash paid for interest $ 43,939 $ 31,431 +Cash paid for income taxes $ 525 $ 563 +Supplemental schedule of non-cash activities: +Capital expenditures in accounts payable and accrued expenses $ 889 $ 1,107 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +NINE ENERGY SERVICE, INC. +NOTES TO THE FINANCIAL STATEMENTS +1. Company and Organization +Company Description +Nine Energy Service, Inc. (the “Company” or “Nine”), a Delaware corporation, is an oilfield services business that provides services integral to the completion of unconventional wells through a full range of tools and methodologies. The Company is headquartered in Houston, Texas. +Risks and Uncertainties +As Nine is a spot-market business, the Company’s business and its pricing depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by current and expected oil and natural gas prices, which have been extremely volatile historically and in recent years. In addition, the Company’s earnings are affected by its ability to maintain current pricing levels, the impact of wage and labor inflation, labor shortages, and supply chain constraints. Due to the spot-market nature of its business, the Company’s revenue and profitability generally move very similarly to rig, frac, and stage counts in U.S. rig count. +2. Significant Accounting Policies +Basis of Presentation +The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). +Principles of Consolidation +The consolidated financial statements as of December 31, 2024 and 2023, and for the years ended December 31, 2024 and 2023, include the accounts of Nine and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in the consolidation. +Use of Estimates +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Such estimates include fair value assumptions used in analyzing long-lived assets for possible impairment, useful lives used in depreciation and amortization expense, recognition of provisions for contingencies, and stock-based compensation fair value. It is at least reasonably possible that the estimates used will change within the next year. +Reclassifications +Certain reclassifications have been made to prior period amounts to conform to the current period financial statement presentation. These reclassifications relate to presenting “Prepaid expenses” and “Other current assets” as separate line items in the Company’s Consolidated Balance Sheets. +Revenue Recognition +The Company recognizes revenue under Accounting Standards Codification Topic 606 (“ASC 606”) when products are received by a customer’s domestic common carrier at the Company’s facility or, for international sales, when the product is shipped to the customer’s exporter. The Company believes this recognition policy reflects the point at which the customer obtains control of the product as required by ASC 606. +Performance Obligations +A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as +F-8 +revenue when, or as, the performance obligation is satisfied. The Company excludes sales taxes, value added taxes, and other taxes it collects concurrent with revenue-producing activities from revenue. +The Company’s revenue is derived from the sale of products and services which are sold directly to customers or are consumed by customers on their well sites. For product sales, the Company typically recognizes revenue when it meets its performance obligation upon the shipment of the products from its facilities to its customer. The Company recognizes service revenue over the time the service is performed as the customer consumes and benefits from the use of the Company’s products and services for well service. Service revenues represent revenue recognized over time, as the Company’s customer arrangements typically provide agreed upon hourly or daily fixed-rates, and the Company recognizes service revenue based upon the number of hours or days services have been performed. +Contracts for the Company’s products and services are negotiated on a per-job basis at a regional level. Contracts vary in nature but typically have a duration of less than a month and have a single performance obligation either for a job, a series of distinct jobs, or a period the Company stands ready to provide its services to its client as needed. +The Company’s payment terms vary by the type and location of its customers and type of product and service offered. The Company receives cash equal to the invoice amount for most services and product sales, and payment terms typically range from 30 to 60 days from the date the Company invoices a customer. Since the period between the delivery of the Company’s products and services and the Company’s receipt of customer payment for these products and services is not expected to exceed one year, the Company has elected not to calculate or disclose a financing component for its customer contracts. +Contract Estimates +The Company receives reimbursements from its customers for the purchase of supplies, equipment, personnel services, and other services provided at a customer’s request. Reimbursable revenues are subject to uncertainty as the timing of the receipt of these amounts is dependent on factors outside of the Company’s influence. Accordingly, these revenues are not recognized until the uncertainty is resolved, which typically occurs when the related costs are incurred on behalf of the customer. The Company is considered a principal in these transactions and records the associated revenues at the gross amount billed to the customer. +Changes and modifications to contracts are routine in the performance of the Company’s contracts due to the dynamic nature of well operations and the services the Company provides for its customers. The Company considers contract modifications to exist when the modification either creates a new contract or changes the existing enforceable rights and obligations of a contract. Most of the Company’s contract modifications are for services or goods that are not distinct from existing contracts due to the significant integration provided or significant interdependencies in the context of the contract and are accounted for as if they were part of the original contract. +Contract Balances +Any contract assets are included in “Accounts receivable, net” in the Company’s Consolidated Balance Sheets. Contract assets arise when recorded revenues for a contract exceed the amounts billed under the terms of the contracts. The Company classifies contract liabilities as unearned income which is included in “Accrued expenses” in the Company’s Consolidated Balance Sheets. Such deferred revenue typically results from advance payments received on well service orders prior to performance of the service. +For information regarding the Company’s revenue, see Note 3 – Revenues. +Leases +The Company determines if an arrangement is a lease at its inception. To the extent an arrangement represents a lease, the Company classifies that lease as an operating lease or a finance lease under Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) and its related ASUs (“ASC 842”). +The Company capitalizes operating leases on its Consolidated Balance Sheets through a Right of Use (“ROU”) asset and a corresponding lease liability. ROU assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the operating lease. Operating lease ROU assets and obligations are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term utilizing an interest rate that the Company would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. +F-9 +Operating leases are included in “Operating lease right of use assets, net,” “Current portion of operating lease obligations,” and “Long-term operating lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2024 and 2023. Lease expense for operating leases is recognized on a straight-line basis over the lease term for 2024 and 2023. +Finance leases are included in the line items “Finance lease right of use assets, net,” “Current portion of finance lease obligations,” and “Long-term finance lease obligations” in the Company’s Consolidated Balance Sheets as of December 31, 2024 and 2023. +For additional information regarding the Company’s leases, see Note 6 – Leases. +Cash and Cash Equivalents +The Company considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. Throughout the year, the Company maintained cash balances that were in excess of their federally insured limits. The Company has not experienced any losses in such accounts. +Cash flows from the Company’s Canadian and Norwegian subsidiaries are calculated based on their functional currency. As a result, amounts related to changes in assets and liabilities reported in the Company’s Consolidated Statements of Cash Flows will not necessarily agree to changes in the corresponding balances in the Company’s Consolidated Balance Sheets . +Foreign Currency +The Company’s functional currency is the United States Dollar (“USD”). The financial position and results of operations of the Company’s Canadian and Norwegian subsidiaries are measured using their local currency as the functional currency. Revenues and expenses of the subsidiary have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the date of the Company’s Consolidated Balance Sheets. The resulting translation gain and loss adjustments have been recorded as a separate component of other comprehensive income (loss) in the Company’s Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) and its Consolidated Statements of Stockholders’ Equity (Deficit). +Accounts Receivable +The Company extends credit to customers in the normal course of business. Accounts receivable are carried at their estimated collectible amount. Trade credit is generally extended on a short-term basis; thus, receivables do not bear interest, although a finance charge may be applied to amounts past due. The Company maintains an allowance for credit losses for estimated losses that may result from the inability of its customers to make required payments. Such allowances are based upon several factors including, but not limited to, credit approval practices and industry and customer historical experience, as well as the current and projected financial condition of the specific customer. Accounts receivable outstanding longer than contractual terms are considered past due. The Company writes off accounts receivable to the allowance for credit losses when they become uncollectible. Any payments subsequently received on receivables previously written off are credited to bad debt expense. +The Company had $ 81.2 million and $ 88.4 million of “Accounts receivable, net” at December 31, 2024 and 2023, respectively. The Company maintains an allowance for credit losses based on the expected collectability of accounts receivable, which is included in “Accounts receivable, net” on the Company’s Consolidated Balance Sheets. The Company had an allowance for credit losses of $ 0.8 million and $ 0.6 million at December 31, 2024 and 2023, respectively. Bad debt expense was $ 0.5 million and $ 0.3 million for the years ended December 31, 2024 and 2023, respectively. +Concentration of Credit Risk +The Company derives a significant portion of its revenues from companies in the exploration and production (“E&P”) industry, and its customer base includes a broad range of integrated and independent domestic E&P companies and international E&P companies operating in the markets that the Company serves. While current energy prices are important contributors to positive cash flow for the customers, expectations about future prices and price volatility are generally more important for determining future spending levels. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development, and production activity as well as the entire health of the oil and natural gas industry and can therefore negatively impact spending by the Company’s customers. No customer accounted for more than 10% of the revenues for the years ended December 31, 2024 and 2023. +F-10 +Concentration of Supplier Risk +Purchases during the years ended December 31, 2024 and 2023 did not include purchases from any supplier that individually represented more than 10% of total operating purchases. +Property and Equipment +Property and equipment is stated at cost and depreciated under the straight-line method over the estimated useful lives of the assets. Equipment held under finance leases is stated at the present value of its future minimum lease payments and is depreciated under the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized within operating expenses. Normal repair and maintenance costs are charged to operating expense as incurred. Significant renewals and betterments are capitalized. +Valuation of Long-Lived Assets +Long-lived assets (defined as property and equipment and definite-lived intangible assets) by country as of December 31, 2024 and 2023 were as follows: +December 31, +2024 2023 +(in thousands) +United States $ 148,839 $ 171,453 +International 925 1,342 +$ 149,764 $ 172,795 +Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for impairment, future cash flows expected to result from the use of the asset and its eventual disposal are estimated. If the undiscounted future cash flows are less than the carrying amount of the assets, there is an indication that the asset may be impaired. The amount of the impairment is measured as the difference between the carrying value and the Level 3 fair value of the asset. The Level 3 fair value is determined either through the use of an external valuation, or by means of an analysis of discounted future cash flows based on expected utilization. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth rates, operating profit margins, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). +Valuation of Intangible Assets +Intangible assets with definite lives include technology, customer relationships, and non-compete agreements. The Level 3 fair value of technology and the Level 3 fair value of customer relationships are estimated using the income approach, specifically the multi-period excess earnings method. The multi-period excess earnings method consists of isolating the cash flows attributed to the intangible asset, which are then discounted to present value to calculate the Level 3 fair value of the intangible asset. The Level 3 fair value of non-compete agreements is estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the non-compete agreement is in place and compared to cash flows assuming the non-compete agreement is not in place. +Intangible assets with definite lives are amortized based on the estimated consumption of the economic benefit over their estimated useful lives. Intangible assets with definite lives are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. +Intangible assets with indefinite useful lives are not subject to amortization. For intangible assets with indefinite useful lives, an assessment for impairment is performed annually on December 31 or when there is an indication an impairment may have occurred. Intangible assets with indefinite useful lives are reviewed for impairment by comparing the carrying value of the intangible asset to the Level 3 fair value of the intangible asset. The Level 3 fair value of intangible assets with indefinite useful lives is estimated using the relief-from-royalty method of the income approach. This approach is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty in order to exploit the related benefits of this intangible asset. Determining fair value requires the use of estimates and assumptions. Such estimates and assumptions include revenue growth +F-11 +rates, operating profit margins, royalty rates, weighted average costs of capital, terminal growth rates, future market share, the impact of new product development, and future market conditions, among others. The Company believes that the estimates and assumptions used in impairment assessments are reasonable and appropriate. The Company recognizes an indefinite-lived intangible asset impairment charge of the amount by which the carrying value of the intangible asset exceeds the Level 3 fair value of the intangible asset. Impairment losses are reflected in “Income (loss) from operations” in the Company’s Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). +Stock-based Compensation +The Company has stock-based compensation plans for certain of its employees. The Company measures employee stock-based compensation awards at fair value on the date they are granted to employees and recognizes compensation cost in its financial statements over the requisite service period. As a result of the adoption of ASU No. 2016-09, the Company elected to account for stock-based compensation forfeitures as they occur. +Restricted Stock and Restricted Stock Units +Compensation expense is recorded for restricted stock and restricted stock units over the applicable vesting period based on the Company’s closing stock price as of the grant date. +Performance Stock Units and Performance Cash Awards +Performance stock units and performance cash awards are recorded at their fair value and expensed over their performance period. Fair value for performance stock units and performance cash awards is measured using a Monte Carlo simulation model. +Options +Options are issued with an exercise price equal to the fair value of the stock on the date of grant. Compensation expense is recorded for the fair value of the stock options and is recognized over the period of the underlying security’s vesting schedule. Consideration paid on the exercise of stock options is credited to share capital and additional paid-in capital. For options, fair value of the stock-based compensation is measured by use of the Black-Scholes pricing model. The following discusses the assumptions used related to the Black-Scholes pricing model. +• The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the simplified method, which is the weighted average vesting term plus the original contractual term, divided by two. +• Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company developed its expected volatility based upon a weighted average volatility of its peer group. +• At the time of the issuance of the options, the Company did not plan to pay cash dividends in the foreseeable future. Therefore, a zero expected dividend yield was used in the valuation model. +• The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. +Income Taxes +The Company accounts for income taxes under Accounting Standards Codification 740, Income Taxes (“ASC 740”). Under this method, deferred income tax assets and liabilities are determined based upon temporary differences between the carrying amounts and tax bases of the Company’s assets and liabilities at the balance sheet date and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period in which the change occurs. The Company records a valuation reserve in each reporting period when management believes that it is more likely than not that any deferred tax asset created will not be realized. +The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. If a tax position meets the “more likely than not” recognition criteria, the tax position is measured at the largest amount of benefit greater than 50% likely of being realized upon ultimate settlement. +F-12 +Fair Value of Financial Instruments +The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value, due to the short maturity of such instruments. +For financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three levels: +• Level 1 – inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; +• Level 2 – inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and +• Level 3 – inputs are unobservable for the asset or liability, which reflect the best judgment of management. +Financial assets and liabilities that are disclosed at fair value are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. +The fair value of the Company’s debt obligations is classified as Level 2 in the fair value hierarchy and is established based on observable inputs in less active markets. For additional information on the fair value of the Company’s debt obligations, see Note 9 – Debt Obligations. +The fair value of the Company’s contingent consideration is classified as Level 3 in the fair value hierarchy and is established on unobservable markets which reflect the best judgment of management. For additional information on the fair value of the Company’s contingent consideration, see Note 12 – Commitments and Contingencies. +Earnings (Loss) Per Share +Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the period, taking into effect, if any, the exercise of potentially dilutive stock options assumed to be purchased from the proceeds using the average market price of the Company’s stock for each of the periods presented as well as potentially dilutive restricted stock, restricted stock units, and performance stock units. There was no dilutive effect for the years ended December 31, 2024 and 2023 as the Company was in a net loss position. For additional information on earnings (loss) per share, see Note 14 – Earnings (Loss) Per Share. +Accounting Pronouncements Recently Adopted +In November 2023, the Financial Accounting Standards Board (the “FASB”) issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The new guidance requires disclosures of significant segment expenses provided to the chief operating decision maker (the “CODM”) and included in reported measures of segment profit and loss. The guidance requires interim and annual disclosures about a reportable segment’s profit or loss and assets. Additionally, the guidance requires disclosure of other segment items by reportable segment including a description of its composition. The Company adopted ASU 2023-07 for the fiscal year ended December 31, 2024, and the adoption of this guidance did not have a significant impact on the Company’s related disclosures. For additional information about the Company’s adoption of ASU 2023-07, see Note 16 – Segment Information. +Accounting Pronouncements Not Yet Adopted +In November 2024, the FASB issued ASU 2024-03, Income Statement- Reporting Comprehensive Income- Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses , an update which requires additional disclosure of certain expense captions presented on the face of the Company’s income statement as well as disclosures about selling expenses. The ASU is effective for annual reporting periods beginning after December 15, 2026, and interim reporting periods within annual reporting periods beginning after December 15, 2027, and should be applied on a prospective or retrospective basis, with early adoption permitted. The Company is currently evaluating the impact that this guidance will have on the disclosures within its consolidated financial statements. +In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax +F-13 +Disclosures. The amendments require disclosure of specific categories in the rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold and further disaggregation of income taxes paid for individually significant jurisdictions. The ASU is effective for fiscal years beginning after December 15, 2024. The Company expects this guidance will have minimal impact on the disclosures within its consolidated financial statements. +3. Revenues +The Company recognizes revenues from the sales of products at a point in time and revenues from the sales of services over time. +Disaggregation of Revenues +Disaggregated revenue for the years ended December 31, 2024 and 2023 was as follows: +Year Ended December 31, +2024 2023 +(in thousands) +Cement $ 200,028 $ 224,761 +Coiled tubing 110,369 122,554 +Wireline 111,341 116,918 +Service revenues $ 421,738 $ 464,233 +Tools $ 132,366 $ 145,293 +Product revenues $ 132,366 $ 145,293 +Total revenues $ 554,104 $ 609,526 +Revenue by country, which is determined based on country of origination, for the years ended December 31, 2024 and 2023 were as follows: +Year Ended December 31, 2024 Year Ended December 31, 2023 +Amount Percentage Amount Percentage +(in thousands, except percentages) +United States $ 545,262 98.4 % $ 602,343 98.8 % +International 8,842 1.6 % 7,183 1.2 % +$ 554,104 100.0 % $ 609,526 100.0 % +Performance Obligations +At December 31, 2024 and December 31, 2023, the amount of remaining performance obligations was not material. +Contract Balances +At December 31, 2024 and December 31, 2023, contract assets and contract liabilities were not material. +4. Inventories +Inventories, consisting primarily of finished goods and raw materials, are stated at the lower of cost or net realizable value. Cost is determined on an average cost basis. The Company reviews its inventory balances and writes down its inventory for estimated obsolescence or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for obsolescence was $ 5.5 million and $ 6.2 million at December 31, 2024 and 2023, respectively. +F-14 +Inventories, net as of December 31, 2024 and 2023 were comprised of the following: +December 31, +2024 2023 +(in thousands) +Raw materials $ 28,900 $ 31,235 +Work in progress 148 542 +Finished goods 27,194 28,867 +Inventories 56,242 60,644 +Reserve for obsolescence ( 5,461 ) ( 6,158 ) +Inventories, net $ 50,781 $ 54,486 +5. Property and Equipment +Property and equipment amounts as of December 31, 2024 and 2023 were as follows: +December 31, +Estimated +Useful Lives 2024 2023 +(in thousands) +Operating equipment +1 to 12 years +$ 315,361 $ 318,553 +Autos and trucks +1 to 7 years +3,038 3,392 +Furniture, fixtures, and equipment +2 to 12 years +2,452 2,469 +Shop equipment +3 to 15 years +11,427 14,220 +Buildings +7 to 39 years +4,687 5,690 +Leasehold improvements +3 to 11 years +4,457 2,279 +Land indefinite 3,202 1,561 +344,624 348,164 +Less: Accumulated depreciation ( 274,106 ) ( 265,798 ) +Property and equipment, net $ 70,518 $ 82,366 +Depreciation expense was $ 25.6 million and $ 29.1 million for the years ended December 31, 2024 and 2023, respectively. +Capital expenditures was $ 14.6 million and $ 22.3 million for years ended December 31, 2024 and 2023, respectively. +6. Leases +Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Company’s Consolidated Balance Sheets. Leases with an initial term greater than 12 months are recognized in the Company’s Consolidated Balance Sheets based on lease classification as either operating or financing. Some of the Company’s lease agreements include lease and non-lease components for which the Company has elected to not separate for all classes of underlying assets. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may sublease its real estate to third parties, subject to certain provisions of the lease, when it has no future use for the property. +Operating Leases +As a lessee, the Company’s operating lease portfolio primarily consists of operating leases for equipment, vehicles, office space, yard facilities, and employee housing. Operating lease ROU assets and operating lease obligations are recognized based on the present value of the future minimum lease payments at commencement date. As most of the Company’s leases do not provide an implicit borrowing rate, the Company uses its incremental borrowing rate based on the lease information available at the commencement date in determining the present value of future payments. The incremental borrowing rate utilized is based upon the interest rate associated with the Company’s ABL Credit Facility (as defined and described in Note 9 – Debt Obligations) which is utilized to fund its working capital needs and planned capital expenditures. The Company’s leases have remaining terms of one to ten years and may include options to extend or terminate the lease. The operating lease ROU +F-15 +assets also include any upfront lease payments made and exclude lease incentives and initial direct costs incurred. +The Company leases most of these properties under long-term (greater than one year) non-cancelable term leases many of which contain renewal options that can extend the lease term from one to five years and some of which contain escalation clauses. The Company may also enter into short-term or month-to-month operating leases. Options to renew these leases are generally not considered reasonably certain to be exercised due to the nature of the Company’s operations and the markets it serves. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease. +The Company also leases supplemental equipment, typically under cancellable short-term contracts which are less than 30 days. This equipment is typically required for a specific project and for a short duration. Due to the nature of the Company’s operations, any option to renew these short-term leases is generally not considered reasonably certain to be exercised. Therefore, the periods covered by such optional periods are not included in the determination of the term of the lease, and the lease payments during these periods are similarly excluded from the calculation of operating lease asset and lease obligation balances. +Operating lease expense consists of rent expense related to leases that were included in ROU assets under ASC 842. The Company recognizes operating lease expense on a straight-line basis, except for certain variable expenses that are recognized when the variability is resolved, typically during the period in which they are paid. Variable operating lease payments typically include charges for property taxes and insurance, and some leases contain variable payments related to non-lease components, including common area maintenance and usage of facilities or office equipment (for example, copiers). The Company does not have variable expenses. +Additional Information +The following table summarizes the components of the Company’s lease expense recognized for the years ended December 31, 2024 and 2023: +Year Ended December 31, +2024 2023 +(in thousands) +Operating lease expense +Operating lease right of use assets $ 13,256 $ 12,524 +Operating lease non right of use assets 2,856 6,810 +Total operating lease expense $ 16,112 $ 19,334 +Finance lease expense +Depreciation of right of use assets $ 26 $ 89 +Interest on lease obligations 27 69 +Total finance lease expense $ 53 $ 158 +Operating lease expense is included in the line items “Cost of revenues” and “General and administrative expenses”, depending on the nature of the lease, in the Company’s Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the years ended December 31, 2024 and 2023. +Supplemental information related to leases was as follows as of December 31, 2024 and 2023: +December 31, +2024 2023 +Operating leases +Weighted average remaining lease term 3.6 4.3 +Weighted average discount rate 6.0 % 5.8 % +Finance leases +Weighted average remaining lease term 0.7 0.7 +Weighted average discount rate 91.7 % 25.1 % +F-16 +Supplemental balance sheet information related to leases was as follows as of December 31, 2024 and 2023: +December 31, +2024 2023 +(in thousands) +Operating lease right of use assets +Operating lease right of use assets, gross $ 70,226 $ 65,026 +Less: Accumulated amortization ( 32,974 ) ( 22,970 ) +Operating lease right of use assets, net $ 37,252 $ 42,056 +Operating lease obligations +Current portion of operating lease obligations $ 11,216 $ 10,314 +Long-term operating lease obligations 26,710 32,594 +Total operating lease obligations $ 37,926 $ 42,908 +Finance lease right of use assets +Finance lease right of use assets, gross $ 39 $ 70 +Less: Accumulated depreciation ( 10 ) ( 19 ) +Finance lease right of use assets, net $ 29 $ 51 +Finance lease obligations +Current portion of finance lease obligations $ 21 $ 31 +Long-term finance lease obligations — — +Total finance lease obligations $ 21 $ 31 +Future annual minimum lease payments as of December 31, 2024 were as follows: +Operating Lease Right of Use Obligations Finance Leases Total +(in thousands) +2025 $ 13,110 $ 28 $ 13,138 +2026 11,419 — 11,419 +2027 8,469 — 8,469 +2028 6,570 — 6,570 +2029 2,185 — 2,185 +Thereafter 356 — 356 +Total lease payments $ 42,109 $ 28 $ 42,137 +Less: present value discount ( 4,183 ) ( 7 ) ( 4,190 ) +Present value of lease obligations $ 37,926 $ 21 $ 37,947 +F-17 +Supplemental cash flow information related to leases for the years ended December 31, 2024 and 2023 were as follows: +Year Ended December 31, +2024 2023 +(in thousands) +Cash paid for amounts included in the measurement of lease obligations: +Operating cash flows from operating leases $ 13,080 $ 12,344 +Operating cash flows from finance leases $ 26 $ 89 +Financing cash flows from finance leases $ 49 $ 217 +Right of use assets obtained in exchange for lease obligations: +Operating leases $ 6,307 $ 15,955 +Finance leases $ 39 $ 70 +7. Intangible Assets +The gross carrying amount and accumulated amortization of intangible assets as of December 31, 2024 and 2023 were as follows: +December 31, 2024 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 55,400 ) $ 7,870 2.8 +Technology 125,110 ( 53,734 ) 71,376 8.8 +Total $ 188,380 $ ( 109,134 ) $ 79,246 +December 31, 2023 +Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Amortization Period +(in thousands, except weighted average amortization period information) +Customer relationships $ 63,270 $ ( 52,622 ) $ 10,648 3.8 +Non-compete agreements 6,500 ( 6,500 ) — 0.0 +Technology 125,110 ( 45,329 ) 79,781 9.7 +Total $ 194,880 $ ( 104,451 ) $ 90,429 +Amortization of Intangibles +Amortization of intangibles was $ 11.2 million and $ 11.5 million for the years ended December 31, 2024 and 2023, respectively. +F-18 +Future estimated amortization of intangibles is as follows: +Year Ending December 31, (in thousands) +2025 $ 11,183 +2026 11,082 +2027 10,315 +2028 8,000 +2029 8,000 +Thereafter 30,666 +$ 79,246 +8. Accrued Expenses +Accrued expenses as of December 31, 2024 and 2023 consisted of the following: +December 31, +2024 2023 +(in thousands) +Accrued interest $ 16,960 $ 17,216 +Accrued compensation and benefits 6,287 9,784 +Accrued bonus 1,016 1,169 +Accrued legal fees and settlements 256 68 +Other accrued expenses 6,157 7,934 +Accrued expenses $ 30,676 $ 36,171 +9. Debt Obligations +The Company’s debt obligations as of December 31, 2024 and 2023 were as follows: +December 31, +2024 2023 +(in thousands) +2028 Notes $ 300,000 $ 300,000 +ABL Credit Facility 47,000 57,000 +Short-term debt (1) +3,580 2,859 +Total debt before deferred financing costs $ 350,580 $ 359,859 +Deferred financing costs ( 29,736 ) ( 36,480 ) +Total debt $ 320,844 $ 323,379 +Less: Current portion of long-term debt ( 3,580 ) ( 2,859 ) +Long-term debt $ 317,264 $ 320,520 +(1) The weighted average interest rate of short-term debt outstanding at December 31, 2024 and 2023, respectively, was 7.9 % and 8.2 %. +Units Offering and 2028 Notes +Units +On January 30, 2023, the Company completed its public offering of 300,000 units with an aggregate stated amount of $ 300.0 million (the “Units”). Each Unit consisted of $1,000 principal amount of the Company’s 13.000 % Senior Secured Notes due 2028 (collectively, the “2028 Notes”) and five shares of common stock (the “Common Stock”) of the Company. The Company received proceeds of $ 279.8 million from the Units offering, after deducting underwriting discounts and commission, which was used to fund a portion of the redemption price of the 2023 Notes (as defined and described below). These proceeds were allocated to the 2028 Notes and the Common Stock based on their relative fair value at the time of issuance. +F-19 +Each Unit separated into its constituent securities (the 2028 Notes and shares of Common Stock) automatically on October 27, 2023. A holder of Units could have elected to separate its Units into its constituent securities, in whole but not in part, on or after March 31, 2023. Prior to such date, the Units could not be separated at the option of the holder. +In the first quarter of 2023, the Company recorded approximately $ 41.7 million of deferred financing costs in connection with the Units offering. These costs are direct deductions from the carrying amount of the 2028 Notes and are being amortized through interest expense through the maturity date of the 2028 Notes using the effective interest method. The unamortized portion of these deferred financing costs was $ 29.7 million at December 31, 2024 . +2028 Notes +On January 30, 2023, the Company and certain of its subsidiaries entered into an indenture, dated as of January 30, 2023 (the “2028 Notes Indenture”), with U.S. Bank Trust Company, National Association, as the trustee and as notes collateral agent, pursuant to which the 2028 Notes were issued. The 2028 Notes will mature on February 1, 2028 and bear interest at an annual rate of 13.000 % payable in cash semi-annually in arrears on each of February 1 and August 1, commencing August 1, 2023. The 2028 Notes are senior secured obligations of the Company and are guaranteed on a senior secured basis by each of the Company’s current domestic subsidiaries and will be so guaranteed by certain future subsidiaries, in each case, subject to agreed guaranty and security principles and certain exclusions. +Prior to February 1, 2026, the Company may, on any one or more occasions, redeem all or a part of the 2028 Notes at a redemption price equal to 100.0 % of the principal amount of the 2028 Notes redeemed, plus a “make-whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, prior to February 1, 2026, the Company may, from time to time, redeem up to 35.0 % of the aggregate principal amount of the 2028 Notes with an amount of cash not greater than the net cash proceeds of certain equity offerings at a redemption price equal to 113.0 % of the principal amount of the 2028 Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption, provided that at least 65.0 % of the aggregate principal amount of the 2028 Notes originally issued under the 2028 Notes Indenture on January 30, 2023 remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of such equity offering. Also, prior to February 1, 2026, the Company may redeem during each 12-month period beginning on January 30, 2023, up to 10 % of the aggregate principal amount of the 2028 Notes outstanding at a redemption price equal to 103.0 % of the aggregate principal amount of the 2028 Notes being redeemed, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +On and after February 1, 2026, the Company may redeem the 2028 Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount of the 2028 Notes to be redeemed) set forth below, plus accrued and unpaid interest, if any, to, but excluding the date of redemption, if redeemed during the periods indicated: +Redemption Price +February 1, 2026 to January 31, 2027 106.500 % +February 1, 2027 to October 31, 2027 103.250 % +November 1, 2027 and thereafter 100.000 % +On each May 15 and November 14, commencing November 14, 2023 (each, an “Excess Cash Flow Offer Date”), the Company is required to make an offer (an “Excess Cash Flow Offer”) to all holders of the 2028 Notes and, if required by the terms of any Pari Passu Notes Lien Indebtedness (as defined in the 2028 Notes Indenture), to any holders of any Pari Passu Notes Lien Indebtedness to purchase, prepay or redeem, together on a pro-rata basis, the maximum principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (plus all accrued interest (including additional interest, if any) on the 2028 Notes and any such Pari Passu Notes Lien Indebtedness and the amount of all fees and expenses, including premiums, incurred in connection therewith) that may be purchased, prepaid or redeemed using an amount of cash equal to the Excess Cash Flow Amount (as defined in the 2028 Notes Indenture and which is 75.0 % of Excess Cash Flow (as defined in the 2028 Notes Indenture), as determined immediately prior to the Excess Cash Flow Offer Date), if any, subject to certain exceptions set forth in the 2028 Notes Indenture. The offer price in any such offer will be equal to 100 % of the principal amount of the 2028 Notes and any such Pari Passu Notes Lien Indebtedness (or, in respect of any such Pari Passu Notes Lien Indebtedness, such lesser price, if any, as may be provided for by the terms of such Pari Passu Notes Lien Indebtedness), plus accrued and unpaid interest and additional interest, if any, to, but excluding, the date of purchase, prepayment or redemption, subject to the rights of holders of the 2028 Notes or any such Pari Passu Notes Lien Indebtedness on the relevant record date to receive interest due on an interest payment date that is on or prior to the date of purchase, prepayment or redemption, and will be payable in cash. +F-20 +If the Company experiences certain changes of control, each holder of 2028 Notes may require the Company to repurchase all or a portion of its 2028 Notes for cash at a price equal to 101.0 % of the principal amount of such 2028 Notes, plus any accrued but unpaid interest, if any, to, but excluding, the date of repurchase. +The 2028 Notes Indenture contains covenants that, among other things and subject to certain exceptions and qualifications, limit the Company’s ability and the ability of its restricted subsidiaries to (i) incur additional indebtedness and guarantee indebtedness; (ii) pay dividends or make other distributions of capital stock; (iii) prepay, redeem or repurchase certain debt; (iv) issue certain preferred stock or similar equity securities, (v) make loans and investments; (vi) sell assets; (vii) incur liens; (viii) enter into transactions with affiliates; (ix) enter into agreements restricting its subsidiaries’ ability to pay dividends; or (x) consolidate, merge, or sell all or substantially all of its assets. The Company was in compliance with the provision of the 2028 Notes Indenture at December 31, 2024. +Upon an event of default, the trustee of the 2028 Notes or the holders of at least 25 % in aggregate principal amount of then outstanding 2028 Notes may declare the 2028 Notes immediately due and payable, except that a default resulting from certain events of bankruptcy or insolvency with respect to the Company, any significant subsidiary or any group of restricted subsidiaries that, taken together, would constitute a significant subsidiary, will automatically cause all outstanding 2028 Notes to become due and payable. +2023 Notes +On October 25, 2018, the Company issued $ 400.0 million principal amount of 8.750 % Senior Notes due 2023 (the “2023 Notes”). The 2023 Notes were issued under an indenture, dated as of October 25, 2018, by and among the Company, certain subsidiaries of the Company and Wells Fargo, National Association, as trustee. The 2023 Notes bore interest at an annual rate of 8.750 % payable on May 1 and November 1 of each year, commencing May 1, 2019. The 2023 Notes were senior unsecured obligations of the Company and were fully and unconditionally guaranteed on a senior unsecured basis by each of the Company’s domestic subsidiaries. +On February 1, 2023, with proceeds received from its public offering of Units and borrowings under its ABL Credit Facility (as defined and described below), the Company redeemed all of the outstanding 2023 Notes at a redemption price of 100.0 % of outstanding principal amount thereof ($ 307.3 million), plus accrued and unpaid interest ($ 6.7 million). The Company also wrote off unamortized deferred financing costs in the amount of $ 1.2 million associated with the 2023 Notes in conjunction with the redemption. +ABL Credit Facility +On October 25, 2018, the Company entered into a credit agreement dated as of October 25, 2018 (the “2018 ABL Credit Agreement”), by and among the Company, Nine Energy Canada, Inc., JP Morgan Chase Bank, N.A., as administrative agent and as an issuing lender, and certain other financial institutions party thereto as lenders and issuing lenders. The 2018 ABL Credit Agreement permitted aggregate borrowings of up to $ 200.0 million, subject to a borrowing base, including a Canadian tranche with a sub-limit of up to $ 25.0 million and a sub-limit of $ 50.0 million for letters of credit (the “ABL Credit Facility”). Pursuant to the 2018 ABL Credit Agreement, loans to the Company and its domestic related subsidiaries (the “U.S. Credit Parties”) under the ABL Credit Facility were base rate loans or London Interbank Offered Rate (“LIBOR”) loans; and loans to Nine Energy Canada Inc., a corporation organized under the laws of Alberta, Canada, and its restricted subsidiaries (the “Canadian Credit Parties”) under the Canadian tranche were Canadian Dollar Offered Rate (“CDOR”) loans or Canadian prime rate loans. +On January 17, 2023, the Company entered into the First Amendment to Credit Agreement (the “First ABL Facility Amendment”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, which became effective on January 30, 2023. Pursuant to the First ABL Facility Amendment, the maturity date of the ABL Credit Facility was extended from October 25, 2023 to January 29, 2027. In addition, the First ABL Facility Amendment, among other changes, revised the terms of the ABL Credit Facility as follows: (a) decreased the size of the ABL Credit Facility from $ 200.0 million to $ 150.0 million, subject to the borrowing base (the “Loan Limit”), (b) changed the interest rate benchmark from LIBOR to Term Secured Overnight Financing Rate with a 10 basis point spread adjustment and increased pricing from the existing range of 1.75 % to 2.25 % to a range of 2.00 % to 2.50 %, in each case depending on the Company’s leverage ratio, (c) modified the financial covenant, enhanced reporting and cash dominion triggers in the ABL Credit Facility from the existing minimum availability threshold of the greater of $ 18.75 million and 12.5 % of the Loan Limit to a minimum availability threshold of (i) $ 12.5 million from January 30, 2023 until May 31, 2023 and (ii) the greater of $ 17.5 million and 12.5 % of the Loan Limit thereafter, (d) decreased the Canadian tranche sub-limit from $ 25.0 million to $ 5.0 million, (e) decreased the letter of credit sub-limit from $ 50.0 million to $ 10.0 million and (f) made satisfaction of the Payment Conditions (as defined in the First ABL Facility Amendment) a condition to an Excess Cash Flow Offer in addition to a condition to voluntary payments of the 2028 +F-21 +Notes. The Payment Conditions in summary are (A) no default or event of default on a pro forma basis and (B) immediately after and at all times during the 30 days prior, on a pro forma basis, (1) (x) availability under the ABL Credit Facility shall not be less than the greater of 15 % of the Loan Limit and $ 22.5 million and (y) the fixed charge coverage ratio shall be at least 1.00 to 1.00 or (2) availability under the ABL Credit Facility shall not be less than the greater of 20 % of the Loan Limit and $ 30.0 million. +On June 7, 2024, the Company entered into the Second Amendment to Credit Agreement (together with the First ABL Facility Amendment, the “ABL Facility Amendments”) with JP Morgan Chase Bank, N.A., as administrative agent, and the lender parties thereto, to change the interest rate benchmark for borrowings denominated in Canadian dollars from CDOR to a rate based on the Canadian Overnight Repo Rate Average (CORRA), effective as of June 14, 2024. +The 2018 ABL Credit Agreement, as amended by the ABL Facility Amendments (the “ABL Credit Agreement”), contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions), and transactions with affiliates. In addition, the ABL Credit Agreement contains a financial covenant requiring a minimum fixed charge ratio of 1.00 to 1.00 that is tested quarterly when (a) the availability under the ABL Credit Facility drops below (i) at any time on or before May 31, 2023, $ 12.5 million and (ii) at any time thereafter, the greater of $ 17.5 million and 12.5 % of the Loan Limit or (b) a default has occurred. This financial covenant applies until the availability exceeds the applicable threshold for 30 consecutive days and no default is ongoing. The Company was in compliance with all covenants under the ABL Credit Agreement as of December 31, 2024. +Pursuant to the ABL Credit Agreement, all of the obligations under the ABL Credit Facility are secured by security interests (subject to permitted liens) in substantially all of the personal property of U.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties, excluding certain assets. +At December 31, 2024, the Company had $ 47.0 million outstanding borrowings under the ABL Credit Facility, and its availability under the ABL Credit Facility was approximately $ 24.2 million, net of outstanding letters of credit of $ 2.2 million . +Short-Term Debt +From time to time, the Company renews certain insurance policies and finances the premium for its excess policy. The outstanding balance on these premiums was $ 3.6 million and $ 2.9 million at December 31, 2024 and 2023, respectively. +Fair Value of Debt Instruments +The estimated fair value of the Company’s debt obligations as of December 31, 2024 and 2023 was as follows: +December 31, +2024 2023 +(in thousands) +2028 Notes $ 197,283 $ 264,750 +ABL Credit Facility $ 47,000 $ 57,000 +Short-term debt $ 3,580 $ 2,859 +The fair value of the 2028 Notes, ABL Credit Facility, and short-term debt is classified as Level 2 in the fair value hierarchy. The fair value of the 2028 Notes is established based on observable inputs in less active markets. The fair value of the ABL Credit Facility and short-term debt approximates their carrying value. +10. Defined Contribution Plans +Background +The Company sponsors a defined contribution plan, the Nine Energy Service 401(k) Plan (the “Nine Plan”), under Section 401(k) of the Internal Revenue Code of 1986, as amended, for all qualified employees. +For the years ended December 31, 2024 and 2023, employee contributions were matched by the Company at 100 % of the first 3 % and 50 % of the remaining up to 5 % of the participant’s eligible compensation. +F-22 +Contributions +For the years ended December 31, 2024 and 2023, the Company made employer contributions of $ 2.1 million and $ 2.0 million, respectively, under the Nine Plan. +11. Stock-based Compensation +Stock Options +Information about stock option activity during the years ended December 31, 2024 and 2023 was as follows: +2024 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 535,491 $ 34.51 2.2 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 51,557 ) 45.67 — — +Total outstanding 483,934 $ 33.32 1.4 $ — +Options exercisable 483,934 $ 33.32 1.4 $ — +2023 Activity Number of +Shares in +Underlying +Options Weighted +Average +Exercise Price Remaining +Weighted Average +Contractual Life +in Years Intrinsic Value +(in thousands) +Beginning balance 587,506 $ 33.80 3.0 $ — +Granted — — — — +Exercised — — — — +Forfeited — — — — +Expired ( 52,015 ) 26.50 — — +Total outstanding 535,491 $ 34.51 2.2 $ — +Options exercisable 535,491 $ 34.51 2.2 $ — +The intrinsic value at December 31, 2024 and 2023 is the amount by which the fair value of the underlying share exceeds the exercise price of an option as of December 31, 2024 and 2023, respectively. +The Company granted no options in 2024 and 2023. +There was no compensation expense recorded for the years ended December 31, 2024 and 2023. As of December 31, 2024, there is no remaining compensation expense related to options for the Company to expense. Future stock option grants will result in additional compensation expense. +F-23 +Restricted Stock and Restricted Stock Units +Information about restricted stock and restricted stock unit activity during the years ended December 31, 2024 and 2023 was as follows: +2024 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2024 1,474,544 $ 2.92 +Granted 1,658,780 2.08 +Vested ( 874,133 ) 2.67 +Forfeited ( 15,162 ) 2.66 +Nonvested at December 31, 2024 2,244,029 $ 2.40 +2023 Activity Number of Shares and Units Weighted Average Grant Date Fair Value +Nonvested at January 1, 2023 1,934,556 $ 2.12 +Granted 662,845 3.51 +Vested ( 1,063,090 ) 1.85 +Forfeited ( 59,767 ) 2.63 +Nonvested at December 31, 2023 1,474,544 $ 2.92 +The total amount of compensation expense related to the restricted stock and restricted stock units recorded was approximately $ 2.9 million and $ 2.2 million for the years ended December 31, 2024 and 2023, respectively. As of December 31, 2024, the Company expects to record compensation expense related to restricted stock and restricted stock units of approximately $ 3.5 million over the remaining term of approximately 1.8 years. Future restricted stock and restricted stock unit grants would result in additional compensation expense. +Performance Cash Awards +In May 2022 and May 2023, the Company granted performance cash awards (the “PCAs”) that vest based upon the Company’s achievement of certain criteria related to its relative total shareholder return (“TSR”) in comparison to TSR of members of its peer group (the “Peer Group”), as defined by the PCA grant. These awards, which the Company granted at a target achievement amount, are subject to three individual year-long performance periods (the “Performance Periods”), and payment related to each Performance Period can range from 0 % to 200 % of the target amount for that Performance Period. +The PCAs were valued on the date of grant based on the estimated fair value, which was based on numerous assumptions including the likelihood of the Company’s stock price performance achieving targeted thresholds, using a Monte Carlo simulation model. The assumptions used to value the awards included the historical volatility of the Company as well as the volatility of its Peer Group and the risk-free rate, which was derived using the U.S. Treasury security rates. +Under the relevant liability accounting, the Level 3 fair value of the unvested PCAs is remeasured at the end of each reporting period and was $ 0.9 million and $ 2.0 million at December 31, 2024 and 2023, respectively. +The following information is related to the Company’s May 2023 grant of PCAs at December 31, 2024 and 2023. +December 31, 2024 December 31, 2023 +Volatility for remeasurement 86.35 % 118.62 % +Risk-free rate 4.15 % 4.11 % +F-24 +The following information is related to the Company’s May 2022 grant of PCAs at December 31, 2024 and December 31, 2023. +December 31, 2024 December 31, 2023 +Volatility for remeasurement 109.01 % 98.16 % +Risk-free rate 4.28 % 4.55 % +Income related to performance cash was $ 0.3 million for the year ended December 31, 2024. Expense related to performance cash was $ 1.3 million for the year ended December 31, 2023. As of December 31, 2024, there was $ 0.3 million of remaining compensation expense related to performance cash for the Company to expense. Future PCA grants will result in additional compensation expense. +12. Commitments and Contingencies +Litigation +The Company records accruals related to litigation and other legal proceedings when they are either known or considered probable and can be reasonably estimated. Legal proceedings are inherently unpredictable and subject to significant uncertainties, and significant judgment is required to determine both probability and the estimated amount. Some of these uncertainties include the stage of litigation, available facts, uncertainty as to the outcome of any legal proceedings or settlement discussions, and any novel legal issues presented. Because of such uncertainties, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to pending litigation. As of December 31, 2024 and 2023, the Company recorded a $ 0.3 million and a $ 0.1 million accrual, respectively, for liabilities related to legal matters, which is included under the caption “Accrued expenses” in its Consolidated Balance Sheets. +From time to time, the Company has various claims, lawsuits, and administrative proceedings that are pending or threatened with respect to personal injury, workers’ compensation, contractual matters, and other matters. Although no assurance can be given with respect to the outcome of these claims, lawsuits, or proceedings or the effect such outcomes may have, the Company believes any ultimate liability resulting from the outcome of such claims, lawsuits, or administrative proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on its business, operating results, or financial condition. +On April 18, 2020, the Company was named as a defendant in a patent infringement lawsuit regarding its Breakthru Casing Flotation Device. On January 18, 2022, the Company received an adverse judgment in this matter. The Company has posted a $ 2.0 million letter of credit representing the judgment amount and accrued royalties from the judgment date through December 31, 2024. While the Company believes it is probable that it will prevail on appeal resulting in no liability, in the event the Company does not prevail on appeal, the Company will be liable for the aggregate letter of credit posted through the date of appeal plus any future royalties awarded. +However, due to the inherent uncertainties of litigation, the Company is unable to determine the exact amount of any potential loss at this time, and thus, no accrual has been made for this matter in the Company’s consolidated financial statements. The Company will continue to monitor the progress of this litigation and will adjust its accrual as necessary if and when additional information becomes available. +Self-insurance +The Company uses a combination of third-party insurance and self-insurance for health insurance claims. The self-insured liability represents an estimate of the undiscounted ultimate cost of uninsured claims incurred as of the balance sheet date. The estimate is based on an analysis of trailing months of incurred medical claims to project the amount of incurred but not reported claims liability. The estimated liability for self-insured medical claims was $ 1.5 million and $ 1.6 million at December 31, 2024 and 2023, respectively, and is included under the caption “Accrued expenses” on the Company’s Consolidated Balance Sheets. +Although the Company does not expect the amounts ultimately paid to differ significantly from the estimates, the self-insurance liability could be affected if future claims experience differs significantly from historical trends and actuarial assumptions. +F-25 +Contingent Liabilities +On October 1, 2018, pursuant to the terms and conditions of a Securities Purchase Agreement (“the Frac Tech Purchase Agreement”), the Company acquired Frac Technology AS, a Norwegian private limited company (“Frac Tech”) focused on the development of downhole technology, including a casing flotation tool and a number of patented downhole completion tools. The Frac Tech Purchase Agreement, as amended, includes, among other things, the potential for additional future payments, based on certain Frac Tech revenue metrics through December 31, 2025 (the “Frac Tech Earnout”). +The Company’s contingent liability (Level 3) associated with the Frac Tech Earnout (in thousands) for the years ended December 31, 2024 and 2023 was as follows: +Frac Tech +(in thousands) +Balance at December 31, 2022 $ 1,169 +Payments ( 387 ) +Revaluation adjustments 437 +Balance at December 31, 2023 $ 1,219 +Payments ( 604 ) +Revaluation adjustments 104 +Balance at December 31, 2024 $ 719 +All contingent liabilities that relate to contingent consideration are reported at fair value, based on a Monte Carlo simulation model. Significant inputs used in the fair value measurement include forecasted sales of the plugs, terms of the agreement, a risk-adjusted discount factor (ranging from 4.2 % to 4.4 %), and a credit-adjusted rate (ranging from 8.2 % to 8.5 %). Contingent liabilities include $ 0.6 million and $ 0.8 million reported in “Accrued expenses” at December 31, 2024 and 2023, respectively, and $ 0.1 million and $ 0.4 million reported in “Other long-term liabilities” at December 31, 2024 and 2023, respectively, in the Company’s Consolidated Balance Sheets. The impact of the revaluation adjustments is included in “Income (loss) from operations” in the Company’s Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). +13. Taxes +The components of the provision (benefit) for income taxes for the years ended December 31, 2024 and 2023 were as follows: +Year Ended December 31, +2024 2023 +(in thousands) +Current +U.S. federal $ ( 69 ) $ — +U.S. state 219 502 +Foreign 48 83 +Total current provision $ 198 $ 585 +Deferred +U.S. federal $ — $ — +U.S. state — — +Foreign — — +Total deferred provision (benefit) — — +Total provision for income taxes $ 198 $ 585 +F-26 +The provision (benefit) for income taxes for the years ended December 31, 2024 and 2023 differed from the provision (benefit) calculated using the applicable statutory federal income tax rate as follows: +Year Ended December 31, +2024 2023 +(in thousands) +Tax benefit at statutory rate $ ( 8,586 ) $ ( 6,642 ) +Foreign rate differential ( 11 ) ( 7 ) +State income taxes, net of federal benefit 274 397 +Nondeductible expenses 783 2,137 +Valuation allowance 7,951 5,158 +Non-cash compensation ( 36 ) ( 515 ) +Other ( 177 ) 57 +Total provision for income taxes $ 198 $ 585 +The tax effects of the cumulative temporary differences resulting in the net deferred tax asset (liabilities) at December 31, 2024 and 2023 were as follows: +December 31, +2024 2023 +(in thousands) +Deferred income tax assets: +Inventories $ 1,727 $ 1,931 +Goodwill and intangible assets 59,790 67,860 +Deferred tax benefit from net losses 92,190 85,708 +Stock-based compensation and cash award expense 2,601 2,260 +Tax credit carryforwards 646 660 +Accrued expenses 736 872 +Interest carryover 27,075 20,814 +Lease liability 8,348 9,757 +Other 581 489 +Total deferred income tax assets 193,694 190,351 +Less: Valuation allowance ( 174,853 ) ( 168,034 ) +Net deferred income tax assets $ 18,841 $ 22,317 +Deferred income tax liabilities: +Property and equipment $ ( 10,641 ) $ ( 12,745 ) +ROU asset ( 8,200 ) ( 9,572 ) +Total deferred income tax liabilities ( 18,841 ) ( 22,317 ) +Net deferred income tax asset (liability) $ — $ — +As of December 31, 2024, the Company had federal and state net operating loss carryforwards (“NOLs”) of approximately $ 498.7 million. The federal NOLs related to tax years 2017 and prior can be used for a 20 -year period and, if unused, will begin to expire in 2034. The state NOLs can be used from 7 to 20 years and vary by state. A small portion of state NOLs expired in 2024. +The Company evaluates its deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. The Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to the expiration of its NOL and tax credit carryforwards. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to recent operating results, the Company continues to be in a three-year cumulative loss position for the year ended December 31, 2024. According to ASC 740, cumulative losses in recent years represent significant negative evidence in +F-27 +considering whether deferred tax assets are realizable. As a result, the Company continues to record a valuation allowance against its U.S. domestic and Canadian deferred tax assets. The 2024 and 2023 results include an increase in the Company’s valuation allowance of approximately $ 6.8 million and $ 5.1 million, respectively. If the Company is able to generate sufficient taxable income in the future, and it becomes more likely than not that the Company will be able to fully utilize the net deferred tax assets on which a valuation allowance was recorded, the allowance will be released resulting in a tax benefit. +The Company is subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The earliest period the Company is subject to examination of federal income tax returns by the Internal Revenue Service is 2021. The state income tax returns and other state tax filings of the Company are subject to examination by the state taxing authorities for various periods, generally up to four years after they are filed. +The Company accounts for uncertain tax positions in accordance with guidance in ASC 740, which prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. The uncertain tax positions for the years ended December 31, 2024 and 2023 was as follows: +(in thousands) +Balance at December 31, 2022 $ 779 +Change in prior year tax positions ( 235 ) +Change in current year tax positions — +Settlements with taxing authorities — +Lapse of statute of limitations — +Balance at December 31, 2023 $ 544 +Change in prior year tax positions ( 69 ) +Change in current year tax positions — +Settlements with taxing authorities ( 374 ) +Lapse of statute of limitations ( 101 ) +Balance at December 31, 2024 $ — +During 2024, the Company released its $ 0.5 million reserve for uncertain tax positions due to settlement of positions with taxing authorities and a lapse of statute of limitations on previously reserved uncertain tax positions. During 2023, the Company released approximately $ 0.2 million of the unrecognized tax benefit due to a decrease in federal refund expected from a prior year. +The Company recognizes interest and penalties related to uncertain tax positions within the provision for income taxes in its Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). As of December 31, 2024, no interest and penalties have been accrued. +14. Earnings (Loss) Per Share +Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of Common Stock outstanding for the period. Diluted earnings (loss) per share is based on the weighted average number of shares outstanding for the period, including the dilutive effect of equity awards. +Basic and diluted earnings (loss) per share of Common Stock was computed as follows: +Year Ended December 31, 2024 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 41,082 ) 37,172,635 $ ( 1.11 ) +Unvested restricted stock and stock units — — — +Diluted $ ( 41,082 ) 37,172,635 $ ( 1.11 ) +F-28 +Year Ended December 31, 2023 +Net Loss Average Shares Outstanding Loss Per Share +(in thousands, except for share and per share amounts) +Basic $ ( 32,213 ) 33,282,234 $ ( 0.97 ) +Unvested restricted stock and stock units — — — +Diluted $ ( 32,213 ) 33,282,234 $ ( 0.97 ) +The diluted earnings (loss) per share calculation excludes all stock options, unvested restricted stock, unvested restricted stock units, and unvested performance stock units for the years ended December 31, 2024 and 2023 because their inclusion would be anti-dilutive given the Company was in a net loss position. The average number of securities that were excluded from diluted earnings (loss) per share that would potentially dilute earnings (loss) per share for the periods in which the Company experienced a net loss were as follows: +2024 2023 +Year ended December 31, 260,447 1,113,033 +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.0 million and $ 1.3 million for the years ended December 31, 2024 and 2023, respectively. The Company also purchased $ 3.0 million and $ 2.9 million of products and services for the years ended December 31, 2024 and 2023, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $ 0.3 million and $ 0.2 million at December 31, 2024 and 2023, respectively. +The Company provides products and rentals to National Energy Services Reunited Corp. (“NESR”), where one of the Company’s former directors serves as a director. The Company billed NESR $ 1.1 million and $ 1.5 million for the years ended December 31, 2024 and 2023, respectively. There were no outstanding receivables due to the Company from NESR at December 31, 2024 and $ 0.4 million of total outstanding receivables due to the Company from NESR at December 31, 2023. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 4.5 million and $ 3.0 million for the years ended December 31, 2024 and 2023, respectively. There were outstanding receivables due from Devon of $ 0.3 million and $ 0.7 million at December 31, 2024 and 2023, respectively. +16. Segment Information +The Company has determined that it operates as one reportable segment, known as Completions Solutions. The Completions Solutions segment provides services and products integral to the completion of unconventional wells through a full range of tools and methodologies. These services and products are similar in purpose and end use by focusing on preparing and enabling a well to produce oil and gas and must be completed in order for a well to begin producing hydrocarbons. These services are also impacted by similar economic drivers, such as current and future expectations of oil and natural gas prices and hydrocarbon demand, and are complementary in nature in the successful completion phase of a well. +The Company evaluates the performance of the Completions Solutions segment based on consolidated net income (loss). Consolidated net income (loss) is determined in accordance with the measurement principles most consistent with consolidated financial statements and is representative of the manner in which the Company’s CODM and its board of directors view the business, manage liquidity, allocate capital resources, and make operational decisions for the Company. The CODM also uses consolidated net income (loss) to monitor budget versus actual results, perform variance analysis of current results to prior period results, and forecast future performance. The Company considers the CODM to be its Chief Executive Officer. The reported segment revenue, segment profit or loss, significant segment expenses, and other segment items (gain or loss on revaluation of contingent liability, gain or loss on sale of property and equipment, interest income, and other income) are the same as the consolidated results disclosed on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The CODM reviews total assets on a consolidated basis as disclosed on the Consolidated Balance Sheets and capital expenditures on a consolidated basis as disclosed within Note 5 – Property and Equipment. +F-29 +17. ATM Program +On November 6, 2023, the Company entered into an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Sandler & Co. (the “Agent”). Pursuant to the Equity Distribution Agreement, the Company may, from time to time, sell shares of Common Stock having an aggregate offering price of up to $ 30.0 million through the Agent acting as the Company’s sales agent. The Agent will receive a commission equal to 3.0 % of the gross sale price of any shares sold under the Equity Distribution Agreement. +Under the Equity Distribution Agreement, the Company will set the parameters for the sale of the shares thereunder, including the number of shares to be sold, the time period during which sales are requested to be made and any price below which sales may not be made. During the year ended December 31, 2024, 5,380,164 shares were sold under the Equity Distribution Agreement, which generated net proceeds to the Company of $ 8.2 million after deducting commissions of $ 0.3 million. +F-30 +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2024. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2024. +Management’s Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2024, our management assessed the effectiveness of our internal control over financial reporting based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on its assessment using the criteria established by COSO, management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +The effectiveness of our internal control over financial reporting as of December 31, 2024 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-1 of this Annual Report and which is included in Item 8 of Part II of this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2024 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information +None . +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +Not applicable. +50 +PART III +Item 10. Directors, Executive Officers and Corporate Governance +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. +Item 11. Executive Compensation +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. +51 +PART IV +Item 15. Exhibit and Financial Statement Schedules +(a) Documents Filed as Part of This Annual Report +1. Financial Statements +The following consolidated financial statements of the Company are filed as a part of this Annual Report: +Report of Independent Registered Public Accounting Firm +F- 1 +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F- 3 +Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the Years Ended December 31, 2024 and 2023 +F- 4 +Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2024 and 2023 +F- 5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2024 and 2023 +F- 6 +Notes to Consolidated Financial Statements +F- 8 +2. Financial Statement Schedules +All financial statement schedules have been omitted because they are not applicable, or the required information is presented in the consolidated financial statements and related notes. +3. Exhibits +The exhibits to this Annual Report required to be filed pursuant to Item 15(b) are listed below. +Exhibit +Number Description +3.1 +Third Amended and Restated Certificate of Incorporation of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +3.2 +Fourth Amended and Restated Bylaws of Nine Energy Service, Inc., dated January 23, 2018 (Incorporated by reference to Exhibit 3.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 23, 2018). +4.1 +Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.2 +Second Amended and Restated Stockholders Agreement, dated as of February 28, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +4.3 +First Amendment to Second Amended and Restated Stockholders Agreement, dated as of July 24, 2017, by and among Nine Energy Service, Inc. and the parties thereto (Incorporated by reference to Exhibit 4.3 of Nine Energy Service, Inc.’s Amendment No. 3 to Registration Statement on Form S-1 filed on August 14, 2017). +4.4 +Registration Rights Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., the former owners of the equity interests of Magnum Oil Tools International, LTD, Magnum Oil Tools Canada Ltd. and Magnum Oil Tools GP, LLC and the other holders that may become party thereto from time to time (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +4.5 +Indenture, dated as of January 30, 2023, by and among Nine Energy Service, Inc., the guarantors party thereto and U.S. Bank Trust Company, National Association, as trustee and as notes collateral agent (including Form of Note) (Incorporated by reference to Exhibit 4.2 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on February 1, 2023). +4.6 +Description of Common Stock (Incorporated by reference to Exhibit 4.7 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 10, 2020). +10.1 +Credit Agreement, dated as of October 25, 2018, by and among Nine Energy Service, Inc., Nine Energy Canada Inc., JPMorgan Chase Bank, N.A. and certain other financial institutions (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on October 26, 2018). +52 +10.2 +First Amendment to Credit Agreement, dated as of January 17, 2023, among Nine Energy Service, Inc., Nine Energy Canada Inc., the guarantors party thereto, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on January 18, 2023). +10.3 +Second Amendment to Credit Agreement, dated as of June 7, 2024, among Nine Energy Service, Inc., Nine Energy Canada, Inc., the guarantors party thereto, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 6, 2024). +10.4+ +Form of Indemnification Agreement between Nine Energy Service, Inc. and its directors and certain officers (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Amendment No. 2 to Registration Statement on Form S-1 filed on May 24, 2017). +10.5+ +Nine Energy Service, Inc. 2011 Stock Incentive Plan, as amended and restated effective February 28, 2017 (Incorporated by reference to Exhibit 10.10 of Nine Energy Service, Inc.’s Registration Statement on Form S-1 filed on May 2, 2017). +10.6+ +First Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of the Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 6, 2021). +10.7+ +Second Amendment to the Nine Energy Service, Inc. 2011 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on May 8, 2023). +10.8+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Executives (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.9+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Executives (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.10+ +Form of Nine Energy Service, Inc. Restricted Stock Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.11+ +Form of Nine Energy Service, Inc. Nonstatutory Stock Option Agreement for Non-Employee Directors (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 14, 2018). +10.12+ +Form of Nine Energy Service, Inc. Performance Share Unit Grant Notice and Form of Performance Share Unit Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 8, 2019). +10.13+ +Form of Nine Energy Service, Inc. Cash Award Grant Notice and Form of Cash Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on May 5, 2022). +10.14+ +Form of Nine Energy Service, Inc. Performance-Based Cash Award Grant Notice and Form of Performance-Based Cash Award Agreement (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 4, 2022). +10.15+ +Form of Nine Energy Service, Inc. Time-based Cash Award Grant Notice and Form of Time-based Cash Award Agreement Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 6, 2024). +10.16+ +Amended and Restated Employment Agreement, dated August 28, 2018, by and between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on August 30, 2018). +10.17+ +Employment Agreement between Guy Sirkes and Nine Energy Service, LLC, dated as of March 31, 2020 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on March 31, 2020). +10.18+ +Amended and Restated Employment Agreement between David Crombie and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.19+ +Amended and Restated Employment Agreement between Theodore R. Moore and Nine Energy Service, LLC, dated as of November 20, 2018 (Incorporated by reference to Exhibit 10.4 of Nine Energy Service, Inc.’s Current Report on Form 8-K filed on November 27, 2018). +10.20+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Ann G. Fox (Incorporated by reference to Exhibit 10.1 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +53 +10.21+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and David Crombie (Incorporated by reference to Exhibit 10.2 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.22+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Guy Sirkes (Incorporated by reference to Exhibit 10.3 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +10.23+ +Letter Agreement, effective as of April 1, 2020, between Nine Energy Service, LLC and Theodore R. Moore (Incorporated by reference to Exhibit 10.5 of Nine Energy Service, Inc.’s Quarterly Report on Form 10-Q filed on August 7, 2020). +19.1* +Nine Energy Service, Inc. Insider Trading Policy. +21.1* +List of Subsidiaries of Nine Energy Service, Inc. +22.1* +List of Subsidiary Guarantors and Affiliates Whose Securities Collateralize Securities of Nine Energy Service, Inc. +23.1* +Consent of PricewaterhouseCoopers LLP. +31.1* +Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act Rules, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1** +Certifications by Chief Executive Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +32.2** +Certifications by Chief Financial Officer pursuant to Title 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. +97.1 +Nine Energy Service, Inc. Clawback Policy (Incorporated by reference to Exhibit 97.1 of Nine Energy Service, Inc.’s Annual Report on Form 10-K filed on March 8, 2024). +101* Interactive Data Files. +___________________________________ +* Filed herewith. +** Furnished herewith. ++ Management contract or compensatory plan or arrangement. +54 +Item 16. Form 10-K Summary +None. +55 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +NINE ENERGY SERVICE, INC. +By: /s/ Ann G. Fox +President and Chief Executive Officer +Date: March 5, 2025 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 5, 2025. +Signature Title +/s/ Ann G. Fox President, Chief Executive Officer, and Director (Principal Executive Officer) +Ann G. Fox +/s/ Guy Sirkes Executive Vice President and Chief Financial Officer (Principal Financial Officer) +Guy Sirkes +/s/ S. Brett Luz Senior Vice President and Chief Accounting Officer (Principal Accounting Officer) +S. Brett Luz +/s/ Scott E. Schwinger Chairman of the Board +Scott E. Schwinger +/s/ Mark E. Baldwin Director +Mark E. Baldwin +Director +Julie A. Peffer +/s/ Gary L. Thomas Director +Gary L. Thomas +/s/ Darryl K. Willis Director +Darryl K. Willis +56 \ No newline at end of file diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/filing_metadata.csv b/raw/filings/0001532286/2024/0001532286-25-000008/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..d8219b1f2004e0b8b3eb20e02f887d7ca673e978 --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001532286,NINE,"Nine Energy Service, Inc.",10-K,2025-03-06,2024-12-31,2025-03-05T22:39:29.000Z,0001532286-25-000008,nine-20241231.htm,10-K,9272351,1,1,https://www.sec.gov/Archives/edgar/data/1532286/000153228625000008/nine-20241231.htm,https://www.sec.gov/Archives/edgar/data/1532286/000153228625000008/,2024,2024,1 diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/item1.txt b/raw/filings/0001532286/2024/0001532286-25-000008/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..bddc87aa425c3126fef4aefcf4d5fec51b7cb71f --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/item1.txt @@ -0,0 +1,101 @@ +Item 1. Business +Overview +Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a Delaware corporation that was formed in February 2013 through a combination of three service companies owned by SCF Partners, L.P. or its affiliates. Nine is a leading completion services provider that targets unconventional oil and gas resource development across North American basins and abroad. We partner with our exploration and production (“E&P”) customers to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. +We provide our comprehensive completion solutions across a diverse set of well-types, including on the most complex, technically demanding unconventional wells. Modern, high-intensity completion techniques are a more effective way for our customers to maximize resource extraction from horizontal oil and gas wells. These completion techniques provide improved estimated ultimate recovery per lateral foot and a superior return on investment by decreasing cycle time, which make them attractive to operators. We compete for the most intricate and demanding projects, which are characterized by extended reach horizontal laterals, increased stage counts per well, multi-well pad development, and increased proppant loading per lateral foot. As stage counts per well and wells per pad increase, so do our operating leverage and returns, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these demanding projects are selected based on their technical expertise and ability to execute safely and efficiently. As our customers continue to improve operational efficiencies in completions design, increasing its complexity and difficulty, oilfield service selection becomes much more critical and selective. +We offer a variety of completion applications and technologies to match customer needs across the broadest addressable completions market. Our comprehensive well solutions range from cementing the well at the initial stages of the completion, preparing the well for stimulation, isolating all the stages of an extended reach lateral, and the drilling out of isolation tools. Our completion techniques are specifically tailored to the customer and geology of each well. At the initial stage of a well completion, our lab facilities produce customized cementing slurries used to secure the production casing to ensure well integrity throughout the life of the well. Once the casing is in place, we utilize our proprietary tools at the toe (end) of the well, often called stage one, to prepare for the well stimulation process. Following stage one, we perform plug-and-perf completions using a wireline or electric wireline truck and reel, as well as our composite, hybrid, or dissolvable frac plugs. Through our wireline units, we provide plug-and-perf services that, when combined with our fully-composite, hybrid, or dissolvable frac plugs, create perforations to isolate and divert the fracture to the correct stage. Our completion tool technology focuses on composite, hybrid, and dissolvable frac plugs that isolate stages in a completion but also includes a number of other patented technologies sold in North America and abroad. Our equipment also includes large-diameter coiled tubing units that are capable of reaching the farthest depths for the removal of plugs and cleaning of the wellbore to prepare for production. +Our website is located at https://nineenergyservice.com, and our investor relations website is located at https://investor.nineenergyservice.com. The information posted on our website is not incorporated into this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at www.sec.gov. Investors and other interested parties should note that we use our investor relations website to publish important information about us, including information that may be deemed material to investors. We encourage investors and other interested parties to review the information we may publish through our investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts. +Our Services +We derive revenue by providing services integral to the completion of unconventional wells through a full range of tools and methodologies. The following is a description of our primary service offerings and deployment methods: +Cementing Services: Our cementing services consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well. We currently operate +4 +four high-quality laboratory facilities capable of designing and testing all of the current industry cement designs. The laboratory facilities operate twenty-four hours a day and are fully staffed by qualified technicians with the latest equipment and modeling software. Additionally, our technicians and engineers ensure that all tests are performed to American Petroleum Institute specifications and results are delivered to customers promptly. Our cement slurries are designed to achieve the proper cement thickening time, compressive strength, and fluid loss control. Our slurries can be modified to address a wide range of downhole needs of our E&P customers, including varying well depths, downhole temperatures, pressures, and formation characteristics. +We deploy our slurries by using our customized design twin-pumping units, which are fully redundant, containing two pumps, two hydraulic systems, two mixing pumps, and two electrical systems. This customized design significantly decreases our risk of downtime due to mechanical failure and eliminates the necessity of having an additional cementing unit on standby. We have invested in the highest quality cementing equipment. +From January 2018 through December 2024, we completed approximately 26,000 cementing jobs, with an on-time rate of approximately 89%. Punctuality of service is one of the primary metrics that E&P operators use to evaluate the cementing services they receive. Key contributors to our 89% on-time rate include our lab capabilities, personnel, close proximity to our customers’ acreage, dual-sided bulk loading plants, and our service-driven culture. +Completion Tools: We provide downhole solutions and technology used for multistage completions. Our comprehensive completion service offerings are mostly comprised of composite, hybrid, and dissolvable frac plugs in a variety of sizes to isolate stages during plug-and-perf operations. We have coupled patented tool designs with proprietary materials for our dissolvable offering, enabling us to serve the entire addressable plug market. With this ability, we have traditional and long-range plugs to address every type of wellbore situation. Our frac plug technology is complemented by our unconventional open hole and cemented completion tool products, such as liner hangers and accessories, fracture isolation packers, frac sleeves, stage one prep tools, casing flotation tools, specialty open hole float equipment, disk subs, composite cement retainers, and centralizers. Our tool portfolio also includes a multi-cycle barrier valve to address the international, conventional markets. +Our systems provide completion efficiencies at the wellsite by reducing our customers’ equipment needs and stimulation time and allowing for specific zonal treatment. Our dissolvable frac plugs help operators reduce cycle times to bring production online faster, decrease the amount of equipment and people needed on location, and significantly reduce carbon emissions compared to a traditional composite plug completion. Through these reductions in cycle time, our dissolvable plugs can help increase our customers’ internal rate of return and provide a safer and more efficient working environment. From January 2018 through December 2024, we deployed approximately 557,700 isolation, stage one, and casing flotation tools. +Wireline Services: Our wireline services involve the use of a wireline or electric wireline unit equipped with a spool of wireline that is unwound and lowered into oil and gas wells to convey specialized tools or equipment for well completion, well intervention, or pipe recovery. We operate a fleet of modern and “fit-for-purpose” cased hole wireline units designed for operating in unconventional completion operations. Our operation is equipped with the latest technology utilized to service long lateral completions, including head tension tools, ballistic release tools, and addressable switches. We have converted several of our hydraulic wireline units to electric, which significantly reduces carbon emissions and the use of diesel. We currently have wireline units equipped with Coated Line, which is a coated wireline that significantly reduces injector oil use. Offering a lower dynamic coefficient of friction, Coated Line wireline requires less pump down fluid to operate and is more conducive for reaching further depths in longer laterals. +The majority of our wireline work consists of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns to a specified depth. We deploy proprietary specialized tools like our fully-composite, hybrid, and dissolvable frac plugs through our wireline units. From January 2018 through December 2024, we completed approximately 189,500 wireline stages with a success rate of over 99%. +Coiled Tubing Services: Coiled tubing services perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet. Coiled tubing provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well using specialized well-control equipment. The live well work capability limits the customer’s risk of formation damage associated with “killing” a well (the temporary placement of heavy fluids in a wellbore to keep reservoir fluids in place) while allowing for safer operations due to minimal equipment handling. Coiled tubing facilitates a variety of services in both new and old wells, such as milling, drilling, fishing, production logging, artificial lift, cementing, and stimulation. +Our coiled tubing units carry data acquisition and dissemination technology, allowing our customers to monitor jobs via a web interface. Our “extended reach” units are capable of reaching the toe of wells with total measured depths of 27,000 feet and beyond, including lateral lengths in excess of 12,500 feet, keeping pace with the industry’s most challenging downhole environments. While we specialize in larger-diameter (2 3/8” and 2 5/8”) coiled tubing units, we also offer 2” and 1 1/4” +5 +diameter solutions to our customers. From January 2018 through December 2024, we have performed approximately 8,300 jobs and deployed more than 218 million running feet of coiled tubing, with a success rate of over 99%. +Geographic Areas of Operation +We operate in all major onshore basins in the U.S., including the Permian Basin, Marcellus and Utica Shales, Eagle Ford Shale, DJ Basin, SCOOP/STACK Formation, Bakken Formation, and Haynesville Formation as well as the Western Canada Sedimentary Basin in Canada. We provide our services through strategically placed operating facilities located in-basin throughout the U.S. This local presence allows us to quickly respond to customer demands and operate efficiently. Additionally, through our extensive footprint, we are able to track and implement best practices around completion trends and technology across all divisions and geography. +A portion of completion tool revenue is generated from outside of North America, and international completion tools are an important part of our revenue stream. +We believe that our strategic geographic diversity will benefit us as activity increases or decreases in select basins by helping to mitigate basin and commodity-risk. Our broad geographic footprint provides us with exposure to potential increases in drilling and completion activity and will allow us to opportunistically pursue new business in basins with the most active drilling environments. +Seasonality +Our operations are subject to seasonal factors, and our overall financial results reflect seasonal variations. Specifically, we typically have experienced a pause by our customers around the holiday season in the fourth quarter, which may be compounded as our customers exhaust their annual capital spending budgets towards year end. +Additionally, our operations are directly affected by weather conditions. During the winter months (portions of the first and fourth quarters) and periods of heavy snow, ice, or rain, particularly in the northeastern U.S., North Dakota, Rocky Mountains, and western Canada, our customers may delay operations or we may not be able to operate or move our equipment between locations. Also, during the spring thaw, which normally starts in late March and continues through June, some areas, primarily in western Canada, impose transportation restrictions to prevent damage caused by the spring thaw. Throughout the year, heavy rains adversely affect activity levels because well locations and dirt access roads can become impassible in wet conditions. Weather conditions may also negatively affect our customers’ activity levels. +Sales and Marketing +Our sales activities are conducted through a network of sales representatives and business development personnel, which provides us coverage at both the corporate and field level of our customers. We have a technical sales organization with expertise and focus within our specific service lines. Sales representatives work closely with local operations managers to target potential opportunities through strategic focus and planning. Customers are identified as targets based on their drilling and completion activity, geographic location, and economic viability. Our marketing activities are performed internally with input and guidance from a third-party marketing agency. Our strategy is based on building a strong brand though multiple media outlets including our website, select social media accounts, print and online advertisements, billboard advertisements, press releases and various industry-specific conferences, publications, and lectures. +Customers +Our customer base includes a broad range of integrated and independent E&P companies. For the year ended December 31, 2024, our top five customers collectively accounted for approximately 25% of our revenues. +Demand for our services and products is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and natural gas. Our customers’ spending plans are generally based on their outlook for near-term and long-term commodity prices. As a result, the demand for our services and products is highly sensitive to current and expected commodity prices. +Competition +We provide our services and products across the U.S., Canada, and abroad, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. We believe that the principal competitive factors in the markets we serve are technology offerings, wellsite execution, service quality, technical expertise, equipment capacity, work force +6 +competency, efficiency, safety record, reputation, and experience. Additionally, projects are often awarded on a bid basis, which tends to create a highly competitive environment. We seek to differentiate our company from our competitors by delivering the highest-quality services, technology, and equipment possible, coupled with superior execution and operating efficiency in a safe working environment. By focusing on cultivating our existing customer relationships and maintaining our high standard of customer service, technology, safety, performance, and quality of crews, equipment, and services, we believe we are differentiated in a competitive market. +Our major competitors include Halliburton Company, Schlumberger Limited, NCS Multistage, Patterson-UTI Energy, KLX Energy Services Holdings, Innovex International, and a significant number of private and locally-oriented businesses. +Suppliers +We purchase a wide variety of raw materials, parts, and components that are manufactured and supplied for our operations from various suppliers. While we are not dependent on any single supplier for those materials, parts, or components, certain product lines depend on a limited number of third-party suppliers and vendors. During the year ended December 31, 2024, no supplier of the materials used in our services provided over 10% of our materials or equipment as a percentage of overall costs. +To date, we have generally been able to obtain the equipment, parts, and supplies necessary to support our operations on a timely basis. While we believe that we will be able to make satisfactory alternative arrangements in the event of any interruption in the supply of these materials and/or products by one of our suppliers, we may not always be able to make alternative arrangements. In addition, certain materials for which we do not currently have long-term supply agreements could experience shortages and significant price increases in the future. As a result, we may be unable to mitigate any future supply shortages, and our results of operations, prospects, and financial condition could be adversely affected. +Research & Technology, Intellectual Property +Our sales and earnings are influenced by our ability to successfully introduce new or improved products and services to the market. We believe we have become a “go-to” provider for piloting new technologies because of our service quality and offering, execution at the wellsite, and geographic footprint. +Our engineering and technology efforts are focused on providing efficient and cost-effective solutions to maximize production for our customers across major North American onshore basins and abroad. We have dedicated resources focused on internally developing new technology and equipment and evolving our existing proprietary tools, as well as resources focused on sourcing and commercializing new technologies through mergers and acquisitions and strategic partnerships, to stay ahead of industry trends and achieve lower completion and production costs for our customers. +We have developed a suite of proprietary downhole tools, products, and techniques through both internal resources, as well as mergers and acquisitions and strategic partnerships with manufacturers and engineering companies looking for a reliable and expansive channel to market. In these partnerships, we have exclusive rights to market and sell technology unavailable to any other service providers in the designated regions, and we sell the technology directly to the customer and order from the manufacturer on an as-needed basis, with no minimum volume requirements and without having to hold excess inventory. These strategic partnerships provide us and our customers with access to unique downhole technology from independent innovators while allowing us to minimize exposure to potential technology adoption risks and the significant costs associated with developing and implementing research and development internally. +Although in the aggregate our patents, licenses, and strategic partnerships are important to us, we do not regard any single patent, license, or strategic partnership as critical or essential to our business as a whole. In general, we depend on our technological capabilities, customer service-oriented culture, and application of our know-how to distinguish ourselves from our competitors, rather than our right to exclude others through patents or exclusive licenses. We also consider the quality and timely delivery of our products, the service we provide to our customers, and the technical knowledge and skill of our personnel to be more important than our registered intellectual property in our ability to compete. +Risk Management and Insurance +Our operations are subject to hazards inherent in the oil and natural gas industry, including, but not limited to, accidents, blowouts, explosions, craterings, fires, oil spills, and hazardous materials spills. These conditions can cause personal injury or loss of life; damage to, or destruction of, property, the environment, and wildlife; and the suspension of our and/or our customers’ operations. +7 +In addition, claims for loss of oil and gas production and damage to formations can occur in the oilfield services industry. If a serious accident were to occur at a location where our equipment and services are being used, it could result in us being named as a defendant in lawsuits asserting large claims. +Because our business involves the transportation of heavy equipment and materials, we may also experience traffic accidents which may result in spills, property damage, and personal injury. +Despite our efforts to maintain high safety standards, from time to time, we have suffered accidents, and there is a risk that we will experience accidents in the future. In addition to the property and personal losses from these accidents, the frequency and severity of these incidents affect our operating costs, insurability, and relationships with customers, employees, and regulatory agencies. In particular, in recent years, many of our large customers have placed an increased emphasis on the safety records of their service providers. Any significant increase in the frequency or severity of these incidents, or the general level of compensatory payments, could adversely affect the cost of, or our ability to obtain, workers’ compensation and other forms of insurance and could have other material adverse effects on our financial condition and results of operations. +We maintain insurance coverage of types and amounts that we believe to be customary in the industry including workers’ compensation, employer’s liability, claims-based pollution, umbrella, comprehensive commercial general liability, business automobile, and property. Our insurance coverage may be inadequate to cover our liabilities. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and commercially justifiable or on terms as favorable as our current arrangements. +We endeavor to allocate potential liabilities and risks between the parties in our Master Service Agreements (“MSAs”). We retain the risk for any liability not indemnified by our customers in excess of our insurance coverage. These MSAs delineate our and our customers’ respective warranty and indemnification obligations with respect to the services we provide. We endeavor to negotiate MSAs with our customers that provide, among other things, that we and our customers assume (without regard to fault) liability for damages to our respective personnel and property. For catastrophic losses, we endeavor to negotiate MSAs that include industry-standard carve-outs from the knock-for-knock indemnities. Additionally, our MSAs often provide carve-outs to the “without regard to fault” concept that would permit, for example, us to be held responsible for events of catastrophic loss only if they arise as a result of our gross negligence or willful misconduct. Our MSAs typically provide for industry-standard pollution indemnities, pursuant to which we assume liability for surface pollution associated with our equipment and originating above the surface (without regard to fault), and our customer assumes (without regard to fault) liability arising from all other pollution, including, without limitation, underground pollution and pollution emanating from the wellbore as a result of an explosion, fire, or blowout. This description of our MSAs is a summary of the material terms of the typical MSA that we have in place and does not reflect every MSA that we have entered into or may enter into in the future, some of which may contain indemnity structures and risk allocations between our customers and us that are different than those described here. +Employees +As of December 31, 2024, we had 1,077 employees, all of which were full-time. We are not a party to any collective bargaining agreements. +Regulatory Matters +Our operations are subject to numerous stringent and complex laws and regulations at the U.S. federal, state, and local levels governing the discharge of materials into the environment, environmental protection, and health and safety aspects of our operations. In addition, due to our operations in Canada, we are subject to Canadian environmental statutes and regulations as well as Canada’s new anti-forced labor law. Failure to comply with these laws and regulations or to obtain or comply with permits may result in the assessment of administrative, civil, and criminal penalties, imposition of remedial or corrective action requirements, and the imposition of injunctions or other orders to prohibit certain activities, restrict certain operations, or force future compliance with environmental requirements. +There is inherent risk of incurring significant environmental costs and liabilities in the performance of our operations due to our handling of petroleum hydrocarbons, other hazardous substances, and wastes, as a result of air emissions and wastewater discharges related to our operations, and because of historical operations and waste disposal practices. Spills or other releases of regulated substances, including such spills and releases that occur in the future, could expose us to material losses, expenditures, and liabilities under applicable environmental laws and regulations. Under certain of such laws and regulations, we could be held strictly and jointly and severally liable for the removal or remediation of previously released materials or property contamination, regardless of whether we were responsible for the release or contamination and even if our operations met previous standards in the industry at the time they were conducted. +8 +The following is a summary of some of the existing laws, rules, and regulations to which we are subject. +Hazardous Substances and Waste Handling +The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the management, generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the guidance issued by the U.S. Environmental Protection Agency (the “EPA”), the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. We are required to manage the disposal of hazardous and non-hazardous wastes in compliance with RCRA and analogous state laws. RCRA currently exempts many E&P wastes from classification as hazardous waste if properly handled. Specifically, RCRA excludes from the definition of hazardous waste drilling fluids, produced waters, and most of the other wastes intrinsically associated with the exploration, development, or production of crude oil and natural gas and, instead, these fluids, waters, and wastes are regulated under RCRA’s less stringent non-hazardous waste provisions, state laws, or other federal laws. However, it is possible that certain oil and natural gas E&P wastes now classified as non-hazardous could be classified as hazardous waste in the future. Stricter regulation of wastes generated during our or our customers’ operations could result in increased costs for our operations or the operations of our customers, which could in turn reduce demand for our services and adversely affect our business. +Comprehensive Environmental Response, Compensation, and Liability Act +The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current and former owner or operator of the site where the release occurred and anyone who transported, disposed, or arranged for the transport or disposal of a hazardous substance released at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA and any state analogs may be subject to joint and several and strict liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources and for the costs of certain health studies. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for many years. These properties and the substances disposed or released on them may be subject to CERCLA and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +Worker Health and Safety +We are subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act (“OSHA”) and comparable state laws, establishing requirements to protect the health and safety of workers. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act, and comparable state statutes require maintenance of information about hazardous materials used or produced in operations and provision of this information to employees, state and local government authorities, and citizens. Additionally, the Federal Motor Carrier Safety Administration (the “FMCSA”) regulates and provides safety oversight of commercial motor vehicles, the EPA establishes requirements to protect human health and the environment, and the federal Bureau of Alcohol, Tobacco, Firearms and Explosives establishes requirements for the safe use and storage of explosives. The federal Nuclear Regulatory Commission establishes requirements for the possession and use of radioactive materials, while most states have entered into agreements that allow them to assume licensing and oversight activities for specified classes of such materials. State agencies typically regulate other sources of ionizing and non-ionizing radiation. Substantial fines and penalties can be imposed, and orders or injunctions limiting or prohibiting certain operations may be issued, in connection with any failure to comply with these laws and regulations. +Transportation Safety and Compliance +As of December 31, 2024, we operated a fleet in excess of 580 commercial motor vehicles. As such, we are subject to regulation as a motor carrier by the U.S. Department of Transportation (the “DOT”) and analogous state agencies and their applicable federal and state laws and regulations, including the Federal Motor Carrier Safety Regulations and Hazardous Materials Regulations for interstate travel promulgated by the FMCSA under the DOT and comparable state regulations for intrastate travel. These regulatory authorities exercise broad powers, governing activities such as the authorization to engage in motor carrier operations, regulatory safety, equipment testing, driver requirements and specifications, and insurance requirements. In connection with these rules, substantial fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection with any failure to comply with laws and regulations relating to the safe operation of commercial motor vehicles. +9 +Water Discharges +The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States (“WOTUS”) and state waters. The discharge of pollutants into, and other impacts to, regulated waters, including jurisdictional wetlands, is prohibited, except in accordance with the terms of a permit issued by the EPA, the U.S. Army Corps of Engineers (the “Corps”) or an analogous state agency. The scope of federal jurisdictional reach over waters of the United States has been subject to substantial revision in recent years. In 2015, the EPA and the Corps issued a rule defining the scope of federal jurisdiction over WOTUS, which never took effect before being replaced by the Navigable Waters Protection Rule (the “NWPR”) in 2020. A coalition of states and cities, environmental groups, and agricultural groups challenged the NWPR, which was vacated by a federal district court in August 2021. In January 2023, the EPA and the Corps issued a final rule that based the definition of WOTUS on the pre-2015 definition. Separately, in May 2023, the U.S. Supreme Court’s decision in Sackett v. EPA narrowed federal jurisdiction over wetlands to “traditional navigable waters” and wetlands or other waters that have a “continuous surface connection” with, or are otherwise indistinguishable from, traditional navigable waters. In September 2023, the EPA and the Corps published a direct-to-final rule that conforms the regulatory definition of WOTUS to the Supreme Court’s May 2023 decision in Sackett . However, roughly half of the states and other plaintiffs are continuing to challenge the September 2023 rule, and the EPA and the Corps are using the pre-2015 definition of WOTUS in these states while litigation continues. As a result, substantial uncertainty exists with respect to future implementation of the September 2023 rule and the scope of Clean Water Act jurisdiction generally. In addition, in an April 2020 decision defining the scope of the Clean Water Act that was issued days after the NWPR was published, the U.S. Supreme Court held that, in certain cases, discharges from a point source to a WOTUS through groundwater require a permit if the discharge is the “functional equivalent” of a direct discharge. The Court rejected the EPA and the Corps’ assertion that groundwater should be totally excluded from the Clean Water Act. In November 2023, the EPA issued draft guidance describing the functional equivalent analysis and the information that should be used to determine which discharges through groundwater may require a permit. However, in January 2025, President Trump issued executive orders directing (i) the EPA and the Corps to identify planned or potential actions that could be subject to emergency treatment under Section 404 of the Clean Water Act and (ii) the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions, including all existing regulations and guidance documents, that are unduly burdensome on the identification, development, or use of domestic energy resources. Accordingly, future implementation and enforcement of these rules and policies is uncertain at this time. To the extent a future rule or court decision expands Clean Water Act jurisdiction, certain energy companies could face increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas, which in turn could reduce demand for our services. The process for obtaining permits has the potential to delay our operations and those of our customers. Spill prevention, control, and countermeasure requirements of federal laws require appropriate containment berms and similar structures to help prevent the contamination of navigable waters by a petroleum hydrocarbon tank spill, rupture, or leak. In addition, the Clean Water Act and analogous state laws require individual permits or coverage under general permits for discharges of wastewater and storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. The Clean Water Act and analogous state laws provide for administrative, civil, and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability, such as strict liability and natural resources damages liability, for the costs of removal, remediation, and damages in connection with any unauthorized discharges. +Air Emissions +Through the federal Clean Air Act, as amended (“CAA”), and comparable state and local laws and regulations, the EPA regulates emissions of various air pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop, stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before work can begin, and modified and existing facilities may be required to obtain additional permits. +In June 2016, the EPA finalized regulations establishing New Source Performance Standards, known as Subpart OOOOa, for methane and volatile organic compounds from new and modified oil and natural gas production and natural gas processing and transmission facilities. In December 2023, the EPA issued a final rule, under the CAA’s New Source Performance Standards, intended to reduce methane emissions from new and existing oil and gas sources. The new rule makes the existing regulations in Subpart OOOOa more stringent and creates a Subpart OOOOb to expand reduction requirements for new, modified, and reconstructed oil and gas sources that commenced construction, modification, or reconstruction after December 6, 2022, including standards focusing on certain source types that have never been regulated under the CAA (including intermittent vent pneumatic controllers, associated gas, and liquids unloading facilities). The new rule phases out +10 +flaring through Subpart OOOOb, which prohibits routine flaring from new oil wells after the phase-in period, and through a new Subpart OOOOc, which prohibits flaring absent a showing of technical infeasibility for existing wells with documented methane emissions of 40 tons per year or more. In addition, the final rule establishes “Emissions Guidelines” in Subpart OOOOc, which requires states to develop plans to reduce methane emissions from existing sources that must be at least as effective as presumptive standards set by EPA. The final rule gives states, along with federal tribes that wish to regulate existing sources, until March 2026 to develop and submit their plans for reducing methane emissions from existing sources. The final emissions guidelines under Subpart OOOOc provide until 2029 for existing sources (i.e., sources constructed prior to December 6, 2022) to comply. The final rule is subject to ongoing litigation but remains in effect. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the final rule remains uncertain at this time. +Although there may be an adverse financial impact (including compliance costs, potential permitting delays and increased regulatory requirements) associated with these regulatory changes, the extent and magnitude of impacts cannot be reliably or accurately estimated due to the present uncertainty regarding any additional measures and how they will be implemented. Any new regulations implementing stricter permitting requirements could delay or impair our or our customers’ ability to obtain air emission permits, and result in increased expenditures for pollution control equipment, the costs of which could be significant. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties, as well as injunctive relief, for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate Change +Numerous reports from scientific and governmental bodies, such as the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, have expressed heightened concerns about the impacts of human activity, especially fossil fuel combustion, on the global climate. In turn, governments and civil society are increasingly focused on limiting the emissions of greenhouse gases (“GHGs”), including emissions of carbon dioxide from the use of oil and natural gas. The EPA has determined that emissions of GHGs, including carbon dioxide and methane, present a danger to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. The EPA has established GHG emission reporting requirements for sources in the oil and gas sector and has also promulgated rules requiring certain large stationary sources of GHGs to obtain preconstruction permits under the CAA and follow “best available control technology” requirements. Although we are not likely to become subject to GHG emissions permitting and best available control technology requirements because none of our facilities are presently major sources of GHG emissions, such requirements could become applicable to our customers and could have an adverse effect on their costs of operations or financial performance, thereby adversely affecting demand for our products and services and our business, financial condition, and results of operations. +In December 2015, the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change resulted in nearly 200 countries, including the U.S., coming together to develop the Paris Agreement, which calls for the parties to undertake “ambitious efforts” to limit the average global temperature. In November 2020, under the first Trump Administration, the U.S. withdrew from the Paris Agreement; however, various corporations, investors, and U.S. state and local governments continued to publicly pledge to further the goals of the Paris Agreement. In February 2021, under the Biden Administration, the United States rejoined the Paris Agreement and set a target to reduce U.S. GHG emissions by 50-52% by the year 2030 as compared with 2005 levels. In addition, in September 2021, the Biden Administration publicly announced the Global Methane Pledge, a pact that commits its signatories to the collective goal of reducing global methane emissions at least 30% below 2020 levels by 2030, including “all feasible reductions” in the energy sector. At the 27th Conference of the Partie s, the United States agreed, in conjunction with the European Union and a number of other partner countries, to develop standards for monitoring and reporting methane emissions to help create a market for low methane-intensity natural gas. At the 28th Conference of the Parties, member countries agreed to the first “global stocktake,” which calls on countries to contribute to global efforts, including a tripling of renewable energy capacity and doubling energy efficiency improvements by 2030, accelerating efforts toward the phase-down of unabated coal power, phasing out inefficient fossil fuel subsidies, and transitioning away from fossil fuels in energy systems. Most recently, at the 29th Conference of the Parties, delegates approved rules to operationalize international carbon markets under Article 6 of the Paris Agreement, including a new Paris Agreement Crediting Mechanism to trade UN-approved carbon credits. However, in January 2025, President Trump issued an executive order directing the immediate notice to the United Nations of the United States’ withdrawal from the Paris Agreement and all other agreements made under the United Nations Framework Convention on Climate Change. The full impact of these actions remains unclear at this time. However, various state and local governments in the U.S. have publicly committed to furthering the goals of the Paris Agreement. +11 +The U.S. Congress has from time to time considered adopting legislation to reduce emissions of GHGs, but no comprehensive federal laws regulating the emission of GHGs or directly imposing a price of carbon have been adopted in recent years. However, such legislation has periodically been introduced in the U.S. Congress and may be proposed or adopted in the future, and energy legislation and other regulatory initiatives have been proposed that are relevant to GHG emissions issues. For example, the Inflation Reduction Act of 2022, which appropriates significant funding for renewable energy initiatives and, for the first time, imposes a fee on GHG emissions from certain oil and gas facilities, was signed into law in August 2022. The Inflation Reduction Act amends the CAA to include a Methane Emissions and Waste Reduction Incentive Program, which requires the EPA to impose a “Waste Emissions Charge” on certain natural gas and oil sources that are already required to report under the EPA’s Greenhouse Gas Reporting Program. To implement the program, in May 2024, the EPA finalized revisions to the Greenhouse Gas Reporting Program for petroleum and natural gas facilities. The emissions reported under the Greenhouse Gas Reporting Program will be the basis for any payments under the Methane Emissions Reduction Program. However, petitions for reconsideration to the EPA are pending and litigation in the D.C. Circuit Court of Appeals has commenced. In November 2024, the EPA finalized a rule implementing the Inflation Reduction Act’s Waste Emissions Charge, which became effective on January 1, 2025. The fee imposed under the Methane Emissions and Waste Reduction Incentive Program for 2024 is $900 per ton emitted over annual methane emissions thresholds and increases to $1,200 in 2025 and $1,500 in 2026. In January 2025, industry associations challenged the Waste Emissions Charge rule in the D.C. Circuit Court of Appeals. The emissions fee and funding provisions of the law could increase operating costs within the oil and gas industry and accelerate the transition away from fossil fuels, which could in turn adversely affect our and our customers’ business and results of operations. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. In addition, based on the timing of the rule’s finalization and statements from congressional Republicans, the Waste Emissions Charge rule is potentially vulnerable to repeal by Congress under the Congressional Review Act, and the Inflation Reduction Act may also be subject to amendment or repeal through Congressional budget reconciliation. However, many U.S. state and local governments have intensified or stated their intent to intensify efforts to support international climate commitments and treaties, in addition to developing programs that are aimed at tracking and reducing GHG emissions by means of carbon taxes, policies or incentives to encourage the use of renewable energy or alternative low-carbon fuels, the development of GHG inventories, and cap-and-trade programs that typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting GHGs. +The adoption of any new climate change-related legislation or regulation, including any such legislation or regulation that restricts emissions of GHGs from the equipment and operations of our customers or with respect to the oil and natural gas they produce, could adversely affect demand for our products and services. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. In June 2024, the U.S. Supreme Court issued a ruling in Loper Bright Enterprises v. Raimondo that ended the use of the Chevron doctrine when courts analyze federal regulations. The Chevron doctrine required courts to defer to the reasonable interpretation of agencies when deciding if a regulation reflected the intent of Congress. While the end of Chevron is likely to introduce new complexity for federal agencies and administration of climate change policy and regulatory programs, many of these initiatives are expected to continue. Moreover, incentives to conserve energy or use alternative energy sources, such as policies designed to increase utilization of zero-emissions or electric vehicles, as a means of addressing climate change could reduce demand for the oil and natural gas produced by our customers and, in turn, could adversely affect demand for our products and services. Finally, most scientists have concluded that increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events; if such effects were to occur, they could have an adverse impact on our operations. +Regulations requiring the disclosure of GHG emissions, and other climate-related information or information substantiating climate-related claims, are also increasingly being adopted or proposed at the federal and state level. For example, at the state level, California enacted legislation in October 2023 that will ultimately require certain companies that do business in California to publicly disclose their Scopes 1, 2, and 3 GHG emissions, with third-party assurance of such data, and issue public reports on their climate-related financial risk and related mitigation measures. +Hydraulic Fracturing +Our businesses are dependent on hydraulic fracturing and horizontal drilling activities. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight formations, including shales. The process, which involves the injection of water, sand, and chemicals under pressure into formations to fracture the surrounding rock and stimulate production, is typically regulated by state oil and natural gas commissions. However, federal agencies have asserted regulatory authority over certain aspects of the process. For example, the EPA has asserted federal regulatory authority pursuant to the federal Safe Drinking Water Act over certain hydraulic fracturing activities involving the use of diesel fuels in fracturing fluids and has issued permitting guidance that applies to such +12 +activities. +There is considerable uncertainty surrounding regulation of the emissions of methane, which may be released during hydraulic fracturing. In addition to the EPA’s new Subpart OOOO regulations discussed above, other federal agencies have promulgated rules regulating methane. In April 2024, the U.S. Bureau of Land Management (the “BLM”) finalized a rule to reduce the waste of natural gas during the production of oil and gas on federal and tribal lands. The final rule took effect in June 2024. However, in May 2024, the states of North Dakota, Texas, Montana, Wyoming, and Utah challenged the rule. In September 2024, the U.S. District Court for the District of North Dakota granted a motion prohibiting the BLM from enforcing the rule against those states pending the outcome of the litigation. However, in January 2025, President Trump issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the final rule remains uncertain at this time. +The EPA has also issued effluent limitation guidelines that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. Also, from time to time, legislation has been introduced, but not enacted, in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. It is unclear how any additional federal regulation of hydraulic fracturing activities may affect our operations, but additional regulatory burdens on our customers could ultimately result in decreased demand for our services. +Various studies analyzing the potential environmental impacts of hydraulic fracturing have also been performed. For example, in December 2016, the EPA issued a report on the potential impacts of hydraulic fracturing on drinking water resources, which concluded that “water cycle” activities associated with hydraulic fracturing may impact drinking water resources “under some circumstances,” noting that the following hydraulic fracturing water cycle activities and local- or regional-scale factors are more likely than others to result in more frequent or more severe impacts: water withdrawals for fracturing in times or areas of low water availability; surface spills during the management of fracturing fluids, chemicals or produced water; injection of fracturing fluids into wells with inadequate mechanical integrity; injection of fracturing fluids directly into groundwater resources; discharge of inadequately treated fracturing wastewater to surface waters; and disposal or storage of fracturing wastewater in unlined pits. As described elsewhere in this Annual Report, these risks are regulated under various state, federal, and local laws. To date, the EPA has taken no further action in response to the 2016 report. +Some states, counties, and municipalities have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, well construction, and temporary or permanent bans on hydraulic fracturing in certain areas. For example, some states have banned the use of high-volume hydraulic fracturing, and others have adopted regulations that impose new or more stringent permitting, disclosure, disposal, and well construction requirements on hydraulic fracturing operations. Alternatively, some municipalities are, or have considered, zoning and other ordinances, the conditions of which could impose a de facto ban on drilling and/or hydraulic fracturing operations. Further, some states, counties, and municipalities are closely examining water use issues, such as permit and disposal options for processed water, which could have a material adverse impact on our financial condition, prospects, and results of operations if such additional permitting requirements are imposed upon our industry. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could reduce demand for our business by making it more difficult or costly for certain customers to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, the business and operations of our customers could be subject to additional permitting requirements, attendant permitting delays, increased operating and compliance costs and process prohibitions, which could have an adverse effect on our business, financial condition, and results of operations. +In light of concerns about seismic activity being triggered by the injection of produced waters into underground wells, certain regulators have also implemented or are considering implementing additional requirements related to seismic safety for hydraulic fracturing activities. A 2015 U.S. Geological Survey report identified eight states, including Texas, with areas of increased rates of induced seismicity that could be attributed to fluid injection or oil and gas extraction. Any regulation that restricts the ability of our customers to dispose of produced waters or increases their cost of doing business could cause them to curtail operations, which in turn could decrease demand for our services and have a material adverse effect on our business. +National Environmental Policy Act +Businesses and operations of our customers that are carried out on federal lands may be subject to the National Environmental Policy Act (“NEPA”), which requires federal agencies, including the Department of the Interior (the “DOI”), to evaluate major agency actions having the potential to significantly impact the human environment. In the course of such evaluations, an agency will evaluate the potential direct, indirect, and cumulative impacts of a proposed project and, if +13 +necessary, will prepare a detailed Environmental Impact Statement that must be made available for public review and comment. In July 2020, the Council on Environmental Quality (“CEQ”) revised NEPA’s implementing regulations in an effort to streamline approvals for projects. In October 2021, the Council on Environmental Quality announced its Phase I rule, the first of two planned rules to roll back the 2020 rule, which was finalized in April 2022. The Phase I final rule generally restores certain regulatory provisions that were in effect prior to the 2020 rule. In May 2024, CEQ finalized the Phase II rule, which accelerates NEPA reviews while maintaining consideration of relevant environmental, climate change, and environmental justice effects of a proposed project. Several states and environmental groups have challenged the Phase II rule in federal district court. The CEQ’s changes could result in increased NEPA review timelines for projects involving agency action regarding federal lands, federal funds, or federal permits or approvals. Additionally, in November 2024, a federal appeals court found that CEQ lacks statutory authority to issue NEPA regulations binding on other federal agencies. However, the court’s holding was confined to striking down the agencies’ action under review on separate grounds, and CEQ’s Phase I and II rules remain in effect. However, in January 2025, President Trump issued an executive order requiring CEQ to provide guidance on implementing NEPA and to propose rescinding and replacing CEQ’s NEPA regulations with implementing regulations at the agency level. The executive order also instructs federal agencies to adhere to only the relevant legislated requirements for environmental reviews and to prioritize efficiency and certainty over any other objectives in such reviews. In February 2025, CEQ sent an interim final rule to the White House Office of Management and Budget that would immediately withdraw the NEPA implementing regulations. The potential impact of further changes to the NEPA regulations and statutory text therefore remains uncertain and could have an effect on our customers’ business and operations, which could ultimately result in decreased demand for our services. +Endangered Species Act and Migratory Bird Treaty Act +The Endangered Species Act (“ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species or its habitat. The U.S. Fish and Wildlife Service (the “FWS”) must also designate the species’ critical habitat and suitable habitat as part of the effort to ensure survival of the species. In April 2024, the FWS finalized three rules that revise regulations regarding listing and reclassification of species and designation of critical habitat. These rules also clarify definitions that impact interagency cooperation and reinstated the general application of the “blanket rule” option for protecting newly listed threatened species. These rules were challenged in August 2024 in the Northern District of California. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act (the “MBTA”), which makes it illegal to, among other things, hunt, capture, kill, possess, sell, or purchase migratory birds, nests, or eggs without a permit. This prohibition covers most bird species in the U.S. In January 2021, the DOI finalized a rule limiting application of the MBTA; however, the DOI revoked the rule in October 2021 and issued an advance notice of proposed rulemaking seeking comment on the DOI’s plan to develop regulations that authorize incidental take under certain prescribed conditions. The DOI has not yet issued a proposed rule. However, in January 2025, President Trump issued an executive order declaring a national energy emergency under the National Emergencies Act. As part of that executive order, agencies were directed to use, to the maximum extent permissible, the ESA regulation on consultations in emergencies to facilitate the domestic energy supply. The executive order also requires the quarterly convening of the Endangered Species Act Committee to ensure prompt and efficient review of all submissions for potential actions that could facilitate energy development. President Trump also issued an executive order directing the heads of all federal agencies to identify and begin the processes to suspend, revise, or rescind all agency actions that are unduly burdensome on the identification, development, or use of domestic energy resources. Consequently, future implementation and enforcement of the rules impacting the ESA and the MBTA are uncertain. If our customers were to have areas within their business and operations designated as critical or suitable habitat for a protected species, it could decrease demand for our services and have a material adverse effect on our business. There is also increasing interest in nature-related matters beyond protected species, such as general biodiversity, which may similarly require us or our customers to incur costs or take other measures that may adversely impact our business or operations. +14 \ No newline at end of file diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/item13.txt b/raw/filings/0001532286/2024/0001532286-25-000008/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..318c84b2d53dd5be04bb5150f0a94936cdd5efeb --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence +The information required in response to this Item will be set forth in our definitive proxy statement for the 2025 annual meeting of stockholders and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/item9a.txt b/raw/filings/0001532286/2024/0001532286-25-000008/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e1cc517f7a144eebf9853344c5a1001986ac14ed --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/item9a.txt @@ -0,0 +1,10 @@ +Item 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. +As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2024. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2024. +Management’s Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. +As of December 31, 2024, our management assessed the effectiveness of our internal control over financial reporting based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on its assessment using the criteria established by COSO, management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +The effectiveness of our internal control over financial reporting as of December 31, 2024 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-1 of this Annual Report and which is included in Item 8 of Part II of this Annual Report. +Changes in Internal Control over Financial Reporting +There have been no changes in our internal control over financial reporting during the quarterly period ended December 31, 2024 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/rp_note.txt b/raw/filings/0001532286/2024/0001532286-25-000008/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..3dcdcb78b9d31c3a58eb4c2ee70c1588773f8e42 --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/rp_note.txt @@ -0,0 +1,4 @@ +15. Related Party Transactions +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by David Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $ 1.0 million and $ 1.3 million for the years ended December 31, 2024 and 2023, respectively. The Company also purchased $ 3.0 million and $ 2.9 million of products and services for the years ended December 31, 2024 and 2023, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $ 0.3 million and $ 0.2 million at December 31, 2024 and 2023, respectively. +The Company provides products and rentals to National Energy Services Reunited Corp. (“NESR”), where one of the Company’s former directors serves as a director. The Company billed NESR $ 1.1 million and $ 1.5 million for the years ended December 31, 2024 and 2023, respectively. There were no outstanding receivables due to the Company from NESR at December 31, 2024 and $ 0.4 million of total outstanding receivables due to the Company from NESR at December 31, 2023. +Ann G. Fox, President and Chief Executive Officer and a director of the Company, is a director of Devon Energy Corporation (“Devon”). The Company generated revenue from Devon of $ 4.5 million and $ 3.0 million for the years ended December 31, 2024 and 2023, respectively. There were outstanding receivables due from Devon of $ 0.3 million and $ 0.7 million at December 31, 2024 and 2023, respectively. \ No newline at end of file diff --git a/raw/filings/0001532286/2024/0001532286-25-000008/rpt_disclosure.txt b/raw/filings/0001532286/2024/0001532286-25-000008/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..17777d8424dc1bc1561b2c784aecf6cdbe75c1a4 --- /dev/null +++ b/raw/filings/0001532286/2024/0001532286-25-000008/rpt_disclosure.txt @@ -0,0 +1,6 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +The Board has adopted a written related person transactions policy, under which a “Related Person Transaction” is defined pursuant to Item 404 of Regulation S-K. Pursuant to this policy, the Audit Committee expects to review all material facts of all Related Person Transactions and either approve or disapprove entry into the Related Person Transaction, subject to certain limited exceptions. +In determining whether to approve or disapprove entry into a Related Person Transaction, the Audit Committee expects to take into account, among other factors, the following: (i) whether the Related Person Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and (ii) the extent of the Related Person’s interest in the transaction. Further, the policy requires that all Related Person Transactions required to be disclosed in our filings with the SEC be so disclosed in accordance with applicable laws, rules and regulations. +The Company leases office space, yard facilities, and equipment and purchases building maintenance and repair services from entities owned by Mr. Crombie, an executive officer of the Company. Total lease expense and building maintenance and repair expense associated with these entities was $1.0 million and $1.3 million for the years ended December 31, 2024 and 2023, respectively. The Company also purchased $3.0 million and $2.9 million of products and services for the years ended December 31, 2024 and 2023, respectively, from an entity in which Mr. Crombie is a limited partner. There were outstanding payables due to these entities of $0.3 million and $0.2 million at December 31, 2024 and 2023, respectively. +52 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/filing.txt b/raw/filings/0001692415/2019/0001493152-20-005305/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..1bf9faa72a7c9ad49b0dfa41a926f56540716d35 --- /dev/null +++ b/raw/filings/0001692415/2019/0001493152-20-005305/filing.txt @@ -0,0 +1,3453 @@ +10-K +1 +form10-k.htm +UNITED +STATES +SECURITIES +AND EXCHANGE COMMISSION +Washington, +D.C. 20549. +Form +10-K +(Mark +One) +[X] +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For +the fiscal year ended December 31, 2019 +OR +[ ] +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For +the transition period from_______to_______ +Commission +File Number 001-38148 +CO-DIAGNOSTICS, +INC. +(Exact +Name of Registrant as Specified in Its Charter) +Utah +3841 +46-2609396 +(State +or other jurisdiction of +incorporation or organization) +(Primary +Standard Industrial +Classification Code Number) +(I.R.S. +Employer +Identification Number) +2401 +S. Foothill Drive, Salt Lake City, Utah 84109 +(Address +of principal executive offices and zip code) +(801) +438-1036 +(Registrant’s +telephone number including area code) +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] +No [X] +Indicate +by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes [ ] +No [X] +Indicate +by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act +of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] +Indicate +by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive +Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the +preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ] +Indicate +by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not +contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements +incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] +Indicate +by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller +reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller +reporting company” in Rule 12b-2 of the Exchange Act. +Large +accelerated filer +[ ] +Accelerated +filer +[ ] +Non-accelerated +filer +[ ] +Smaller +reporting company +[X] +Emerging +Growth Company +[X] +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] +The +aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at +which the common stock was last sold as of the last business day of the registrant’s most recently completed second fiscal +quarter was approximately $10,333,831. +As +of March 22, 2020, there were 27,438,701 shares of common stock, par value $0.001 per share, outstanding. +Table +of Contents +Page +PART I +Item +1. +Business. +4 +Item +1A. +Risk Factors. +9 +Item +1B. +Unresolved Staff Comments. +9 +Item +2. +Properties. +10 +Item +3. +Legal Proceedings. +10 +Item +4. +Mine Safety Disclosures. +10 +PART II +Item +5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +10 +Item +6. +Selected Financial Data. +11 +Item +7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations. +11 +Item +7A. +Quantitative and Qualitative Disclosures About Market Risk. +18 +Item +8. +Financial Statements and Supplementary Data. +17 +Item +9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +19 +Item +9A. +Controls and Procedures. +19 +Item +9B. +Other Information. +19 +PART III +Item +10. +Directors, Executive Officers and Corporate Governance. +20 +Item +11. +Executive Compensation. +23 +Item +12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +26 +Item +13. +Certain Relationships and Related Transactions, and Director Independence. +27 +Item +14. +Principal Accountant Fees and Services. +27 +PART IV +Item +15. +Exhibits and Financial Statement Schedules. +29 +2 +PART +I +Forward-Looking +Statements +This +Annual Report on Form 10-K contains “forward-looking statements” that involve risks and uncertainties. All statements +other than statements of historical fact contained in this Annual Report and the documents incorporated by reference herein, including +statements regarding future events, our future financial performance, business strategy, and plans and objectives of management +for future operations, are forward-looking statements. We have attempted to identify forward-looking statements by terminology +including “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” +“expects,” “intends,” “may,” “plans,” “potential,” “predicts,” +“should,” or “will” or the negative of these terms or other comparable terminology. Although we do not +make forward looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. +These statements are only predictions and involve known and unknown risks, uncertainties and other factors and the documents incorporated +by reference herein, which may affect our or our industry’s actual results, levels of activity, performance or achievements +expressed or implied by these forward-looking statements. Moreover, we operate in a highly regulated, very competitive, and rapidly +changing environment. New risks emerge from time to time and it is not possible for us to predict all risk factors, nor can we +address the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause our +actual results to differ materially from those contained in any forward-looking statements. +We +have based these forward-looking statements largely on our current expectations and projections about future events and financial +trends that we believe may affect our financial condition, results of operations, business strategy, short term and long-term +business operations, and financial needs. These forward-looking statements are subject to certain risks and uncertainties that +could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could +cause or contribute to such differences include, but are not limited to, those discussed in this Annual Report, and in particular, +the risks discussed below and under the heading “Risk Factors” in other documents we file with the SEC. The following +discussion should be read in conjunction with the consolidated financial statements for the fiscal years ended December 31, 2019 +and 2018 and notes incorporated by reference therein. We undertake no obligation to revise or publicly release the results of +any revision to these forward-looking statements, except as required by law. In light of these risks, uncertainties and assumptions, +the forward-looking events and circumstances discussed in this Annual Report may not occur and actual results could differ materially +and adversely from those anticipated or implied in the forward-looking statement. +You +should not place undue reliance on any forward-looking statement, each of which applies only as of the date of this Annual Report. +Except as required by law, we undertake no obligation to update or revise publicly any of the forward-looking statements after +the date of this Annual Report to conform our statements to actual results or changed expectations. +You +are advised, however, to consult any further disclosures we make on related subjects in our reports on Forms 10-Q, 8-K and 10-K +filed with the SEC. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should +not consider this list to be a complete set of all potential risks or uncertainties. +Important +factors that could cause actual results to differ materially from those in the forward-looking statements include, without limitation: +● +the +results of clinical trials and the regulatory approval process; +● +market +acceptance of any products that may be approved for commercialization; +● +our +ability to protect our intellectual property rights; +● +the +impact of any infringement actions or other litigation brought against us; +● +competition +from other providers and products; +● +our +ability to develop and commercialize new and improved products and services; +● +changes +in government regulation; +● +and +other factors (including the risks contained in the section entitled “Risk Factors” in other documents we file +with the SEC) relating to our industry, our operations and results of operations. +3 +Should +one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results +may differ significantly from those anticipated, believed, estimated, expected, intended or planned. +Factors +or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict +all of them. We cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable +law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform +these statements to actual results. +As +used in this Annual Report, the terms “we”, “us”, “our”, and “Co-Diagnostics” +means Co-Diagnostics, Inc., a Utah corporation and its consolidated subsidiaries (the “Company”), unless otherwise +indicated. +ITEM +1: BUSINESS +Overview +Co-Diagnostics, +Inc., a Utah corporation (“Company,” or “CDI,”) is developing robust and innovative molecular tools for +detection of infectious diseases, liquid biopsy for cancer screening, and agricultural applications. We have developed and we +manufacture and sell reagents used for diagnostic tests that function via the detection and/or analysis of nucleic acid molecules +(DNA or RNA). In connection with the sale of our tests we may sell diagnostic equipment from other manufacturers as self-contained +lab systems (which we refer to as the “MDx device”). +Our +diagnostics systems enable very rapid, low-cost, molecular testing for organisms and genetic diseases by automating historically +complex procedures in both the development and administration of tests. CDI’s newest technical advance involves a novel +approach to Polymerase Chain Reaction (“PCR”) test design (“Co-Primers”) that eliminates one of the key +vexing issues of PCR amplification, the exponential growth of primer-dimer pairs (false positives and false negatives) which adversely +interferes with identification of the target DNA. +Our +proprietary molecular diagnostics technology is paving the way for innovation in disease detection and life sciences research +through our enhanced detection of genetic material. Because we own our platform, we are able to accomplish this faster and more +economically, allowing for wider margins while still positioning Co-Diagnostics to be a low-cost provider of molecular diagnostics +and screening services. +In +addition, continued development has demonstrated the unique properties of our Co-Primer technology that make them ideally suited +to a variety of applications where specificity is key to optimal results, including multiplexing several targets, enhanced Single +Nucleotide Polymorphism (“SNP”) detection and enrichment for next gen sequencing. +Our +scientists use the complex mathematics of DNA test design, to “engineer” a DNA test and to automate algorithms that +rapidly screen millions of possible options to pinpoint the optimum design. Dr. Satterfield, our Chief Technology Officer, developed +the Company’s intellectual property consisting of the predictive mathematical algorithms and proprietary reagents used in +the testing process, which together represent a major advance in PCR testing systems. CDI technologies are now protected by seven +granted or pending US and foreign patents, as well as certain trade secrets and copyrights. Ownership of our proprietary platform +permits us the advantage of avoiding payment of patent royalties required by other PCR test systems, which enables the sale of +diagnostic tests at a lower price than competitors, while generating a profit margin. +We +may either sell or lease the MDX Device to labs and diagnostic centers, through sale or lease agreements, and sell the reagents +that comprise our proprietary tests to those laboratories and testing facilities. +We +designed our tests by identifying the optimal locations on the target gene for amplification and paired the location with the +optimized primer and probe structure to achieve outputs that meet the design input requirements identified from market research. +This is done by following planned and documented processes, procedures and testing. In other words, the data resulting from our +tests verify that we succeeded in designing what we intended at the outset. Verification is a series of testing that concludes +that the product is ready to proceed to validation in a clinical evaluation setting using initial production tests to confirm +that the product as designed meets the user needs. +CDI’s +diagnostics systems enable very rapid, low-cost, sophisticated molecular testing for organisms and genetic diseases by greatly +automating historically complex procedures in both the development and administration of tests. CDI’s newest technical advance +involves a novel approach to PCR test design (cooperative primers) that eliminates one of the key vexing issues of PCR amplification, +the exponential growth of primer-dimer pairs (false positives and false negatives) which adversely interferes with identification +of the target DNA. +4 +Using +its proprietary test design system and proprietary reagents, CDI has designed and obtained regulatory approval in the European +Community and in India to sell PCR diagnostic tests for COVID-19, tuberculosis, hepatitis B and C, human papilloma virus, Malaria, +chikungunya, dengue, and the Zika virus. +In +addition to testing for infectious disease, the technology lends itself to identifying any section of a DNA strand that describe +any type of genetic trait, which creates a number of significant applications. We are active in designing and licensing tests +that identify genetic traits in plant and animal genomes. We also have a number of tests developed to test mosquitos for the identification +of diseases carried by the mosquitos to enable municipalities to concentrate their efforts in spraying mosquito populations on +the specific areas known to be breeding the mosquitos that carry deadly viruses. +Recent +Developments +On +January 23, 2020, we announced the completion of the principle design work for a PCR screening test for new coronavirus, COVID-19, +intended to address potential need for detection of the virus. An outbreak of respiratory illness caused by the pneumonia-like +COVID-19 has spread rapidly over past few months, after first being discovered in the Chinese city of Wuhan on December 31, 2019. +China confirmed human-to-human transmission of the virus and the United States announced the first infection in this country, +detected in a traveler returning from Wuhan. Our COVID-19 test features the Company’s patented CoPrimer™ technology, +and was designed using our proprietary software system, following the guidelines published by the World Health Organization and +Centers for Disease Control. +On +February 20, 2020, we announced that our Logix Smart™ COVID-19 Test technical file had been submitted for registration with +the European Community, and that it was expected to be available late February as an in vitro diagnostic (“IVD”) for +markets that accept a CE marking as valid regulatory approval. Subsequently, on February 24, 2020, we announced that our test +obtained regulatory clearance to be sold as an in vitro diagnostic for the diagnosis of SARS-CoV-2 (COVID-19) in markets that +accept CE-marking as valid regulatory approval, and became available for purchase from the Company’s Utah-based ISO-13485:2016 +certified facility. The Declaration of Conformity for the Logix Smart COVID-19 test confirms that it meets the Essential Requirements +of the European Community’s In-Vitro Diagnostic Medical Device Directive (IVDD 98/79/EC), permitting export and sales of +the product as an IVD to commence immediately in the European Community. We shipped samples of the Research Use Only version of +our test to distributors in various countries, which allowed future customers to confirm the quality and sensitivity +of the product, and for us to accelerate the sales efforts of the COVID-19 test. We commenced sales of the COVID-19 +tests in February and March and have sold the tests in numerous countries around the world as well as sales to labs in the United +States. +Infectious +Disease Product Offering +Using +its proprietary test design system and proprietary reagents, CDI designs and sells PCR diagnostic tests for diseases and pathogens +such as COVID-19, tuberculosis, hepatitis B and C, Malaria, dengue, human papilloma virus, chikungunya, and Zika virus, all of +which tests have been designed and verified in CDI’s laboratory. Our tuberculosis test and Zika test received a CE Mark +in 2018, and a triplex test for Zika, Dengue and Chikungunya received a CE Mark in 2019, qualifying our test to be sold throughout +the European community and in most countries in central and South America. In December, 2019, our Indian joint venture received +a license to manufacture and sell Tuberculosis, Hepatitis B, Hepatitis C, Human Papilloma virus 16/18 and Malaria tests in India +from the Central Drugs Standard Control Organization (“CDSCO”). In February 2020, we received a CE Mark for our Logix +Smart COVID-19 test. +As +explained above, the development of our Logix Smart COVID-19 test was designed, developed, submitted for regulatory approved and +ready to be used both as a Research Use Only (“RUO”) and as an IVD in countries that accept a CE Mark as approval +for use of the test in a period of just over thirty days. This is a real world example of how in an evolving epidemic that the +CDI technology can be used to get diagnostics tools in the hands of medical professionals without delay. It can be similarly used +to design a test for mutations of the virus should they occur. +Caribbean +and Central and South America +Our +initial sales were to entities within the Caribbean Public Health Agency Members States (Anguilla, Antigua and Barbuda, Aruba, +Bahamas, Barbados, Belize, Bermuda, BES Islands, British Virgin Islands, Cayman Islands, Curacao, Dominica, Grenada, Haiti, Guyana, +Jamaica, Montserrat, Saint Kitts and Nevis, Saint Lucia, St Maarten, Saint Vincent and the Grenadines, Suriname, Trinidad and +Tobago, Turks and Caicos Islands). +5 +In +some of these countries, there are no regulatory hurdles and we can start offering our tests immediately. We have applied for +registration of our tests in those countries that require registration and our distributors in those countries have provided us +with in country assistance in completing such registrations. +We +first offered our Zika test in this region because of the demand for such test, followed quickly by tests for tuberculosis, our +triplex test for Zika, chikungunya, and dengue, hepatitis B and C, and dengue. Products are manufactured for sale upon receipt +of purchase orders from labs and hospitals. +India +The +Company has entered into an agreement to manufacture diagnostics tests for seven infectious diseases with a pharmaceutical manufacturing +company in India and formed an Indian joint venture which is CoSara Diagnostics, Pvt. The agreement provides for the construction +of a manufacturing plant and the manufacture of the tests named above and the joint sales and marketing of those tests in India. +We have completed licensing of the plant in Rinoli, India, that will be used for testing and manufacturing for the Indian market. +Since +the tests will be conducted in India on Indian citizens, no FDA approval or inspection will be required. As mentioned above, the +CDSCO has given us the approval for manufacture and sale of the five tests referred above and the Company has begun to take orders +for our tests. The Company has commenced a reagent rental program in India with our Mx Device. We have placed five of our Mx Devices +with labs in India and have purchased an additional fifteen Mx Devices in the first quarter of 2020. Each of the reagent rental +placements requires the purchase of a minimum of 250 tests per month. We have submitted to the CDSCO our technical file requesting +approval for the manufacture and sale of our COVID-19 test in India and have received authorization to begin manufacture and sale +of COVID-19 tests on a RUO basis. We intend to submit technical files to the CDSCO requesting approval tests for HIV and Dengue +as well as a blood bank panel before the end of the second quarter of 2020 and expect them to be approved for sale in 2020. +India +is the country with the highest burden of tuberculosis. World Health Organization (WHO) tuberculosis statistics for India for +2015 give an estimated incidence figure of 2.2 million cases of tuberculosis for India out of a global incidence of 9.6 million. +The tuberculosis incidence for India is the number of new cases of active tuberculosis disease in India during a certain time +period (usually a year). +Europe +Molecular +diagnostics, such as our tests, are governed in Europe by the framework for in vitro diagnostics (IVDs), which encompasses diagnostic +products such as reagents, instruments and systems intended for use in diagnosis of disease. The regulatory system for IVDs is +built largely on a self-certification procedure, placing heavy responsibility on manufacturers. Non self-certified products are +subject to the same standards as self-certified products but are subject to audit and review by a notified body prior to receiving +approval to be CE-marked. A CE-marking is a manufacturer’s declaration that a product meets the requirements of the applicable +European Commission directive. Examples of current obligations include having in place a qualitative manufacturing process, user +instructions that are clear and fit for purpose, ensuring that the ‘physical’ features of devices and diagnostics +do not pose any danger. If a product fulfils these and other related control requirements, it may be CE-marked as an indication +that the product is compliant with EU legislation and sold in the European Union. We have received CE Marks for four of our tests +including COVID-19, tuberculosis, Zika, and our zika, dengue, chikungunya triplex tests. +We +have received ISO 13485 and ISO 9001 certifications relating to the design and manufacture of our medical device products. The +ISO certification indicates that we meet the standards required to self-certify certain of our products and affix a CE-marking +for sales of our products in countries accepting the CE marking (not in the United States) with only minimal further governmental +approvals in each country. +United +States +The +U.S. Food and Drug Administration (FDA) has granted permission for us to export many of our products. The FDA’s permission +to export was granted under Section 801(e) of the Federal Food, Drug, and Cosmetic Act, as amended (the “FDC Act”). +Section 801(e) of the FDA Act covers certain medical devices that have not yet received an approved Premarket Approval in the +United States by the FDA, such as our products. We have not commenced any Premarket Approval steps with the FDA. Section 801(e) +applies to medical devices that are acceptable to the importing country and that are manufactured under the FDA’s Good Manufacturing +Practices. We have applied to the FDA for Emergency Use Authorization for our COVID-19 test, which would allow sales in the US +to qualified labs. +We +do not anticipate offering our tests in the United States in the near future. We believe, however, our tests may be able to qualify +as Laboratory Developed Tests (LDT’s), diagnostic tests that are developed and manufactured by CLIA certified laboratories. +These tests are developed by the lab for use only in that laboratory. CLIA laboratories develop the performance characteristics, +perform the analytical validation for their LDT’s and obtain licenses to offer them as diagnostic services. The FDA has +publicly announced its intention to regulate certain LDTs in a phased-in approach, but draft guidance that was published a couple +of years ago was withdrawn at the end of the Obama administration and replaced by an informal non-enforceable discussion paper +reflecting some of the feedback that it received on LDT regulation. +6 +Market +Opportunity +The +molecular diagnostics market is a fast-growing portion of the in vitro (test tube based, controlled environment) diagnostics market. +Using estimates of the incidence of disease by the Centers for Disease Control, the World Health Organization and other international +health agencies and sources, the Company estimates that the global annual demand for diagnostic tests are: +Tuberculosis +10,400,000 +HIV +36,700,000 +Multi-drug +resistant Tuberculosis +580,000 +Malaria +214,000,000 +Zika +324,000,000 +Sexually +Transmitted Illnesses +357,000,000 +Hepatitis +B +240,000,000 +Human +papilloma virus +291,000,000 +Hepatitis +C +130,000,000 +Dengue +390,000,000 +Total +Annual Tests +1,993,680,000 +There +are several advantages of molecular tests, such as the ones we market and sell, over other forms of diagnostic testing, which +include higher sensitivities, the ability to perform multiplex tests and the ability to test for drug resistance or individual +genes. +Mosquito +Vector Control Services . +In +response to market demand, we introduced our first diagnostics tests to be used exclusively to test mosquito DNA in June 2019. +Municipalities in the US and many other countries in the world are concerned about the diseases carried by mosquitos and which +infect the human population. To prevent outbreaks of potentially harmful viruses, such as Zika or West Nile, from infecting the +public the municipalities conduct spraying operations to eliminate the mosquito populations carrying the diseases. Because it +is too expensive to spray all mosquito breeding areas, the problem is to identify which particular area has mosquitos that are +carrying the harmful viruses. To know where the host mosquitos with the harmful viruses are located, traps are set, mosquitos +collected and then tested to find the areas that most needed spraying. There are over three thousand mosquito abatement districts +throughout the United States and almost all of them conduct testing to help make the spraying more effective. +Our +first test is a triplex test that tests for West Nile, Western Equine and St. Louis encephalitis. We began shipping the tests +in June 2019. We have since added a second test that tests mosquitos for Zika, chikungunya and dengue in a triplex test. Finally, +in November, we completed a test for West Nile, Eastern Equine and St. Louis encephalitis, specifically for use in the eastern +United States. As a result, mosquito abatement districts can test for three target viruses in one test for the same cost as one +test would cost ($10-$15) using other market available PCR tests. Additionally, the districts are more effective because they +can get test results in a matter of hours using our product instead of weeks when they have to wait for a central lab to process +the mosquito tests. +We +have sold our Vector Smart test products and/or related lab equipment to seven different testing districts and are marketing our +products through trade shows, electronic and regular mail solicitations and have hired additional sales personal in the eastern +US to more economically and efficiently market to the east coast areas. +Competitive +Advantages of Co-Diagnostics +We +believe that we have the following competitive advantages: +● +Affordability: +Lower-cost test kits and low-cost MDx-device. +● +Flexibility: +CDI’s tests have been designed to run on many vendors’ DNA diagnostic testing machines. These tests are +particularly well suited to the new generation of “lab-on-a-chip” and “point-of-care” (“LOC +and POC”), highly portable analysis machinery for field, clinic and office applications. +● +Speed : +We believe our rapid assay design system software provides shorter time to product release. This has been demonstrated +with the conception, design, product manufacture, clinical verification and submission for a CE Mark for our Logix Smart coronavirus +disease (COVID-19) test being approximately 30 days. +● +Accuracy : +We believe our tests are more accurate than competitors’ and can detect more strains of viruses. +7 +● +Exclusivity : +CDI owns all patents and all intellectual property used in preparation of its tests. +● +Personalized +Medicine : We project that rising health care costs in developed and developing nations will increasingly require that +health care systems be patient specific to eliminate waste, misdiagnoses, and ineffectiveness. A critical component will be +accurate, more affordable DNA-based diagnostics, which CDI plans to offer. +● +Low-cost +Provider : We plan to keep the Company’s overhead low. Its platform technology obviates the need to pay patent +royalties typically required of its competitors, which use patented test platforms to design their tests. +● +Worldwide +Footprint : With a dynamic technology that encompasses markets worldwide, the Company anticipates that it can identify +the best target markets, not only in high burden developing countries (HBDC’s) but also in developed nations. +● +Growth +Industry Category : We believe that DNA testing is the fastest-growing segment of in-vitro diagnostic testing. +● +Combination +Product Offering : CDI’s ultra-sensitive tests can be a well-designed match for a new generation of handheld +and other small point-of-care devices now entering the market. Used together, these affordable tests and devices may revolutionize +the molecular diagnostics industry in cost, speed of test results and simplification. +● +Multi-plexing: +Our initial development efforts have demonstrated that our Co-Primer designed tests will be able to test for multiple +targets in the same sample without the distortion caused by false negatives and false positives that generally occur in multiplexed +tests. +Liquid +Biopsy for Cancer Screening +The +development of the liquid biopsy test will spur low cost testing in many developing countries. We believe that our liquid biopsy +cancer screening shall be ready for testing in 2020 if we have sufficient development resources to dedicate to the project. Medical +applications of our SNP detection technology can determine the presence of cancer cells or cell-free genetic material in a liquid +or tissue biopsy, and to determine the distinct type of cancer involved. A real-life example of this includes being able to identify +specific mutation(s) in genes linked to breast cancer in order to determine a patient’s prognosis, initiate the most effective +and affordable treatment and to determine whether chemotherapy is necessary. After diagnosis the relative cost of our technology +allows for frequent testing to measure the effectiveness of the treatment. +Our +technology has for all practical purposes essentially eliminated, primer-dimers, which opens up some very unique applications +for liquid biopsy for cancer detection. Our ability to multiplex the reaction in testing for several DNA targets allows technicians +to detect multiple cancers as free-circulating DNA fragments or whole cells in a blood sample at the same time +Agricultural +Applications +SNP +detection is also used in the agricultural industry to identify variations in crop genomes to achieve improved seed viability +and other desired characteristics, including drought resistance, disease resistance, pest resistance and higher yield. +In +mid-2017, the Company was first approached by a large agribusiness to evaluate our ability to multiplex certain target genomes. +The results of the development project have been to successfully demonstrate our ability to not only multiplex the target genomes, +but targeted SNP’s as well. The project was undertaken in conjunction with the manufacturer of our CoPrimer tests. The results +of the project encouraged the parent of our manufacturer to seek a world-wide licensing arrangement for our CoPrimers in the agricultural +industry, which was completed in October 2018. Pursuant to the exclusive license for the agrigenomics industry, the licensee will +pay us a royalty for all CoPrimers sold to the licensee’s customers. In January 2019, the licensee formally introduced the +product at a large agricultural conference and has branded the product to sell as BHQCoPrimers. +Additional +Licensing and Assay Development +In +addition, the unique properties of our CoPrimer technology make them ideally suited to a variety of applications where sensitivity +is key to optimal results, including multiplexing several targets, enhanced SNP detection and enrichment for next gen sequencing. +Our licensee for our agricultural testing requested an expansion of our license agreement to include test design services for +their customers and potential customers, both in the infectious disease arena as well as for agricultural customers. The license +was amended in July 2019 and we will derive a license fee from our licensee for its design services. If any of its customers desire +to commercialize the tests designed, they will need to seek a commercial license directly from us. Because of these unique characteristics +of CoPrimers, research companies and institutions have requested that we design diagnostics to locate and identify uncommon gene +sequences and SNPs and create tests for the target sequences in a multiplexed reaction. This application of our technology is +in its beginning stages, but we believe that the results from our initial research indicate a significant step forward in defining +the capabilities of our technology, which we believe can be translated to revenue producing licensing arrangements. +8 +Organizational +History and Corporate Information +We +were incorporated as Co-Diagnostics, Inc., in Utah on April 18, 2013. Our principal executive office is located 2401 S. Foothill +Drive, Salt Lake City, Utah 84109. Our telephone number is (801) 438-1036. Our web address is http://codiagnostics.com. +Implications +of Being an Emerging Growth Company +We +are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an +emerging growth company until the earlier of (i) the last day of the fiscal year following the fifth anniversary of July 12, 2017, +the date of the first sale of our common stock pursuant to an effective registration statement under the Securities Act of 1933, +as amended (the “Securities Act”); (ii) the last day of the fiscal year in which we have total annual gross revenues +of $1 billion or more; (iii) the date on which we have issued more than $1 billion in nonconvertible debt during the previous +three years; or (iv) the date on which we are deemed to be a large accelerated filer under applicable SEC rules. We expect that +we will remain an emerging growth company for the foreseeable future, but cannot retain our emerging growth company status indefinitely. +We refer to the Jumpstart Our Business Startups Act of 2012 herein as the “JOBS Act”. For so long as we remain an +emerging growth company, we are permitted and intend to rely on exemptions from specified disclosure requirements that are applicable +to other public companies that are not emerging growth companies. These exemptions include: +● +being +permitted to provide only two years of audited financial statements, in addition to any required unaudited interim financial +statements, with correspondingly reduced “Management’s Discussion and Analysis of Financial Condition and Results +of Operations” disclosure; +● +not +being required to comply with the requirement of auditor attestation of our internal controls over financial reporting; +● +not +being required to comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding +mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit +and the financial statements; +● +reduced +disclosure obligations regarding executive compensation; and +● +not +being required to hold a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute +payments not previously approved. +For +as long as we continue to be an emerging growth company, we expect that we will take advantage of the reduced disclosure obligations +available to us as a result of that classification. Accordingly, the information contained herein may be different than the information +you receive from other public companies in which you hold stock. +An +emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities +Act for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of certain +accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected to avail ourselves +of this extended transition period and, as a result, we will not be required to adopt new or revised accounting standards on the +dates on which adoption of such standards is required for other public reporting companies. +We +are also a “smaller reporting company” as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended, +or the Exchange Act, and have elected to take advantage of certain of the scaled disclosure available for smaller reporting companies. +ITEM +1A. RISK FACTORS +Not +applicable to smaller reporting companies. +ITEM +1B. UNRESOLVED STAFF COMMENTS +None. +9 +ITEM +2. PROPERTIES +Our +executive offices are located at 2401 S. Foothill Drive, Salt Lake City, Utah 84109. We occupy the space at the executive offices +under a lease, which expired January 31, 2020. We currently occupy the space on a month to month basis as we negotiate a longer-term +lease. The lease covers approximately 10,273 square feet of lab and office space leased at a rate of $14,831 per month. We have +no other properties. +ITEM +3. LEGAL PROCEEDINGS +From +time to time, we may become involved in litigation relating to claims arising out of our operations in the normal course of business. +There is one lawsuit pending in the State of Florida alleging liable, which we believe is groundless and has no relevance to our +products or services and which will be vigorously defended. To the best of our knowledge, no governmental authority is contemplating +any proceeding to which we are a party or to which any of our properties or businesses are subject, which would reasonably be +likely to have a material adverse effect on the Company. We have received inquiries relative to the sudden rise in the price of +our stock from FINRA and NASDAQ, to which we have responded. +ITEM +4. MINE SAFETY DISCLOSURES +Not +applicable. +PART +II +ITEM +5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER EQUITY SECURITIES +Market +Information +Our +common stock, from July 12, 2017, was quoted on the NASDAQ market under the symbol “CODX”. The following table sets +forth the high and low prices for our common stock for the periods indicated, as reported by NASDAQ. +2020 +HIGH +LOW +First Quarter (through March 15, 2020) +$ 21.75 +$ 0.88 +2019 +First +Quarter +$ +3.77 +$ +.90 +Second +Quarter +$ +1.20 +$ +.69 +Third +Quarter +$ +2.00 +$ +.79 +Fourth +Quarter +$ +1.20 +$ +.85 +2018 +HIGH +LOW +First +Quarter +$ +3.27 +$ +1.45 +Second +Quarter +$ +6.66 +$ +1.57 +Third +Quarter +$ +4.30 +$ +2.60 +Fourth +Quarter +$ +3.10 +$ +1.15 +Holders +As +of March 13, 2020, the last reported sales price reported on NASDAQ for our common stock was $9.86 per share. As of the date of +this filing, we had approximately 336 record holders of our common stock. The number of record holders was determined from the +records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various +security brokers, dealers, and registered clearing agencies. The transfer agent for our common stock is VStock Transfer LLC located +at 18 Lafayette Pl, Woodmere, New York 11598. +Dividends +We +have never declared or paid any cash dividends on our capital stock. The payment of dividends on our common stock in the future +will depend on our earnings, capital requirements, operating and financial condition and such other factors as our Board of Directors +may consider appropriate. We currently expect to use all available funds to finance the future development and expansion of our +business and do not anticipate paying dividends on our common stock in the foreseeable future. +10 +Recent +Sales of Unregistered Securities +We +relied on the exemption from registration under the Securities Act set forth in Section 4(2) thereof for each of these issuances. +Purchases +of Equity Securities by the Issuer and Affiliated Purchasers +None. +ITEM +6. SELECTED FINANCIAL DATA +Not +required. +ITEM +7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS +The +following management’s discussion and analysis of financial condition and results of operations describes the principal +factors affecting the results of our operations, financial condition, and changes in financial condition. This discussion should +be read in conjunction with the accompanying audited financial statements, and notes thereto, included elsewhere in this report. +The information contained in this discussion is subject to a number of risks and uncertainties. We urge you to review carefully +the sections of this report entitled “ Risk Factors ” in other filings with the SEC and “ Forward-Looking +Statements ” in this Annual Report for a more complete discussion of the risks and uncertainties associated with an investment +in our securities. +Overview +Business +Overview +Co-Diagnostics, +Inc., a Utah corporation (“Company,” or “CDI,”) is developing robust and innovative molecular tools for +detection of infectious diseases, liquid biopsy for cancer screening, and agricultural applications. We have developed and we +manufacture and sell reagents used for diagnostic tests that function via the detection and/or analysis of nucleic acid molecules +(DNA or RNA). In connection with the sale of our tests we may sell diagnostic equipment from other manufacturers as self-contained +lab systems (which we refer to as the “MDx device”). +Our +diagnostics systems enable very rapid, low-cost, molecular testing for organisms and genetic diseases by automating historically +complex procedures in both the development and administration of tests. CDI’s newest technical advance involves a novel +approach to Polymerase Chain Reaction (“PCR”) test design (“Co-Primers”) that eliminates one of the key +vexing issues of PCR amplification, the exponential growth of primer-dimer pairs (false positives and false negatives) which adversely +interferes with identification of the target DNA. +Our +proprietary molecular diagnostics technology is paving the way for innovation in disease detection and life sciences research +through our enhanced detection of genetic material. Because we own our platform, we are able to accomplish this faster and more +economically, allowing for wider margins while still positioning Co-Diagnostics to be a low-cost provider of molecular diagnostics +and screening services. +In +addition, continued development has demonstrated the unique properties of our Co-Primer technology that make them ideally suited +to a variety of applications where specificity is key to optimal results, including multiplexing several targets, enhanced Single +Nucleotide Polymorphism (“SNP”) detection and enrichment for next gen sequencing. +Our +scientists use the complex mathematics of DNA test design, to “engineer” a DNA test and to automate algorithms that +rapidly screen millions of possible options to pinpoint the optimum design. Dr. Satterfield, our Chief Technology Officer, developed +the Company’s intellectual property consisting of the predictive mathematical algorithms and proprietary reagents used in +the testing process, which together represent a major advance in PCR testing systems. CDI technologies are now protected by seven +granted or pending US and foreign patents, as well as certain trade secrets and copyrights. Ownership of our proprietary platform +permits us the advantage of avoiding payment of patent royalties required by other PCR test systems, which enables the sale of +diagnostic tests at a lower price than competitors, while generating a profit margin. +We +may either sell or lease the MDX Device to labs and diagnostic centers, through sale or lease agreements, and sell the reagents +that comprise our proprietary tests to those laboratories and testing facilities. +11 +We +designed our tests by identifying the optimal locations on the target gene for amplification and paired the location with the +optimized primer and probe structure to achieve outputs that meet the design input requirements identified from market research. +This is done by following planned and documented processes, procedures and testing. In other words, the data resulting from our +tests verify that we succeeded in designing what we intended at the outset. Verification is a series of testing that concludes +that the product is ready to proceed to validation in a clinical evaluation setting using initial production tests to confirm +that the product as designed meets the user needs. +CDI’s +diagnostics systems enable very rapid, low-cost, sophisticated molecular testing for organisms and genetic diseases by greatly +automating historically complex procedures in both the development and administration of tests. CDI’s newest technical advance +involves a novel approach to PCR test design (cooperative primers) that eliminates one of the key vexing issues of PCR amplification, +the exponential growth of primer-dimer pairs (false positives and false negatives) which adversely interferes with identification +of the target DNA. +Using +its proprietary test design system and proprietary reagents, CDI has designed and obtained regulatory approval to sell PCR diagnostic +tests for COVID-19, tuberculosis, hepatitis B and C, human papilloma virus, Malaria, chikungunya, dengue, and the Zika virus. +In +addition to testing for infectious disease, the technology lends itself to identifying any section of a DNA strand that describe +any type of genetic trait, which creates a number of significant applications. We are active in designing and licensing tests +that identify genetic traits in plant and animal genomes. We also have a number of tests developed to test mosquitos for the identification +of diseases carried by the mosquitos to enable municipalities to concentrate their efforts in spraying mosquito populations on +the specific areas known to be breeding the mosquitos that carry deadly viruses. +Recent +Developments +On +January 23, 2020, we announced the completion of the principle design work for a PCR screening test for new coronavirus, COVID-19, +intended to address potential need for detection of the virus. An outbreak of respiratory illness caused by the pneumonia-like +COVID-19 has spread rapidly over past few months, after first being discovered in the Chinese city of Wuhan on December 31, 2019. +China confirmed human-to-human transmission of the virus and the United States announced the first infection in this country, +detected in a traveler returning from Wuhan. Our COVID-19 test features the Company’s patented CoPrimer™ technology, +and was designed using our proprietary software system, following the guidelines published by the World Health Organization and +Centers for Disease Control. +On +February 20, 2020, we announced that our Logix Smart™ COVID-19 Test technical file had been submitted for registration with +the European Community, and that it was expected to be available late February as an in vitro diagnostic (“IVD”) for +markets that accept a CE marking as valid regulatory approval. Subsequently, on February 24, 2020, we announced that our test +obtained regulatory clearance to be sold as an in vitro diagnostic for the diagnosis of SARS-CoV-2 (COVID-19) in markets that +accept CE-marking as valid regulatory approval, and became available for purchase from the Company’s Utah-based ISO-13485:2016 +certified facility. The Declaration of Conformity for the Logix Smart COVID-19 test confirms that it meets the Essential Requirements +of the European Community’s In-Vitro Diagnostic Medical Device Directive (IVDD 98/79/EC), permitting export and sales of +the product as an IVD to commence immediately in the European Community. We shipped samples of the Research Use Only version of +our test to distributors in Italy and Germany, which allows future customers to confirm the quality and sensitivity of the product +prior to the IVD being available, and for us to accelerate the sales efforts of its diagnostic. Many other global markets also +accept a CE marking as valid regulatory approval following routine local product registration, which allows sales of our COVID-19 +IVD into these areas. +Agreement +with Synbiotics +The +Company has entered into a joint venture agreement to manufacture diagnostics tests for seven infectious diseases with Synbiotics +Limited, a pharmaceutical manufacturing company in India. The Company and Synbiotics shall be equal partners in the joint venture. +The agreement provides for the manufacture of the tests named above and the joint sales and marketing of those tests in India. +The Company will license its technology to the joint venture on a royalty-free basis. The profits from the partnership shall be +divided as follows: +Profit +Level +CDI +Share +Synbiotics +Share +Up +to $1,000,000 +50 +% +50 +% +$1,000,000-$2,000,000 +60 +% +40 +% +$2,000,000-$3,000,000 +70 +% +30 +% +Above +$3,000,000 +80 +% +20 +% +12 +Synbiotics +will be reimbursed by the joint venture for some expenses, such as approximately $96,000 in rent for the manufacturing plant and +office space. If the joint venture needs additional funding, it will be achieved through loans obtained by the joint venture, +or if loans are not available on commercially reasonable terms, from capital contributions. There is no term to the joint venture +agreement but it can be dissolved by mutual agreement or by one party upon a material breach by the other party. +In +December 2019, we announced that CoSara Diagnostics Pvt Ltd (“CoSara,” or the “JV”), our joint venture +for manufacturing, obtained regulatory clearance for five tests to be manufactured and sold as in vitro diagnostics (“IVDs”) +from their facility in Ranoli India. +The +tests for Mycobacterium tuberculosis, malaria, hepatitis B, hepatitis C and human papillomavirus (HPV) met the requirements of +the Central Drug Standard Control Organization (“CDSCO”) Medical Device Rules (MDR) 2017, File no. 29/Misc./3/2017-DC +(292), to be manufactured and sold as IVDs. CDSCO approval was granted following the completion of the CoSara manufacturing facility +and a comprehensive inspection of the location, presentation of the technology, quality system, procedures, product validation +data and performance evaluation by an independent NABL & CAP accredited laboratory. The licenses and regulatory clearance +allow CoSara for the first time to manufacture and sell the tests for the detection of the respective pathogens and microorganisms. +CoSara +distributors have begun taking pre-orders for the five IVDs. The JV has the exclusive manufacturing rights in India for the complete +menu of our infectious disease molecular diagnostics kits, designed by us using our patented CoPrimer™ technology platform. +Additional tests such as our COVID-19 test have been submitted to the CDSCO for approval and others such as consist a drug-resistant +tuberculosis, HIV and more, including a multiplexed panel specifically for blood-bank screening will be submitted in 2020. Since +the tests will be conducted in India on Indian citizens, no FDA approval or inspection will be required. +India +is the country with the highest burden of tuberculosis. According to the World Health Organization (WHO) tuberculosis statistics +for India for 2015 give an estimated incidence figure of 2.2 million cases of tuberculosis for India out of a global incidence +of 9.6 million. The tuberculosis incidence for India is the number of new cases of active tuberculosis disease in India during +a certain time period (usually a year). +Intellectual +Property Protection +Because +much of our future success and value depends on our proprietary technology, our patent and intellectual property strategy is of +critical importance. Four of our initial U.S. patents related to our technology have been granted by the U.S. Patent and Trademark +Office, or PTO, including the patent for our CoPrimer technology, which we consider our most important patent. One of our patents +has been issued in Great Britain, but is still pending in the United States. As of March 15, 2020, we had three additional patents +pending in the U.S. and foreign counterpart applications. Two of our issued patents expire in 2034, one in 2036 and one in 2038. +We +have identified additional applications of the technology, which represent potential patents that further define specific applications +of the processes that are covered by the original patents. We intend to continue building our intellectual property portfolio +as development continues and resources are available. +We +have copyrighted our development software that can be used by any lab or developer to develop diagnostic tests based on our technology. +We have allowed one customer access to our development software and intend to sell customized reagents through that customer to +labs serviced by that customer throughout the world. To date we have not sold any products through that customer. +Major +Customers +We +had no major customers in 2019, but one customer in the first quarter of 2020 comprised approximately 20% of our sales +to date and payment was received in advance of shipment of the tests. +Competition +The +molecular diagnostics industry is extremely competitive. There are many firms that provide some or all of the products we provide +and provide many diagnostic tests that we have yet to develop. Many of these competitors are larger than us and have significantly +greater financial resources. Because we are not established, many of our competitors have a competitive advantage in the diagnostic +testing industry because they also have other lines of business in the pharmaceutical industry from which they derive revenues +and for which they are well known and respected in the medical profession. We will need to overcome the disadvantage of being +a start up with no history of success and no respect of the medical and testing professionals. In the diagnostic testing industry, +we compete with such companies as Roche, BioMerieux, Siemans, Qiagen, and Cephied and with such pharmaceutical companies as Abbott +Laboratories, Becton, Dickinson and Johnson and Johnson. +13 +Many +of these competitors already have an established customer base with industry standard technology, which we must overcome to be +successful. +Employees +We +currently employ 23 full-time personnel at our executive offices and lab facilities in Salt Lake City, Utah, and two employees +outside of Utah. We have engaged independent contractors in the US and India to promote the use of our products and develop outlets +for products and employ the services of an independent sales representatives in our mosquito vector sales efforts. +Government +Regulation +We +will be regulated by the U.S. Federal Drug Administration and our products must be approved by the FDA before we will be allowed +to sell our tests in the United States. Because our lab is ISO certified we are allowed to apply for CE-Marking, which will allow +us to sell in most countries in Europe, South America and Asia. We currently have CE Marks issued for our COVID-19 test, tuberculosis +test, our zika virus test, and a triplex test that tests for zika, dengue, and chikungunya simultaneously. Our joint venture in +India is regulated by the CDSCO and has approved the manufacture and sale of five diagnostic tests and has approved the manufacture +and sale of COVID-19 tests on as a Research Use Only test pending approval for full manufacture and sale. +Properties +Our +executive offices are located at 2401 S. Foothill Drive, Salt Lake City, Utah 84109. We occupy the space at the executive offices +under a month to month lease. The lease covers approximately 10,273 square feet of lab and office space leased at a rate of $14,831 +per month. We have no other properties. +Legal +Proceedings +From +time to time, we may become involved in litigation relating to claims arising out of our operations in the normal course of business. +There is one lawsuit pending in the State of Florida alleging liable, which we believe is groundless and has no relevance to our +products or services and which will be vigorously defended. To the best of our knowledge, no governmental authority is contemplating +any proceeding to which we are a party or to which any of our properties or businesses are subject, which would reasonably be +likely to have a material adverse effect on the Company. We have received inquiries relative to the sudden rise in the price of +our stock from FINRA and NASDAQ, to which we have responded. +RESULTS +OF OPERATIONS +Results +of Operations for the Years Ended December 31, 2019 and 2018 +Table derived from audited financial statements +For the years ended +December 31, +December 31, +2019 +2018 +Net sales +$ 214,974 +$ 39,911 +Cost of sales +112,431 +9,391 +Gross profit +102,543 +30,520 +Operating expenses: +Selling and marketing +1,061,676 +1,165,631 +Administrative and general +3,497,273 +3,570,786 +Research and development +1,371,433 +1,361,154 +Depreciation and amortization +65,902 +50,765 +Total operating expenses +5,996,284 +6,148,336 +Total operating loss +(5,893,741 ) +(6,117,816 ) +Other expense: +Interest expense +(28,196 ) +(134,947 ) +Loss on extinguishment of debt +(78,241 ) +— ) +Net gain (loss) from investment in joint venture +(232,881 ) +(38,764 ) +Net gain (loss) on disposition of assets +850 +— +Interest income +36,652 +19,804 +Total other expense +(301,816 ) +(153,907 ) +Loss before income taxes +(6,195,557 ) +(6,271,723 ) +Provision for income taxes +— +— +Net loss +$ (6,195,557 ) +$ (6,271,723 ) +14 +Revenues +Sales +of products in the twelve months ended December 31, 2019 were $214,974, which consisted of sales of testing equipment of +$128,124, sales from the license of our technology in the agriculture industry of $50,000 and $36,850 which represented the initial +sales of our diagnostic tests, primarily of our mosquito vector products. For the twelve months ending December 31, 2018, we realized +revenue from the sale of diagnostic equipment of $10,123 and had licensing revenue of $29,088 and test revenue of $700. +Cost +of Revenues and Gross Profit +We +recorded costs of sales for the twelve months ended December 31, 2019 of $112,431 compared to costs of sales of $9,391 for the +twelve months ended December 31, 2018. The increase in costs of sales of $103,040 was due to the increase in sales. Most of the +increased related to the cost of equipment sold, which was $93,171 as equipment has the highest cost of sales. Costs of sales +of tests increased $9,869 as a result of increased sales. There were no costs associated with the license revenue. +Operating +Expenses +We +incurred total operating expenses of $5,996,284 for the year ended December 31, 2019 compared to total operating expenses of $6,148,336 +for the year ended December 31, 2018. The decrease of $152,052 was due to a decrease in general and administrative expense of +$73,513 and a decrease in sales and marketing costs of $103,955, partially offset by an increase of $15,137 in depreciation and +amortization expense and an increase of $10,279 in our research and development expenses. +Our +general and administrative expenses decreased $73,513 from $3,570,786 for the year ended December 31, 2018 to $3,497,273 for the +year ended December 31, 2019. The decrease was primarily the result of a decrease of $975,417 in consulting fees and a decrease +of $46,249 in attorney fees. These decreases were partially offset by an increase of $529,602 in other professional services, +an increase in salaries and related benefits of $116,419 and an increase of $121,443 in option and warrant expense reflecting +the issuance of options to our employees and others. In addition, insurance costs increased $77,757 and travel expenses increased +$64,873. +Our +sales and marketing expenses for the year ended December 31, 2019 were $1,061,676 compared to sales and marketing expenses of +$1,165,631 for the year ended December 31, 2018. The decrease of $103,955 was due primarily to incurring a marketing expense of +$497,208 related to acquisition of a distributor network in 2018 that was not repeated in 2019. Other sales and marketing costs +generally increased. We experience an increase of $192,786 in salaries and related benefits, an increase of $118,026 in travel +and convention related expenses and an increase of $90,573 in consulting expenses, all of which were incurred as we increased +our sales efforts. +Our +research and development expenses increased by $10,279 from $1,361,154 for the year ended December 31, 2018 to $1,371,433 for +the year ended December 31, 2019. The increase was primarily due to an increase of $163,319 in salaries and related benefits as +we increased research and development activities. The increase was partially offset by a decrease of $76,795 in consulting fees +for research services, a decrease of $72,528 in other professional services and a decrease of $22,528 in other lab services. +Interest +and Other Expense +Interest +and other expense items increased for the year ended December 31, 2019 by $147,909. The increase in expenses related primarily +to an increased loss of $194,117 related to our India joint venture and a loss on extinguishment of debt of $78,241, which occurred +when a loan was converted to preferred stock. The increase in loss was partially offset by a decrease in interest expense of $106,751and +an increase in interest income of $16,848. +Net +Loss +We +had net loss of $6,271,723 for the year ended December 31, 2018 compared to a net loss of $6,195,557 for the year ended December +31, 2019. The decrease in net loss for the year ended December 31, 2019 compared to the year ended December 31, 2018 was $76,166. +Our total operating expenses decreased by $152,052 and our total other expenses increased by $147,909 as explained in more detail +above. +15 +LIQUIDITY +AND CAPITAL RESOURCES +Liquidity +is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise +operate on an ongoing basis. Significant factors in the management of liquidity are funds generated by operations, levels of accounts +receivable and accounts payable and capital expenditures. +To +date we have financed our operations through sales of common stock and the issuance of debt. +At +December 31, 2019, we had cash and cash equivalents of $893,138, total current assets of $1,584,254, total current liabilities +of $328,070 and total stockholders’ equity of $1,737,256. At December 31, 2018, we had cash and cash equivalents of $950,237, +total current assets of $1,051,913, total current liabilities of $2,351,983 and total stockholders’ deficit of $1,058,811. +We +experienced negative cash flow used in operations during the twelve months ended December 31, 2019 of $5,525,091 compared to negative +cash flow used in operations for the twelve months ended December 31, 2018 of $4,080,036. In addition, we used $592,764 of our +cash in financing transactions and used $322,000 in contributions to our joint venture in India. The negative cash flow in 2019 +was met by cash reserves received from the completion of a registered direct offering in February 2019 pursuant to our S-3 shelf +registration filed in 2018 and declared effective in September 2018. We received net proceeds of $5,000,000 from that offering. +In addition, in January 2019 we sold preferred stock from which we received net proceeds of approximately $1,000,000 and converted +$2,000,000 of our debt to the preferred stock. The amount of our operating deficit could decrease or increase significantly depending +on strategic and other operating decisions, thereby affecting our need for additional capital. We expect our operating losses +will continue until we are able to generate revenue and our operations become profitable. We will continue to rely on proceeds +received from our public offerings of stock. We expect additional investment capital to come from (i) additional issuances of +our common stock with existing and new investors and (ii) the private placement of other securities with investors similar to +those that have provided funding in the past. +Our +monthly cash operating expenses, including our technology research and development expenses and interest expense, were approximately +$460,000 per month during the year ended December 31, 2019. We completed the registered direct offering described above in January +2019 to fund operations through 2019. The foregoing estimates, expectations and forward-looking statements are subject to change +as we make strategic operating decisions from time to time and as our expenses fluctuate from period to period. +On +February 28, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 470,000 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $ 9.00 per +share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $4.00 +million. The closing of the offering occurred on or about February 28, 2020. In the same manner as February 10, 2020 offering, +the Common Shares sold in the offering were offered and sold by the Company pursuant to an effective shelf registration statement +on Form S-3, that was originally filed on August 14, 2018 and declared effective by the Securities and Exchange Commission (“SEC”) +on September 7, 2018, and the base prospectus contained therein (File No. 333-226835). +On +February 10, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 3,324,676 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $ 3.08 +per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $10.2 +million. The closing of the offering occurred on or about February 13, 2020. In the same manner as January 23, 2020 offering, +the Common Shares sold in the offering were offered and sold by the Company pursuant to an effective shelf registration statement +on Form S-3, that was originally filed on August 14, 2018 and declared effective by the Securities and Exchange Commission (“SEC”) +on September 7, 2018, and the base prospectus contained therein (File No. 333-226835). +On +January 23, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 3,448,278 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $1.45 +per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $5,000,000. +The closing of the offering occurred on or about January 28, 2020. The Common Shares sold in the offering were offered and sold +by the Company pursuant to an effective shelf registration statement on Form S-3, that was originally filed on August 14, 2018 +and declared effective by the Securities and Exchange Commission (“SEC”) on September 7, 2018, and the base prospectus +contained therein (File No. 333-226835). +On +March 6, 2020, one of our warrant holders exercised its warrants for 25,000 shares of our common stock at $2.00 per share and +paid us $50,000. In February and March, 2020 an additional 15 warrant holders exercised an aggregate of 759,445 +warrants to purchase 694,492 shares of our common stock on a cashless basis. +16 +On +January 30, 2019, we entered into a securities purchase agreement with investors, whereby the investors purchased from the Company +30,000 shares of Series A Convertible Preferred Stock of the Company for a purchase price of $3,000,000. The purchase price was +paid by the investors with $1.0 million in cash and the conversion of a $2.0 million note owed by the Company to one of the investors. +The investors may not convert the Series A Preferred Stock to the extent that such conversion would result in beneficial ownership +by the investors and their affiliates of more than 4.99% of the issued and outstanding Common Stock of the Company. +On +February 4, 2019, we completed the sale of 3,925,716 shares of the Company’s common stock, par value $0.001 per share, at +a purchase price of $1.40 per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares +was $5,496,002 and we received net proceeds after offering costs of $4,996,322. +The +amount of our operating deficit could decrease or increase significantly depending on strategic and other operating decisions, +thereby affecting our need for additional capital. We expect our operating loses will continue until we are able to generate revenue. +Revenue commenced in 2019 and has increased substantially in 2020 and our need for additional investment will depend on the amount +of revenue generated. At our current level of operating expenditures, we have sufficient cash to fund operations for the next +twelve months. Absent a significant acquisition or capital expansion, we do not expect to raise additional capital. +Our +long-term liquidity is dependent upon execution of our business model and the commencement of revenue generating activities and +working capital as described above, and upon capital needed for continued commercialization and development of our diagnostic +testing technology. Commercialization and future development of diagnostic tests utilizing our PCR technology are expected to +require additional capital estimated to be approximately $1,350,000 annually for the foreseeable future. This estimate will increase +or decrease depending on specific opportunities and available funding. +Off-Balance +Sheet Arrangements +As +of December 31, 2019, we had no off-balance sheet arrangements. +ITEM +7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Not +required. +17 +ITEM +8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATE. +CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER +31, 2019 AND 2018 +Table +of Contents +Report of Independent Registered Public Accounting Firm +F-1 +Balance Sheets +F-2 +Statements of Operations +F-3 +Statement of Changes in Stockholders’ Equity (Deficit) +F-4 +Statements of Cash Flows +F-5 +Notes to Financial Statements +F-6 +18 +REPORT +OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of Co-Diagnostics, Inc. +Opinion +on the Financial Statements +We +have audited the accompanying balance sheets of Co-Diagnostics, Inc. (the Company) as of December 31, 2019 and 2018, and the related +statements of operations, changes in stockholders’ equity (deficit), and cash flows for each of the years in the two-year +period ended December 31, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, +the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 +and 2018 and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, +2019, in conformity with accounting principles generally accepted in the United States of America. +Basis +for Opinion +These +financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on +the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company +Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance +with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the +PCAOB. +We +conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit +to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error +or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial +reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but +not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. +Accordingly, we express no such opinion. +Our +audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to +error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence +regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles +used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. +We believe that our audits provide a reasonable basis for our opinion. +Haynie +& Company +Salt +Lake City, Utah +March +30, 2020 +We +have served as the Company’s auditor since 2016. +F- 1 +CO-DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +BALANCE SHEETS +December 31, 2019 +December 31, 2018 +ASSETS: +Current Assets +Cash and cash equivalents +$ 893,138 +$ 950,237 +Accounts receivable, net +131,382 +13,420 +Inventory +197,168 +18,153 +Prepaid expenses +362,566 +70,103 +Total current assets +1,584,254 +1,051,913 +Property and equipment, net +196,832 +156,138 +Investment in joint venture +434,240 +345,121 +Total other long-term assets +631,072 +501,259 +Total assets +$ 2,215,326 +$ 1,553,172 +LIABILITIES AND STOCKHOLER’S EQUITY (DEFICIT) : +Current Liabilities +Accounts payable +$ 5,959 +$ 148,967 +Accrued expenses +200,788 +174,444 +Accrued expenses (related party) +120,000 +120,000 +Current notes payable net of $0 and $91,427 discount, respectively +— +1,908,572 +Deferred income current +1,323 +— +Total current liabilities +328,070 +2,351,983 +Long-term Liabilities +Accrued liabilities (related-party) +150,000 +260,000 +Total long-term liabilities +150,000 +260,000 +Total liabilities +478,070 +2,611,983 +Commitments and contingencies +STOCKHOLDERS’ EQUITY (DEFICIT): +Preferred stock, $.001 par value, 5,000,000 shares authorized; 25,600 and no shares issued and outstanding, respectively +26 +— +Common stock, $.001 100,000,000 shares authorized; 17,342,922 and 12,923,383 shares issued and outstanding, respectively +17,343 +12,923 +Additional paid-in capital +26,687,701 +17,622,433 +Accumulated deficit +(24,967,814 ) +(18,694,167 ) +Total stockholders’ equity (deficit) +1,737,256 +(1,058,811 ) +Total liabilities and stockholders’ equity (deficit) +$ 2,215,326 +$ 1,553,172 +See +accompanying notes to consolidated financial statements +F- 2 +CO-DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENTS OF OPERATIONS +For +the years ended +December +31, +2019 +2018 +Net +sales +$ +214,974 +$ +39,911 +Cost +of sales +112,431 +9,391 +Gross +profit +102,543 +30,520 +Operating +expenses: +Selling +and marketing +1,061,676 +1,165,631 +Administrative +and general +3,497,273 +3,570,786 +Research +and development +1,371,433 +1,361,154 +Depreciation +and amortization +65,902 +50,765 +Total +operating expenses +5,996,284 +6,148,336 +Total +operating loss +(5,893,741 +) +(6,117,816 +) +Other +expense: +Interest +expense +(106,437 +) +(134,947 +) +Interest +income +36,652 +19,804 +Gain +on disposition of assets +850 +— +Net +loss from investment in joint venture +(232,881 +) +(38,764 +) +Total +other expense +(301,816 +) +(153,907 +) +Loss +before income taxes +(6,195,557 +) +(6,271,723 +) +Provision +for income taxes +— +— +Net +loss +$ +(6,195,557 +) +$ +(6,271,723 +) +Net +loss per share – basic and diluted +$ +(0.36 +) +$ +(0.50 +) +Weighted +average shares – basic and diluted +16,756,912 +12,484,617 +See +accompanying notes to consolidated financial statements. +F- 3 +CO-DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT) +FOR +THE YEARS ENDED DECEMBER 31, 2019 AND 2018 +Convertible +Preferred Stock +Common +Stock +Additional +Paid-In- +Accumulated +Total +Stockholders’ +Equity +Shares +Amount +Shares +Amount +Capital +Deficit +(Deficit) +Balance +as of December 31, 2017 +— +$ — +12,317,184 +$ 12,317 +$ 16,260,651 +$ (12,422,444 ) +$ 3,850,524 +Stock +issued for the exercise of warrants +— +— +272,727 +273 +29,7272 +— +30,000 +Stock-based +compensation +— +— +333,472 +333 +1,332,055 +— +1,332,388 +Net +loss +— +— +— +— +— +(6,271,723 ) +(6,271,723 ) +Balance +as of December 31, 2018 +— +$ — +12,923,383 +$ 12,923 +$ 17,622,433 +$ (18,694,167 ) +$ (1,058,811 ) +Public +Offering, net of offering costs of $592,764 +— +— +3,925,716 +3,926 +4,899,312 +— +4,903,238 +Issuance +of preferred stock +30,000 +30 +— +— +2,999,970 +3,000,000 +Stock +-based compensation +— +— +127,156 +127 +1,088,259 +— +1,088,386 +Conversion +of Preferred Stock to Common +(4,400 ) +(4 ) +366,667 +367 +(363 ) +— +— +Warrant +exercise price reset +— +— +— +78,090 +(78,090 ) +— +Net +loss +— +— +— +— +— +(6,195,557 ) +(6,195,557 ) +Balance +as of December 31, 2019 +25,600 +$ 26 +17,342,922 +$ 17,343 +$ 26,687,701 +$ (24,967,814 ) +$ 1,737,256 +See +accompanying notes to consolidated financial statements. +F- 4 +CO-DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENTS OF CASH FLOWS +FOR +THE YEARS ENDED DECEMBER 31, 2019 AND 2018 +Years Ended +December 31, +2019 +2018 +Cash flows from operating activities: +Net loss +$ (6,195,557 ) +$ (6,271,723 ) +Adjustments to reconcile net loss to net cash used in operating activities: +Depreciation and amortization +65,902 +50,765 +Stock based compensation +1,088,386 +1,332,388 +Accretion of notes payable discount +91,428 +— +Gain on disposition of assets +(850 ) +— +Allowance for doubtful accounts +11,000 +— +Loss on equity method investment +232,881 +38,764 +Changes in assets and liabilities: +Increase (decrease) deferred income +1,323 +(194,338 ) +Decrease (increase) in prepaid and other assets +(292,463 ) +900,666 +Increase in accounts receivable +(121,462 ) +(13,420 ) +Increase in inventory +(179,015 ) +(9,085 ) +Increase (decrease) in accounts payable and accrued expenses +(226,664 ) +85,947 +Net cash used in operating activities +(5,525,091 ) +(4,080,036 ) +Cash flows from investing activities: +Purchase of property and equipment +(113,246 ) +(41,336 ) +Investment in joint venture +(322,000 ) +(339,000 ) +Net cash used by investing activities +(435,246 ) +(380,336 ) +Cash flows from financing activities: +Proceeds from sale of common stock +5,496,002 +30,000 +Proceed from sale of preferred stock +1,000,000 +— +Proceeds from debt financing +— +2,000,000 +Offering costs +(592,764 ) +(153,845 ) +Net cash provided by financing activities +5,903,238 +1,876,155 +Net increase (decrease) in cash +(57,099 ) +(2,584,217 ) +Cash and cash equivalents beginning of period +950,237 +3,534,454 +Cash and cash equivalents end of period +$ 893,138 +$ 950,237 +Supplemental disclosure of cash flow information: +Interest paid +$ 15,000 +$ 71,000 +Income taxes paid +$ — +$ — +Schedule of non-cash (investing) and financing activities: +Warrants issued for services +$ 379,487 +— +Conversion of preferred stock to common +$ 440,000 +$ — +Conversion of debt for preferred stock +$ 2,000,000 +$ — +See +accompanying notes to consolidated financial statements. +F- 5 +CO-DIAGNOSTICS, +INC. AND SUBSIDIARIES +NOTES +TO CONSOLIDATED FINANCIAL STATEMENTS +YEARS +ENDED DECEMBER 31, 2019 AND 2018 +NOTE +1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Co-Diagnostics, +Inc. (“Company,” “CDI,” “we”), a Utah corporation headquartered in Salt Lake City, Utah, is +a molecular diagnostics company formed in April, 2013 that develops, manufactures and markets a new diagnostics technology. +The +accompanying consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiary. All intercompany +account balances and transactions have been eliminated in consolidation. +We +entered into a joint venture agreement with a company in India for the purpose of setting up a manufacturing location in India +of our products and for distribution of our products in India. We invested $322,000 and $339,000 in 2019 and 2018, respectively +for our 50% interest in the joint venture. We determined that we had a variable interest in the joint venture company, which is +considered a variable interest entity, but that we were not the primary beneficiary as the power to direct the significant activities +of the joint venture company are shared. Therefore, we used the equity method of accounting to record our investment in the joint +venture. Our equity method investees are recorded in other long-term assets in the accompanying consolidated balance sheet. Our +share of earnings or losses from equity method investees is included in other losses in the accompanying consolidated statements +of operations. +The +Company evaluates its equity method investments for impairment whenever events or changes in circumstances indicate that the carrying +amounts of such investments may not be recoverable. The difference between the carrying value of the equity method investment +and its estimated fair value is recognized as an impairment charge when the loss in value is deemed other than temporary. +Profits +from the joint venture shall be divided as follows: +Profit +Level +CDI +Share +Partner +Share +Up to $1,000,000 +50 % +50 % +$1,000,000-$2,000,000 +60 % +40 % +$2,000,000-$3,000,000 +70 % +30 % +Above $3,000,000 +80 % +20 % +The +joint venture partner will be reimbursed for some expenses, such as approximately $96,000 per year for office space. If the joint +venture needs additional funding, it will be achieved through loans obtained by the joint venture, or if loans are not available +on commercially reasonable terms, from capital contributions. There is no term to the joint venture agreement but it can be dissolved +by mutual agreement or by one party upon a material breach by the other party. +Basis +of Presentation +The +accompanying audited consolidated financial statements of Co-Diagnostics, Inc. have been prepared to reflect the financial position, +results of operations and cash flows of the Company and have been prepared in accordance with accounting principles generally +accepted in the United States of America (“GAAP”). +F- 6 +Significant +Account Policies +Cash +and Cash Equivalents +The +Company considers all cash on hand and in banks, and highly liquid investments to be cash equivalents. At December 31, 2019, the +Company had $389,147 in bank balances in excess of amounts insured by the Federal Deposit Insurance Corporation. At December 31, +2018, the Company had $700,237 in bank balances in excess of amounts insured by the Federal Deposit Insurance Corporation. Included +in cash and cash equivalents at December 31, 2019 was $253,991 in short-term federally insured certificates of deposits. The Company +has not experienced any losses in such accounts, and management believes the Company is not exposed to any significant credit +risk on cash and cash equivalents. +I nventory +Inventory +is stated at the lower of cost or market. Inventory cost is determined on a first-in first-out basis that approximates average +cost in accordance with ASC 330-10-30-12. Provisions are made to reduce slow-moving, obsolete, or unusable inventories to their +estimated useful or scrap values. The Company establishes reserves for this purpose. +Accounts +Receivable +Trade +accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of +all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled +accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. +Recoveries of trade receivables previously written off are recorded when collected. At December 31, 2019 and 2018 total net accounts +receivable was $131,382 and $13,420 which included an allowance for uncollectable accounts of $11,000 and $0, respectively. +Property +and Equipment +Property +and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the +property, generally from three to five years. Repairs and maintenance costs are expensed as incurred except when such repairs +significantly add to the useful life or productive capacity of the asset, in which case the repairs are capitalized. +Equity-Method +Investments +Our +equity method investments are initially recorded at costs and are included in other long-term assets in the accompanying consolidated +balance sheet. We adjust the carrying value of our investment based on our share of the earnings or losses in the periods which +they are reported by the investee until the carrying amount is zero. The earnings or losses are included in other losses in the +accompanying consolidated statements of operations. +Earnings +(Loss) per Share +Basic +earnings or loss per common share is computed by dividing net income or loss applicable to common shareholders by the weighted +average number of shares outstanding during each period. As the Company experienced net losses during the years ending December +31, 2019 and 2018, no common stock equivalents have been included in the diluted earnings per common share calculations as the +effect of such common stock equivalents would be anti-dilutive. As of December 31, 2019, and 2018, there were 3,005,352 and 1,656,242 +potentially dilutive shares, respectively. +Stock-based +Compensation +The +Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation-Stock Compensation (“ASC +718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees +and directors based on estimated fair values on the grant date. The Company estimates the fair value of stock-based awards on +the date of grant using the Black-Scholes-Merton option-pricing model (the “Black-Scholes Model”). The value of the +portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the +straight-line method. +The +Company estimates forfeitures at the time of grant and revises its estimate in subsequent periods if actual forfeitures differ +from those estimates. +The +Company accounts for stock-based compensation awards to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments +to Non-Employees (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based +compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments +issued, whichever is more reliably measurable. +F- 7 +All +issuances of stock options or other equity instruments to employees and non-employees as the consideration for goods or services +received by the Company are accounted for based on the fair value of the equity instruments issued or the fair market value of +the services provided. Any stock options issued to non-employees are recorded in expense and additional paid-in capital in shareholders’ +equity over the applicable service periods using variable accounting through the vesting dates based on the fair value of the +options at the end of each reporting period. +Income +Taxes +We +account for income taxes in accordance with the asset and liability method of accounting for income taxes prescribed by ASC Topic +740. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences +attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective +tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in +the years in which those temporary differences are expected to be recovered or settled. +Deferred +taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences +and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. +Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred +tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion +or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes +in tax laws and rates on the date of enactment. +Research +and Development +Research +and development costs are expensed when incurred. The Company expensed $1,371,433 and $1,361,154 of research and development costs +for the years ended December 31, 2019 and 2018, respectively. +Use +of Estimates +The +preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates +and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Such estimates include +receivables and other long-lived assets, legal and regulatory contingencies, income taxes, share based arrangements, and others. +These estimates and assumptions are based on management’s best estimates and judgments. Actual amounts and results could +differ from those estimates. +Fair +Value Measurements +The +carrying amounts of our accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their +immediate or short-term maturities. The aggregate carrying amount of the notes payable approximates fair value as the individual +notes bear interest at market interest rates and there has not been a significant change in our operations and risk profile. +Patents +and Intangibles +Patents +represent initial legal costs incurred to apply for United States and international patents on the diagnostic testing technology, +and are amortized on a straight-line basis over their useful life of approximately 20 years. Because much of our future success +and value depends on our proprietary technology, our patent and intellectual property strategy is of critical importance. Four +of our initial U.S. patents related to our technology have been granted by the U.S. Patent and Trademark Office, or PTO, including +the patent for our CoPrimer technology, which we consider our most important patent. One of our patents has been issued in Great +Britain, but is still pending in the United States. As of March 15, 2020, we had two additional patents pending in the U.S. and +foreign counterpart applications. While we are unsure whether we can develop the technology in order to obtain the full benefits +of the issued patents, the patents themselves hold value and could be sold to companies with more resources to complete the development. +On-going legal expenses incurred for patent follow-up have been expensed from April 2013 forward. +F- 8 +Long-Lived +Assets +We +review our long-lived assets, including patents, whenever events or changes in circumstances indicate that the carrying amount +of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount +of an asset to future un-discounted net cash flows expected to be generated by the asset. If such assets are considered to be +impaired, then the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the +estimated fair value of the assets. Fair value is determined by using cash flow analyses and other market valuations. After our +review at December 31, 2019, it was determined that no adjustment was required. +Customer +Leased Equipment +Customer +leased equipment is capitalized and depreciated using the straight-line method over the estimated useful life of the equipment, +generally from three to five years. The expense for the depreciation on this equipment is included in cost of sales. The company +typically retains ownership of this equipment. +Revenue +Recognition +The +Company generates revenue from product sales and license sales. The Company recognizes revenue when all of the following criteria +are satisfied: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised +goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement +of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the +performance obligations; and (v) recognition of revenue when, or as the Company satisfies each performance obligation. +The +Company constrains revenue by giving consideration to factors that could otherwise lead to a probable reversal of revenue. The +Company records any payments received from customers prior to the Company fulfilling its performance obligation(s) as deferred +revenue. +Related-Party +Transactions +Parties +are considered to be related to the Company if the parties directly or indirectly, through one or more intermediaries, control, +are controlled by, or are under common control with the Company. Related parties also include principal stockholders of the Company, +its management, members of the immediate families of principal stockholders of the Company and its management and other parties +with which the Company may deal where one party controls or can significantly influence the management or operating policies of +the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. +The Company discloses all material related-party transactions. All transactions shall be recorded at fair value of the goods or +services exchanged. Property purchased from a related party is recorded at the cost to the related party and any payment to or +on behalf of the related party in excess of the cost is reflected as compensation or distribution to related parties depending +on the transaction. +Recently +Issued Accounting Standards +From +time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) that are +adopted by the Company as of the specified effective date. If not discussed, management believes that the impact of recently issued +standards, which are not yet effective, will not have a material impact on the Company’s financial statements upon adoption. +The +Company, an emerging growth company (“EGC”), has elected to take advantage of the benefits of the extended transition +period provided for in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, for complying with new or revised accounting +standards which allows the Company to defer adoption of certain accounting standards until those standards would otherwise apply +to private companies. +In +August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and +Cash Payments, to clarify guidance on the presentation and classification of certain cash receipts and payments in the statement +of cash flows. This update was issued with the intent of reducing diversity in practice with respect to eight types of cash flows. +This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, +for public EGC companies like us. The update did not have a significant impact on the Company’s financial statements. +F- 9 +In +February 2016, the FASB issued ASU No. 2016-02 Leases (Topic 842), which requires recognition of leased assets and liabilities +on the balance sheet and disclosing key information about leasing arrangements. This update is effective for annual periods and +interim periods with those periods beginning after December 15, 2020, for public EGC companies like us. Management is currently +evaluating the impact that the updated standard will have on its consolidated financial statements and related disclosures. +In +May 2014, the FASB issued ASU No. 2014-09: “Revenue from Contracts with Customers (Topic 606)” which supersedes the +revenue recognition requirements in ASC Topic 605, “Revenue Recognition”, and requires entities to recognize revenue +in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to +which the entity expects to be entitled in exchange for those goods or services. Additional revenue recognition updates were also +issued in 2016 and 2017, which further clarified certain aspects of the new revenue recognition guidance. The new authoritative +guidance is effective for interim and annual periods beginning after December 15, 2018, for public EGC companies like us. The +guidance permits two methods of adoption: retrospectively to each prior reporting period presented (the full retrospective method), +or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application +(the modified retrospective method). The Company adopted the modified retrospective method. The update did not have a significant +impact on the Company’s financial statements. +In +March 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-08, Receivables – Nonrefundable Fees +and Other Costs (Subtopic 310-20). The amendments in this update shorten the amortization period for certain callable debt securities +held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments +do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For +public business entities, the amendments in this update are effective for fiscal years, and interim periods within those fiscal +years, beginning after December 15, 2019, for public EGC companies like us. This update did not have a significant impact on the +Company’s financial statements. +F- 10 +NOTE +2: NOTES PAYABLE +The +recorded value of our notes payable (net of $91,427 debt discount) for the years ending December 31, 2019 and 2018, were as follows: +December +31, 2019 +December +31, 2018 +Notes payable, +net of debt discount +Robert +Salna Promissory Note Payable +— +1,908,572 +Total +— +1,908,572 +Less Current +Portion +— +(1,908,572 ) +Total Long-term +$ — +$ — +Robert +Salna Promissory Note +On +August 3, 2018, we entered into a Note Purchase Agreement with an existing shareholder of the Company and prior investor in the +Company’s convertible debt securities. Pursuant to the agreement, the Company issued to the shareholder a Promissory Note, +dated August 3, 2018, in the principal amount of $2,000,000 (the “Note”) in exchange for a loan to the Company of +equal principal amount. +On +January 30, 2019, we entered into a securities purchase agreement with two investors, whereby the investors purchased from the +Company 30,000 shares of Series A Convertible Preferred Stock of the Company for a purchase price of $3,000,000. The purchase +price was paid by the investors with $1.0 million in cash and the conversion of a $2.0 million note owed by the Company to the +investors. Upon conversion we recognized $78,241 as interest expense for the unamortized debt discount. For the year ended December +31, 2019 we recorded $106,409 in interest expense, of which $15,000 was for interest paid and $91,427 was for accretion of note +discount. +For +the year ended December 31, 2018, we recorded $71,000 in interest expense. We incurred $153,845 in note origination costs which +are being accreted of the life of the note. For the year ended December 31, 2018, we recorded $62,417 in interest expense for +the accretion of these note origination costs. +At +December 31, 2019 we had no outstanding notes payable. +NOTE +3: STOCK-BASED COMPENSATION +Stock +Incentive Plans +Under +the Co-Diagnostics, Inc. 2015 Long-term Incentive Plan (the “2015 Plan”), the board of directors may issue incentive +stock options, share equivalents such as restricted stock awards, stock bonus awards, performance shares and restricted stock +units to employees and directors and non-qualified stock options to consultants of the company. Options generally expire ten years +after being granted. Options granted vest in accordance with the vesting schedule determined by the board of directors, usually +ratably over a three-year vesting schedule upon anniversary date of the grant with the first 1/3 vesting on the grant date. Should +an employee terminate before the vesting period is completed, the unvested portion of each grant is forfeited. The Company has +used the Black-Scholes valuation model to estimate fair value of our stock-based awards, which requires various judgmental assumptions +including estimated stock price volatility, forfeiture rates, and expected life. Our computation of expected volatility is based +on market-based implied volatility. The 2015 Plan reserves an aggregate of 6,000,000 shares. The number of unissued stock options +authorized under the 2015 Plan at December 31, 2019 was 3,978,183. On February 10, 2020 we issued an aggregate of 100,000 options +to the four independent members of our Board of Directors. +F- 11 +Stock +Options +There +were 890,000 and 850,000 options granted in the years ended December 31, 2019 and 2018, respectively. The Black-Scholes valuation +model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and expected option +term. In determining the expected volatility our computation is based the stock prices of 3 comparable companies and is based +on a combination of historical and market-based implied volatility. The risk-free interest rate was based on the yield curve of +a zero-coupon U.S. Treasury bond on the date the option was granted with a maturity equal to the expected term of the option. +The fair values for the options granted were estimated at the date of grant using the Black Scholes option-pricing model with +the following weighted average assumptions: +Year +Ended +December 31, 2019 +Year +Ended +December 31, 2018 +Risk free interest rate +1.56 % +2.95 % +Expected life (in years) +10.0 +5.5 +Expected volatility +63.65 % +47.75 % +Expected dividend yield +0.00 % +0.00 % +Stock price +$ 1.07 +$ 2.63 +The +weighted average fair value of options granted during the years ended December 31, 2019 and 2018 was $0.52 and $1.24, respectively. +The +Company recorded stock-based compensation expense of $589,683 and 468,240 for the years ended December 31, 2019 and 2018, respectively, +and all of it is included general and administrative expenses per the Consolidated Statements of Operations. +The +following table summarizes option activity during the years ended December 31, 2019 and December 31, 2018, respectively. +Options +Outstanding +Weighted +Average Exercise Price +Weighted +Average Fair Value +Weighted +Average +Remaining Contractual +Life (years) +Outstanding at January 1, 2018 +332,707 +$ 1.29 +$ 0.70 +7.05 +Options granted +850,000 +2.63 +1.24 +9.73 +Expired +— +— +— +— +Forfeited options +— +— +— +— +Exercised +— +— +— +— +Outstanding at December 31, 2018 +1,172,707 +$ 2.23 +$ 1.09 +8.72 +Options granted +890,000 +1.07 +0.52 +9.66 +Expired +— +— +— +— +Forfeited options +(40,890 ) +(3.85 ) +(1.59 ) +(8.04 ) +Exercised +— +— +— +— +Outstanding at December 31, 2019 +2,021,817 +$ 1.69 +$ 0.83 +8.73 +The +intrinsic value of the outstanding options at December 31, 2019 and 2018 was $102,366 and 245,690, respectively. +Warrants +The +Company estimates the fair value of issued warrants on the date of issuance as determined using a Black-Scholes pricing model. +The Company amortizes the fair value of issued warrants using a vesting schedule based on the terms and conditions of each associated +underlying contract, as earned. The Black-Scholes valuation model requires various judgmental assumptions including the estimated +volatility, risk-free interest rate and expected warrant term. In determining the expected volatility our computation is based +the stock prices of 3 comparable companies and is based on a combination of historical and market-based implied volatility. The +risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the warrant was issued with +a maturity equal to the expected term of the warrant. +F- 12 +There +were 500,000 and 50,000 warrants issued in the years December 31, 2019 and 2018, respectively. The fair values for the warrants +issued were estimated at the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions: +Year +Ended +December 31, 2019 +Year +Ended +December 31, 2018 +Risk free interest rate +1.98 % +2.94 % +Expected life (in years) +5.0 +5.0 +Expected volatility +50.88 % +47.95 % +Expected dividend yield +0.00 % +0.00 % +Stock price +$ 1.53 +$ 2.41 +The +weighted average fair value of warrants issued during the years ended December 31, 2019 and 2018 was $1.46 and $1.22 per share, +respectively. +Included +in stock-based compensation for the year ended December 31, 2019, the Company recognized $390,265 -based compensation expense +in general and administrative expenses for the year ended December 31, 2019 for the issuance of 500,000 warrants to two companies +for services rendered. +There +are 313,779 warrants outstanding that have a down round feature whereby the warrants exercise price could adjust if the Company +issues equity below the warrants exercise price. The original exercise price of the warrants was $2.59. During the year ended +December 31, 2019, the exercise price of these warrants was adjusted to $1.20 as a result of the issuance of equity below the +original exercise price. The value of the effect of the warrant exercise price reset was $78,090 and was recorded to retained +earnings and additional paid-in capital. +In +the year ended December 31, 2018, the Company included $61,100 of stock-based compensation in sales and marketing expenses for +50,000 warrants issued to a company as part of the repurchasing of a market licensing agreement. +The +following table summarizes warrant activity during the years ended December 31, 2019 and 2018, respectively. +Warrants +Outstanding +Weighted +Average Exercise Price +Weighted +Average Fair Value +Weighted +Average +Remaining Contractual +Life (years) +Outstanding at January 1, 2018 +706,262 +$ 3.27 +$ 1.48 +4.22 +Warrants issued +50,000 +2.00 +1.22 +5.00 +Expired +— +— +— +— +Forfeited warrants +— +— +— +— +Exercised +272,727 +0.11 +0.54 +3.39 +Outstanding at December 31, 2018 +483,535 +$ 4.92 +$ 1.99 +3.29 +Warrants issued +500,000 +1.53 +1.46 +5.00 +Expired +— +— +— +— +Forfeited warrants +— +— +— +— +Exercised +— +— +— +— +Outstanding at December 31, 2019 +983,535 +$ 1.44 +$ 1.03 +3.34 +The +following table summarizes information about stock options and warrants outstanding at December 31, 2019. +Outstanding +Exercisable +Range +of +Weighted +Average +Remaining +Weighted +Average +Weighted +Average +Exercise +Prices +Number +Outstanding +Contractual +Life (years) +Exercise +Price +Number +Exercisable +Exercise +Price +$ +0.01-1.40 +1,855,151 +6.69 +$ +0.82 +1,328,484 +$ +0.70 +2.00-3.85 +1,055,445 +7.87 +2.54 +772,112 +2.51 +5.61-7.20 +94,756 +2.37 +6.64 +94,756 +6.64 +$ +0.01-7.20 +3,005,352 +6.97 +$ +1.61 +2,195,352 +$ +1.60 +F- 13 +Common +Stock +During the +twelve months ending December 31, 2019, we issued an aggregate of 127,516 shares of our common stock to a company valued at $108,463 +to three companies for services rendered pursuant to professional services agreements. The shares were issued pursuant to consulting +agreements and the services performed were comprised of financial services and media and shareholder relation services. +In +the year ended December 31, 2018, the Company issued 606,199 shares of our common stock as follows: 1) 272,727 shares for the +exercise of outstanding warrants for $30,000 in cash, 2) 84,112 shares valued at $202,090 to 4 companies for consulting services, +in our general and administrative department and, 3) 249,360 shares valued at $600,958 issued to 1 company as part of the repurchasing +of a market licensing agreement in our sales and marketing department. +Total +unrecognized stock-based compensation was $459,560 at December 31, 2019 which the Company expects to recognize as follows: +Year +Amount +2020 +$ 369,379 +2021 +90,181 +Total +$ 459,560 +NOTE +4: LEASE OBLIGATIONS +Our +offices are located at 2401 S Foothill Dr. Suite D Salt Lake City Utah 84109-1479. The space consists of approximately 10,273 +square feet and is leased month to month a rate of $14,831 per month. For the years ending December 31, 2019 and 2018, the Company +expensed $175,137 and $166,146, respectively for rent. +NOTE +5: RELATED PARTY TRANSACTIONS +The Company acquired +the exclusive rights to the Co-Primer technology pursuant to a license agreement dated April 2014, between us and DNA Logix, Inc., +which was assigned to Dr. Satterfield prior to our acquisition of DNA Logix, Inc. Pursuant to the license the Company was to pay +Dr. Satterfield minimum royalty payments of $30,000 per month until the Company receives an equity funding of at least $4,000,000, +at which time the payments increase to $60,000 per month for the remainder of the year. The payment terms were orally modified +to maintain the monthly royalties at $30,000 per month through December 2016. On March 1, 2017, the Company entered into an amendment +effective January 1, 2017, to its Exclusive License Agreement for its Cooperative Primers (“License”) technology with +Dr. Satterfield, a former member of our Board of Directors. The amendment provides in part that all accrued royalties under +the License cease as of January 1, 2017, and we began in January to pay $700,000 of accrued royalties at the rate of $10,000 per +month. For the years ended December 31, 2019 and 2018, the Company paid $110,000 and $100,000, respectively for this license agreement. +At +December 31, 2019, and 2018 the Company had $270,000 and $380,000 respectively, in unpaid accrued expenses for technology royalty’s +payable to Dr. Satterfield. +F- 14 +NOTE +6: EQUITY +2019 +In +January 2019, we entered into a securities purchase agreement with investors, whereby the investors purchased from the Company +30,000 shares of Series A Convertible Preferred Stock of the Company for a purchase price of $3,000,000. Series A Convertible +Preferred Stock is convertible to common stock at a conversion price calculated by multiplying the number of preferred shares +being converted by $100 and dividing the result by $1.20. +During +the twelve months ending December 31, 2019, we issued 366,667 shares of our common stock to two individuals who converted 4,400 +shares of our Series A Preferred Stock to common stock at a conversion price calculated by multiplying the number of preferred +shares being converted by $100 and dividing the result by $1.20. +In +February 2019, we completed the sale of 3,925,716 shares of the Company’s common stock, par value $0.001 per share, at a +purchase price of $1.40 per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares +was $5,496,002 and we received net proceeds of $4,903,238 after offering costs of $592,764. +During +the twelve months ending December 31, 2019, we issued an aggregate of 127,516 shares of our common stock to a company valued at +$108,463 to three companies for services rendered pursuant to professional services agreements. +During +the year ended December 31, 2019, the Company issued warrants to purchase 500,000 shares of our common stock valued at $390,265 +to 2 companies for services rendered. +2018 +For +the year ended December 31, 2018, the Company issued warrants to purchase 50,000 shares of our common stock with a weighted average +exercise price of $2.00 with an aggregate value of $61,100 to a company as part of the repurchasing of a market licensing agreement, +as stock-based compensation. +In +the year ended December 31, 2018, the Company issued 606,199 shares of common stock as follows: (i) 272,727 shares for the exercise +of warrants, (ii) 249,360 shares for the repurchasing of a market licensing agreement, and (iii) 84,122 shares for services rendered. +On +December 28, 2018 the Company amended its Articles of Incorporation to authorized two classes of stock, Common Stock and Preferred +Stock. The total number of shares which the company is authorized to issue is 105,000,000 shares, 100,000,000 shares shall be +Commons Stock, par value $.001 and 5,000,000 shares shall be Preferred Stock, par value $.001. +NOTE +7: INCOME TAXES +Net +deferred tax assets consist of the following components as of December 31, 2019 and 2018: +2019 +2018 +Deferred tax assets +NOL carry-forward +$ +5,131,100 +$ 3,841,400 +Sec 179 carry-forwards +1,600 +1,600 +Depreciation +28,800 +9,500 +Valuation allowance +(5,161,500 ) +(3,852,500 ) +Net deferred +tax asset +$ — +$ — +The +income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income +from continuing operations for the years ended December 31, 2019 and 2018 due to the following: +2019 +2018 +Book loss +$ (1,610,800 ) +$ (1,630,600 ) +Depreciation +6,100 +(3,000 ) +Meals and entertainment +2,900 +400 +Other non-deductible expenses +343,500 +356,500 +Change in valuation allowance +1,258,300 +1,276,700 +$ — +$ — +At +December 31, 2019, the Company had net operating loss carry-forwards of approximately $19,735,000 that may be offset against +future taxable income from the year 2020 through 2036. No tax benefit has been reported in the December 31, 2019 and 2018, consolidated +financial statements since the potential tax benefit is offset by a valuation allowance of the same amount. Additionally, DNA +Logix, Inc. is a pass-through entity and therefore no provision or liability for federal income tax has been included in the consolidated +financial statements for that entity. +F- 15 +Due +to change in ownership provisions of the Tax Reform Act of 1986, net operating loss carry-forwards for Federal income tax reporting +purposes are subject to annual limitations. Should a change in ownership occur, net operating loss carry-forwards may be limited +as to use in future years. +The +Company’s policy on the classification of interest and penalties related to income taxes is to recognize the interest and +penalties in the period incurred. There were no penalties or interest incurred for the years ending December 31, 2019 and 2018, +related to income taxes. +NOTE +8: SUBSEQUENT EVENTS +On +January 23, 2020, we announced the completion of the principle design work for a PCR screening test for new coronavirus, COVID-19, +intended to address potential need for detection of the virus. An outbreak of respiratory illness caused by the pneumonia-like +COVID-19 has spread rapidly over past few months, after first being discovered in the Chinese city of Wuhan on December 31, 2019. +China confirmed human-to-human transmission of the virus and the United States announced the first infection in this country, +detected in a traveler returning from Wuhan. Our COVID-19 test features the Company’s patented CoPrimer™ technology, +and was designed using our proprietary software system, following the guidelines published by the World Health Organization and +Centers for Disease Control. +On +January 23, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 3,448,278 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $1.45 +per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $5,000,000. +The closing of the offering occurred on or about January 28, 2020. The Common Shares sold in the offering were offered and sold +by the Company pursuant to an effective shelf registration statement on Form S-3, that was originally filed on August 14, 2018 +and declared effective by the Securities and Exchange Commission (“SEC”) on September 7, 2018, and the base prospectus +contained therein (File No. 333-226835). +On +February 10, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 3,324,676 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $ 3.08 +per share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $10.2 +million. The closing of the offering occurred on or about February 13, 2020. In the same manner as the January 23, 2020 offering, +the Common Shares sold in the offering were offered and sold by the Company pursuant to an effective shelf registration statement +on Form S-3, that was originally filed on August 14, 2018 and declared effective by the Securities and Exchange Commission (“SEC”) +on September 7, 2018, and the base prospectus contained therein (File No. 333-226835). +On +February 20, 2020, we announced that our Logix Smart™ COVID-19 Test technical file had been submitted for registration with +the European Community, and that it was expected to be available late February as an in vitro diagnostic (“IVD”) for +markets that accept a CE marking as valid regulatory approval. Subsequently, on February 24, 2020, we announced that our test +obtained regulatory clearance to be sold as an in vitro diagnostic for the diagnosis of SARS-CoV-2 (COVID-19) in markets that +accept CE-marking as valid regulatory approval, and became available for purchase from the Company’s Utah-based ISO-13485:2016 +certified facility. The Declaration of Conformity for the Logix Smart COVID-19 test confirms that it meets the Essential Requirements +of the European Community’s In-Vitro Diagnostic Medical Device Directive (IVDD 98/79/EC), permitting export and sales of +the product as an IVD to commence immediately in the European Community. We shipped samples of the Research Use Only version of +our test to distributors in Italy and Germany, which allows future customers to confirm the quality and sensitivity of the product +prior to the IVD being available, and for us to accelerate the sales efforts of its diagnostic. Many other global markets also +accept a CE marking as valid regulatory approval following routine local product registration, which allows sales of our COVID-19 +IVD into these areas. +On +February 28, 2020, the Company entered into securities purchase agreements with certain institutional investors for the sale by +the Company of 490,000 shares of the Company’s common stock, par value $0.001 per share, at a purchase price of $ 9.00 per +share in a registered direct offering. The aggregate gross proceeds for the sale of the Common Shares were approximately $4.00 +million. The closing of the offering occurred on or about February 28, 2020. In the same manner as February 10, 2020 offering, +the Common Shares sold in the offering were offered and sold by the Company pursuant to an effective shelf registration statement +on Form S-3, that was originally filed on August 14, 2018 and declared effective by the Securities and Exchange Commission (“SEC”) +on September 7, 2018, and the base prospectus contained therein (File No. 333-226835). +On +March 6, 2020, one of our warrant holders exercised its warrants for 25,000 shares of our common stock at $2.00 per share and +paid us $50,000. In February and March, 2020 an additional 15 warrant holders exercised an aggregate of 759,445 warrants to purchase +694,492 shares of our common stock on a cashless basis. +In +February and March the holder of 25,600 preferred stock converted all of his preferred shares to 2,133,333 shares of common stock. +The +Company evaluated subsequent events pursuant to ACS Topic 855 and determined that there are no additional events that need to +be reported. +F- 16 +ITEM +9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +None. +ITEM +9A. CONTROLS AND PROCEDURES +Evaluation +of Disclosure Controls and Procedures +We +maintain a set of disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) designed to ensure that +information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, +and reported within the time periods specified in rules and forms adopted by the SEC. Disclosure controls and procedures include, +without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports +that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its +principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. +In +accordance with Rule 13a-15(b) of the Exchange Act, as of the end of the period covered by this annual report on Form 10-K, an +evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer +and Chief Financial Officer, to assess the effectiveness of our disclosure controls and procedures. Based on the evaluation of +our disclosure controls and procedures as of December 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded +that, as a result of material weaknesses in our internal control over financial reporting and discussed below, our disclosure +controls and procedures were not effective as of December 31, 2019. +Management’s +Annual Report on Internal Control over Financial Reporting +Our +management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule +13a-15(f) under the Exchange Act). Our management, including our Chief Executive Officer and Chief Financial Officer, conducted +an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019. In making its evaluation, +management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal +Control – Integrated Framework (2013). +Based +on this evaluation, management determined that our internal control over financial reporting was not effective as of December +31, 2019 due to the material weakness described below. +A +material weakness is a significant deficiency, or combination of significant deficiencies, that results in there being a more +than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected +on a timely basis. +The +material weakness identified during management’s assessment was the lack of sufficient technical expertise on certain accounting +and tax requirements for new and unusual transactions. These control deficiencies could result in a material misstatement of accounts +or disclosures that would result in a material misstatement to the Company’s interim or annual financial statements that +would not be prevented or detected. Accordingly, management has determined that these control deficiencies constitute a material +weakness. +The +Company hired an independent consulting company to provide recommendations for improving our internal control given the size of +the Company’s accounting staff. To the extent possible with the current accounting staff, some of the internal control recommendations +have been implemented. However, the material weakness had not been fully remediated as December 31, 2019. The Company plans to +further increase the involvement of consultants with the required expertise and or increase the accounting staff to remediate +the material weakness. +Notwithstanding +the material weaknesses, management has concluded that the Consolidated Financial Statements included in this Annual Report on +Form 10-K present fairly, in all material respects, the Company’s financial position, results of operations and cash flows +of the Company for the periods presented in conformity with U.S. GAAP. +This +Annual Report does not include an attestation report by our independent registered public accounting firm regarding internal control +over financial reporting since we are an emerging growth company. Management’s report was not subject to attestation by +our registered public accounting firm pursuant to rules of the SEC that permit emerging growth companies to provide only management’s +report in the 10-K. +ITEM +9B. OTHER INFORMATION +None. +19 +PART +III +ITEM +10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. +The +following table sets forth the names, ages and positions of our executive officers and directors: +Name +Age +Position +Dwight +H. Egan +66 +Chief +Executive Officer, President and Chairman of the Board +Reed +L Benson +73 +Chief +Financial Officer and Secretary +Eugene +Durenard +50 +Director +James +Nelson +67 +Director +Richard +S. Serbin +75 +Director +Ted +Murphy +60 +Director +Dwight +H. Egan has been an officer and director since April 2013. Mr. Egan has been engaged in private investment business from February +1999 to the present. He was a senior executive at Data Broadcasting Corporation, a leading provider of wireless, real-time financial +market data, news and sophisticated fixed- income portfolio analytics to 27,000 individual and professional investors from 1995 +to 1999. He co-founded and served as CEO and Chairman of the Board of Broadcast International, Inc. from 1984 to 1995, when Data +Broadcasting Corporation acquired Broadcast International and created CBS MarketWatch , a leading financial news site and +participated in its initial public offering. Mr. Egan’s prior experience in directing a public company and working with +capital markets gives him valuable experience in advising the board on matters of finance and operations. +Reed +L Benson has been Chief Financial Officer and Secretary from November 2014 to the present and a director from November 2014 +to May 2017. Since September, 2008 to the present, in addition to the private practice of law, he is a founder and partner of +Legends Capital Group, LLC, a privately held venture capital group that identifies investment opportunities in natural resources, +bio tech and technology fields. From October 2004 to September 2008 he was employed as Chief Financial Officer, Secretary, and +General Counsel and member of Board of Directors of Broadcast International, Inc., a publicly traded communications services company. +From 2001 to October 2004, he was in the private practice of law where his practice focused on tax and business related matters. +From July 1995 to January 2001 he was secretary and general counsel for Data Broadcasting Corporation, a provider of market information +to individual investors. Mr. Benson received his J.D. degree from the University of Utah School of Law in 1976 and a Bachelor +of Science Degree in Accounting from the University of Utah in 1971. Mr. Benson became a Certified Public Accountant in 1974. +Mr. Benson’s experience in finance, accounting and business consulting, together with his role as our CFO and prior public +company directorship, provide Mr. Benson with expertise enabling critical input to our company. +Eugene +Durenard is the Founder and CEO of Hyperbolic Holdings, a Swiss-based holding, management consulting and investment advisory +company specialized in healthcare since February 2018. He is co-Founder and CIO of Healthcare Impact Holdings, an investment fund +specialized in later-stage healthcare private ventures since May 2018. He is co-Founder and Trustee of Healthcare Impact Foundation +(Europe), a charitable organization designed to sustainably fund the translation of innovation in life sciences since September +2017. He is co-Founder of Global Better Health, a platform designed to provide scientifically-based corporate wellness and preventive +programs since December 2018. Since 2013 he has been advisor to certain family offices in healthcare investments and philanthropy. +In 2006 he co-founded Orion Investment Management, an institutional asset manager in Bermuda. After its sale in 2011 to Capital +G and until 2013 he co-headed their asset management group. Dr. Durenard brings a thorough multi-asset class investment and entrepreneurial +experience spanning 20 years to the Company’s Board of Directors. He received his Ph.D. in Mathematics at Harvard in 1995 +before beginning his career with Salomon Brothers in London in proprietary research. +20 +Edward +L. Murphy, who joined our Board of Directors in June 2019, currently serves as a senior vice president and a partner of Dover +Investments Ltd., a private investment firm. Throughout his career, Mr. Murphy’s duties have included investment analysis +of various types of investment projects in real estate and financial services. Currently, Mr. Murphy serves on the board of directors +of several Canadian publicly reporting companies that have interests in various industries. He has been a Director at Empire Minerals +Corporation Inc. since January 2016, at Digicrypts Blockchain Solutions Inc. since June 2011, at Lakefield Marketing Corporation +since February 2018, and at the Mosport Park Entertainment Corporation since April 30, 1997. He served as a Director at Aurquest +Resources from May 2003 to December 2017. Mr. Murphy’s experience in the capital markets outside the United States and his +involvement in investment analysis shall be a benefit to the Board of Directors. +Richard +S. Serbin, who joined our Board of Directors in May 2017, currently serves as a consultant to many companies in the healthcare +industry. He was the President of Corporate Development and In-House Legal Counsel at Life Science Institute, LLC, from June 1, +2013 to July 15, 2014. Mr. Serbin is a global strategy advisor, pharmacist and entrepreneur with credentials both in pharmacy +and law, complemented by more than 40 years of service as an FDA regulatory attorney and patent attorney in the healthcare industry. +He was appointed to the Advisory Board of Cure Pharmaceutical in January 2017 and has been a Member of Advisory Board at Prime +Access, Inc. since September 2015. Mr. Serbin has been a Director at Rapid Nutrition Plc since November 18, 2014. He served as +Director at Viropro Inc. from May 2013 to June 2014. He was Head of Business Advisory Board at Mazal Plant Pharmaceuticals Inc. +from October 2006 to September 2007 and also served as its Member of Business Advisory Board. He served as Chief Executive Officer +of Optigenex Inc. from July 2002 to September 15, 2005 and a director from July 2004 to September 2005. From January 1999 until +July 2002 Mr. Serbin served as a consultant to various pharmaceutical companies. He served as the President of Bradley Pharmaceuticals. +He served as Vice President of Corporate Development at Ortho Pharmaceuticals, a Johnson & Johnson subsidiary, and practiced +Patent and FDA law at Revlon Johnson & Johnson and Schering-Plough. He served as Patent Attorney for Schering Plough Corporation +and Chief FDA Counsel for Revlon Corporation and Johnson and Johnson Corporation. Subsequently, he worked at Revlon Corporation, +as its Chief Food, Drug and Cosmetic Counsel. He founded Radius Scientific Corporation. He was J&J’s Vice President +of Corporate Development, and later led a successful public offering venture based on technology developed at Stanford Medical +School. Mr. Serbin spent a large portion of his career focusing on international markets and clients. While at J&J, Mr. Serbin +served on the Board of Directors of 16 US and international subsidiary companies, including Ethicon, Ortho, J&J Consumer Products, +Pittman-Moore, Mc Neil, and J&J Development Corporation. He worked on multiple international acquisitions and strategic relationships, +and sat on the Board of Directors of several of its international subsidiaries, including those in India, Hong Kong, Japan, Taiwan, +Germany, and England. Mr. Serbin has a B.S. and a B. Pharmacy from Rutgers University and Rutgers University College of Pharmacy, +a J.D. degree from Seton Hall Law School and a Masters Degree in Trade Regulations and Law from NYU Law School. Mr. Serbin’s +experience in business, law and medicine and knowledge gained as an advisor to the healthcare industry will be critical to our +Board of Directors as it commercializes its products. +James +Nelson is the retired Chairman and CEO of Sunworks, Inc., a NASDAQ traded commercial, agriculture, and residential solar Integrator +which he helped found in October 2010. Mr. Nelson currently serves as strategic advisor to three other publicly traded companies. +Jim has spent most of his career working in private equity as a general partner with Peterson Partners and with Millennial Capital +Partners. In addition to his investment and financial responsibilities, he served as CEO of two of his firms’ portfolio +companies. Prior to his years in private equity, Mr. Nelson served as Vice President of Marketing at Banana Republic, where he +managed company-wide marketing, as well as the company’s international expansion initiative. He was also general manager +for Banana Republic’s catalog division. He was Vice President of Marketing and Corporate Development at Saga Corporation, +a multi-billion-dollar food service company. Jim began his executive career over 35 years ago at Bain and Company, a business +strategy consulting firm, where he managed teams of consultants on four continents. Mr. Nelson received his MBA from Brigham Young +University, where he graduated summa cum laude and was named the Outstanding Master of Business Administration Graduate. Mr. Nelson’s +advice to the Board of Directors from his experiences as a chief executive officer and strategic advisor shall be useful to the +Board of Directors. +Our directors generally +serve until the next annual or special meeting of shareholders held for the purpose of electing directors. Our officers generally +serve at the discretion of the Board of Directors. Mr. Egan serves as our president and chief executive officer. +Significant Employees +Brent +Satterfield has been our chief science officer and director since April 2013. Dr. Satterfield has been employed by the Company +from January 31, 2015 to the present. Prior to that he was the sole shareholder and owner of DNA Logix, Inc. from January 2013 +to January 31, 2015, and in DNA Logix he developed and patented the technology now owned by the Company. He founded Co-Diagnostics +in April 2013 and is the first in his field to use engineering mathematics to design new DNA testing technology. From 2006 to +2008, he was employed by Arcxis Biotechnologies where he developed new diagnostic platforms for groups such as the Department +of Homeland Security, the National Biodefense Analysis and Countermeasures Center, the United States Army Medical Research Institute +of Infectious Disease, Sandia National Laboratories, the California Department of Public Health and numerous others. Under fellowship +from the Department of Homeland Security, he received his Ph.D. in 2007 in Bioengineering with an emphasis in entrepreneurship +and intellectual property law from Arizona State University in a dual-enrollment program with UC Berkeley. Dr. Satterfield’s +experience with the science underlying all of the Company’s products and technology gives him valuable experience in advising +the board on the status of the products and our positioning in the diagnostic testing industry. +Involvement +in Certain Legal Proceedings +To +the best of our knowledge, none of our directors or executive officers have, during the past ten years, been involved in any legal +proceedings described in subparagraph (f) of Item 401 of Regulation S-K. +Board +and Committee Matters +We +maintain an audit committee of the board, a compensation committee of the board and a corporate governance and nominating committee +of the board, each of which is discussed below. We have not established a nominating committee of the board. Our board has determined +that Messrs. Durenard, Nelson, Murphy and Serbin are “independent” under the definition of independence in the Marketplace +Rules of the NASDAQ listing requirements. +21 +We +do not have a formal policy concerning shareholder recommendations of candidates for board of director membership. Our board views +that such a formal policy is not necessary at the present time given the board’s willingness to consider candidates recommended +by shareholders. Shareholders may recommend candidates by writing to our Secretary at our principal offices: 2401 S. Foothill +Drive, Suite D, Salt Lake City, Utah 84109, giving the candidate’s name, contact information, biographical data and qualifications. +A written statement from the candidate consenting to be named as a candidate and, if nominated and elected, to serve as a director +should accompany any such recommendation. Shareholders who wish to nominate a director for election are generally advised to submit +a shareholder proposal no later than December 31 for the next year’s annual meeting of shareholders. +Audit +Committee and Financial Expert +Our +audit committee currently is comprised of Messrs. Durenard, Nelson, Murphy and Serbin with Mr. Durenard serving as chairman of +the audit committee. The functions of the audit committee include engaging an independent registered public accounting firm to +audit our annual financial statements, reviewing the independence of our auditors, the financial statements and the auditors’ +report, and reviewing management’s administration of our system of internal control over financial reporting and disclosure +controls and procedures. The Board of Directors has adopted a written audit committee charter. A current copy of the audit committee +charter is available to security holders on our website at www.codiagnostics.com. Our board has determined that all of our directors +that are serving on the audit committee are “independent” under the definition of independence in the Marketplace +Rules of the NASDAQ listing standards. +Our +Board of Directors has determined that Mr. Durenard meets the requirements of an “audit committee financial expert” +as defined in applicable SEC regulations. +Compensation +Committee +Our +compensation committee currently includes Messrs. Serbin, Nelson, and Durenard with Mr. Serbin serving as chairman of the compensation +committee. The functions of the compensation committee include reviewing and approving corporate goals relevant to compensation +for executive officers, evaluating the effectiveness of our compensation practices, evaluating and approving the compensation +of our chief executive officer and other executives, recommending compensation for board members, and reviewing and making recommendations +regarding incentive compensation and other employee benefit plans. The Board of Directors has adopted a written compensation committee +charter. A current copy of the compensation committee charter is available to shareholders on our website at www.codiagnostics.com . +Our board has determined that both of our directors serving on the compensation committee are “independent” under +the definition of independence in the Marketplace Rules of the NASDAQ listing standards. +Corporate +Governance and Nominating Committee +Our +corporate governance and nominating committee currently include Messrs. Nelson, Murphy and Serbin with Mr. Nelson serving as chairman +of the corporate governance and nominating committee. The functions of the corporate governance and nominating committee is identifying +and recommending candidates to fill vacancies on the Board of Directors. Among its duties and responsibilities, the corporate +governance and nominating committee periodically evaluates and assesses the performance of the officers and directors; reviews +the qualifications of candidates for director positions; assists in identifying, interviewing and recruiting candidates for the +Board of Directors and reviews the composition of each committee of the Board of Directors. A current copy of the corporate governance +and nominating committee charter is available to shareholders on our website at www.codiagnostics.com . Our board has determined +all directors serving on the corporate governance and nominating committee are “independent” under the definition +of independence in the Marketplace Rules of the NASDAQ listing standards. +Communication +with the Board +We +have not, to date, developed a formal process for shareholder communications with the board of directors. We believe our current +informal process, in which any communication sent to the board of directors, either generally or in care of the chief executive +officer, secretary or other corporate officer or director, is forwarded to all members of the board of directors, has served the +board’s and the shareholders’ needs. +22 +Conflicts +of Interests +On +an annual basis, each director and executive officer is obligated to complete a director and officer questionnaire that requires +disclosure of any transactions with our company, including related person transactions reportable under SEC rules, in which the +director or executive officer, or any member of his or her immediate family, have a direct or indirect material interest. Under +our company’s standards of conduct for employees, all employees, including the executive officers, are expected to avoid +conflicts of interest. Pursuant to our code of ethics for the chief executive officer and senior finance officers (as discussed +below), such officers are prohibited from engaging in any conflict of interest unless a specific exception has been granted by +the board. All of our directors are subject to general fiduciary standards to act in the best interests of our company and our +shareholders. Conflicts of interest involving an executive officer or a director are generally resolved by the board. +Compliance +with Section 16(a) of the Exchange Act +Section +16(a) of the Exchange Act requires our directors and executive officers, and persons who own more than 10% of our common stock, +to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. +Executive officers, directors and greater than 10% shareholders are required by SEC regulations to furnish us with copies of all +Section 16(a) forms they file. +To +our knowledge, during the year ended December 31, 2019, our directors, executive officers and greater than 10% shareholders complied +with all Section 16(a) filing requirements. +Code +of Ethics +We +have adopted a code of ethics for our principal executive officer, principal financial officer, controller, or persons performing +similar functions. A copy of the code of ethics is included on our website at www.codiagnostics.com. +Family +Relationships +There +are no family relationships among our directors and executive officers. +ITEM +11. EXECUTIVE COMPENSATION +Throughout +this section, the individuals who served as our chief executive officer and chief financial officer during 2018 and 2019 are collectively +referred to as the “named executive officers.” +The +compensation committee has overall responsibility to review and approve our compensation structure, policy and programs and to +assess whether the compensation structure establishes appropriate incentives for management and employees. The compensation committee +annually reviews and determines the salary and any bonus and equity compensation that may be awarded to our chief executive officer, +or CEO, and our chief financial officer, or CFO. The compensation committee oversees the administration of our long-term incentive +plan and employee benefit plans. +The +compensation committee’s chairman regularly reports to the board on compensation committee actions and recommendations. +The compensation committee has authority to retain, at our expense, outside counsel, experts, compensation consultants and other +advisors as needed. +Company +Performance . Because of the stage of our company’s development, the compensation committee looks at various factors +in evaluating the progress the company has made and the services provided by the named executive officers. In considering executive +compensation, the compensation committee noted certain aspects of our financial performance and accomplishments in 2019 and 2018 +including the following: (a) Development Milestones, (b) Financial Milestones and (c) Sales and Marketing Milestones. +Compensation +Philosophy . Our general compensation philosophy is designed to link an employee’s total cash compensation with our performance, +the employee’s department goals and individual performance. Given our stage of operations and limited capital resources, +we are subject to various financial restraints in our compensation practices. As an employee’s level of responsibility increases, +there is a more significant level of variability and compensation at risk. The compensation committee believes linking incentive +compensation to our performance creates an environment in which our employees are stakeholders in our success and, thus, benefits +all shareholders. +Executive +Compensation Policy . Our executive compensation policy is designed to establish an appropriate relationship between executive +pay and our annual performance, our long-term growth objectives, individual performance of the executive officer and our ability +to attract and retain qualified executive officers. The compensation committee attempts to achieve these goals by integrating +competitive annual base salaries with bonuses based on corporate performance and on the achievement of specified performance objectives, +and to a lesser extent, awards through our long-term incentive plan. The compensation committee believes that cash compensation +in the form of salary and bonus provides our executives with short-term rewards for success in operations. The compensation committee +also believes our executive compensation policy and programs do not promote inappropriate risk-taking behavior by executive officers +that could threaten the value of our company. +23 +In +making compensation decisions, the compensation committee compares each element of total compensation against companies referred +to as the “compensation peer group.” The compensation peer group is a group of companies that the compensation committee +selected from readily available information about small companies engaged in similar businesses and with similar resources. The +compensation committee selected these companies from research on its own and with limited consultation with outside consultants +given the size of the company and its resources to retain such experts. The types of companies selected for the peer group included +publicly-traded technology development companies in the diagnostic testing industry. Since there are relatively few companies +in the rather narrow field of diagnostic testing the comparisons were limited to those that are publicly traded whose financial +information could be readily accessed. The compensation committee determined these companies were appropriate for inclusion in +the peer group because of the similar nature of their businesses and their general stage of development and financial resources. +Role +of Executive Officers in Compensation Decisions +The +compensation committee makes all compensation decisions for the named executive officers and approves recommendations regarding +equity awards to all of our other senior management personnel. The CEO annually reviews the performance of the CFO and other senior +management. The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and +annual award amounts, are presented to the compensation committee. The compensation committee is charged with the responsibility +of ensuring a consistent compensation plan throughout the company and providing an independent evaluation of the proposed adjustments +or awards at all levels of management. As such, the compensation committee has determined that it have the discretion to modify +or adjust any proposed awards and changes to management compensation to be able to satisfy these responsibilities. +Stock +Option Plans +Under +our 2015 Long-term Incentive Plan (the “2015 Plan”), the board of directors may issue incentive stock options to employees +and directors and non-qualified stock options to consultants of the company. Options expire ten years after being granted. Options +granted vest in accordance with the vesting schedule determined by the board of directors, usually ratably over a two-year vesting +schedule upon the anniversary date of the grant. Should an employee’s director’s or consultant’s relationship +with the company terminate before the vesting period is completed, the unvested portion of each grant is forfeited. We continue +to maintain and grant awards under the 2015 Plan which will remain in effect its expiration by its terms. The number of unissued +stock options authorized under the 2015 Plan at December 31, 2019 was 3,978,183. On February 10, 2020 we issued an aggregate +of 100,000 options to the four independent members of our Board of Directors. +The +purpose of our incentive plan is to advance the interests of our stockholders by enhancing our ability to attract, retain and +motivate persons who are expected to make important contributions to the company by providing them with both equity ownership +opportunities and performance-based incentives intended to align their interests with those of our stockholders. These plans are +designed to provide us with flexibility to select from among various equity-based compensation methods, and to be able to address +changing accounting and tax rules and corporate governance practices by optimally utilizing stock options and shares of common +stock. +Summary +Compensation Table +The +table below summarizes the total compensation paid or earned by each of the named executive officers in their respective capacities +for the fiscal years ended December 31, 2019, 2018 and 2017. When setting total compensation for each of the named executive officers, +the compensation committee reviewed tally sheets which show the executive’s current compensation, including equity and non-equity-based +compensation. We have omitted in this report certain columns otherwise required to be included because there was no compensation +made with respect to such columns, as permitted by applicable SEC regulations. +Option +All +Name and +Salary +Bonus +Awards +Other +Total +Principal +Position +Year +($) +($) +($) +Compensation +($) +Dwight +H. Egan +2019 +$ 275,000 +$ 20,000 +$ 165,000 +$ — +$ 460,000 +President & Chief Executive Officer +2018 +275,000 +12,500 +186,000 +— +463,500 +2017 +195,000 +15,000 +— +— +210,000 +Reed L Benson +2019 +$ 200,000 +$ 15,000 +$ 137,500 +$ — +$ 352,500 +Chief Financial Officer and Secretary +2018 +200,000 +10,000 +155,000 +— +365,000 +2017 +195,000 +10,000 +— +— +205,000 +Brent Satterfield +2019 +$ 237,500 +$ — +$ — +$ — +$ 237,500 +Chief Technology Officer (1) +2018 +237,500 +— +— +— +237,500 +2017 +159,300 +— +— +— +159,300 +(1) +Dr. +Satterfield also received royalties from the Company in the amount of $170,000 in 2017, $100,000 in 2018 and $110,000 in 2019 +pursuant to a technology license agreement that was amended in January 2017 to terminate the ongoing royalties and the payments +in 2017, 2018 and 2019 reduced accrued royalties. +24 +Other +Compensation +We +do not have any non-qualified deferred compensation plan. +Outstanding +Equity Awards at Fiscal Year-End +Option +Awards +Stock +Awards +Name +Number +of +Securities +Underlying +Unexercised +Options +(#) +Exercisable +Number +of +Securities +Underlying +Unexercised +Options +(#) +Unexercisable +Option +Exercise +Price +($) +Option +Expiration +Date +Number +of +Shares +or +Units +of +Stock +that +have +not +Vested +(#) +Market +Value +of +shares +or +Units +of +Stock +that +have +not +Vested +($) +Number +of +Unearned +shares, +units +or +other +rights +that +have +not +vested +(#) +Market +or +payout +value +of +unearned +shares, +units +or +other +rights +that +have +not +vested +($) +(a) +(b) +(c) +(d) +(e) +(f) +(g) +(h) +(i) +Dwight +H. Egan +100,000 +50,000 +2.63 +01/15/2023 +— +— +— +— +50,000 +100,000 +1.10 +09/03/2024 +Reed L Benson +83,333 +41,667 +2.63 +01/15/2023 +— +— +— +— +41,666 +83,333 +1.10 +09/03/2024 +Potential +Payments Upon Termination or Change of Control +There +is no compensation payable to the named executive officers upon voluntary termination, retirement, involuntary not-for-cause termination, +termination following a change of control or in the event of disability or death of the executive. +Compensation +Committee Interlocks and Insider Participation in Compensation Decisions +None +of our executive officers served as a member of the compensation committee or as a director of any other company. +Director +Compensation +We +use a combination of cash and stock-based incentive compensation to attract and retain qualified candidates to serve on its board +of directors. In setting director compensation, we consider the significant amount of time that directors expend in fulfilling +their duties as well as the skill-level required by our members of the board. +Our +non-employee directors generally receive fees of $35,000 per year, paid quarterly, $10,000 per year for serving as chairman of +any Board committee and $5,000 for serving as a member of other Board committees. In addition, each director receives an initial +grant of stock options to purchase 25,000 shares (thereafter annual grants of 25,000 options or restricted stock units) of our +common stock with an exercise price equal to the fair market value of the stock on the date of grant. The board approved and the +non-employee directors accepted the 2018 and 2019 compensation set forth in the director summary compensation table below. In +addition, non-employee directors may be entitled to receive special awards of stock options from time to time as determined by +the board. The chairman of the board and the chairman of each of the audit and compensation committees receive no additional fees +for serving in such capacities, except as shown above. There is no additional compensation for meeting attendance. Directors who +are employees of the Company receive no additional compensation for serving as directors. All stock options granted to outside +directors are immediately exercisable and expire ten years from the date of grant or 30 days after the date they cease to be directors. +Directors are reimbursed for ordinary expenses incurred in connection with attending board and committee meetings. +25 +Director +Summary Compensation Table +The +table below summarizes the compensation paid or accrued by us to our directors for the fiscal year ended December 31, 2019. +(a) +(b) +(c) +(d) +(e) +Name +Fees +Earned or +Paid +in Cash +($) +Options/Awards +($) +Restricted +Stock Units +($) +Total +($) +Dwight H. Egan (1) +$ — +— +$ — +$ — +Frank Kiesner (2) +$ 27,500 +$ — +— +$ 27,500 +Richard Serbin +55,000 +17,750 +— +72,750 +Edward J. Borkowski (2) +27,500 +— +— +27,500 +James Nelson +$ 18,333 +27,500 +45,833 +Edward Murphy +$ 12,000 +17,750 +29,750 +Eugene Durenard +$ 27,500 +17,750 +— +45,250 +(1) +Mr. +Egan receives no compensation for serving as a director, but is compensated in his capacity as Company President. +(2) +Messer’s +Kiesner and Borkowski resigned as members of the Board effective June 30, 2019. Mr. Kiesner received $35,000 additional compensation +for consulting services prior to his retirement from the Board. Mr. Serbin received $30,000 additional compensation for consulting +services. +ITEM +12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The +following table sets forth certain information, as of March 19, 2020, with respect to the holdings of (1) each person who is the +beneficial owner of more than 5% of our Common Stock, (2) each of our directors, (3) each executive officer, and (4) all of our +current directors and executive officers as a group. +Beneficial +ownership of the common stock is determined in accordance with the rules of the Securities and Exchange Commission and includes +any shares of common stock over which a person exercises sole or shared voting or investment power, or of which a person has a +right to acquire ownership at any time within 60 days of the date of this Annual Report. Except as otherwise indicated, we believe +that the persons named in this table have sole voting and investment power with respect to all shares of common stock held by +them. Applicable percentage ownership in the following table is based on 27,438,701 shares of common stock plus, for each individual, +any securities that individual has the right to acquire within 60 days of March 19, 2020. +To +the best of our knowledge, except as otherwise indicated, each of the persons named in the table has sole voting and investment +power with respect to the shares of our common stock beneficially owned by such person, except to the extent such power may be +shared with a spouse. To our knowledge, none of the shares listed below are held under a voting trust or similar agreement, except +as noted. To our knowledge, there is no arrangement, including any pledge by any person of securities of the Company, the operation +of which may at a subsequent date result in a change in control of the Company. +Name +and Address of Beneficial Owner Officers and Directors +Title +Beneficially +Percent +of Class +Dwight H. Egan (1)(2) +Chief Executive Officer, +President and Chairman +150,000 +* +Reed L. Benson (1)(3) +Chief Financial Officer and Secretary +125,000 +* +Edward Murphy +Director +25,000 +* +Eugene Durenard +Director +25,000 +* +James Nelson +Director +25,000 +* +Richard S. Serbin +Director +45,455 +* +Officers +and Directors as a Group (total of 6 persons) (4) +395,455 +1.4 % +5% Stockholders +Reagents, LLC (5) +1,746,796 +6.3 % +* +less than 1% +(1) +The +address is 2401 S. Foothill Drive, Suite D, Salt Lake City, Utah 84109. +(2) +Includes +presently exercisable options to acquire 150,000 shares of common stock. +(3) +Includes +presently exercisable options to acquire 125,000 shares of common stock. +(4) +Includes +presently exercisable options to acquire a total of 395,455 shares of common stock held by all directors and executive officers. +(5) +Reagents, +LLC, with an address of 8160 S. Highland Drive, Salt Lake City, UT 84093, is beneficially owned by Seth Egan. +26 +ITEM +13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The Company acquired +the exclusive rights to the CoPrimer technology pursuant to a license agreement dated April 2014, between us and DNA Logix, Inc., +which was assigned to Dr. Satterfield prior to our acquisition of DNA Logix, Inc. Pursuant to the license the Company was to pay +Dr. Satterfield minimum royalty payments of $30,000 per month until the Company receives an equity funding of at least $4,000,000, +at which time the payments increase to $60,000 per month for the remainder of the year. The payment terms were orally modified +to maintain the monthly royalties at $30,000 per month through December 2016. On March 1, 2017, the Company entered into an amendment +effective January 1, 2017, to its Exclusive License Agreement for its CoPrimer (“License”) technology with Dr. Satterfield, +a former member of our Board of Directors. The amendment provides in part that all royalties under the License cease as +of January 1, 2017, and we began in January 2017 to pay $700,000 of accrued royalties at the rate of $10,000 per month. In 2018 +and 2019, we paid Dr. Satterfield $100,000 and $110,000, respectively, in payment of the accrued royalties. +The +Company entered into a consulting arrangement with its former director, Frank Keisner, for consulting services during the year +ended December 31, 2019. Pursuant to the consulting agreement, we paid Mr. Keisner a one-time fee of $35,000. +The +Company entered into a consulting arrangement with its director, Richard Serbin, for consulting services during the year ended +December 31, 2019. Pursuant to the consulting agreement, we paid Mr. Serbin a one-time fee of $30,000. +ITEM +14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +Fees +for professional services provided by our current independent auditors for each of the last two fiscal years, in each of the following +categories, are as follows: +2019 +2018 +Audit fees +$ 69,000 +$ 66,000 +Audit-related fees +— +— +Tax fees +3,000 +3,000 +All other +fees +— +— +Total +$ 72,000 +$ 69,000 +Audit +fees included fees associated with the annual audit and reviews of our annual and quarterly reports for 2019 and our annual report +for 2018. All audit fees incurred during 2019 were pre-approved by the audit committee. All audit fees incurred during 2018 were +pre-approved by our Board of Directors. +Tax +fees included fees associated with tax compliance and tax consultations. All tax fees incurred during 2019 were pre-approved by +the audit committee. All tax fees incurred during 2018 were pre-approved by our Board of Directors. +The +audit committee has adopted a policy that requires advance approval of all services performed by the independent auditor when +fees are expected to exceed $15,000. The audit committee has delegated to the audit committee chairman, Mr. Durenard has authority +to approve services, subject to ratification by the audit committee at its next committee meeting. +27 +PART +IV +Item +15. Exhibits, Financial Statement Schedules. +Exhibit +Number +Description +1.1 +Underwriting Agreement (5) +3.1 +Articles of Incorporation (1) +3.1.1 +Amendment to the Articles of Incorporation (1) +3.2 +Bylaws (1) +5.1 +Legal Opinion of Carmel, Milazzo & DiChiara LLP (6) +10.1 +Subscription Agreement between Co-Diagnostics, Inc. and CoDiagnostics, Ltd., dated April 30, 2013 (1) +10.1.1 +Amendment to Subscription Agreement between Co-Diagnostics, Inc. and CoDiagnostics, Ltd., dated May 1, 2015 (1) +10.2 +Exclusive Agreement between Co-Diagnostics, Inc. and DNA Logix, Inc., dated April 18, 2014 (1) +10.3 +Stock Exchange Agreement among Co-Diagnostics, Inc., DNA Logix, Inc., and the Shareholders of DNA Logix, Inc., dated January 22, 2015 (1) +10.4 +Revolving Line of Credit Promissory Note between Co-Diagnostics, Inc. and Co-Diagnostics, LTD, dated August 1, 2015 (1) +10.5 +10% Convertible Note between Co-Diagnostics, Inc. and Robert Salna for $200,000, dated September 1, 2016 (1) +10.6 +Exclusive License Agreement between Co-Diagnostics, Inc. and Watermark Group Inc., dated October 13, 2016 (1) +10.7 +Securities Purchase Agreement with Exhibits between Co-Diagnostics and Senior Holders, dated December 12, 2016 (1) +10.7.1 +Form of Amendment Agreement (6) +10.8 +Securities Purchase Agreement with Exhibits between Co-Diagnostics and Beaufort Capital Partners, LLC, dated December 12, 2016 (1) +10.9 +2015 Long-Term Incentive Plan (2) +10.10 +Subscription Agreement between Co-Diagnostics and Co-Diagnostics, Ltd. for 454,545 shares of Co-Diagnostic’s common stock, dated April 20, 2013 (3) +10.11 +Subscription Agreement between Co-Diagnostics and Prosperity Investments for $100,000, dated June 2014. (3) +10.12 +12% Convertible Note between Co-Diagnostics, Inc. and Beaufort Capital Partners, LLC for $500,000, dated May 15, 2015 (3) +10.13 +Form Revolving Line of Credit Promissory Note between Co-Diagnostics and Turks and Caicos Limited Company, Pine Valley Investments, LLC, Clavo Rico Incorporated, Legends Capital Group, LLC, Hamilton Mining Resources, Inc., and Machan 1988 Property Trust. (3) +10.13.1 +Amendment to 12% Revolving Line of Credit Promissory Note, dated August 1, 2015, between Co-Diagnostics and Co-Diagnostics, Ltd., for $750,000, dated September 14, 2016. (3) +10.13.2 +Amendment to 12% Revolving Line of Credit Promissory Note, December 30, 2015, between Co-Diagnostics and Pine Valley Investments, LLC for $100,000, dated September 14, 2016. (3) +10.13.3 +Amendment to 12% Revolving Line of Credit Promissory Note, February 22, 2016, between Co-Diagnostics and Clavo Rico Incorporated for $10,000, dated September 14, 2016. (3) +10.13.4 +Amendment to 12% Revolving Line of Credit Promissory Note, March 1, 2016, between Co-Diagnostics and Legends Capital Group, LLC for $100,000, dated September 14, 2016. (3) +10.13.5 +Amendment to 12% Revolving Line of Credit Promissory Note, May 15, 2016, between Co-Diagnostics and Hamilton Mining Resources, Inc. for $75,000, dated September 14, 2016. (3) +10.13.6 +Amendment to 12% Revolving Line of Credit Promissory Note, May 30, 2016, between Co-Diagnostics and Machan 1988 Property Trust for $50,000, dated September 14, 2016. (3) +10.13.7 +Form Second Amendment to 12% Revolving Line of Credit Promissory Note Due 2017 between Co-Diagnostics, Inc. and CoDiagnostics, Ltd., Pine Valley Investments, LLC, Clavo Rico Incorporated, Legends Capital Group, LLC, and Hamilton Mining Resources, Inc. (4) +10.13.8 +Form of Indemnification Agreement. (4) +10.14 +Form 8.5% Convertible Note between Co-Diagnostics and Legends Capital Group, LLC for $100,000, dated November 12, 2015 and R. Phillip Zobrist for $100,000, dated December 1, 2015. (3) +10.15 +Form 10% Convertible Note between Co-Diagnostics and Legends Capital Opportunity Fund, LLC for $15,000, DAV Capital Management Corp. for $15,000, April Kameka for $40,000, and Mark Kovacic for $50,000. (3) +10.16 +Shareholders’ Agreement between Co-Diagnostics and Synbiotics Limited, dated January 27, 2017. (3) +10.17 +Amended Exclusive License Agreement between Co-Diagnostics, Brent Satterfield, and DNA Logix, Inc., dated January 1, 2017. (3) +10.18 +Stock Purchase Agreement between Co-Diagnostics and Ted Murphy for 1,800,000 shares of Watermark Group, Inc.’s common stock, dated September 22, 2016. (3) +10.19 +Non-Interest Bearing Note between Co-Diagnostics and Zika Diagnostics, Inc. f/k/a/ Watermark Group, Inc. for $445,000, dated March 20, 2017. (3) +10.20 +Mutual Rescission Agreement of the Stock Purchase Agreement, dated September 22, 2016, and the License Agreement, dated October 13, 2016, between Co-Diagnostics, Robert Salna, and Ted Murphy, dated March 30, 2017. (3) +14.1 +Code of Ethics of the Company +21.1 +Subsidiaries of Registrant (1) +23.1 +Consent of Haynie & Company +23.2 +Consent of Carmel, Milazzo & DiChiara LLP (see Exhibit 5.1) +31.1 +Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002 +31.2 +Certification of Principal Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002 +32.1 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +32.2 +Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +* +Management +contract or compensatory plan or arrangement. +(1) +Incorporated +by reference to the Draft Registration Statement filed with the SEC on January 11, 2017. +(2) +Incorporated +by reference to the Draft Registration Statement filed with the SEC on March 27, 2017. +(3) +Incorporated +by reference to the Form S-1 filed with the SEC on April 28, 2017. +(4) +Incorporated +by reference to the Form S-1/A filed with the SEC on May 24, 2017. +(5) +Incorporated +by reference to the Form S-1/A filed with the SEC on June 9, 2017. +(6) +Incorporated +by reference to the Form S-1/A filed with the SEC on June 23, 2017. +28 +SIGNATURES +Pursuant +to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf +by the undersigned thereunto duly authorized. +CO-DIAGNOSTICS, +INC. +Date: +March 30, 2020 +By: +/s/ +Dwight Egan +Dwight +Egan +Chief +Executive Officer, President and Director +(Principal +Executive Officer and Interim Principal Financial and Accounting Officer) +By: +/s/ +Reed L. Benson +Reed +L. Benson +Chief +Financial Officer and Secretary +(Principal +Financial and Accounting Officer +In +accordance with the Exchange Act, this report has been signed below by the following persons on March 30, 2020, on behalf +of the registrant and in the capacities Indicated. +Signature +Title +/s/ +Dwight Egan +Chief +Executive Officer, President and Director +Dwight +Egan +/s/ +Reed L. Benson +Chief +Financial Officer and Secretary +Reed +L. Benson +/s/ +Eugen Durenard +Director +Eugene +Durenard +/s/ +Edward Murphy +Director +Edward +Murphy +/s/ +James Nelson +Director +Frank +J. Kiesner +/s/ +Richard S. Serbin +Director +Richard +S. Serbin +29 \ No newline at end of file diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/filing_metadata.csv b/raw/filings/0001692415/2019/0001493152-20-005305/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a730b06e7affe300c651d75b8ffd620c5b0d0db7 --- /dev/null +++ b/raw/filings/0001692415/2019/0001493152-20-005305/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001692415,CODX,"Co-Diagnostics, Inc.",10-K,2020-03-30,2019-12-31,2020-03-31T01:30:19.000Z,0001493152-20-005305,form10-k.htm,,3724270,1,0,https://www.sec.gov/Archives/edgar/data/1692415/000149315220005305/form10-k.htm,https://www.sec.gov/Archives/edgar/data/1692415/000149315220005305/,2019,2019,1 diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/item1.txt b/raw/filings/0001692415/2019/0001493152-20-005305/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/item13.txt b/raw/filings/0001692415/2019/0001493152-20-005305/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/item9a.txt b/raw/filings/0001692415/2019/0001493152-20-005305/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/rp_note.txt b/raw/filings/0001692415/2019/0001493152-20-005305/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad99a07c68f8b352dfd9057192e4fa1fc50b013f --- /dev/null +++ b/raw/filings/0001692415/2019/0001493152-20-005305/rp_note.txt @@ -0,0 +1,16 @@ +5: RELATED PARTY TRANSACTIONS +The Company acquired +the exclusive rights to the Co-Primer technology pursuant to a license agreement dated April 2014, between us and DNA Logix, Inc., +which was assigned to Dr. Satterfield prior to our acquisition of DNA Logix, Inc. Pursuant to the license the Company was to pay +Dr. Satterfield minimum royalty payments of $30,000 per month until the Company receives an equity funding of at least $4,000,000, +at which time the payments increase to $60,000 per month for the remainder of the year. The payment terms were orally modified +to maintain the monthly royalties at $30,000 per month through December 2016. On March 1, 2017, the Company entered into an amendment +effective January 1, 2017, to its Exclusive License Agreement for its Cooperative Primers (“License”) technology with +Dr. Satterfield, a former member of our Board of Directors. The amendment provides in part that all accrued royalties under +the License cease as of January 1, 2017, and we began in January to pay $700,000 of accrued royalties at the rate of $10,000 per +month. For the years ended December 31, 2019 and 2018, the Company paid $110,000 and $100,000, respectively for this license agreement. +At +December 31, 2019, and 2018 the Company had $270,000 and $380,000 respectively, in unpaid accrued expenses for technology royalty’s +payable to Dr. Satterfield. +F- 14 +NOTE \ No newline at end of file diff --git a/raw/filings/0001692415/2019/0001493152-20-005305/rpt_disclosure.txt b/raw/filings/0001692415/2019/0001493152-20-005305/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001692415/2020/0001493152-21-006810/item1.txt b/raw/filings/0001692415/2020/0001493152-21-006810/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001692415/2020/0001493152-21-006810/item9a.txt b/raw/filings/0001692415/2020/0001493152-21-006810/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391